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Seventh Edition In this chapter,
Principles of look for the answers to these questions
Economics )
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9 • What kinds of questions does economics
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CHAPTER Ten Principles • What are the principles of how people interact?
• What are the principles of how the economy as
1 of Economics a whole works?
Modified by Joseph Tao-yi Wang
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What Economics Is All About The principles of
Scarcity: the limited nature of society’s HOW PEOPLE
resources MAKE DECISIONS
Economics: the study of how society manages
its scarce resources, e.g.
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 ©lithian/Shutterstock.com
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
PRINCIPLE 1 PRINCIPLE 1
People Face Tradeoffs People Face Tradeoffs
All decisions involve tradeoffs. Examples: Society faces an important tradeoff:
Going to a party the night before your midterm efficiency vs. equality
leaves less time for studying. Efficiency: when society gets the most from its
Having more money to buy stuff requires scarce resources
working longer hours, which leaves less time Equality: when prosperity is distributed
for leisure. uniformly among society’s members
Protecting the environment requires resources Tradeoff: To achieve greater equality,
that could otherwise be used to produce could redistribute income from wealthy to poor.
consumer goods. But this reduces incentive to work and produce,
shrinks the size of the economic “pie.”
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
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PRINCIPLE 2 PRINCIPLE 2
The Cost of Something Is The Cost of Something Is
What You Give Up to Get It What You Give Up to Get It
Making decisions requires comparing the costs Examples:
and benefits of alternative choices. The opportunity cost of2
The opportunity cost of any item is 2going to college for a year is not just the tuition,
whatever must be given up to obtain it. books, and fees, but also the foregone wages.
It is the relevant cost for decision making. 2seeing a movie is not just the price of the ticket,
but the value of the time you spend in the theater.
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
PRINCIPLE 3 PRINCIPLE 3
Rational People Think at the Margin Rational People Think at the Margin
Rational people Examples:
systematically and purposefully do the best they When a student considers whether to go to
can to achieve their objectives. college for an additional year, he compares the
make decisions by evaluating costs and benefits fees & foregone wages to the extra income
of marginal changes, incremental adjustments he could earn with the extra year of education.
to an existing plan. When a manager considers whether to increase
output, she compares the cost of the needed
labor and materials to the extra revenue.
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
PRINCIPLE 4 ACTIVE LEARNING 1
People Respond to Incentives Applying the principles
Incentive: something that induces a person to You are selling your old Asus laptop. You have
act, i.e. the prospect of a reward or punishment. already spent $10,000 on repairs.
Rational people respond to incentives. At the last minute, the hard drive dies. You can pay
Examples: $6,000 to have it repaired, or sell the laptop “as is.”
When gas prices rise, consumers buy more In each of the following scenarios, should you have
hybrid cars and fewer gas guzzling SUVs. the hard drive repaired? Explain.
When cigarette taxes increase, A. eBay value (what you could get for the laptop) is
teen smoking falls. $25,000 if hard drive works, $17,000 if it doesn’t
B. eBay value is $20,000 if hard drive works,
$15,000 if it doesn’t
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ACTIVE LEARNING 1 ACTIVE LEARNING 1
Answers Observations
Cost of fixing hard drive = $6,000 The $10,000 you previously spent on repairs is
A. eBay value is $25,000 if hard drive works, irrelevant. What matters is the cost and benefit
$17,000 if it doesn’t of the marginal repair (the hard drive).
Benefit of replacing the hard drive = $8,000 The change in incentives from scenario A
($25,000 – 17,000). to scenario B caused your decision to change.
Get the hard drive replaced.
B. eBay value is $20,000 if hard drive works,
$15,000 if it doesn’t
Benefit of replacing the hard drive is only $5,000.
Do not pay $6,000 to replace it.
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
The principles of PRINCIPLE 5
HOW PEOPLE Trade Can Make Everyone Better Off
Rather than being self-sufficient,
INTERACT people can specialize in producing one good or
service and exchange it for other goods.
Countries also 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
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PRINCIPLE 6 PRINCIPLE 6
Markets Are Usually A Good Way to Markets Are Usually A Good Way to
Organize Economic Activity Organize Economic Activity
Market: a group of buyers and sellers A market economy allocates resources through
(need not be in a single location) the decentralized decisions of many households
“Organize economic activity” means determining and firms as they interact in markets.
what goods to produce Famous insight by Adam Smith in
how to produce them The Wealth of Nations (1776):
how much of each to produce Each of these households and firms
who gets them acts as if “led by an invisible hand”
to promote general economic well-being.
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
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PRINCIPLE 6 PRINCIPLE 7
Markets Are Usually A Good Way to Governments Can Sometimes
Organize Economic Activity Improve Market Outcomes
The invisible hand works through the price Important role for govt: enforce property rights
system: (with police, courts)
The interaction of buyers and sellers People are less inclined to work, produce,
determines prices. invest, or purchase if large risk of their property
Each price reflects the good’s value to buyers being stolen.
and the cost of producing the good.
Prices guide self-interested households and
firms to make decisions that, in many cases,
maximize society’s economic well-being.
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
PRINCIPLE 7 PRINCIPLE 7
Governments Can Sometimes Governments Can Sometimes
Improve Market Outcomes Improve Market Outcomes
Market failure: when the market fails to allocate Govt may alter market outcome to
society’s resources efficiently promote equity.
Causes of market failure: If the market’s distribution of economic well-being
Externalities, when the production or consumption is not desirable, tax or welfare policies can
of a good affects bystanders (e.g. pollution) change how the economic “pie” is divided.
Market power, a single buyer or seller has
substantial influence on market price
(e.g. monopoly)
Public policy may promote efficiency.
© 2015 CengageLearning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as 20 © 2015 CengageLearning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as 21
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
ACTIVE LEARNING 2
Discussion Question What Economics is ReallyAbout?
In each of the following situations, what is the Traditionally: Economics is the study of how
government’s role? Does the government’s society produces and distributes goods to satisfy
intervention improve the outcome? the wants and needs of their members.
a. Public schools for K-12 My View: Economics is a study of institutions and
b. National health insurance human behavior (reactions to institutions)
c. Patent laws, which allow drug companies to (Classical) market mechanism is just one
charge high prices for life-saving drugs example!
Other mechanisms: Auctions, match-making
Other institutions: governments, congress,
national health insurance, families, social norms23
© 2015 CengageLearning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as © 2015 CengageLearning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
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