Chapter 1: Ten Principle of

Economics

ECN 104 – Introductory Economics

 ECONOMICS IS ABOUT…
• Scarcity: The limited nature of society’s resources
• Natural resource, land and worker’s time are all limited
in its availability.
• Economics is about how the society manages its
limited resources.
• Two agents: firms and consumers
• Firms: what to produce, how much to produce, how
many workers to hire, etc.
• Consumers/Individuals: what to purchase, how much
to save, how many hours to work, etc.
• We will study about how these decisions are made.
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 HOW PEOPLE MAKE DECISIONS
Principle
Principle #1:
#1: People
People Face
Face Tradeoffs
Tradeoffs
• To get one thing, we usually have to give up
something else.
• Think of the allocations of your time and money etc.
• If you buy a new iPhone today, you have to wait
before buying a new laptop.
• If you invest in TFSA, you are giving up other
forms of investments, such as RESP and RRSP.
• For every hour you spend on studying, you could
have worked.
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Principle
Principle #1:
#1: People
People Face
Face Tradeoffs
Tradeoffs

• Society faces the tradeoff between efficiency

and equity.
• Efficiency: getting the most out of resources.
• Equity: fairness of economic allocation
• Efficiency can be referred to the economic pie,
and equity to how the economic pie is divided
among society’s members.

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Principle
Principle #2:
#2: The
The Cost
Cost of
of Something
Something is
is What
What You
You
Give
Give Up
Up to
to Get
Get ItIt
• Opportunity cost : what you give up to obtain
something.
• To become a doctor, you need to go to
medical school. In addition, you are giving
up other career paths.
• Waiting in a long line for a free item costs
your time.
• “There is no such thing as free lunch.”
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Principle
Principle #3:
#3: Rational
Rational People
People Think
Think at
at the
the Margin
Margin

• Rational people: someone always try to do

their best to achieve their objectives.
• In economics, we usually assume that firms’
objective is to maximize its profit and
consumers' objective is to achieve the highest
level of satisfaction.
• Marginal changes: small incremental
adjustments to an existing situation or plan.
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Principle
Principle #3:
#3: Rational
Rational People
People Think
Think at
at the
the Margin
Margin

• Rational people make decision by comparing

marginal benefits and marginal costs.
• Suppose you have already eaten 3 tacos.
Whether to have an extra taco depends on
price of the taco (marginal cost) and the
extra satisfaction it gives (marginal benefit).
• To study one more hour the night before the
exam has benefits and costs (less sleep).

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Principle
Principle #4:
#4: People
People Responds
Responds to
to Incentives
Incentives

• Incentive: something, such as a punishment or

reward, that induces action.
• Rational people responds to incentive
• If price of gasoline rises, people drive less.
• If a neighboring country let people visit without
a visa, the number of tourists will increase.
• If a famous food critic is waiting for a dinner,
the chef is trying her/his best.

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Principle
Principle #4:
#4: People
People Responds
Responds to
to Incentives
Incentives

• When government changes a rule or regulation, it gives

an incentive to (some) people to change their action.
• When the government didn’t think thoroughly about all
the incentives, unintended consequences can happen.
• Seat belt law changes how people drive. As result,
there were no change in the number of driver
deaths.
• Some say, to decrease the number of concussions in
the NFL, you need to stop the use of helmets.

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 HOW PEOPLE INTERACT
Principle
Principle #5:
#5: Trade
Trade can
can Make
Make Everyone
Everyone Better
Better Off
Off
• Trade allows each individual to specialize in the
activities she or he does best. By doing so,
everyone will be better off (than being self
sufficient).
• Similarly, countries benefit from trade and
specialization.
• We will study about benefits of trade in
Chapter 3.

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Principle
Principle #6:
#6: Markets
Markets Are
Are Usually
Usually aa Good
Good Way
Way to
to
Organize
Organize Economic
Economic Activity
Activity
• Market economy: an economy that allocates
resources through market forces.
• In a market economy, firms and households
make self-interested decisions guided by the
market price .
• Price reveals the buyer’s valuation of the good
and the seller’s cost of producing it.

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Principle
Principle #6:
#6: Markets
Markets Are
Are Usually
Usually aa Good
Good Way
Way to
to
Organize
Organize Economic
Economic Activity
Activity
• Usually, prices adjust to guide the economy to
the outcome that maximizes society’s economic
well-being (resources allocated efficiently).
• In his famous book, Wealth of Nations (1776),
Adam Smith wrote:
“Every individual… neither intends to promote the
public interest, nor knows how much he is promoting
it… He intends only his own gain, and he is in this, as in
many other cases, led by an invisible hand to promote
an end which was no part of his intention.”
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Principle
Principle #7:
#7: Government
Government Can
Can Sometimes
Sometimes
Improve
Improve Market
Market Outcomes
Outcomes
• Market failure refers to a situation where
allocation of recourses of market outcome is not
efficient. It can happen if there is:
• Externality: one person’s action affects bystander
positively or negatively. Example: Pollution.
• Market power: an ability of a single (or a small
number of) firm (or buyer) to influence market
price. Example: Monopoly.

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Principle
Principle #7:
#7: Government
Government Can
Can Sometimes
Sometimes
Improve
Improve Market
Market Outcomes
Outcomes
• If there is market failure, government can intervene in
the economy and improve the market outcome. In
this case, government intervention is promoting
efficiency.
• Government also can take actions that promote
equity. Income tax and welfare system are examples
of such action.
• One of the most important government role is to
enforce property right by law.

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 HOW ECONOMY AS A WHOLE WORKS
Principle
Principle #8:
#8: AA Country’s
Country’s Standard
Standard of
of Living
Living
Depends
Depends onon Its
Its Ability
Ability to
to Produce
Produce Goods
Goods andand
Services
Services
• Living standards vary a lot across countries and over
time.
• The main determinant of living standard is
productivity, the quantity of goods and services
produced from each hour of a worker’s time.
• Productivity depends on technology, skills of workers
and equipment/machinery.

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• We skip Principle #9 and Principle #10, since
these are macroeconomic principles and we will
not use them in this course.

• We skip Principle #9 and Principle #10, since

these are macroeconomic principles and we will
not use them in this course.

• Some Review Questions (from textbook):

• 1. Give three examples of important tradeoffs that
face in your life.
• 2. What is the opportunity cost of a seeing a
movie?
• 3. Water is necessary for life. Is the marginal
benefit of a glass of water large or small? ….