Topic 1

Ten Principles of Economics

 Overview
 Scarcity and Economics
 How People Make Decisions
(Principle 1 to 4)

 How People Interact

(Principle 5 to 7)
 How the Economy as a Whole Works
(Principle 8 to 10 are related to macroeconomics)
The word Economy . . .
comes from
ancient Greek
word oikos
nomos --
“One who
manages a
household.”
 Resources
 Also known as factors of production
 There are 4 FoPs
 Land / Natural resources
 Labour
 Capital
 Entreprenuer
 ALL are limited
 Wants and needs

 Three types of needs

 Bare necessities (limited)
 Clothing, house, food
 Needs (limited)
 Anything else other than the 3 above (?)
 Wants (unlimited)
 Anything that adds to comfort or status (?)
Scarcity and Economics
Economics is the study
of how society
manages its scarce
resources
Scarcity arises
because wants are
unlimited and
resources are limited.
 Scarcity and Economics
Scarcity is not the same as poverty.

Society can
eradicate
poverty but not
scarcity.
Microeconomics and Macroeconomics
Microeconomics focuses on “the individual
parts of the economy.”
● How households and firms make decisions
and how they interact in specific markets.
Macroeconomics looks at the “economy as a
whole.”
● Economy-wide phenomena like inflation,
unemployment, economic growth.
 Ten Principles of Economics
How People Make Decisions
1) People face tradeoffs.
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.
How People Interact
5) Trade can make everyone better off.
6) Markets are usually a good way to organize economic activity.
7) Government can sometimes improve market outcomes.
How the Economy Works as A Whole
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.
 Principle 1: People face tradeoffs

Every choice has a trade-off — giving

up one thing to get something else.
Guns vs. Butter
Food vs. Clothing
Leisure Time vs. Work
Efficiency vs. Equity
Principle 1: People face tradeoffs

Efficiency means getting the

most you can from scarce
resources.
Equity means benefits of
resources are distributed fairly
among society.
Principle 1: People face tradeoffs

Efficiency refers
to the size of the
economic pie.
Equity refers to
how the pie is
divided.
Principle 1: People face tradeoffs

Efficiency and equity often conflict.

 Age pension or unemployment benefits
help to achieve a more equitable
distribution of wealth.
 But, it reduces efficiency because
higher taxes cause people to work less.
Principle 2: The Cost of Something Is
What You Give Up to Get It

Decisions require comparing costs and

benefits of alternatives.
Example: Going to university vs. going to work

Opportunity cost is what you give up to

get what you want.
Principle 3: Rational People Think at
the Margin
Best decisions are made by thinking at
the margin.
People compare extra benefits (MB)
and extra costs (MC) before making
decision.
 Airlines can raise profits by thinking at the
margin. How?
 Principle 4: People Respond to
Incentives
People change their behavior when the costs
or benefits change.
If marginal benefit exceeds marginal cost,
people have an incentive to do more of that
activity.
If marginal cost exceeds marginal benefit,
people have an incentive to do less of that
activity.
Principle 5: Trade Can Make Everyone
Better Off
Individuals gain from
their ability to trade
with others.
Competition results in
gains from trading.
Trade allows one to
specialize in what they
do best.
Principle 6: Markets Are Usually a Good
Way to Organize Economic Activity
In a market economy,
households and firms
determine what to buy,
who to work for, who to
hire and what to
produce.
Interaction between
household and business
is as if by an “invisible
hand.”
Principle 7: Governments Can
Sometimes Improve Market Outcomes

Invisible hand does not always work well and

may cause market failure.
Market failure is a situation in which market
on its own fails to allocate resources
efficiently.
Market failure may be the result of an
externality or market power.
Principle 7: Governments Can
Sometimes Improve Market Outcomes

Externality is caused by an impact of

one person’s actions on the well-being
of a bystander (pollution).
Market power is the ability of a single
person or small group to have a strong
influence on market prices.
Principle 7: Governments Can
Sometimes Improve Market Outcomes

When the market fails, the

government intervenes to
a) promote efficiency
b) promote equity