Econ 1b03 Textbook Notes

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CHAPTER 1
Economics
oStudy of how societies manage their scarce resources
Ten Principles of Economics
oPeople face tradeoffs
Making decisions involves trading off one goal for another Example: In order to study properly for a final exam, students must give up most of their social life during exams •Societies face the tradeoff between efficiency and equity An efficient society gets the most it can from its scarce resources An equitable society distributes the benefits of its resources fairly amongst its members To achieve one goal completely, society must give up the other •Example: Welfare increases equity, but decreases efficiency (higher unemployment) oCost of a decision/goal is what was given up to achieve it •Known as opportunity cost

Good decisions are made by taking opportunity cost into account oRational people think at the margin
Rational people know that decisions are not black and white •By comparing the marginal benefit of a decision to the marginal cost, individuals make marginal changes to an already existing plan of action •Example: Water vs. Diamonds

Diamonds are more expensive because the marginal benefit of an additional cup of water is small due to the abundance of water, and the marginal benefit of an additional diamond is high because of the scarcity of diamonds oPeople respond to incentives

Incentive is something that induces a person to act
Is usually the prospect of a reward or punishment
Influences decisions heavily because it affects marginal costs and benefits oEveryone benefits from trade
Specialization is much more efficient than producing all necessary goods alone •It is therefore more efficient to specialize in producing a certain good and then trading the excess for all other necessities oMarket economies are the best way to organize economic activity •Decisions of firms and households drive the economy to be more efficient •Individual decisions are selfish but act on the economy in a positive way •Invisible hand is the unintended consequence of a market economy •Firms that are in competition with each other compete to become more efficient so they can make an increased profit •Combination of demand and supply result in prices that reflect the value of a good or service to society •Efficiency is rewarded

oGovernment can improve market outcomes
Government needed because invisible hand only works if certain rules and regulations are followed Government enforces property rights
Individuals will not work if there is too great a risk of the product of their work to be taken from them •Government needed to intervene in market in certain situations Market failure
When market fails to produce efficient allocation of resources •Negative externality
oNegative effect of an interaction between 2 parties on a third neutral party •Unbalanced market Power
oEnd result of uncontrolled market economy is a monopoly or an oligopoly where a single person or a small group of people have the ability to set market prices without competition Unequal distribution of wealth

Governments will introduce welfare and taxation programs when too much wealth is controlled by too few individuals oCountry’s standard of living depends on its ability to produce goods and services •Living standards directly proportionate to productivity

Productivity: amount of goods and services produced per hour per worker oPrices rise when governments print too much money
Inflation is the increase in the overall level of prices in the economy Caused by an increase in the amount of money in the economy Since the total value of the economy is independent of the amount of money in the system, each unit of money is worth less Prices therefore increase

oSociety faces a short run tradeoff between inflation and unemployment •Primary effect of increased money in the economy is inflation Short term effect is that an increased amount of money...
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