Date: 30/11/2020

PRINCIPLE OF MICROECONOMICS REPORT

TOPIC: Ten Principle Of economics

Table of contents:

1. People face trade-offs

2. The cost of something is what you give up to get it
3. Rational people think at the margin
4. People respond to incentives
5. Trade can make everyone better off
6. Markets are usually a good way to organize economic activity
7. Governments can sometimes improve market outcomes
8. A country's standard of living depends on its ability to produce goods and services
9. Prices rise when the government prints too much money
10. Society faces a short-run tradeoff between Inflation and unemployment.

1-People face trade-offs

Human life is all about making choices and decisions. Whenever individual makes a decision, he
is deciding between alternative courses of action, individual has to decide how much to work so
he can tradeoff between work and leisure, has to decide what to eat so he can tradeoff between
food he like and his health, and has to decide how to drive so he can tradeoff between driving
fast and saving himself to get into car crash.
In simple words, the definition of trade of is:

“To get one thing that we like, we usually

have to give up another thing that we like.
Making decisions requires trading one
goal for another.”
Important tradeoff that society faces:
The important trade-off that society faces is between efficiency and equality. For example, tax
paid by wealthy people and
Equality:
The
then distributed to poor may property of
distributing
improve equality but lower the
economic
prosperity
uniformly
incentive for hard work; and among the
therefore, reduce the level our members
of society

resources.

Adopting equality approach not only discourages

Efficiency
:
The
those who risk the most capital, but also property of
society
getting the
discourages the groups who tends to increase their most it can
from scare
resources.
incomes in inequitable way

Society faces trade-off:

Society as whole also faces tradeoffs, consider the

congressmen deciding how much to allocate a defense budget and how much to allocate for
producing consumer goods.

Some examples of trade-off are:

  there are three ways to do things i.e., quick, good, and cheap. but you can do things only
with the combination of two for example if it is quick and good, it is not cheap; if it is
cheap and quick, it is not good; if it is good and cheap, it is not quick.

 person goes to store he faces a tradeoff between buying one good and buying another. All
of our decisions at our heart involve a trade-off.

 Steps taken by industries to keep environment increases the cost of their production
which results in the form of less income or loss of jobs

2- The cost of something is what you give up to get it

Because people face tradeoffs in alternative courses of action, making decision requires
comparing the cost and benefits of alternative choices. On comparing the cost and benefits of the
action one is doing or would do; individual has to decide the real cost of that action, because
sometimes the cost of an action is not as obvious as it might first appear. Usually, “Time” is the
cost that individuals neglect while comparing cost and benefits of an action. In general speaking,
there is always some opportunity cost of an action/choice that one would make.

The opportunity cost of getting

free lunch for fish is getting
caught by the fisherman.

Opportunity cost:
The opportunity cost of an item is whatever must be given up to
obtain it.
As there are some sort of cost which are not as obvious as it might first appear, there are also
factors which seems as cost but actually they don’t.

For better understanding of opportunity cost, consider the Carmen who can either built 8 tables
or 32 bookshelves by working one week.
 Carmen work strength for one week
Maximum number of tables made in one week

9
8
7
6
5
4
3
2
1
0
0 2 4
Maximum number of bookshelves made in one week

So, for Carmen, the opportunity cost is:

Opportunity cost
For one table For one bookshelf
4 bookshelves ¼ table

means, the opportunity cost of one table for Carmen is 4 bookshelves.

3: RATIONAL PEOPLE THINK AT THE MARGIN

Mostly economist assume that people think rationally and are rational. Rational People are those
who can do their job systematically and purposefully to achieve their objectives in a best way to
grape the available opportunities. When we study economics, we can recognize that how many
employees will hire to achieve the highest level of satisfaction i.e. to earn maximum profit.
Rational people took decision in white and black but usually involve gray. At lunchtime, the
question you face “should I eat like beef steak or not”. When the exam are nearby around 10 or
15 days before, you should not think I would do twenty-four doing studies or watching tv, but
you can think that I will spend extra hour on studies or watching tv.
Economist mostly use the term:

Marginal Change:
it means that small incremental adjustment in your plan or action. Margin signifies "edge" so
margin changes are the adjustment around the edges of what individuals are doing. Rational
people usually took decision by comparing marginal cost and marginal benefits.

Example: assume you are thinking about calling a companion on your wireless. You conclude
that conversing with her for 10 minutes would give you an advantage that you esteem at about
$7. Your mobile phone administration costs you $40 every month in addition to $0.50 per minute
for whatever calls you make. You as a rule talk for 100 minutes per month, so your all out month
to month bill is $90 ($0.50 every moment times 100 minutes, in addition to the $40 fixed
expense). Under these conditions, would it be a good idea for you to settle on the decision? You
may be enticed to reason as follows: "In light of the fact that I pay $90 for 100 minutes of calling
every month, the normal moment on the telephone costs me $0.90. So a 10-minute call costs $9.
Since that $9 cost is more prominent than the $7 advantage, I am going to skirt the call." That
end isn't right, in any case.

In spite of the fact that the average expense of a 10-minute call is $9, the marginal cost—the
sum your bill increments on the off chance that you settle on the additional decision—is just $5.
You will settle on the correct choice simply by looking at the minimal advantage and the minor
expense. Since the minor advantage of $7 is more noteworthy than the minimal expense of $5,
you should settle on the decision. This is a rule that individuals inherently comprehend: Cell
telephone clients with limitless minutes (that is, minutes that are free at the edge) are frequently
inclined to make long and silly calls.

Marginal Decision: making can help clarify some generally bewildering monetary marvels.
Here is an exemplary inquiry: Why is water so modest, while diamonds are so costly? People
need water to endure, while diamonds are superfluous; yet for reasons unknown, individuals are
happy to pay significantly more for a diamond than for cup of water. The explanation is that an
individual's eagerness to pay for a great depends on the marginal benefit that an additional unit of
the great would yield.

The marginal benefit, thusly, relies upon the number of units an individual as of now has.
Water is fundamental; however, the marginal advantage of an additional cup is little since water
is ample. Paradoxically, nobody needs diamond to endure, but since diamonds are so uncommon,
individuals think about the marginal advantage of an additional diamond to be huge. A sane
choice takes an action if and just if the minimal bit of leeway of the movement outperforms the
peripheral cost. This principle clarifies why individuals utilize their mobile phones as much as
they do and why individuals are happy to pay more for diamonds than for water. It can set aside
some effort to become acclimated to the rationale of marginal reasoning, however the
investigation of economics will give you adequate occasion to rehearse.
 4: PEOPLE RESPOND TO INCENTIVES

An Incentive is something (such as reward or prospect of a punishment) which induces people to

act. Because Rational People settle on choices by contrasting costs what's more, benefits, they
react to incentives. You will see that incentives play a focal function in the investigation of
economics. One economic analyst ventured to such an extreme as to recommend that the whole
field could be summed up as essentially "people react to incentives. The rest is commentary."

EXAMPLE: At the point when the cost of a carrots rises, individuals choose to eat less carrots.
Simultaneously, carrot plantations choose to enlist more laborers and gather more carrots. All in
all, a more exorbitant cost in a market gives incentives to purchasers to burn-through less and an
incentive for merchants to deliver more. As we will see, the impact of costs on the conduct of
purchasers and makers is essential for how a market economy dispenses scant assets.
CASE STUDY 1: THE EFFECT OF INCENTIVE DUE TO GASOLINE PRICES
From 2005 to 2008 the cost of oil in world markets soar, the consequence of restricted supplies
along with flooding interest from strong world development, particularly in China. The cost of
fuel in the United States rose from about $2 to about $4 a gallon. At that point, the news was
loaded up with tales about how individuals reacted to the expanded impetus to moderate here and
there in evident manners, at times in more subtle ways. Here is a sampling of different stories:

• “As Gasoline Prices raises, Buyers Are preferring to hybrid Cars”

• “As oil Prices soared, Motorcycles Sales are increase too”
• “when the gasoline price increase student will go for online classes”: For Michael Jordan, a
senior student at Lawrence College, the 50-minute drive from city park to his home, college has
become a financial issue now that oil prices have raised to more than $9 a gallon. It means that
this semester he decided to take an online semester to save himself the money and the trip.

5-TRADE CAN MAKE EVERYONE BETTER OFF:

Trade allows each person to specialize at what he or she does best, whether it's farming, sewing,
or home building.
Trade involves the exchange of goods and services for commercial purposes. Individuals,
companies, and nations that engage in trade become better off because they meet each other's
needs.
BALANCE OF TRADE:
The difference between the value of goods and services exported out of a country and the value
of goods and services imported into the country. The balance of trade is the official term for net
exports that makes up the balance of payments. The balance of trade can be a “favorable” surplus
(exports exceed imports) or an “unfavorable” deficit (imports exceed exports). The official
balance of trade is separated into the balance of merchandise trade for tangible goods and the
balance of service.

TYPES OF TRADE:
There are two types of trade.
1-International trade
2-National trade

1-INTERNATIONAL TRADE:
International trade is the exchange of capital, goods, and services across international borders or
territories.
e.g. The Americans and the Japanese are often mentioned in the news as being competitors to
Europeans in the world economy. In some ways this is true, because American and Japanese
firms do produce many of the same goods as European firms. Trade between Europe and the
United States or Japan is not like a sports contest, where one side wins and the other side loses.
In fact, the opposite is true: trade between two economies can make each economy better off.

Trade allows each person to specialize in the activities he or she does best. By trading with
others, people can buy a greater variety of goods and services at lower cost. So Japanese and
Americans are as much our partners in the world economy as they are our competitors.

2-NATIONAL TRADE:
Trade among parties in the same country but residing in different parts or states is referred as
regional or national trade.
ADVANTAGES OF TRADE:

COUNTER-BALANCE MONOPSONY:
unions can bargain for higher wages – overcoming unfair wages in monopsony.

REPRESENT WORKERS:
unions can represent workers at employment tribunals.

PRODUCTIVITY DEALS:
a trade union can help a firm to bring in new working practices which increase labor
productivity.

CO-OPERATION:
unions in theory, can help bring workers closer to management and represent interests.

EFFICIENCY WAGE THEORY:

the states higher wages increase motivation and productivity of workers.

DISADVANTAGES OF TRADE:

UNEMPLOYMENT:
in competitive labor market, unions pushing wages above equilibrium cause unemployment.

COST-PUSH INFLATION:
powerful unions can push up wages causing inflation.

TIME LOST TO STRIKE:

unions can lead to lost productivity by strikes.

CONFRONTATION:
unions can also create a confrontation attitude- leading to disputes and poor morale
.
LESS RELEVANT:
in economy, it is harder for unions to organize and have impact.

6: Markets are usually a good way to organize economic activities

A market economy allocates resources through the decentralized decisions of many household
and firms as they interact in market.

MARKET:
A market is the set of social arrangements under which people buy and sell specific goods and
services at a specific point in time.
ECONOMY:
An economy is how money and goods circulate.

MARKET ECONOMY:
The decisions of a central planner are replaced by decisions of millions of market participants.
Firm decide what and how much to make and household decide where to work and what to buy.

ECONOMIC ACTIVITY:
Activity of providing, making, buying or selling products to people.

TYPES OF ECONOMIC ACTIVITIES:

There are four types of economic activities.
1-Primary Economic Activity
2-Secondary Economic Activity
3-Tertiary Economic Activity
4-Quaternary Economic Activity

1-PRIMARY ECONOMIC ACTIVITY:

Economic activities that come by using and extracting earth’s natural resources.
Example; farming, fishing, mining, extracting of raw materials etc.

2-SECONDARY ECONOMIC ACTIVITY:

Economic activities that includes making usable products by using primary materials.
Example; make paper or pencil from wood etc.
3-TERTIARY ECONOMIC ACTIVITY:
Tertiary level economic activities provides services to distribute and sell the products in the
industries or communities or individual consumers.
Example; communication, real estate, information technology etc.

4-QUATERNARY ECONOMIC ACTIVITY:

An activity includes searching for new ways to make a product and searching of how to make a
product better.
Example; teaching, education, journalism etc.
*Countries can have up to four levels of economic activity, but not every country has all four.
GRAPH OF ECONOMIC SECTORS:

7: Governments Can Sometimes Improve Market Outcomes

According to the principles of economics, the government of a country has several important
roles. There are many ways the market can fail, it breaks down, and the Government is then
required to intervene. Market failure can be due to inefficient allocation of resources, or due to
externality, or because of market power. Therefore it is the government that enforces rules and
maintains institutions that are crucial for the market economy. 

Firstly, it plays an important role in enforcing property rights; it is extremely crucial that the
insufficient resources are owned by both individuals and firms. The government therefore
enforces these rules and also provides protection to such institutions. This is essential, because if
the people and their rights are not protected, and are at the risk of getting stolen then people will
be less inclined to work and will refuse to produce their products in the future then. Markets are
only able to work if the property rights are being enforced.

For example, a farmer will only grow his crop as long as he knows that it will not get stolen, or
a restaurant will only operate as long as it knows that the customers will pay for their food before
they leave, etc. Therefore the market relies on the government to provide police and courts to
help ensure that these property rights are being implemented.

Secondly, government intervention also leads to greater efficiency and equality.   

While markets usually tend to be a good way to organize economic activities however sometimes
government intervention in the economy is really important. The government is able to allocate
resources accordingly to promote efficiency and equity. Market failure refers to when the market
fails to efficiently allocate resources on its own. There are many reasons for market failure, one
of the causes of market failure is the market power, and this refers to an individual’s or a group
of people’s ability to influence the market prices.

Moreover the impact of one’s actions on the well-being of a bystander can also cause the market
to fail. In the presence of market power and externalities it is important to have a well-designed
public policy that can enhance the economy's efficiency. Moreover it is important to ensure that
the economic prosperity is equitably distributed. The government can improve the market
outcomes; the government designs policies to help promote efficiency or equity in the market.

There are many public policies that have been introduced including the income tax and the
welfare system policies, to help achieve an equitable distribution of the economic well-being in a
country. These policies are extremely important especially if the market’s distribution of the
economic well being is not beneficial. In such cases such tax and welfare policies help ensure
how the wealth of a country is distributed. 

8: A COUNTRY’S STANDARD OF LIVING DEPENDS ON ITS ABILITY TO PRODUCE GOODS AND SERVICES

The standard of living is used to measure the material aspects of any country and its economy. It
is measured by counting the amount of goods and services a country is producing, and are
available for an individual, household, group, or nation to purchase.
The living standards of countries worldwide are faltering. As expected the huge difference in the
average income of different countries reflects the quality of life there. The higher the income the
more you are likely to see citizens of that country enjoy all the basic necessities and luxuries of
life, including better healthcare, better nutrition, these citizen also tend to have a longer life
expectancy compared to citizens of developing, low income countries.
Changes in the income are expected to bring about a change in the living standards, over the
years many developed countries including America has seen an increase in the average income.
So what is the main reason behind these large differences in the living standards of different
countries over the time? Well these differences in the living standards are primarily due to the
differences in the country’s productivity levels. This means how much the amount of goods and
services are being produced in an hour of a worker’s time. Countries where the labor force is
skilled and is capable of producing large quantities of goods and services per unit of time,
majority of the people living there are able to experience a high standard of living. Meanwhile,
countries where productivity levels aren’t high and the labor force isn’t that skilled, then the
people living there have endure a more meager life. Moreover, the growth rate of a country also
helps determines the growth rate of the average income.
The standard of living focuses on the value of the goods and services that are being produced and
consumed. In order to measure the living standards of a country you need to find out the GDP
per capita. The Gross Domestic Product is the measure of the total goods and services that are
being produced in a year's time, within the country. Therefore you take the GDP of a country and
divide it by the total population. And so the country with a higher level of productivity, offers
higher wages allowing the people there to have better living standards. 

There are some other factors as well that can be used to determine the living standards of a
country. These factors include ones that affect the GDP; consumer spending, business
investments, the government spending and net exports. 

The first factor is consumer spending, when consumers spend, this economic activity helps
businesses, who in return are able to provide employment to more people. Business investments
include firms introducing new plants and equipment and products. When companies invest the
economy of the country improves. The same goes for government spending, when the
government spends on the infrastructure and on municipal services, the citizens of the country
are able to experience higher standards of living. Moreover, the net exports of a country helps
improve the living standards, as when the country’s exports are more than its imports it leads to
an increase in employment. 

9: PRICES RISE WHEN THE GOVERNMENT PRINTS TOO MUCH MONEY

Inflation: an increase in the general price level of an economy. The faster the government make
money the greater the Inflation. For example, Jane drinks coffee every morning it is part of her
routine. In 2000, the purchasing cost for 1 cup of coffee was $1.00, but in 2010 the price for the
same cup of coffee increases to $1.75. Why? Because government was creating too much money
and the demand for coffee increased, and in contrast the suppliers also increased their prices.
This is an example of how and why prices rise. Coffee. The overall price for the same goods and
services increases which were purchased before for a relatively low price refers to inflation.
Inflation can be in opposition with deflation, which happens when the buying influence of cash
increments and costs decrease.

Figure 1.1

In figure 1.1, inflation rate of four countries are given, United States, Japan, Germany and United
kingdom. U.S faced an hyperinflation from 1978 to 1980. Secondly Japan faced the highest level
of inflation in 1974, but inflation rate was increasing from 1972 to 1976 but the peak of inflation
was in 1974. Thirdly as it can be seen in the graph above, Germany’s inflation rate was highest
from 1973-2975 and it remained constant for two years with a 7% inflation rate. As compare to
other countries Germany’s inflation rate was relatively low. Lastly. As shown in the graph, UK
faced the highest inflation rate among other countries with a inflation rate of 25%.

Below are two types of inflation:

Demand-Pull inflation: Demand-pull inflation is the upward tension on costs that follows a
deficiency in supply. Business analysts depict it as "such a large number of dollars pursuing on
too few goods." When the total interest in an economy unequivocally exceeds the total flexibly,
costs go up

Cost-Push inflation:
Cost-push inflation happens when in general costs increment (inflation) because of increase in
the expense of wages and crude materials. Greater expenses of creation can diminish the total
gracefully (the measure of all out creation) in the economy. Since the demand for merchandise
hasn't changed, the cost increments from creation are gone to purchasers making cost-push
inflation.
What causes inflation?
There are many causes of inflation, but in most cases, economies faces inflation because of the
growth in the quantity of money. When government starts printing too much money the value of
money falls automatically and in contrast prices of goods and services rise. When consumers
have too much money in their pockets they can buy goods and services more easily as compared
to the past, and prices rise. Suppliers produce more goods and charge a higher price, as the law
of supply claims that, other things being equal (ceteris paribus), the quantity supplied of a good
rises when the price of that good rises.

Figure 1.2

In the above diagram, number of goods are 1 million, money of supply is $10 million and
average price of goods is 10. Similarly when government prints too much money, the money
supply doubles, from $10 million now it is $20 million, and average price of goods also doubles
from 10 to 20. It can be concluded that when money supply increases, suppliers also increase the
prices of their goods.

For example:
In Germany, when price were rising, they were tripling every month in 1920s, similarly the
quantity of money was also increasing in the same pace. The economic history of United State
was similar as Germany’s economic history and their conclusions were same. In 1970s the
reason for high inflation was the rapid growth in the quantity of money, the US government was
printing too much money.

HOW CAN GOVERNMENT CONTROL/REDUCE INFLATION?

One effective way to control inflation is by applying monetary policy. The objective of this
policy is to control the excessive money supply by increasing the interest rates. This will result in
people spending less and saving more, because when there is less money in economy which
means there is less credit so people will spend less and prices will decrease for the goods and
services.
Figure 1.3

10: SOCIETY FACES A SHORT-RUN TRADEOFF BETWEEN INFLATION AND

UNEMPLOYEMNT.

Inflation in long run can be caused because of an increase in the quantity of money and when
governments print too much money as explained in the 9th principle. But what about in short run?
The situation of inflation is much more complex in short run than in long run, because inflation
is also directly related to unemployment.

If the lawmakers expand the aggregate demand, there are high chances that they can lower the
unemployment rate but it will cost them something, because there is no such thing as free lunch
in economics. This means in order to lower the unemployment rate, the cost will be high
inflation.
Similarly, if the lawmakers contract aggregate demand, there are chances of low inflation but
again they have to have to give up something, in this case the cost will be high unemployment.

Opportunity cost:
The concept of opportunity cost has been used in this principle. Opportunity cost is the best next
alternative foregone. In order to get something, we have to make a choice and give up something
else. When this concept is used in context with inflation and unemployment, it refers that, in
order to increase or decrease inflation and unemployment, policymakers have to give up on one
thing.
If inflation increases than unemployment will decrease, and when inflation decreases the
unemployment will increase.
Figure 1.0

The Phillips Curve:

The Phillips curve was named after William Phillips. It is an economic model which tells about
the relation between inflation and unemployment. It describes that there is an inverse relation
between rates of unemployment and in increasing prices of goods and services (inflation).
Phillips curve only talks about short run tradeoff between unemployment and inflation, it is not
applicable in the long run. As seen in figure 1.0, when inflation was 2%, the unemployment rate
was 8%, but when inflation increased from 2% to 6%, the unemployment decreased and was
relatively low as it decreased from 8% to 3%. The inverse relation can be clearly seen in the
graph above. The green line in Phillips curve is the long run effect. Phillips curve is not effective
in long run because as it can be seen in figure 1.0, the inflation rate is increasing but the
unemployment remains same, this means in the long- run inflation have no effect on
unemployment.

For example: the law of supply claims that the quantity supplied increases when the prices of
good increases. On a broader side, this claim can be used in a example for firms, when inflation
rises the company increases the prices of goods and services and they will want to produce more
goods, and in order to do so they need to hire more workers and unemployment will be lower
and similarly, when inflation decreases, prices of goods and services also decrease, so the
company would produce less good, and it will hire less workers, automatically this will result in
high unemployment.

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Book: Principle of microeconomics by N. Gregory Mankiw, 7th edition