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The Basics of Economics (Chapter 1)
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“Billions of people could benefit from better economic policies. Millions are dying because of bad ones. Sometimes the logic of economics is so compelling that it’s impossible for economists not to take a stand.”• Tim Hartford (author of The Undercover
Economist)
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EconomicsThe study of how society
manages its scarce resources by making decisions.
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Are these scarce?
CHAPTER 1 TEN PRINCIPLES OF ECONOMICS
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Yes! All goods and services are scarce!!!
CHAPTER 1 TEN PRINCIPLES OF ECONOMICS
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Good Service
Something that you can use or consume
Something that is done for you
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So back to what economics is…
CHAPTER 1 TEN PRINCIPLES OF ECONOMICS
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Lets pretend you have found a new tropical island that is inhabited by strange individuals...These people need so much
help that they gave you the power to make all of their societal decisions.
Currently, the society relies on themselves and their surroundings.
Based on all of this info, what are your first areas of concern as the leader of this
society?
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MICROECONOMICS is based on the same concept but the
decisions that are made are on a much smaller scale…
CHAPTER 1 TEN PRINCIPLES OF ECONOMICS
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© 2007 Thomson South-Western
1. Key Economic QuestionsSociety faces many decisions:
What goods and services will be produced?
Who will produce the goods and services? Who will consume the goods and
services?
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© 2007 Thomson South-Western
2. The Factors of Production
LAND LABOR CAPITAL
The resources that are used to produce goods and services
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© 2007 Thomson South-Western
3. Physical vs. Human Capital• Physical Capital are the man made assets that
are used in production.• Ex. shovel, nail, plastic, etc.
• Human Capital is the knowledge that is needed in production.• Ex. a doctor administering an X-Ray, Mr. Vesper
teaching the most awe-inspiring lessons in the history of education.
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© 2007 Thomson South-Western
4. Market•A group of buyers (consumers) and sellers (producers) of a particular good or service
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© 2007 Thomson South-Western
5. The People Who Make Up A Market• Households
• Consumer of goods and services.
• They ARE the factors of production.
• Firms• Producers of goods and services.
• They USE the factors of production.
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© 2007 Thomson South-Western
Household or Firm?
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© 2007 Thomson South-Western
Household or Firm?
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© 2007 Thomson South-Western
6. Society and Scarce Resources• The management of society’s resources is
important because resources are scarce.
• Scarcity. . . means that society has limited resources and therefore cannot produce all the goods and services people wish to have.
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© 2007 Thomson South-Western
Basic Principles of Economics
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© 2007 Thomson South-Western
Principle #1: People Face Trade-offs
• What you give up because of a decision
• Efficiency v. Equity• Efficiency means society gets the most that it can
from its scarce resources.• Equity means the benefits of those resources are
distributed fairly among the members of society.
Basket of Knowedge!
If society decides to be more equitable, what will happen to
efficiency?
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© 2007 Thomson South-Western
Result…
Equity Efficiency
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© 2007 Thomson South-Western
Principle #2: The Cost of Something Is What You Give Up to Get It.
• Basketball star LeBron James decided to give up college and play pro basketball. So, what was his cost? Do you think that was the correct decision?
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© 2007 Thomson South-Western
Opportunity Cost
The MOST desirable alternative that is given up because of a decision
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© 2007 Thomson South-Western
Which is the opportunity cost of this decision?
You decide to
buy a $50,000
car.
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© 2007 Thomson South-Western
High Opportunity Cost Low Opportunity Cost
Should I rob a bank?
Should I steal one strawberry from the produce section at
Jewel?
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© 2007 Thomson South-Western
• Marginal changes are small, incremental adjustments to a decision.
People make decisions by comparing costs and benefits at the margin.
Principle #3: Rational People Think at the Margin.
Example: Should I hire one more additional worker?
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© 2007 Thomson South-Western
Principle #4: When making decisions, people use the Cost Benefit Analysis
• When thinking at the margin, you only add one more unit if the benefit is still larger than the cost.
• Benefits can also be called incentives.
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© 2007 Thomson South-Western
What if….
Marginal Cost = $2,000Marginal Benefit = You play the game for a month and quickly lose interest
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© 2007 Thomson South-Western
Principle #5: Trade Can Make Everyone Better Off.
• Trade allows people to specialize in what they do best.
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© 2007 Thomson South-Western
Principle #6: Markets Are Usually a Good Way to Organize Economic Activity.
• A market economy is an economy that allocates resources through the decentralized decisions of many firms and households as they interact in markets for goods and services.
I will let the citizens decide how to answer
the key economic questions
Hey Congress, that’s smart because I am
only going to produce what keeps my business running. So, most of society will get what
they want.
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© 2007 Thomson South-Western
Principle #6: Markets Are Usually a Good Way to Organize Economic Activity.
• Adam Smith made the “invisible hand” theory. • Because households and firms look at prices
when deciding what to buy and sell, they unknowingly regulate the market.
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© 2007 Thomson South-Western
Principle #7: Governments Can Sometimes Improve Market Outcomes.
• Markets work only if property rights are enforced.• Property rights are the ability of an individual to
own and exercise control over a scarce resource
• Market failure occurs when the market fails to allocate resources efficiently.
• When the market fails (breaks down) government can intervene to promote efficiency and equity.
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© 2007 Thomson South-Western
Principle #7: Governments Can Sometimes Improve Market Outcomes.
• Market failure may be caused by:• an externality, which is the impact of one person or
firm’s actions on the well-being others.• market power, which is the ability of a single person
or firm to unduly influence market prices.
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© 2007 Thomson South-Western
Principle #8: A Country’s Standard of Living Depends on Its Ability to Produce Goods and Services.
• Almost all living standards are linked to the countries’ productivity.
• Productivity is the amount of goods and services produced from each hour of a worker’s time.