Part I: Introduction Chapter 1: Ten Principles of Economics Chapter 1: Ten Principles of Economics.

Part I: IntroductionPart I: IntroductionPart I: IntroductionPart I: Introduction

Chapter 1:Chapter 1:

Ten Principles of Ten Principles of EconomicsEconomics

Chapter 1:Chapter 1:

Ten Principles of Ten Principles of EconomicsEconomics

ObjectivesObjectivesObjectivesObjectives1. Understand the concept of 1. Understand the concept of scarcityscarcity and how it necessitates and how it necessitates allocative allocative

decisionsdecisions

2. Recognize that 2. Recognize that tradeoffstradeoffs are a part of every decision are a part of every decision

3. Learn the meaning of 3. Learn the meaning of opportunityopportunity cost cost

4. Understand what decision making at the 4. Understand what decision making at the marginmargin means means

5. Recognize that 5. Recognize that incentivesincentives are an important part of the decision are an important part of the decision making processmaking process

1. Understand the concept of 1. Understand the concept of scarcityscarcity and how it necessitates and how it necessitates allocative allocative decisionsdecisions

2. Recognize that 2. Recognize that tradeoffstradeoffs are a part of every decision are a part of every decision

3. Learn the meaning of 3. Learn the meaning of opportunityopportunity cost cost

4. Understand what decision making at the 4. Understand what decision making at the marginmargin means means

5. Recognize that 5. Recognize that incentivesincentives are an important part of the decision are an important part of the decision making processmaking process

ObjectivesObjectivesObjectivesObjectives

6. Understand that specialization and exchange usually 6. Understand that specialization and exchange usually benefit all market participantsbenefit all market participants

7. Begin to see how markets are an efficient way to 7. Begin to see how markets are an efficient way to organizeorganize productionproduction and and allocate resourcesallocate resources

8. Learn about the relationship among8. Learn about the relationship amonginflationinflation, , outputoutput and and employmentemployment for forthe economy as a wholethe economy as a whole

6. Understand that specialization and exchange usually 6. Understand that specialization and exchange usually benefit all market participantsbenefit all market participants

7. Begin to see how markets are an efficient way to 7. Begin to see how markets are an efficient way to organizeorganize productionproduction and and allocate resourcesallocate resources

8. Learn about the relationship among8. Learn about the relationship amonginflationinflation, , outputoutput and and employmentemployment for forthe economy as a wholethe economy as a whole

What is Economics?What is Economics?What is Economics?What is Economics?

Economics is the science that studies Economics is the science that studies the administration of scarce resources the administration of scarce resources and the determinants of employmentand the determinants of employmentand income.and income.

Economics is the science that studies Economics is the science that studies the administration of scarce resources the administration of scarce resources and the determinants of employmentand the determinants of employmentand income.and income.

ScarcityScarcityScarcityScarcity

HumanHumanWantsWants

HumanHumanWantsWants

ScarceScarceResourcesResources

ScarceScarceResourcesResources

EconomicEconomicSystemSystem

EconomicEconomicSystemSystem

Allocation Allocation ofof

WHAT?WHAT?HOW?HOW?

Allocation Allocation ofof

WHAT?WHAT?HOW?HOW?

DistributionDistributionFOR FOR

WHOM?WHOM?

DistributionDistributionFOR FOR

WHOM?WHOM?

ScarcityScarcityScarcityScarcity

When wants exceed the resources available When wants exceed the resources available to satisfy them, there is scarcity.to satisfy them, there is scarcity.

People have unlimited wants.People have unlimited wants.

Resources to satisfy those wants are limited.Resources to satisfy those wants are limited.

When wants exceed the resources available When wants exceed the resources available to satisfy them, there is scarcity.to satisfy them, there is scarcity.

People have unlimited wants.People have unlimited wants.

Resources to satisfy those wants are limited.Resources to satisfy those wants are limited.

Scarcity & PovertyScarcity & PovertyScarcity & PovertyScarcity & Poverty Scarcity is not poverty.Scarcity is not poverty.

The poor and the rich alike face scarcity.The poor and the rich alike face scarcity.

Faced with scarcity, people must make choices.Faced with scarcity, people must make choices.

““I cried because I had no premium channels until I cried because I had no premium channels until I met a man who had no cable.”I met a man who had no cable.”

Scarcity is not poverty.Scarcity is not poverty.

The poor and the rich alike face scarcity.The poor and the rich alike face scarcity.

Faced with scarcity, people must make choices.Faced with scarcity, people must make choices.

““I cried because I had no premium channels until I cried because I had no premium channels until I met a man who had no cable.”I met a man who had no cable.”

The Central Economic ProblemThe Central Economic ProblemThe Central Economic ProblemThe Central Economic Problem

• Scarcity and how to overcome itScarcity and how to overcome it

• Scarcity refers to economic resources Scarcity refers to economic resources (factors of production)(factors of production)

• any economic system must solve this any economic system must solve this central problem of economicscentral problem of economics

• Scarcity and how to overcome itScarcity and how to overcome it

• Scarcity refers to economic resources Scarcity refers to economic resources (factors of production)(factors of production)

• any economic system must solve this any economic system must solve this central problem of economicscentral problem of economics

Central Economic Problem Central Economic Problem Imposes certain basic questionsImposes certain basic questions

Central Economic Problem Central Economic Problem Imposes certain basic questionsImposes certain basic questions

• With the resources available what should be With the resources available what should be produced?produced?

• Given a certain socially acceptable output Given a certain socially acceptable output objective, how should the society’s output objective, how should the society’s output be produced?be produced?

• After producing its output, who should After producing its output, who should receive what shares of the goods?receive what shares of the goods?

• With the resources available what should be With the resources available what should be produced?produced?

• Given a certain socially acceptable output Given a certain socially acceptable output objective, how should the society’s output objective, how should the society’s output be produced?be produced?

• After producing its output, who should After producing its output, who should receive what shares of the goods?receive what shares of the goods?

Answers to the 3 basic Answers to the 3 basic questions by a Market Economyquestions by a Market Economy


• What?What?

• In the In the long runlong run only profitable goods and only profitable goods and services should be produced.services should be produced.

• How?How?

• Goods and services must be produced at the Goods and services must be produced at the lowest production cost.lowest production cost.

• What?What?

• In the In the long runlong run only profitable goods and only profitable goods and services should be produced.services should be produced.

• How?How?

• Goods and services must be produced at the Goods and services must be produced at the lowest production cost.lowest production cost.

• How?How?

• To reduce the cost of production of a good To reduce the cost of production of a good or service requires or service requires – a. the specialization and division of labor to a. the specialization and division of labor to

increase efficiency increase efficiency – b. the introduction of capital goods to reduce b. the introduction of capital goods to reduce

labor costs and raise outputlabor costs and raise output

• How?How?

• To reduce the cost of production of a good To reduce the cost of production of a good or service requires or service requires – a. the specialization and division of labor to a. the specialization and division of labor to

increase efficiency increase efficiency – b. the introduction of capital goods to reduce b. the introduction of capital goods to reduce

labor costs and raise outputlabor costs and raise output



• For whom?For whom?

• The factors of production will divide the The factors of production will divide the share of goods or services depending on share of goods or services depending on their contributions to the producing of these their contributions to the producing of these goods.goods.

• The value of each factors contribution will The value of each factors contribution will be found in the factor markets.be found in the factor markets.

• For whom?For whom?

• The factors of production will divide the The factors of production will divide the share of goods or services depending on share of goods or services depending on their contributions to the producing of these their contributions to the producing of these goods.goods.

• The value of each factors contribution will The value of each factors contribution will be found in the factor markets.be found in the factor markets.



Factors of ProductionFactors of ProductionFactors of ProductionFactors of Production

LandLand is not just physical ground space, but is not just physical ground space, but the totality of the raw materials of the earth.the totality of the raw materials of the earth.

2 LaborLabor is the human physical exertion is the human physical exertion performed in the production of a good or performed in the production of a good or service.service.

3 Capital Capital (physical) the tools, buildings, and (physical) the tools, buildings, and machines used by labor to fashion goods machines used by labor to fashion goods and services from raw materials. and services from raw materials.

LandLand is not just physical ground space, but is not just physical ground space, but the totality of the raw materials of the earth.the totality of the raw materials of the earth.

2 LaborLabor is the human physical exertion is the human physical exertion performed in the production of a good or performed in the production of a good or service.service.

3 Capital Capital (physical) the tools, buildings, and (physical) the tools, buildings, and machines used by labor to fashion goods machines used by labor to fashion goods and services from raw materials. and services from raw materials.

4 EntrepreneurEntrepreneur is the human resource which is the human resource which has the following attributes:has the following attributes:- organizes and directs the other factors of organizes and directs the other factors of

production.production.- Accepts the responsibility for all final decisions Accepts the responsibility for all final decisions

in the production process.in the production process.- Accepts the risks for the firm in the dynamic Accepts the risks for the firm in the dynamic

and changing market situations.and changing market situations.

4 EntrepreneurEntrepreneur is the human resource which is the human resource which has the following attributes:has the following attributes:- organizes and directs the other factors of organizes and directs the other factors of

production.production.- Accepts the responsibility for all final decisions Accepts the responsibility for all final decisions

in the production process.in the production process.- Accepts the risks for the firm in the dynamic Accepts the risks for the firm in the dynamic

and changing market situations.and changing market situations.

Factors of ProductionFactors of ProductionFactors of ProductionFactors of Production

Returns to the factors of Returns to the factors of productionproduction

Returns to the factors of Returns to the factors of productionproduction

• LandLand --rent --rent

• LaborLabor -- wages -- wages

• CapitalCapital -- interest -- interest

• EntrepreneurEntrepreneur --profits --profits

• LandLand --rent --rent

• LaborLabor -- wages -- wages

• CapitalCapital -- interest -- interest

• EntrepreneurEntrepreneur --profits --profits

ChoiceChoiceChoiceChoice

Economics is the study of the Economics is the study of the choices choices people people make to cope with make to cope with scarcityscarcity..

Economics is sometimes called the science of Economics is sometimes called the science of choice - the science that explains the choices choice - the science that explains the choices that people make and predicts how choices that people make and predicts how choices change as circumstances change.change as circumstances change.

Economics is the study of the Economics is the study of the choices choices people people make to cope with make to cope with scarcityscarcity..

Economics is sometimes called the science of Economics is sometimes called the science of choice - the science that explains the choices choice - the science that explains the choices that people make and predicts how choices that people make and predicts how choices change as circumstances change.change as circumstances change.

1. People face tradeoffs.1. People face tradeoffs.1. People face tradeoffs.1. People face tradeoffs.

““There is no such thing as a There is no such thing as a free lunch!”free lunch!”

““There is no such thing as a There is no such thing as a free lunch!”free lunch!”

1. People face tradeoffs.1. People face tradeoffs.1. People face tradeoffs.1. People face tradeoffs.To get one thing, we usually have To get one thing, we usually have to give up another thing.to give up another thing. Guns v. butterGuns v. butter Food v. clothingFood v. clothing Leisure time v. workLeisure time v. work Efficiency v. equityEfficiency v. equity

To get one thing, we usually have To get one thing, we usually have to give up another thing.to give up another thing. Guns v. butterGuns v. butter Food v. clothingFood v. clothing Leisure time v. workLeisure time v. work Efficiency v. equityEfficiency v. equity

Making decisions requires trading off one goal against another.

TradeoffTradeoffTradeoffTradeoff

1.) Efficiency is the property of society getting 1.) Efficiency is the property of society getting the most it can from its scarce resources.the most it can from its scarce resources.

2.) Equity is the property of distributing 2.) Equity is the property of distributing economic prosperity fairly among all economic prosperity fairly among all members of society.members of society.



Rational BehaviorRational BehaviorRational BehaviorRational Behavior

Economics is based on the assumption of Economics is based on the assumption of rational self-interest.rational self-interest.

Individuals make rational decisions to achieve Individuals make rational decisions to achieve maximum fulfillment of their goals.maximum fulfillment of their goals.

Adam Smith and the “Invisible Hand”.Adam Smith and the “Invisible Hand”.




Choice and Opportunity Choice and Opportunity CostCost


Choosing more of one thing means Choosing more of one thing means having less of something else.having less of something else.

There is no such thing as a free lunch. There is no such thing as a free lunch. Every choice involves an opportunity Every choice involves an opportunity cost.cost.



Opportunity CostOpportunity CostOpportunity CostOpportunity Cost

Opportunity Cost of some decision is the Opportunity Cost of some decision is the valuevalue of the of the nextnext best best alternativealternative which which you have to give up because of the you have to give up because of the decision.decision.


Marginal AnalysisMarginal AnalysisMarginal AnalysisMarginal Analysis

Economic analysis uses marginal Economic analysis uses marginal analysis to study choices made by analysis to study choices made by people, businesses and governments.people, businesses and governments.

Choices are made in small steps -Choices are made in small steps -at the margin.at the margin.



3. Rational people think at 3. Rational people think at the margin.the margin.

Marginal changesMarginal changes areare small, incremental small, incremental adjustments to an existing plan of adjustments to an existing plan of action.action.

People make decisions by comparing costs and benefits at the

margin.

Marginal Cost and Marginal Cost and Marginal BenefitMarginal Benefit


The cost of a small increase in an The cost of a small increase in an activity is called marginal cost.activity is called marginal cost.

The benefit that arises from a small The benefit that arises from a small increase in an activity is called marginal increase in an activity is called marginal benefit.benefit.



Substitution and Substitution and IncentivesIncentives


A central principle of economics - the principle A central principle of economics - the principle of substitution - is that when the opportunity of substitution - is that when the opportunity cost of an activity increases, people substitute cost of an activity increases, people substitute other activities which have lower opportunity other activities which have lower opportunity costs.costs.

Every activity has a substitute.Every activity has a substitute.



IncentivesIncentivesIncentivesIncentives

An incentive is an inducement toAn incentive is an inducement totake a particular action.take a particular action.

Substituting away from more costly Substituting away from more costly activities toward less costly ones is activities toward less costly ones is responding to incentives.responding to incentives.


Substituting away from more costly Substituting away from more costly activities toward less costly ones is activities toward less costly ones is responding to incentives.responding to incentives.

Incentives and Incentives and Economic AnalysisEconomic Analysis


Whenever some event disrupts the Whenever some event disrupts the normal state of affairs, the economist normal state of affairs, the economist always asks: How will opportunity always asks: How will opportunity costs change and what substitutions costs change and what substitutions will arise from the changed incentives?will arise from the changed incentives?


Ten Principles of EconomicsTen Principles of EconomicsTen Principles of EconomicsTen Principles of Economics

1.) People face tradeoffs1.) People face tradeoffs

2.) The cost of something is what you give up to get it2.) The cost of something is what you give up to get it

3.) Rational people think at the margin3.) Rational people think at the margin

4.) People respond to incentives4.) People respond to incentives





How People Make DecisionsHow People Make DecisionsHow People Make DecisionsHow People Make Decisions











TradeoffTradeoffTradeoffTradeoff





Rational BehaviorRational BehaviorRational BehaviorRational Behavior























Opportunity CostOpportunity CostOpportunity CostOpportunity Cost



Kerry KittlesKerry KittlesVillanova UniversityVillanova University

Class of 1996Class of 1996

Kerry KittlesKerry KittlesVillanova UniversityVillanova University

Class of 1996Class of 1996

Tim ThomasTim ThomasVU Freshman,VU Freshman,

entered Fall, 1996entered Fall, 1996

Tim ThomasTim ThomasVU Freshman,VU Freshman,

entered Fall, 1996entered Fall, 1996

Alvin WilliamsVillanova University

Class of 1997

Entered Villanova University 1999

Left V.U. June of 2001











Marginal AnalysisMarginal AnalysisMarginal AnalysisMarginal Analysis



























IncentivesIncentivesIncentivesIncentives


Substituting away for more costly Substituting away for more costly activities toward less costly ones is activities toward less costly ones is responding to incentives.responding to incentives.


Substituting away for more costly Substituting away for more costly activities toward less costly ones is activities toward less costly ones is responding to incentives.responding to incentives.






5.) Trade can make everyone better off5.) Trade can make everyone better off

6.) Markets are usually a good way to organize 6.) Markets are usually a good way to organize economic activityeconomic activity

7.) Governments can sometimes improve market 7.) Governments can sometimes improve market outcomesoutcomes




How People InteractHow People InteractHow People InteractHow People Interact









5. 5. Trade can make everyone Trade can make everyone better off.better off.

People gain from their ability to trade People gain from their ability to trade with one another.with one another.

Competition results in gains from Competition results in gains from trading.trading.

Trade allows people to specialize in Trade allows people to specialize in what they do best.what they do best.









Market Economy Market Economy “Invisible Hand” / Prices“Invisible Hand” / Prices

Market Economy Market Economy “Invisible Hand” / Prices“Invisible Hand” / Prices

Market economy - an economy that Market economy - an economy that allocates resources through the allocates resources through the decentralized decisions of many firms decentralized decisions of many firms and households as they interact in and households as they interact in markets for goods and services.markets for goods and services.

Market economy - an economy that Market economy - an economy that allocates resources through the allocates resources through the decentralized decisions of many firms decentralized decisions of many firms and households as they interact in and households as they interact in markets for goods and services.markets for goods and services.

6. Markets are usually a 6. Markets are usually a good way to organize good way to organize

economic activity.economic activity.Adam Smith made the Adam Smith made the

observation that households and observation that households and firms interacting in markets act as firms interacting in markets act as if guided by an “if guided by an “invisible handinvisible hand.”.”

6. Markets are usually a 6. Markets are usually a good way to organize good way to organize

economic activity.economic activity. Because households and firms look at Because households and firms look at

prices when deciding what to buy and sell, prices when deciding what to buy and sell, they unknowingly take into account the they unknowingly take into account the social costs of their actions.social costs of their actions.

As a result, prices guide decision makers As a result, prices guide decision makers to reach outcomes that tend to maximize to reach outcomes that tend to maximize the welfare of society as a whole.the welfare of society as a whole.









Government Intervention - Government Intervention - Why?Why?

Government Intervention - Government Intervention - Why?Why?

2.) 2.) Externality - Externality - the impact of one person’s action on the well being the impact of one person’s action on the well being of a bystander.of a bystander.

3.)3.) Market Power - Market Power - the ability of a single economic ( or a small group the ability of a single economic ( or a small group of factors) to have a substantial influence on market prices.of factors) to have a substantial influence on market prices.

2.) 2.) Externality - Externality - the impact of one person’s action on the well being the impact of one person’s action on the well being of a bystander.of a bystander.

3.)3.) Market Power - Market Power - the ability of a single economic ( or a small group the ability of a single economic ( or a small group of factors) to have a substantial influence on market prices.of factors) to have a substantial influence on market prices.

1.) 1.) Market Failure - Market Failure - a situation in which a a situation in which a market left on its own fails to allocate market left on its own fails to allocate resources efficiently.resources efficiently.

1.) 1.) Market Failure - Market Failure - a situation in which a a situation in which a market left on its own fails to allocate market left on its own fails to allocate resources efficiently.resources efficiently.


8.) A country’s standard of living depends on 8.) A country’s standard of living depends on its ability to produce goods and servicesits ability to produce goods and services

9.) Prices rise when the government prints 9.) Prices rise when the government prints too much moneytoo much money

10.) Society faces a short-run tradeoff 10.) Society faces a short-run tradeoff between Inflation and between Inflation and

UnemploymentUnemployment

8.) A country’s standard of living depends on 8.) A country’s standard of living depends on its ability to produce goods and servicesits ability to produce goods and services

9.) Prices rise when the government prints 9.) Prices rise when the government prints too much moneytoo much money

10.) Society faces a short-run tradeoff 10.) Society faces a short-run tradeoff between Inflation and between Inflation and

UnemploymentUnemployment

How the Economy as a Whole WorksHow the Economy as a Whole WorksHow the Economy as a Whole WorksHow the Economy as a Whole Works


8.) A country’s standard of living depends on its ability 8.) A country’s standard of living depends on its ability to produce goods and servicesto produce goods and services

9.) Prices rise when the government prints too much 9.) Prices rise when the government prints too much moneymoney

10.) Society faces a short-run tradeoff between 10.) Society faces a short-run tradeoff between Inflation and unemploymentInflation and unemployment





8. The standard of living 8. The standard of living depends on a country’s depends on a country’s

production.production.Standard of livingStandard of living may be measured in may be measured in

different ways:different ways: By comparing personal incomes.By comparing personal incomes. By comparing the total market value of a By comparing the total market value of a

nation’s production.nation’s production.


production.production.Almost all variations in living standards Almost all variations in living standards

are explained by differences in are explained by differences in countries’ countries’ productivitiesproductivities..


production.production.

ProductivityProductivity is the amount of goods is the amount of goods and services produced from each hour and services produced from each hour

of a worker’s time.of a worker’s time.

Higher productivity Higher standard of living

ProductivityProductivityProductivityProductivity

Productivity is the amount of output Productivity is the amount of output obtained from a given amount of inputs.obtained from a given amount of inputs.

Labor Productivity is amount of output Labor Productivity is amount of output per worker hour.per worker hour.

Productivity is the amount of output Productivity is the amount of output obtained from a given amount of inputs.obtained from a given amount of inputs.

Labor Productivity is amount of output Labor Productivity is amount of output per worker hour.per worker hour.









InflationInflationInflationInflation

Inflation refers to a sustained increase Inflation refers to a sustained increase in the average price level.in the average price level.

Inflation refers to a sustained increase Inflation refers to a sustained increase in the average price level.in the average price level.









10. Society faces a short-run tradeoff 10. Society faces a short-run tradeoff between inflation and unemployment.between inflation and unemployment.

The The Phillips CurvePhillips Curve illustrates the tradeoff illustrates the tradeoff between inflation and unemployment:between inflation and unemployment:

Inflation Inflation UnemploymentUnemployment

It’s a short-run tradeoff!It’s a short-run tradeoff!

SummarySummary

When individuals make decisions, they When individuals make decisions, they face tradeoffs.face tradeoffs.

Rational people make decisions by Rational people make decisions by comparing marginal costs and marginal comparing marginal costs and marginal benefits.benefits.

SummarySummary

People can benefit by trading with each People can benefit by trading with each other.other.

Markets are usually a good way of Markets are usually a good way of coordinating trades.coordinating trades.

Government can potentially improve Government can potentially improve market outcomes.market outcomes.

SummarySummary

A country’s productivity determines its A country’s productivity determines its living standards.living standards.

Society faces a short-run tradeoff Society faces a short-run tradeoff between inflation and unemployment.between inflation and unemployment.

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Part I: Introduction Chapter 1: Ten Principles of Economics Chapter 1: Ten Principles of Economics.

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