Principles of Economics

Economics
• The word economy comes from the Greek word oikonomos,

Prof. Stigler
• “Economics is the study of the principles governing the allocation of scarce means among
competing ends when the objective of allocation is to maximize the attainment of the ends.”
Wicksteed, Schoenfeld, Hans Mayhers, Carl Manger, Stigler, Fetter, Schaffle, Spaan, Cohen,
Maxweber, Voigt etc. also called economics as “a science of scarcity and choice.”
Prof. Lionel Robbins
• “Economics is the science which studies human behavior as a relationship between multiple
ends and scarce means which have alternative uses”.
• Four fundamental propositions that constitute the basis of the structure of economic science.
 Human wants or ends are unlimited.
 Human wants are different in importance.
 Resources to fulfill human wants are limited.
 Resources have alternative uses.
 Principles of Economics
Principle 1: People Face Trade-offs
• a decision where choosing one option means giving up the other.

• trade-offs occur because resources (like time, money, or energy) are

limited, and we have to make choices
• Individual
• Society- gun and bread, efficiency and equality, Clean environment
and Income
Principle 2: The Cost of Something Is What You
Give Up to Get It

• Explicit Costs: These are the direct, out-of-pocket expenses incur to

get something.

• Opportunity Costs: This represents the value of the next best

alternative forgo when making a choice.
Principle 3- Rational People Think at the
Margin

• Marginal Benefit: This is the additional benefit gained from consuming or

producing one more unit of a good or service.
• Marginal Cost: This is the additional cost incurred from consuming or producing
one more unit.
• Decision-Making at the Margin: Rational people make decisions based on
comparing the marginal benefit and marginal cost. They will choose to undertake
an action if the marginal benefit exceeds the marginal cost.
• Diamond- Water Paradox
Principle 4: People Respond to
Incentives
Incentives can influence decision-making and actions

• Incentives: These are rewards or penalties that influence behavior. They can be
financial (like bonuses or fines) or non-financial (like praise or criticism).
• Behavioral Response: This is how people change their actions in reaction to
incentives.
• Motivation: This component refers to the drive or willingness to act in response
to incentives.
Principle 5: Trade Can Make Everyone
Better Off
When countries specialize in what they do best and then trade with
others, everyone can benefit.

• Specialization: This involves focusing on producing goods or services that one does best.
Specialization increases efficiency and productivity.
• Exchange: This is the act of trading goods or services between people or entities. It allows
people to obtain items they don’t produce themselves.
• Mutual Benefit: Trade often benefits both parties by allowing them to enjoy a greater
variety of goods and services and to use their resources more effectively.
• Comparative Advantage: This principle underlies the idea that trade is beneficial. It
suggests that each party should specialize in what they produce most efficiently compared
to others, and trade to get what they need.
Principle 6: Markets Are Usually a Good Way to Organize
Economic Activity
Letting people buy and sell freely in markets often leads to efficient and
effective outcomes.

Markets: These are platforms or systems where buyers and sellers interact to exchange goods
and services. They can be physical (like markets or stores) or virtual (like online marketplaces).
Prices: Prices in markets are determined by supply and demand. They signal how much people
value different goods and services and help allocate resources accordingly.
Competition: Competition among sellers can drive innovation, improve quality, and reduce
prices. It ensures that resources are used efficiently and that consumers get better choices.
Efficiency: Markets can efficiently allocate resources by responding to changing demands and
supplying goods where they are most valued. This often results in better outcomes compared to
centrally planned systems.
Principle 7: Governments Can Sometimes Improve
Market Outcomes
Sometimes markets don’t work perfectly on their own. In these cases, government
intervention can help correct problems and make outcomes better for society.

Market Failures: Situations where markets do not allocate resources efficiently on their own.
Government Intervention: Actions taken by the government to correct market failures and
improve outcomes.
Public Goods: Goods that are non-excludable and non-rivalrous, meaning one person’s use doesn’t
reduce availability for others.
Externalities: Costs or benefits of a transaction that affect third parties who are not directly
involved. Government policies can help internalize these costs or benefits (e.g., taxes on pollution).
Regulation: Government rules and laws designed to correct market failures, protect consumers, or
ensure fair competition. For example, safety standards for products or financial regulations for
banks.
Principle 8: A Country’s Standard of Living Depends on Its
Ability to Produce Goods and Services

The wealth and quality of life in a country are closely related to how effectively it can produce
goods and services

• Productivity: This is the measure of how efficiently goods and services are produced. Higher
productivity means more output for the same amount of input, which leads to a higher standard of
living.
• Economic Output: A higher output generally correlates with higher income and better quality of life for
its citizens.
• Technological Advancement: Improvements in technology can increase productivity, allowing a
country to produce more goods and services more efficiently.
• Human Capital: The skills, knowledge, and experience of the workforce. A more skilled workforce can
improve productivity and contribute to a higher standard of living.
• Investment: Investments in infrastructure, education, and research can enhance a country’s ability to
produce goods and services, leading to economic growth and improved living standards.
Principle 9: Prices Rise When the
Government Prints Too Much Money
if a government creates too much money, the value of that money decreases, leading to higher
prices for goods and services.

• Money Supply: The total amount of money available in an economy. Increasing the money supply
without a corresponding increase in the production of goods and services can lead to inflation.
• Inflation: The rate at which the general level of prices for goods and services rises, eroding
purchasing power. More money in the economy usually means higher inflation.
• Purchasing Power: The value of money in terms of what it can buy. When there is too much
money in circulation, the purchasing power of each unit of currency decreases.
• Demand and Supply: When more money is in the economy, demand for goods and services
increases. If the supply of goods and services doesn’t keep up, prices go up.
• Hyperinflation: An extreme case where prices rise rapidly and uncontrollably, often resulting
from excessive money printing. This is a severe form of inflation and can lead to economic
instability.
Principle 10: Society Faces a Short-Run Trade-
off between Inflation and Unemployment

In the short term, there is trade-off between controlling inflation (rising prices) and reducing
unemployment (joblessness).

• Inflation: The rate at which the general level of prices for goods and services increases, reducing
purchasing power.
• Unemployment: The percentage of people who are actively looking for work but cannot find a job.
• Short-Run Trade-off: In the short term, policies that reduce inflation might lead to higher
unemployment, and policies that reduce unemployment might lead to higher inflation.
• Phillips Curve: An economic concept that illustrates the inverse relationship between inflation and
unemployment. It suggests that as inflation decreases, unemployment may increase, and vice versa.
• Policy Measures: Tools used by governments or central banks to influence inflation and
unemployment, such as adjusting interest rates, changing tax rates, or modifying government
spending.