What is Economics in General?

• Economics is the science of scarcity.

• Scarcity is the condition in which our wants are
greater than our limited resources.
• Since we are unable to have everything we desire, we
must make choices on how we will use our resources.
• In economics we will study the choices
of individuals, firms, and governments.
• Examples:
• You must choosebetween buying jeans
or buying shoes.
• Businesses must choosehow many
people to hire
• Governments must choosehow much
to spend on welfare.
 Micro vs. Macro
MICRO economics-
• Study of small economic units such as
individuals, firms, and industries
(competitive markets, labor markets,
personal decision making, etc.)
MACRO economics-
• Study of the large economy as a whole or in
its basic subdivisions (National Economic
Growth, Government Spending, Inflation,
Unemployment, etc.)
 Economics
Economics is the study of how
society manages its scarce
resources.
or
the study of how society meets its
unlimited wants and needs with
its limited resources.
 Ten Principles of
Economics

Chapter 1
1.How People Make Decisions
2.How People Interact
3.How the Economy as a Whole
Works
How People Make Decisions
1. People face tradeoffs.
“There is no such thing
as a free lunch!”
• Examples include how students spend their time, how a
family decides to spend its income, how the government
spends revenue, and how regulations may protect the
environment at a cost to firm owners.
– Definition of efficiency: the property of society
getting the maximum benefits from its scarce
resources.
– Definition of equity: the property of distributing
economic prosperity fairly among the members of
society.
– For example, tax paid by wealthy people and then
distributed to poor may improve equity but lower the
incentive for hard work and therefore reduce the level
of output produced by our resources.
 This implies that the cost of this increased
equality is a reduction in the efficient use of
our resources.
• Another Example is “guns and butter”: The
more we spend on national defense(guns) to
protect our borders, the less we can spend
on consumer goods (butter) to raise our
standard of living at home.
• Recognizing that trade-offs exist does not
indicate what decisions should or will be
made.
2. The cost of something is what
you give up to get it.

The opportunity cost of an

item is the next best alternative
choice that you give up to
obtain that item.
• Because people face trade-offs, making
decisions requires comparing the costs
and benefits of alternative courses of
action.
• The cost of…
seeing a movie is not just the price of the ticket,
but the value of the time you spend in the
theater
• This is called opportunity cost of resource
• Definition of opportunity cost: whatever
must be given up in order to obtain
some item next best alternative forgone
3. Rational people think at the
margin.

People make decisions by comparing

costs and benefits at the margin.

Marginal changes are small,

incremental adjustments to
an existing plan of action.
• Definition of rational: systematically and
purposefully doing the best you can to
achieve your objectives.
• Consumers want to purchase the bundle
of goods and services that allow them the
greatest level of satisfaction given their
incomes and the prices they face.
• Firms want to produce the level of output
that maximizes the profits.
Example: Suppose that flying a 200-seat
plane across the country costs the airline
$1,000,000, which means that the average
cost of each seat must cost $5000 to
break even. Suppose that the plane is
minutes away from departure and a
passenger is willing to pay $3000 for a
seat. Should the airline sell the seat for
$3000? In this case, the marginal cost of
an additional passenger is very small.
4. People respond to incentives.

LA Laker basketball
star Kobe Bryant
chose to skip college
and go straight to the
NBA from high school
when offered a $10
million contract.
How People Interact
 5. Trade can make everyone
better off.
Trade allows people to specialize in
what they do best.
Trade increases the variety of goods
and services available.
Trade lowers costs for consumers
• Trade is not like a sports competition, where one
side gains and the other side loses.
• Consider trade that takes place inside your
home. Your family is likely to be involved in trade
with other families on a daily basis. Most families
do not build their own homes, make their own
clothes, or grow their own food.
• Countries benefit from trading with one another
as well.
• Trade allows for specialization in products that
benefits countries (or families)
 6. Markets are usually a good way
to organize economic activity.
In a market economy, households freely
decide what to buy and who to work for and
firms freely decide who to hire and what to
produce.

Adam Smith made the observation that households

and firms interacting in markets act as if guided by an
“invisible hand.”
7. Governments can sometimes
improve market outcomes.
When the market fails government
can intervene to promote efficiency
and equity.

Market failure occurs when the market

fails to allocate resources efficiently.
How the Economy as a Whole
Works
 8. A country’s standard of living
depends on its ability to produce
goods & services.
Standard of living may be measured in different
ways:
By comparing personal incomes.
By comparing the total market value of a
nation’s production.
Therefore, how much each
worker can produce per
hour of work determines
overall living standards
within a nation.
 9. Prices rise when the
government prints too much
money.
Inflation is an increase in the overall
level of prices in the
economy.
• The more money there is available
within an economy, the more people
are willing to pay for goods and
services (inflation), therefore each
dollar is buying less and less.
 10. Society faces a short-run
tradeoff between inflation and
unemployment.
The Phillips Curve illustrates the tradeoff
between inflation and unemployment:
Lower prices are the result of high
unemployment and
Higher prices are the result of low
unemployment.