Ten Principles of Economics

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Ten Principles of Economics

WHAT’S NEW IN THE FOURTH EDITION:

The discussion of Principle #3, “Rational people think at the margin,” is more thorough and has a new example. The discussions of Principle #4, “People respond to incentives,” Principle #7, “Governments can sometimes improve market outcomes,” and Principle #10, “Society faces a short-run trade-off between inflation and unemployment” have been clarified. Definitions for the terms “rational,” “incentives,” and “property rights” have been added.

LEARNING OBJECTIVES:

By the end of this chapter, students should understand:

➢ that economics is about the allocation of scarce resources.

➢ that individuals face trade-offs.

➢ the meaning of opportunity cost.

➢ how to use marginal reasoning when making decisions.

➢ how incentives affect people’s behavior.

➢ why trade among people or nations can be good for everyone.

➢ why markets are a good, but not perfect, way to allocate resources.

➢ what determines some trends in the overall economy.

CONTEXT AND PURPOSE:

Chapter 1 is the first chapter in a three-chapter section that serves as the introduction to the text. Chapter 1 introduces ten fundamental principles on which the study of economics is based. In a broad sense, the rest of the text is an elaboration on these ten principles. Chapter 2 will develop how economists approach problems while Chapter 3 will explain how individuals and countries gain from trade.

The purpose of Chapter 1 is to lay out ten economic principles that will serve as building blocks for the rest of the text. The ten principles can be grouped into three categories: how people make decisions, how people interact, and how the economy works as a whole. Throughout the text, references will be made repeatedly to these ten principles.

KEY POINTS:

1. The fundamental lessons about individual decisionmaking are that people face trade-offs among alternative goals, that the cost of any action is measured in terms of forgone opportunities, that rational people make decisions by comparing marginal costs and marginal benefits, and that people change their behavior in response to the incentives they face.

2. The fundamental lessons about interactions among people are that trade can be mutually beneficial, that markets are usually a good way of coordinating trades among people, and that the government can potentially improve market outcomes if there is some sort of market failure or if the market outcome is inequitable.

3. The fundamental lessons about the economy as a whole are that productivity is the ultimate source of living standards, that money growth is the ultimate source of inflation, and that society faces a short-run trade-off between inflation and unemployment.

CHAPTER OUTLINE:

I.Introduction

A.The word “economy” comes from the Greek word oikonomos meaning “one who manages a household.”

B.This makes some sense because in the economy we are faced with many decisions (just as a household is).

C.Fundamental economic problem: resources are scarce.

D.Definition of scarcity: the limited nature of society’s resources.

E.Definition of economics: the study of how society manages its scarce resources.

II.How People Make Decisions

A.Principle #1: People Face Trade-offs

1.“There is no such thing as a free lunch.” Making decisions requires trading one goal for another.

2.Examples include how students spend their time, how a family decides to spend its income, how the U.S. government spends tax dollars, and how regulations may protect the environment at a cost to firm owners.

3.A special example of a trade-off is the trade-off between efficiency and equity.

a.Definition of efficiency: the property of society getting the maximum...
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