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Chapter 1: Ten Principles of Microeconomics

Principles of Individual Decision Making 1. People Face Trade-offs To get one thing that we like, we usually have to give up another thing that we like. 2. The Cost of Something Is What You Give Up to Get It Opportunity cost - whatever must be given up to obtain some item 3. Rational People Think at the Margin Rational people - people who systematically and purposefully do the best they can to achieve their objectives Marginal changes - small incremental adjustments to a plan of action Keep in mind that margin means "edge," so marginal changes are adjustments around the edges of what you are doing. Rational people often make decisions by comparing marginal benets and marginal costs 4. People Respond to Incentives Incentive - something that induces a person to act Principles Concerning How People Interact with One Another 5. Trade Can Make Everyone Better Off Trade between two countries can make each country better off. Trade allows each person to specialize in the activities he or she does best, whether it is farming, sewing, or home building. 6. Markets Are Usually a Good Way to Organize Economic Activity Market economy - an economy that allocates resources through the decentralized decisions of many rms and households as they interact in markets for goods and services Firms decide whom to hire and what to make. Households decide which rms to work for and what to buy with their incomes. These rms and households interact in the marketplace, where prices and self-interest guide their decisions. 7. Governments Can Sometimes Improve Market Outcomes Property rights - the ability of an individual to own and exercise control over scarce resources Eg. A farmer won't grow food if he expects his crop to be stolen

There are two broad reasons for a government to intervene in the economy and change the allocation of resources that people would choose on their own: to promote efciency or to promote equality. Efciency - the property of society getting the most it can from its scarce resources Equality - the property of distribution economic prosperity uniformly among the members of society Market failure - a situation in which a market left on its own fails to allocate resources efciently Externality - the impact of one person's actions on the well-being of a bystander E.g. Pollution Market power - the ability of a single economic actor (or small group of actors) to have a substantial inuence on market prices E.g. If everyone in town needs water but there is only one well, the owner of the well is not subject to the rigorous competition with which the invisible hand normally keeps selfinterest in check. Principles Concerning the Workings of the Economy as a Whole 8. A Country's Standard of Living Depends on Its Ability to Produce Goods and Services Productivity - the quantity of goods and services produced from each unit of labor input In nations where workers can produce a large quantity of goods and services per unit of time, most people enjoy a high standard of living; in nations where workers are less productive, most people endure a more meagre existence. 9. Prices Rise When the Government Prints Too Much Money Ination - an increase in the overall level of prices in the economy What causes ination? In almost all cases of large or persistent ination, the culprit is growth in the quantity of money. When a government creates large quantities of the nation's money, the value of the money falls. nm 10. Society Faces a Short-Run Trade-off between Ination and Unemployment Most economists describe the short-run effects of monetary infections as follows: Increasing the amount of money in the economy stimulates the overall level of spending and thus the demand for goods and services.

Higher demand may over time cause rms to raise their prices, but in the meantime, it also encourages them to hire more workers and produce a larger quantity of goods and services More hiring means lower unemployment Business cycle - uctuations in economic activity, such as employment and production By changing the amount that the government spends, the amount it taxes, and the amount of money it prints, policymakers can inuence the overall demand for goods and services. Changes in demand in turn inuence the combination of ination and unemployment that the economy experiences in the short-run.