Principles of Economics

1. Principles of Economics Lecturer: Jack Wu Economics 101

2. WHAT IS ECONOMY? • The word economy originally comes from a Greek word for “one who manages a household.” • Broader definition: household, society, and country. • Taiwan was called Newly Industrialized Economy (NIE) or Country (NIC).

3. FUNDAMENTAL PROBLEM FACED BY ECONOMY • Fundamental economic problem: scarce resources. -- Scarcity. . . means that society has limited resources and therefore cannot produce all the goods and services people wish to have.

4. WHAT IS ECONOMICS? • Economics is the study of how society manages its scarce resources. • It comprises of Microeconomics and Macroeconomics.

5. MICROECONOMICS • Microeconomics: the study of how households and firms make decisions and how they interact in markets (Econ 101: introductory Microeconomics, Econ 201: intermediate Microeconomics)

6. MACROECONOMICS • Macroeconomics: the study of economy-wide phenomena including inflation, unemployment, and economic growth (Econ 102: Introductory Macroeconomics, Econ 202: Intermediate Macroeconomics)

7. Everybody Should Learn Economics • <Reason>. Economics is a subject that we must confront in our everyday lives. As a matter of fact, we already spend a great deal of our time thinking about economic issues: prices(inflation), incomes (economic growth), consumption decisions, use of our time, job opportunity (unemployment), and so on.

8. MICRO AND MACRO EFFECTS • Event: An increase in gasoline price • _ Micro effect: vehicle driver, bicycle market, electricity • _Macro effect: inflation, unemployment

9. Ten Principles of Economics • How people make decisions. (4 principles) • How people interact with each other. (3 principles) • The forces and trends that affect how the economy as a whole works. (3 principles)

10. How People Make Decisions

11. Principle #1: People Face Tradeoffs. • There is no such thing as a free lunch. • To get one thing, we usually have to give up another thing. • Making decisions requires trading off one goal against another.

12. Examples of Trade Off • How a student spends her time • How a family decides to spend its income • How the Taiwanese government spends tax dollars • How regulations may protect the environment at a cost to firm owners

13. Special Example of Tradeoff • Efficiency v. Equity • Efficiencymeans society gets the most that it can from its scarce resources. • Equitymeans the benefits of those resources are distributed fairly among the members of society. Example: Tax paid by wealthy Taiwanese and then distributed to those less fortunate. Outcome: Increased equity and reduced efficiency

14. Principle #2: The Cost of Something is What You Give Up to Get It. • Decisions require comparing costs and benefits of alternatives. • Whether to go to college or to work? • The opportunity costof an item is what you give up to obtain that item.

15. Quick Quiz • What are the costs of going to college? _ Tuition costs? _ Room and board? _ Forgone pay?

16. Quick Quiz • What is the opportunity cost of seeing a movie? _ cost of admission? _ time cost of going to the theater? _ time cost of attending the show? Note: Time cost depends on what else you might do with that time. Examples: staying at home and watch TV, working an extra three hours at paid job.

17. Principle #3: Rational People Think at the Margin • Many decisions in life involve incremental decisions: should I take another course this semester? • Marginal changesare small, incremental adjustments to an existing plan of action. • People make decisions by comparing costs and benefits at the margin.

18. Principle #4: People Responds to Incentives • Because people make decisions by weighing costs and benefits, their decisions may change in response to changes in costs and benefits. • Example: Seat Belt Laws increase use of seat belts and lower the incentives of individuals to drive safely.

19. How People Interact

20. Principle #5: Trade can Make Everyone Better Off • People gain from their ability to trade with one another. • Competition results in gains from trading. • Trade allows people to specialize in what they do best. • Examples: Most families do not build their own homes, make their own clothes, or grow their own food.

21. 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. • Adam Smith made the observation that households and firms interacting in markets act as if guided by an “invisible hand”—Market Prices.

22. Principle #7: Government Can Sometimes Improve Market Outcomes • Market failure occurs when the market fails to allocate resources efficiently. • Market failure may be caused by • an externality, which is the impact of one person or firm’s actions on the well-being of a bystander. • market power, which is the ability of a single person or firm to unduly influence market prices. • When the market fails (breaks down) government can intervene to promote efficiency and equity.

23. How the Economy as a Whole Works

24. Principle #8: The Standard of Living Depends on a Country’s Production • Standard of living may be measured in different ways: • By comparing personal incomes. • By comparing the total market value of a nation’s production (GDP, Gross Domestic Product). • Almost all variations in living standards are explained by differences in countries’ productivities. • Productivity is the amount of goods and services produced from each hour of a worker’s time.

25. Principle #9:Prices Rise When the Government Prints Too Much Money • Inflation is an increase in the overall level of prices in the economy. • One cause of inflation is the growth in the quantity of money. • When the government creates large quantities of money, the value of the money falls.

26. Principle #10: Society Faces a Short-Run Tradeoff Between Inflation and Unemployment • The Phillips Curve illustrates the tradeoff between inflation and unemployment: Inflation is lowerð Unemployment is higher It’s a short-run tradeoff!