SocSci1b

The word economy comes from the Greek word for “one who manages a household.”

Scarcity means that society has limited resources and therefore cannot produce all the goods and
services people wish to have.

Economics is the study of how society manages its scarce resources.

Economists therefore study how people make decisions: how much they work, what they buy, how
much they save, and how they invest their savings. Economists also study how people interact with one
another.

Efficiency means that society is getting the most it can from its scarce resources.

An incentive is something that induces a person to act, such as the prospect of a punishment or a
reward.

Trade allows each person to specialize in the activities he or she does best, whether it is farming, sewing,
or home building. By trading with others, people can buy a greater variety of goods and services at lower
cost.

Equity means that the benefits of those resources are distributed fairly among society’s members.

The opportunity cost of an item is what you give up to get that item.

Economists use the term marginal changes to describe small incremental adjustments to an existing plan
of action.

“Margin” means “edge,” so marginal changes are adjustments around the edges of what you are doing.

A country's standard of living depends on its ability to produce goods & services.

The most important determinant of living standards: productivity, the amount of goods and services
produced per unit of labor. Productivity depends on the equipment, skills, and technology available to
workers.

The relationship between productivity and living standards also has profound implications for public
policy.

If policymakers expand aggregate demand, they can lower unemployment, but only at the cost of higher
inflation.

If they contract aggregate demand, they can lower inflation, but at the cost of temporarily higher
unemployment.

There are two broad reasons for a government to intervene in the economy: to promote efficiency and
to promote equity.

In a market economy, the decisions of a central planner are replaced by the decisions of millions of firms
and households.
Today, most countries that once had centrally planned economies have abandoned this system and are
trying to develop market economies.

Economists use the term market failure to refer to a situation in which the market on its own fails to
allocate resources efficiently.

One possible cause of market failure is an externality. An externality is the impact of one person’s
actions on the well-being of a bystander.

Another possible cause of market failure is market power. Market power refers to the ability of a single
person (or small group of people) to unduly influence market prices.

Inflation, an increase in the overall level of prices in the economy.

PRINCIPLE #1: PEOPLE FACE TRADEOFFS - Under this principle, the first lesson to decision making is:
“There is no such thing as a free lunch.” To get one thing that we like, we usually have to give up
another thing that we like. Making decisions requires trading off one goal against another.

PRINCIPLE #5: TRADE CAN MAKE EVERYONE BETTER OFF - Trade allows each person to specialize in the
activities he or she does best, whether it is farming, sewing, or home building. By trading with others,
people can buy a greater variety of goods and services at lower cost. Countries as well as families benefit
from the ability to trade with one another.

PRINCIPLE #2: THE COST OF SOMETHING IS WHAT YOU GIVE UP TO GET IT

Because people face tradeoffs, making decisions requires comparing the costs and benefits of
alternative courses of action. The opportunity cost of an item is what you give up to get that item. When
making any decision, such as whether to attend college, decisionmakers should be aware of the
opportunity costs that accompany each possible action.

PRINCIPLE #3: RATIONAL PEOPLE THINK AT THE MARGIN - Economists use the term marginal changes to
describe small incremental adjustments to an existing plan of action. Keep in mind that “margin” means
“edge,” so marginal changes are adjustments around the edges of what you are doing.

PRINCIPLE #4: PEOPLE RESPOND TO INCENTIVES -An incentive is something that induces a person to act,
such as the prospect of a punishment or a reward. Because rational people make decisions by
comparing costs and benefits, they respond to incentives. People make decisions by comparing costs
and benefits, their behavior may change when the costs or benefits change. That is, people respond to
incentives.

PRINCIPLE #8: A COUNTRY’S STANDARD OF LIVING DEPENDS ON ITS ABILITY TO PRODUCE GOODS AND
SERVICES - A country's standard of living depends on its ability to produce goods & services. The most
important determinant of living standards: productivity, the amount of goods and services produced per
unit of labor. Productivity depends on the equipment, skills, and technology available to workers. The
relationship between productivity and living standards also has profound implications for public policy.
PRINCIPLE #10: SOCIETY FACES A SHORT-RUN TRADEOFF BETWEEN INFLATION AND UNEMPLOYMENT-
Society faces a short-run tradeoff between unemployment and inflation. If policymakers expand
aggregate demand, they can lower unemployment, but only at the cost of higher inflation. If they
contract aggregate demand, they can lower inflation, but at the cost of temporarily higher
unemployment.

PRINCIPLE #6: MARKETS ARE USUALLY A GOOD WAY TO ORGANIZE ECONOMIC ACTIVITY - Today, most
countries that once had centrally planned economies have abandoned this system and are trying to
develop market economies. In a market economy, the decisions of a central planner are replaced by the
decisions of millions of firms and households. Firms decide whom to hire and what to make. Households
decide which firms to work for and what to buy with their incomes. These firms and households interact
in the marketplace, where prices and self-interest guide their decisions

PRINCIPLE #7: GOVERNMENTS CAN SOMETIMES IMPROVE MARKET OUTCOMES - Although markets are
usually a good way to organize economic activity, this rule has some important exceptions. There are
two broad reasons for a government to intervene in the economy: to promote efficiency and to promote
equity.

PRINCIPLE #9: PRICES RISE WHEN THE GOVERNMENT PRINTS TOO MUCH MONEY - When too much
money is floating in the economy, there will be higher demand for goods and services. This will cause
firms to increase their price in the long run causing inflation. Disadvantages: *If governments print
money to pay off national debt, inflation would rise.

Economists use models as the primary tool for explaining or making predictions about economic issues
and problems.

OUR FIRST MODEL: THE CIRCULAR-FLOW DIAGRAM - This diagram is a schematic representation of the
organization of the economy. Decisions are made by households and firms. Households and firms
interact in the markets for goods and services (where households are buyers and firms are sellers) and in
the markets for the factors of production (where firms are buyers and households are sellers). The outer
set of arrows shows the flow of dollars, and the inner set of arrows shows the corresponding flow of
goods and services.

The production possibility frontier (PPF) is a curve on a graph that illustrates the possible quantities that
can be produced of two products if both depend upon the same finite resource for their manufacture. it
can demonstrate that a nation's economy has reached the highest level of efficiency possible.

The PPF is also referred to as the production possibility curve.

The PPF is a decision-making tool for managers deciding on the optimum product mix for the company.

The PPF demonstrates that the production of one commodity may increase only if the production of the
other commodity decreases.

The PPF is the area on a graph representing production levels that cannot be obtained given the
available resources; the curve represents optimal levels.
OUR SECOND MODEL: THE PRODUCTION POSSIBILITIES FRONTIER - The production possibility frontier
(PPF) is a curve on a graph that illustrates the possible quantities that can be produced of two products
if both depend upon the same finite resource for their manufacture. The PPF is also referred to as the
production possibility curve. PPF also plays a crucial role in economics. For example, it can demonstrate
that a nation's economy has reached the highest level of efficiency possible.

Microeconomics – is the study of how households and firms make decisions and how they interact in
specific markets.

Microeconomics – shows how and why different goods have different values, how individuals and
businesses conduct and benefit from efficient production and exchange, and how individuals best
coordinate and cooperate with one another.

Microeconomics – provides a more complete and detailed understanding than macroeconomics.

Microeconomics – can be applied in a positive or normative sense.

Mikros – means small, the term micro was originated from Greek word.

Main Objective of Micro-economics – is to explain the principles, problems and policies related to the
optimum allocation of resources.

Scope of Microeconomics:

1. Theory of Product Pricing.

2. Theory of Factor Pricing.
3. Theory of Economic Welfare.

Theory of Economic Welfare – the study of how the allocation of resources and goods affects social
welfare.

Theory of Factor Pricing – also called theory of distribution. It deals with prices paid for factor services
(land, labor, capital and entrepreneur).

Theory of Product Pricing – is an economic theory that states that the price for a specific good or service
is determined by the relationship between its supply and demand at any given point.

Market conditions and forces – determine the optimal price of goods and services, this means pricing
reacts to the market.

Welfare Economics – seeks the economic state that will create the highest overall level of social
satisfaction.

Positive economics – describes and explains various economic phenomena. Based on facts and cannot
be approved or disapproved. Focuses on the description, quantification and explanation of economic
developments, expectations, and associated phenomena. Relies on objective data analysis, relevant
facts, and associated figures.

1. Connects cause and effects.

2. Based on tested facts.
 3. Tells you what is/ what was.
4. Descriptive.
5. Objective.
Normative economics – focuses on the value of economic fairness or what the economy should be.
Based on value judgements. Focuses on value-based judgements aimed at improving economic
development, investment projects, and the distribution of wealth.

1. Makes Recommendations.
2. Not based on tested facts.
3. Tells you what/should be/have been.
4. Prescriptive.
5. Subjective.

Two Standard branches of modern economics:

1. Positive economics.
2. Normative economics.

Microeconomics – consider taxes, regulations, and government legislation. It does not try to explain
which actions should take place in a market but rather the effects of changes in certain conditions.

Key terms to know:

1. Trade
2. Labor Economics
3. Public Finance
4. Welfare Economics
5. Market Economics

Macroeconomics – analyze entire industries and economies rather than individuals or specific
companies. Determine the optimal rate of inflation and factors that may stimulate economic growth.

Key terms to know:

1. National Income
2. Savings
3. Overall Price Level
Demand – buyer

Supply -supplier

Demand curve

Law of Demand and Supply

The higher the price, the lower the quantity demanded.

5 Demand shifters (factors)

1. The price of goods and services.

2. The income of buyer.
3. The price of related goods and services.
4. Consumer preferences.
5. Consumer expectation.

Economics’ Marginal Utility = Satisfaction

Law of Demand:

1. Elastic – increase and decrease is significant.

2. Inelastic.

Income of Buyer

1. Normal Goods- income increases, quantity demanded increases. Directly.

2. Inferior Goods – income increases, quantity demanded decreased.

Law of Supply – willingness of quantities to be sold.

The higher the price to be sold, the higher the quantity to be produced.

S(sub1) – upward sloping.

Supply Shifters (factors):

1. Price of inputs – labor, capital, etc.

2. Number of firms in the market.
3. Taxes.
4. Level of Technology.
5. Producer expectation.

Consumer Surplus – price that the consumer pays vs. the price that they are willing to pay.

Elasticity – sensitivity of one variable due to a change in other variables.

Elastic if its more than 1.

Inelastic if its less than 1.

Unitary if its equal to 1.

4 types of Elasticity:

1. Price Elasticity of Demand (PED).

2. Cross Elasticity of Demand (XED).
3. Income Elasticity of Demand (YED).
4. Price Elasticity of Supply (PES).

Price Elasticity of Demand (PED) – responsiveness of quantity demanded to a change in price.

Arc Computation of PED Arc of PED PED point formula

Cross Elasticity (XED)

Income Elasticity of Demand (YED) – responsiveness of quantity demand based on the change of real
income of the consumer.

Price Elasticity of Supply (PES) – responsiveness to the supply of a good or service after a change in its
market price.

“High prices, more supplies”.