Economics Notes 2

Applied Economics (SESSION 2) Making decisions requires individuals to
consider the benefits and costs of some action.

The application of economic theories and
principles to real world situations with the
desired aim of predicting potential outcomes
Example: What are the costs of going to college?
ECONOMY
◦ OPPORTUNITY COST - the loss of potential gain
From greek word “Oikonomos” meaning “One from other alternatives when one alternative is
who manage the household” chosen.
ECONOMICS
REAL LIFE EXAMPLE: Athletes who can earn
The study of how society manages its scarce millions if they drop out of school and play
resource professional sports are well aware that their
SCARCITY opportunity cost of college is very high.
The limited nature of society’s resources 3. Principle #3: Rational People Think at the
Margin
FUNDAMENTAL ECONOMIC PROBLEM
Resources are scarce Economists generally assume that people are

rational.
PRINCIPLES OF ECONOMICS
1. Principle 1: People Face Trade-offs ◦ ◦ Rational: systematically and purposefully doing

the best you can to achieve your objectives.
“There ain’t no such thing as a free lunch.”
Making decisions requires trading one goal for Consumers want to purchase the goods and
another services that allow them the greatest level of
satisfaction given their incomes and the prices
. A special example of a trade-off is the trade-off they face.
between efficiency and equality.
 ◦ Efficiency - ◦ the property of society ◦ Marginal changes: Small incremental

getting the maximum benefits from its adjustments to a plan of action
scarce resources.
 ◦ Equality - ◦ the property of distributing ◦ EXAMPLE: Suppose that flying a 200-seat plane
economic prosperity uniformly among across the country costs the airline Php100,000,
the members of society. which means that the average cost of each seat
is Php500. Suppose that the plane is minutes
LIFE EXAMPLE: A student faces a trade from departure and a passenger is willing to pay
off between studying for exam or to Php300 for a seat. Should the airline sell the seat
watch a much awaited movie. for Php300? In this case, the marginal cost of an
additional passenger is very small.
2. Principle #2: The Cost of Something Is What
You Give Up to Get It 4. Principle #4: People Respond to Incentives ◦
Incentive: something that induces a person to activity in a way that promoted economic well-
act. being for the country as a whole.
Many public policies change the costs and 7. Principle #7: Governments Can Sometimes
benefits that people face. Sometimes Improve Market Outcomes The invisible hand
policymakers fail to understand how policies will only work if the government enforces
alter incentives and behavior and a policy may property rights.
lead to unintended consequences.
Property Rights - the ability of an individual to
◦ Example: Seat belt laws increase the use of own and exercise control over scarce resources.
seat belts but lower the incentives of individuals There are two broad reasons for the government
to drive safely. This leads to an increase in the to interfere with the economy:
number of car accidents. This also leads to an
increased risk for pedestrians. 1. To promote efficiency
5. Principle #5: Trade Can Make Everyone Better ◦ Market Failure – a situation in which a market
Off left on its own fails to allocate resources
efficiently
➢Trade is not like a sports contest, where one
side gains and the other side loses. ◦ Externality – the impact of one person’s
➢Consider trade that takes place inside your actions on the well-being of a bystander (e.g
home. Your family is likely to be involved in trade POLLUTION)
with other families on a daily basis. Most families
do not build their own homes, make their own ◦ Market Power – the ability of a single
clothes, or grow their own food. ➢Countries economic actor (or small group of actors) to have
benefit from trading with one another as well. a substantial influence on market prices. 2. To
promote equality ◦ A market economy rewards
➢Trade allows for specialization in products that
people according to their ability to produce
countries (or families) can do best
things that other people are willing to pay for.
6. Principle #6: Markets Are Usually a Good Way
2. 2. To promote equality
to Organize Economic Activity
◦ A market economy rewards people according

➢Communist countries operated on the
to their ability to produce things that other
premise that government officials were in the
people are willing to pay for.
best position to allocate the economy’s scarce
resources.
8. A Country’s Standard of Living Depends on Its
Ability to Produce Goods and Services
➢These central planners decided WHAT goods
and services were produced, HOW much was Differences in living standards from one country
produced, and WHO produced and consumed to another are quite large.
these goods and services.
Changes in living standards over time are also
➢The theory behind central planning was that great.
only the government could organize economic
➢The increase in the quantity of goods and
The explanation for differences in living services sold will cause firms to hire additional
standards lies in differences in productivity. workers.
◦ Productivity: the quantity of goods and ➢An increase in the demand for goods and
services produced from each unit of labor input. services leads to higher prices over time. ➢Some
economists question whether this relationship
High productivity implies a high standard of still exists.
living.
➢The short-run trade-off between inflation and
unemployment plays a key role in the analysis of
Thus, policymakers must understand the impact
the business cycle.
of any policy on our ability to produce goods and
➢Business Cycle: fluctuations in economic
services.
activity, such as employment and production.
9. Principle #9: Prices Rise When the
Government Prints Too Much Money
When the government creates a large amount

of money, the value of money falls, leading to
price increases.
Inflation: an increase in the overall level of

prices in the economy.
Deflation: a decrease in the general price level of

goods and services.
LIFE EXAMPLE: When there is a lot of money in

circulation in the economy, then the income of
the consumer rises and this will push up the
demand for goods and services. If purchasing
power increases it leads to excess demand the
producer will not the able to fulfill the demand ,
and since excess doesn't exist in the market, the
producer will increase the price. This will lead to
inflation.
10. Principle #10: Society Faces a Short-Run
Trade-off between Inflation and Unemployment
➢An increase in the amount of money in the

economy stimulates spending and increases the
quantity of goods and services sold in the
economy.

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Applied Economics (SESSION 2) Making decisions requires individuals to

consider the benefits and costs of some action.

Resources are scarce Economists generally assume that people are

1. Principle 1: People Face Trade-offs ◦ ◦ Rational: systematically and purposefully doing

 ◦ Efficiency - ◦ the property of society ◦ Marginal changes: Small incremental

◦ A market economy rewards people according

When the government creates a large amount

Inflation: an increase in the overall level of

Deflation: a decrease in the general price level of

LIFE EXAMPLE: When there is a lot of money in

➢An increase in the amount of money in the

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