Define and explain 10 principles of economies

Although the study of economics has many facets, the field is unified by several central ideas. The Ten Principles of Economics offer an overview of what economics is all about.

People Face Tradeoffs.  To get one thing, you have to give up something else. Making decisions requires trading off one goal against another.

“There is no such thing as a free lunch!”

To get one thing, we usually have to give up another thing.

Guns v. butter

Food v. clothing

Leisure time v. work

Efficiency v. equity

Making decisions requires trading off one goal against another.

Efficiency v. Equity

Efficiency means society gets the most that it can from its scarce resources.

Equity means the benefits of those resources are distributed fairly among the members of society. When individuals make decisions, they face tradeoffs among alternative goals.

The Cost of Something is What You Give Up to Get It.  Decision-makers have to consider both the obvious and implicit costs of their actions. Decisions require comparing costs and benefits of alternatives.

Whether to go to college or to work?

Whether to study or go out on a date?

Whether to go to class or sleep in?

The opportunity cost of an item is what you give up to obtain that item.

LA Laker basketball star Kobe Bryant chose to skip college and go straight from high school to the pros where he has earned millions of dollars. The cost of any action is measured in terms of foregone opportunities.

Rational People Think at the Margin. A rational decision-maker takes action if and only if the marginal benefit of the action exceeds the marginal cost.

Marginal changes are small, incremental adjustments to an existing plan of action. People make decisions by comparing costs and benefits at the margin

Rational people make decisions by comparing marginal costs and marginal benefits.

People Respond to Incentives. Behavior changes when costs or benefits change.

Marginal changes in costs or benefits motivate people to respond.

The decision to choose one alternative over another occurs when that alternative’s marginal benefits exceed its marginal costs!

People change their behavior in response to the incentives they face.

Trade Can Make Everyone Better Off. Trade allows each person to specialize in the activities he or she does best. By trading with others, people can buy a greater variety of goods or services. People gain from their ability to trade with one another.

Competition results in gains from trading.

Trade allows people to specialize in what they do best. Trade can be mutually beneficial.

Markets Are Usually a Good Way to Organize Economic Activity. Households and firms that interact in market economies act as if they are guided by an "invisible hand" that leads the market to allocate resources efficiently. The opposite of this is economic activity that is organized by a central planner within the government.

A market economy is an economy that allocates resources through the decentralized decisions of many firms and households as they interact in markets for goods and services.

Households decide what to buy and who to work for.

Firms decide who to hire and what to produce.

Adam Smith made the observation that households and firms interacting in markets act as if guided by an “invisible hand.”

Because households and firms look at prices when deciding what to buy and sell, they unknowingly take into account the social costs of their actions.

As a result, prices guide decision makers to reach outcomes that tend to maximize the welfare of society as a whole. Markets are usually a good way of coordinating trade among people.

Governments Can Sometimes Improve Market Outcomes. When a market fails to allocate resources efficiently, the government can change the outcome through public policy. Examples are regulations against monopolies and pollution.

Market failure occurs when the market fails to allocate resources efficiently.

When the market fails (breaks down) government can intervene to promote efficiency and equity.

Market failure may be caused by

an externality, which is the impact of one person or firm’s actions on the well-being of a bystander.

market power, which is the ability of a single person or firm to unduly influence market prices.

Government can potentially improve market outcomes if there is some market failure or if the market outcome is inequitable.

A Country's Standard of Living Depends on Its Ability to Produce Goods and Services. Countries whose workers produce a large quantity of goods and services per unit of time enjoy a high standard of living. Similarly, as a nation's productivity grows, so does its average income. Standard of living may be measured in different ways:By comparing personal incomes.By comparing the total market value of a nation’s production.

Almost all variations in living standards are explained by differences in countries’ productivities.Productivity is the amount of goods and services produced from each hour of a worker’s time.

Standard of living may be measured in different ways:

By comparing personal incomes.

By comparing the total market value of a nation’s production. Productivity is the ultimate source of living standards.

Prices Rise When the Government Prints Too Much Money. When a government creates large quantities of the nation's money, the value of the money falls. As a result, prices increase, requiring more of the same money to buy goods and services. Inflation is an increase in the overall level of prices in the economy.One cause of inflation is the growth in the quantity of money.

When the government creates large quantities of money, the value of the money falls. Money growth is the ultimate source of inflation.

Society Faces a Short-Run Tradeoff Between Inflation and Unemployment. Reducing inflation often causes a temporary rise in unemployment. This tradeoff is crucial for understanding the short-run effects of changes in taxes,government spending and monetary policy.

The Phillips Curve illustrates the tradeoff between inflation and unemployment:

Inflation falls when Unemployment rise

It’s a short-run tradeoff!

Society faces a short-run tradeoff between inflation and unemployment.

3. Difference between micro and macro economics.Role of economists in making policy

Microeconomics focuses on the individual parts of the economy.

How households and firms make decisions and how they interact in specific markets

Microeconomics. The study of decision making undertaken by individuals (or households) and by firms. Like looking though a microscope to focus on the smaller parts of the economy

Decision of a worker to work overtime or not

A family’s choice of having a baby

An individual firm advertising

Macroeconomics looks at the economy as a whole.

Economy-wide phenomena, including inflation, unemployment, and economic growth

Macroeconomics .The study of the behavior of the economy as a whole. Deals with economy wide phenomena

The national unemployment rate

The rate of growth in the money supply

The national government’s budget deficit

THE ECONOMIST AS POLICY ADVISOR

When economists are trying to explain the world, they are scientists.

When economists are trying to change the world, they are policy advisor.

4 . Absolute advantage and comparative advantage.

Absolute Advantage

The comparison among producers of a good according to their productivity—absolute advantage

Describes the productivity of one person, firm, or nation compared to that of another.

The producer that requires a smaller quantity of inputs to produce a good is said to have an absolute advantage in producing that good.

The Rancher needs only 10 minutes to produce an ounce of potatoes, whereas the Farmer needs 15 minutes.

The Rancher needs only 20 minutes to produce an ounce of meat, whereas the Farmer needs 60 minutes.

The Rancher has an absolute advantage in the production of both meat and potatoes.

Opportunity Cost and Comparative Advantag

Compares producers of a good according to their opportunity cost.

Whatever must be given up to obtain some item

The producer who has the smaller opportunity cost of producing a good is said to have a comparative advantage in producing that good.

Compares producers of a good according to their opportunity cost.

Whatever must be given up to obtain some item

The producer who has the smaller opportunity cost of producing a good is said to have a comparative advantage in producing that good.

Comparative Advantage and Trade

Who has the absolute advantage?

The farmer or the rancher?

Who has the comparative advantage?

The farmer or the rancher?

5. How comparative advantage explains the gains from trade

Comparative Advantage and Trade

The Rancher’s opportunity cost of an ounce of potatoes is ¼ an ounce of meat, whereas the Farmer’s opportunity cost of an ounce of potatoes is ½ an ounce of meat.

The Rancher’s opportunity cost of a pound of meat is only 4 ounces of potatoes, while the Farmer’s opportunity cost of an ounce of meat is only 2 ounces of potatoes...

…so, the Rancher has a comparative advantage in the production of meat but the Farmer has a comparative advantage in the production of potatoes.

Comparative advantage and differences in opportunity costs are the basis for specialized production and trade.

Whenever potential trading parties have differences in opportunity costs, they can each benefit from trade.

Benefits of Trade

Trade can benefit everyone in a society because it allows people to specialize in activities in which they have a comparative advantage.