Study guides are intended to guide your note taking in-class.

I leave blanks for you to provide your own

additional notes and examples. The book provides a more in-depth reference.

Chapter 1: The Ten Principles of Economics

Resources are scarce: There are limits to their access.
Examples: Time, Money, Physical resources


Economists study societys management of these scarce resources.

The ten principles are the driving assumptions of economic models of behavior.

Principle 1: People face trade-offs
Since resources are scarce, people have to make decisions on how to allocate their own resources.
Individuals: How to spend time, money


Society: Guns vs. butter, efficiency vs. equality


Principle 2: The cost of something is what you give up to get it
When people make a decision in the face of trade-offs (Principle 1), they give up something to get
something else.

The opportunity cost of a decision is the benefit foregone of the best alternative decision.
Example: Time costs http://xkcd.com/951/


Principle 3: Rational people think at the margin
Rational people systematically & purposefully do the best they can to achieve their objectives. They
optimize their decision making

by making incremental changes on the margin to their plan of action, and seeing if theyre better or
worse off, until no marginal change improves the plan of action. (Calculus isnt required in this course,
but the mathematically-inclined can think of finding first and second order conditions for a global
optimum).

In general, make a decision if the marginal benefit > marginal cost, noting what cost means from
Principle 2.


Principle 4: People respond to incentives
Incentives are anything that induces a person to act. Doesnt have to force someone to act indirect
mechanisms, like a price in a market, can influence behavior.

Example: Oil and gas prices increase. No one forces me to cut back on gas, but because the marginal
cost of gas consumption increases, I decrease my consumption. Oil producers decide to produce more
oil, because the marginal benefit (selling at the going rate for oil) has increased.



Principle 5: Trade can make everyone better off
Without trade, if you want different kinds of goods, you have to produce all of them yourself.
The goods youre bad at producing take a lot of time, so you have less time to produce the goods youre
good at.

If you meet a trade partner, and you two specialize in the things youre relatively good at, both you and
the trade partner can consume more of all types of goods.

To learn later: Pareto improvements



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

To allocate resources efficiently, a central planner has to know everyones preferences and specialties.
Otherwise he will make mistakes. People will produce things theyre bad at, some goods will be over-
produced, and others will be under-produced.

Example 1: Black markets for basic goods in former USSR; citizens undergo high risk to correct for central
planning mistakes.
Example 2: Line costs time cost for waiting for a good, see Principle 2 offset low individual cost of
obtaining an in-demand good.



Markets use decentralized actors, who know their own preferences and specialties, to make individual
decisions that influence the market.

The price reflects all of these individual decisions/preferences/specialties without having to distribute
everyones private information.

Adam Smiths invisible hand = individuals guided by self interest


Principle 7: Governments can sometimes improve market outcomes

Government can enforce rules and maintain institutions, enforce property rights
Build the structure of the market, so it can exist

Promote efficiency, avoid market failure
Externalities when a bystander is affected by actions in a market, the markets price does not
reflect that benefit or cost.



Market power Healthy markets have competition, which needs many actors on both sides of the
market. When a single actor or small group of actors can influence the price with their decisions, they
can distort the allocation of resources in that market for their own gain. The government can step in
and create more competition.



Equality The government can transfer economic wellbeing from more prosperous groups to less
prosperous groups, in the interest of social welfare and/or a feeling of justice. Not without cost;
incentives get distorted, transactions costs (well get into those later). Remember Principle 1: People
(and societies) face tradeoffs.



Principle 8: A countrys standard of living depends on its ability to produce goods and services
Generally, the more goods and services a person consumes the better off he is.
Goods and services include food, shelter, health care, security, and other basics, along with luxuries.

The more productive the average individual is in a country, the more goods that country can produce
per person. In the long run, a country can only consume as much as it produces.

Differences in living standards among countries and over time can be explained by difference in
productivity. (What explains differences in productivity is explained in more depth in macroeconomics).




Principle 9: Prices rise when the government prints too much money
Inflation: An increase in the overall price level
Remember, the cost of something is what you give up to get it. So if the price of all goods and services
increase proportionally, relative prices do not change.

Example: Two good economy produces apples and oranges, both originally $1 apiece. My cost of buying
1 apple is 1 orange. If both prices increase to $2 apiece, the cost of buying 1 apple is still 1 orange.



Large and persistent inflation is caused by a growth in the quantity of money. If everyone has twice as
much money, the relative value of money falls to its original worth, meaning prices will double.


Principle 10: Society faces a short-run trade-off between inflation and unemployment
Prices dont adjust automatically; theyre sticky.
If prices dont adjust, and theres more money in the system, people can buy more goods and services.
Firms slowly raise prices, hire more workers to meet demand.
Eventually prices (including wages) rise to the point that the economy is back where it was, except with
higher prices.
More in-depth analysis in macroeconomics.