Chapter 1 Economics

Topics: Economics, Financial services, Finance Pages: 5 (2172 words) Published: October 13, 2014
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Chapter 1
Ten Principles of Economics
One of the most important events in economics in recent times occurred during 2007 – 2009. The financial crisis and the recession which followed have generated problems for almost every country on the planet. The textbook looks in some detail at the events which led to the crisis and some of the questions which have arisen as a result. Such an event highlights the dynamic nature of economics, how the subject is always evolving and how our understanding of the world is shaped by these changes and developments.

The financial crisis and the debate which has followed also highlighted a number of the Ten Principles of Economics covered in the first chapter of the book. The article which follows outlines some of the key issues associated with the financial crisis. We will then look at how these issues relate to some of the Ten Principles of Economics and the pose some questions for you to think about and try to answer to help some initial understanding about these principles.

Here is a reminder of the Ten Principles of Economics:

Principle 1: People Face Trade-Offs
Principle 2: The Cost of Something Is What You Give Up to Get It Principle 3: Rational People Think at the Margin
Principle 4: People Respond to Incentives
Principle 5: Trade Can Make Everyone Better Off
Principle 6: Markets Are Usually a Good Way to Organize Economic Activity Principle 7: Governments Can Sometimes Improve Market Outcomes Principle 8: An Economy’s Standard of Living Depends on Its Ability to Produce Goods and Services

Principle 9: Prices Rise When the Government Prints Too Much Money

Economics, 2nd edition
N. Gregory Mankiw and Mark P. Taylor
ISBN 978-1-84480-870-0 © 2011 Cengage Learning EMEA


Principle 10: Society Faces a Short-Run Trade-Off Between Inflation and Unemployment

In July 2010, Adair Turner, the head of the UK Financial Services Authority (FSA), at the time on of the regulators of the financial services industry, presented a paper at a conference organised by the London School of Economics under the title ‘The Future of Finance’. In his address, Lord Turner highlighted a number of issues that needed to be addressed in any reform of the financial services industry. One of the key messages at this conference was that the problems in the financial markets affected millions of people around the world, many of whom have little understanding (or desire to understand) and that any subsequent reform of the industry would equally affect these same people.

Part of the reason for the financial crisis arising was that the markets took advantage of deregulation both in Europe and in the United States and developed new products and new ways of doing business. The benefits of this were that consumers accessed credit far more easily than had previously been the case and the price that they paid was “too low”. The cost was that financial markets became less stable. To address this problem, regulators are looking to find a balance between creating a financial system that is more stable and the ease with which consumers are able to access credit. In other words there is a trade-off (Principle 1); this trade-off is greater financial stability through higher capital and liquidity requirements at banks and other financial institutions (taking care not to hinder growth too much in the process) but at the expense of easier access to credit by consumers and less choice. Prior to the financial crisis there were a series of trade-offs between consumer choice and consumer protection in addition to consumer and producer responsibility. What this resulted in was a market where consumers had relatively easy access to loans and mortgages with a huge range of such products available to choose from. Markets seemed to be working to the benefit of everyone (Principle 6). But as highlighted in Principle 7, sometimes governments can improve market outcomes. The...
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