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PowerPoint Slides prepared by:

Andreea CHIRITESCU

Eastern Illinois University

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© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

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Ten Principles of Economics

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© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

PowerPoint Slides prepared by:

Andreea CHIRITESCU

Eastern Illinois University

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Ten Principles of Economics

  • Ten Principles of Economics
    • What drives economic decisions?
    • How do people, markets, and governments interact?

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© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

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Scarcity and Choice

  • Scarcity
    • Resources are limited.
  • Economics
    • Economics studies how we manage those scarce resources.
  • Household - many decisions

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How People Make Decisions

Principle 1: People face trade-offs

    • Choosing one thing means forgoing another.
    • Examples:
      • Students: time studying vs. leisure
      • Societies: defense vs. consumer goods, clean environment vs. higher income

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How People Make Decisions

Principle 2: Opportunity Cost

    • The real cost of something is what you give up to get it.
    • Opportunity cost = the next best alternative.
      • Every choice involves trade-offs, but the opportunity cost is the most important trade-off — the best alternative you didn’t choose.

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How People Make Decisions

Principle 3: Rational people think at the margin

    • Rational people compare extra costs with extra benefits.
    • Take action only if:
      • Marginal benefits > Marginal costs
      • Marginal means additional

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How People Make Decisions

Principle 4: People respond to incentives

    • Incentives: rewards and penalties that shape behavior.
    • Public polices change incentives
      • Change costs or benefits
      • Change people’s behavior

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How People Interact

Principle 5: Gains from Trade

  • Trade
    • Trade allows specialization.
    • People specialize in the activities he or she does best
    • Everyone enjoys a greater variety of goods and services at lower cost.
      • Trade works best when markets allocate resources efficiently.

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How People Interact

Principle 6: Markets are usually a good way to organize economic activity

  • Communist countries – central planning
    • Government officials (central planners)
      • Allocate economy’s scarce resources
        • What goods & services were produced
        • How much was produced
        • Who produced & consumed these goods & services

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How People Interact

  • Market economy - allocates resources
    • Market economy: decisions made by households and firms.
    • Guided by prices and self-interest.
    • Adam Smith’s “invisible hand”: coordination without central planning.

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How People Interact

Principle 7: Role of Government in the Market Economy

    • Enforce rules and maintain institutions
      • Enforce property rights
    • Correct market failures
      • Externalities, Market power
    • Promote efficiency
    • Promote equality

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© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

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How People Interact

  • Property rights
    • Ability of an individual to own and exercise control over scarce resources
  • Market failure
    • Situation in which the market on its own fails to produce an efficient allocation of resources

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How People Interact

  • Externality
    • Impact of one person’s actions on the well-being of a bystander
  • Market power
    • Ability of a single economic actor (or small group of actors) to have a substantial influence on market prices

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How the Economy as a Whole Works

Principle 8: Productivity and Living Standards

  • Productivity
    • Quantity of goods and services produced from each unit of labor input
    • Higher productivity
      • Higher standard of living
      • Higher incomes

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How the Economy as a Whole Works

Principle 8: Productivity and Living Standards

  • Large differences in living standards
    • Among countries
    • Over time
  • Explanation: differences in productivity

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How the Economy as a Whole Works

Principle 9: Prices rise when the government prints too much money

  • Inflation
    • An increase in the overall level of prices in the economy
  • Causes for large / persistent inflation
    • Growth in quantity of money
    • Significant decrease in the FED’s rate
      • Value of money falls

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How the Economy as a Whole Works

Principle 10: Inflation vs. Unemployment

    • In the short run, there’s a trade-off.
    • More money → higher spending → lower unemployment but higher inflation.
  • Business cycle
    • Fluctuations in economic activity
      • Employment
      • Production

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Table 1

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Ten Principles of Economics

© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.