10 PRINCIPLES OF ECONOMICS

Principle #1: People Face Tradeoffs

 no such thing as a free lunch

 classic trade-off is between “guns and butter”

 trade-off between a clean environment and a high level of income

 reduce pollution raise the cost of producing goods and services

 higher costs, end up earning smaller profits, paying lower wages, charging higher prices, or some
combination of these three.

Principle #2: The Cost of Something Is What You Give Up to Get It

 be aware of the opportunity costs that accompany each possible action. (Opportunity cost of an
item is what you give up to get that item)

o Example: College-age athletes who can earn millions if they drop out of school and play
professional sports.

Principle #3: Rational People Think at the Margin

 rational decision-maker takes an action if and only if the marginal benefit of the action exceeds
the marginal costs.

Principle #4: People Respond to Incentives

 in analyzing any policy, one must consider not only the direct effects but also the indirect effect
that work through the incentives. If the policy changes objectives, it will cause people to alter
their behavior. Example: seat belts law: Change in the number of driver deaths and an increase
in the number of pedestrian deaths.

Principle #5: Trade Can Make Everyone Better Off

 trade allows countries to specialize in what they do best and to enjoy a greater variety of goods
and services.

Principle #6: Markets Are Usually a Good Way to Organize Economic Activity

 markets act as if guided by “invisible hand” that leads them to desirable market outcomes.

 prices as the instrument with which the invisible hand directs economic activity.
  Sz67market economy, an economy that allocates resources through the decentralized decisions
of many firms and households.

 taxes adversely affect the allocation of resources by distorting prices and thus decisions
of households and firms.

Principle #7: Governments Can Sometimes Improve Market Outcomes

 Two(2) broad reasons for government to intervene in the economy:

 Promote efficiency (enlarge the pie)

 Promote equity (change how the pie is divided)

 Exceptions on why “invisible hands” sometimes does not work:

o Market failure

o possible cause is externality (impact of one person’s actions on the well-being of a

bystander.)

o market Power (ability of a single person (or a small group of people) to unduly influence
market prices).

o monopoly over the activity

o no rigorous competition

o Less able to ensure that economic prosperity is distributed fairly.

o Does not ensure that everyone has sufficient food, decent clothing, and adequate health
care.

Principle #8: A Country’s Standard of Living Depends on Its Ability to Produce Goods and Services

 large differences in living standards among countries attributed to differences in countries’

productivity (the quantity of goods and services produced from each hour of a worker’s time),
i.e., growth rate of a nation’s productivity determines the growth rate of its average income.

Principle #9: Prices Rise When the Government Print Too Much Money

 inflation vs. growth of money

Principle #10: Society Faces a Short-Run Tradeoff between Inflation and Unemployment
 Phillips curve (a short-run tradeoff between inflation and unemployment)