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Chapter 1 Notes - Summary Principles of Economics
Principles of Economics (ECON 2)
University of California Los Angeles
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Chapter 1 Notes—Ten Principles of Economics
Intro
Economies allocate scarce resources among the members, taking into account each member’s abilities, efforts, and desires o Societies allocate people (as well as land, buildings, and machines) to various jobs in addition to allocating the goods and services they produce Scarcity—the limited nature of society’s resources (and therefore cannot produce all the goods and services people wish to have) Economics—the study of how society manages its scarce resources o Resources are allocated through combined choices of millions of firms and houses o Economists study How people make decisions: how much to work, what they buy, how much to save, and how to invest their savings How people interact with each other (ex. how many buyers and sellers of a good together determine the price and quantity of the good sold Analyze forces and trends that affect the economy as a whole (ex. growth in average income, fraction of the population who cannot find work, the rate prices are rising)
How People Make Decisions
Principle 1 —People Face Trade-offs o Making decisions require trading off one goal against another Ex. how a college student allocate her time. She can either spend all time studying for econ, all time studying for psych, some time on both. Or all time on studying and none going out, napping, watching tv, etc. Ex. how parents spend their income. They can buy food, clothing, or a family vacation. Or they can save for retirement or for children’s college education o Societies face different trade-offs Guns and butter—the more society pays on national defense to protect, the less it spends on consumer goods to raise the stand of living at home Clean environment and a higher income—laws that require firms to reduce pollution raise cost of producing goods. To combat these costs, firms earn smaller profits, pay lower wages, and/or charge higher prices Efficiency and Equality Efficiency—the property of society getting the most it can from its scarce resources (the size of the pie) Equality—the property of distributing economic prosperity uniformly among the members of society (now many slices in the pie) Governments try to equalize the distribution of economic well-being o Welfare and unemployment help members most in need
o Individual income tax make those financially successful to give more to the government Governments try for equality reduces efficiency o Redistribution of income from the rich reduces the reward for working hard o people work less and produce fewer goods and services Principle 2 —The Cost of Something is What you Give Up to get It o Making decisions requires comparing costs and benefits of alternative courses of action Ex. going to college—Benefits are intellectual enrichment and better job opportunities. Costs are tuition, books, room and board (which is required even without college), and your time. The students give up years of potential earnings o Opportunity cost—whatever must be given up to obtain some items Ex. college athletes who drop out to play professionally for millions are aware that the opportunity cost of staying in college is high Principle 3 —Rational People Think at the Margin o Rational people—people who systematically and purposefully do the best they can to achieve their objectives, given available opportunities Ex. firms that decide how many people to hire and how much product to manufacture and sell to maximize profits Individuals who decide how much time to spend working and what foods and services to buy with income to achieve highest level of satisfaction o These questions are usually grey, not black and white Ex. Question isn’t starve or stuff you face, but rather to eat an extra spoonful o Marginal change—a small incremental adjustment to a plan of action Marginal (edge) changes are adjustments around the edges of what you are doing This consist of marginal benefits and costs Ex. airplane adding a standby passenger for less than the price costs Ex. people pay more for a diamond (unnecessary) that water (necessary). The reason is since water is plentiful, the marginal benefit is small. Since diamonds are rare, the marginal benefit is large o A rational person needs the marginal benefit to be greater than the marginal cost Principle 4 —People Respond to Incentives o Incentive—something that induces a person to act (such as punishment or reward) Ex. As apple prices rise, people have incentive to buy less and consumers have incentive to hire more workers and produce more o Changes to costs or benefits alters the behavior of the people Ex. As gas prices rise, people buy more hybrids, carpool, take public transportation, move closer to school/work Ex. The requirement for seatbelts made it safer for drivers, but they increased their speed which made it more dangerous for the pedestrians
Equality—a market economy rewards people according to their ability to produce things that other people are willing to pay for Ex. Basketball players get paid more than chess players because people are willing to pay more to watch basketball
How the Economy as a Whole Works
Principle 8 —A Country’s Standard of Living Depends on its Ability to Produce Goods and Services o There are differences in the living standards of different countries Citizens of high-income countries have more tv’s and car, better nutrition and healthcare, and longer life expectancy that lost of low-income countries o Changes also happen over time In the US, incomes grow about 2% per year o What explains these differences among countries and over time Productivity—the quantity of goods and services produced from each unit of labor input The more productive the worker, the higher the standard of living The question is how will productivity affect our ability to produce goods and services Possible ways to raise productivity—workers are well educated, have tools to produce goods and services, and access to the best technology available Principle 9 —Prices Rise When the Government Prints Too Much Money o Inflation—an increase in the overall level of prices in the economy Ex. Germany. Cheaper to burn money than buy logs o Causes of inflation—growth in the quantity of money Printing more money causes the value of money to fall Principle 10 —Society Faces a Short-Run Trade-off between inflation and Unemployment o Short-run effects of printing more money Level of spending increases, so demand for goods and services increases Higher demand causes firms to raise prices, but encourages them to hire more workers and produce a greater quantity of goods and services More hiring means lower unemployment o Business cycle—the irregular and largely unpredictable fluctuations in economic activity, such as employment and production (measured by production of goods and services or number of people employed) o Policymakers can exploit the short-run trade-offs between inflation and unemployment By changing the amount government spends, amount it taxes, amount it prints o Ex. At the 2008 crash, Obama’s first initiative was a stimulus package that reduced taxes and increased government spending. The Federal Reserve also printed more money People feared that these policies might over time lead to a rising inflation
Chapter 1 Notes - Summary Principles of Economics
Course: Principles of Economics (ECON 2)
University: University of California Los Angeles
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