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Basic Principles of Economics 3

The document outlines the basic principles of economics, focusing on how individuals and firms make decisions, interact, and how the economy functions as a whole. Key principles include trade-offs, opportunity costs, the role of incentives, and the impact of government on market outcomes. It emphasizes the importance of productivity in determining living standards and discusses the relationship between inflation and unemployment.

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14 views33 pages

Basic Principles of Economics 3

The document outlines the basic principles of economics, focusing on how individuals and firms make decisions, interact, and how the economy functions as a whole. Key principles include trade-offs, opportunity costs, the role of incentives, and the impact of government on market outcomes. It emphasizes the importance of productivity in determining living standards and discusses the relationship between inflation and unemployment.

Uploaded by

lexii.obersonn
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PPTX, PDF, TXT or read online on Scribd
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Basic Principles of

Economics
Basic Principles of Economics
• What kinds of questions does economics
address?
• What are the principles of how people
make decisions?
• What are the principles of how people
interact?
• What are the principles of how the
economy as a whole works?
Basic Economic Questions
WHAT EVERY ECONOMY, BUSINESS AND
CONSUMER MUST ANSWER!
Basic Principles of Economics
(review)
• Economists study:
• How people decide what to buy, how much to work,
save, and spend
• How firms decide how much to produce, how many
workers to hire
• How society decides how to divide its resources
between national defense, consumer goods, protecting
the environment, and other needs
Economics Principles: How People
Make Decisions

Principle 1: People face trade-offs


Principle 2: The cost of something is what
you give up to get it
Principle 3: People respond to incentives
Principle 1: People Face Trade-offs
• To get something that we like, we have to
give up something else that we also like
• Going to a party the night before an exam
• Less time for studying
• Having more money to buy stuff
• Working longer hours, less time for leisure
• Protecting the environment
• Resources could be used to produce consumer goods
Principle 2: The cost of something is
what you give up to get it.
• Making decisions:
• Compare costs with benefits of alternatives
• Need to include opportunity costs

• Opportunity cost
• Whatever must be given up to obtain some item
Principle 2: The cost of something is
what you give up to get it.
• The opportunity cost of:
• Going to college for a year
• Tuition, books, and fees
• PLUS foregone wages
• Going to the movies
• The price of the movie ticket
• PLUS the value of the time you spend in the theater
Principle 3: People Respond to
Incentives
• Incentive
• Something that induces a person to act. You
incentivize behavior you want increase.
• Subsidies are one way to incentivize people
• Opposite: you tax behavior you want to stop

• Examples:
• $7500 tax credit (a subsidy) to get people to buy EV’s
• Tax deductions and/or tax-free growth to get people to
invest in retirement
Active Learning 1 Applying the principles

You are selling your 2007 Mustang. You have already


spent $1,000 on repairs. At the last minute, the
transmission dies. You can pay $900 to have it repaired,
or sell the car “as is.”
In each of the following scenarios, should you have the
transmission repaired? Explain.
A. Blue book value (what you could get for the car) is $7,500 if
transmission works, $6,200 if it doesn’t.
B. Blue book value is $6,300 if transmission works, $5,500 if it
doesn’t.
Active Learning 1 Applying the principles

Cost of fixing the transmission = $900


A. Blue book value is $7,500 if transmission works,
$6,200 if it doesn’t
• Benefit of fixing transmission = $1,300 (= 7500 – 6200)
• Get the transmission fixed

B. Blue book value is $6,300 if transmission works,


$5,500 if it doesn’t
• Benefit of fixing the transmission = $800 (= 6300 – 5500)
• Do not pay $900 to fix it
Economic Principles: How People
Interact

Principle 4: Trade can make everyone better off


Principle 5: Markets are the best way to organize
economic activity
Principle 6: Governments can sometimes improve
market outcomes
Principle 4: Trade can make everyone
better off

• People benefit from trade:


• People can buy a greater variety of goods and
services at lower cost
• Countries benefit from trade and
specialization
• Get a better price abroad for goods they
produce
• Buy other goods more cheaply from abroad
than could be produced at home
Principle 5: Markets Are Usually a
Good Way to Organize Economic
Activity
• Market
• A group of buyers and sellers (need not be in a single
location)

• “Organize economic activity” means


determining
• What goods and services to produce
• How much of each to produce
• Who produced and consumed these
Principle 5: Markets Are the Best
Way to Organize Economic Activity

• A market economy allocates resources


• Decentralized decisions of many firms and households
– as they interact in markets

• Famous insight by Adam Smith in


The Wealth of Nations (1776):
• Each of these households and firms acts as if “led by
an invisible hand” to promote general economic well-
being
Principle 5: Markets Are the Best
Way to Organize Economic Activity

• Prices:
• Determined: interaction of buyers and sellers
• Reflect the good’s value to buyers
• Reflect the cost of producing the good

• Invisible hand:
• Prices guide self-interested households and firms to
make decisions that maximize society’s economic well-
being
Principle 6: Governments Can
Sometimes Improve Market
Outcomes

• Enforce rules and maintain institutions


that are key to a market economy
• People are less inclined to work, produce, invest, or
purchase if large risk of their property being stolen
Active Learning 2 Discussion Question

In each of the following situations, what is the


government’s role?
Does the government’s intervention improve the
outcome?
a. Public schools for K-12
b. Workplace safety regulations
c. Public highways
d. Patent laws, which allow drug companies to charge
high prices for life-saving drugs
Economics Principles: How the
economy as a whole works

Principle 7: A country’s standard of living


depends on its ability to produce goods and
services
Principle 8: Prices rise when the government
prints too much money
Principle 9: Society faces a short-run trade-off
between inflation and unemployment
Principle 7: A country’s standard of living depends
on its ability to produce goods and services

• Huge variation in living standards


• Across countries and over time
• Average income in rich countries
• Is more than ten times average income in poor
countries
• The U.S. standard of living today
• Is about eight times larger than 100 years ago
Principle 7: A country’s standard of living depends
on its ability to produce goods and services

• Productivity: most important determinant


of living standards
• Quantity of goods and services produced from each
unit of labor input
• Depends on the equipment, skills, and technology
available to workers
Principle 8: Prices rise when the
government prints too much money

• Inflation
• An increase in the overall supply of money which leads
to a rise of prices in the economy

• In the long run


• Inflation is almost always caused by excessive growth
in the quantity of money, which causes the value of
money to fall
• The faster the government creates money,
the greater the inflation rate
Principle 9: Society faces a short-run trade-
off between inflation and unemployment

• Short-run trade-off between


unemployment and inflation
• Over a period of a year or two, many economic policies
push inflation and unemployment in opposite
directions
• Other factors can make this tradeoff more or less
favorable, but the tradeoff is always present
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