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ch01.docx
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ch01
Chapter1
1
TenPrinciplesofEconomics
TENPRINCIPLESOFECONOMICS
WHAT’SNEW:
ThediscussionsofPrinciple#4,“Peoplerespondtoincentives,”Principle#7,“Governmentscansometimesimprovemarketoutcomes,”andPrinciple#10,“Societyfacesashort-runtradeoffbetweeninflationandunemployment”havebeenshortened.Adefinitionfortheterm“businesscycle”hasbeenadded.AnewFYIboxon“HowtoReadThisBook”hasbeenaddedandprovidesstudentswithtipsonstudying.
LEARNINGOBJECTIVES:
Bytheendofthischapter,studentsshouldunderstand:
Øthateconomicsisabouttheallocationofscarceresources.
Øthatindividualsfacetradeoffs.
Øthemeaningofopportunitycost.
Øhowtousemarginalreasoningwhenmakingdecisions.
Øhowincentivesaffectpeople’sbehavior.
Øwhytradeamongpeopleornationscanbegoodforeveryone.
Øwhymarketsareagood,butnotperfect,waytoallocateresources.
Øwhatdeterminessometrendsintheoveralleconomy.
CONTEXTANDPURPOSE:
Chapter1isthefirstchapterinathree-chaptersectionthatservesastheintroductiontothetext.Chapter1introducestenfundamentalprinciplesonwhichthestudyofeconomicsisbased.Inabroadsense,therestofthetextisanelaborationonthesetenprinciples.Chapter2willdevelophoweconomistsapproachproblemswhileChapter3willexplainhowindividualsandcountriesgainfromtrade.
ThepurposeofChapter1istolayoutteneconomicprinciplesthatwillserveasbuildingblocksfortherestofthetext.Thetenprinciplescanbegroupedintothreecategories:
howpeoplemakedecisions,howpeopleinteract,andhowtheeconomyworksasawhole.Throughoutthetext,referenceswillbemaderepeatedlytothesetenprinciples.
KEYPOINTS:
1.Thefundamentallessonsaboutindividualdecisionmakingarethatpeoplefacetradeoffsamongalternativegoals,thatthecostofanyactionismeasuredintermsofforgoneopportunities,thatrationalpeoplemakedecisionsbycomparingmarginalcostsandmarginalbenefits,andthatpeoplechangetheirbehaviorinresponsetotheincentivestheyface.
2.Thefundamentallessonsaboutinteractionsamongpeoplearethattradecanbemutuallybeneficial,thatmarketsareusuallyagoodwayofcoordinatingtradesamongpeople,andthatthegovernmentcanpotentiallyimprovemarketoutcomesifthereissomesortofmarketfailureorifthemarketoutcomeisinequitable.
3.Thefundamentallessonsabouttheeconomyasawholearethatproductivityistheultimatesourceoflivingstandards,thatmoneygrowthistheultimatesourceofinflation,andthatsocietyfacesashort-runtradeoffbetweeninflationandunemployment.
CHAPTEROUTLINE:
I.Introduction
Beginbypointingoutthateconomicsisasubjectthatstudentsmustconfrontintheireverydaylives.Pointoutthattheyalreadyspendagreatdealoftheirtimethinkingabouteconomicissues:
prices,buyingdecisions,useoftheirtime,etc.
A.Theword“economy”comesfromtheGreekwordmeaning“onewhomanagesahousehold.”
B.Thismakessomesensesinceintheeconomywearefacedwithmanydecisions(justasahouseholdis).
C.Fundamentaleconomicproblem:
resourcesarescarce.
Youwillwanttostartthesemesterbyexplainingtostudentsthatpartoflearningeconomicsisunderstandinganewvocabulary.Economistsgenerallyuseveryprecise(andsometimesdifferent)definitionsforwordsthatarecommonlyusedoutsideoftheeconomicsdiscipline.Therefore,itwillbehelpfultostudentsifyoufollowthedefinitionsprovidedinthetextasmuchaspossible.
D.Definitionofscarcity:
thelimitednatureofsociety’sresources.
E.Definitionofeconomics:
thestudyofhowsocietymanagesitsscarceresources.
Becausemostcollegefreshmenandsophomoreshavelimitedexperienceswithviewingtheworldfromacause-and-effectperspective,donotunderestimatehowchallengingtheseprincipleswillbeforthestudent.
Asyoudiscussthetenprinciples,makesurethatstudentsrealizethatitisokayiftheydonotgraspeachoftheconceptscompletelyorfindeachoftheargumentsfullyconvincing.Theseideaswillbeexploredmorecompletelythroughoutthetext.
II.HowPeopleMakeDecisions
Table1
A.Principle#1:
PeopleFaceTradeoffs
1.“Thereisnosuchthingasafreelunch.”Makingdecisionsrequirestradingoffonegoalforanother.
2.Examplesincludehowastudentspendshertime,howafamilydecidestospenditsincome,howtheU.S.governmentspendstaxdollars,howregulationsmayprotecttheenvironmentatacosttofirmowners.
3.Aspecialexampleofatradeoffisthetradeoffbetweenefficiencyandequity.
a.Definitionofefficiency:
thepropertyofsocietygettingthemostitcanfromitsscarceresources.
b.Definitionofequity:
thepropertyofdistributingeconomicprosperityfairlyamongthemembersofsociety.
c.Forexample,taxdollarspaidbywealthyAmericansandthendistributedtothoselessfortunatemayimproveequitybutlowerthereturntohardworkandthereforereducethelevelofoutputproducedbyourresources.
d.Thisimpliesthatthecostofthisincreasedequityisareductionintheefficientuseofourresources.
4.Recognizingthattradeoffsexistdoesnotindicatewhatdecisionsshouldbemade.
B.Principle#2:
TheCostofSomethingIsWhatYouGiveUptoGetIt
1.Makingdecisionsrequiresindividualstoconsiderthebenefitsandcostsofsomeaction.
2.Whatarethecostsofgoingtocollege?
a.Wecannotcountroomandboard(atleastallofthecost)becausethepersonwouldhavetopayforfoodandshelterevenifhewasnotinschool.
b.Wewouldwanttocountthevalueofthestudent’stimesincehecouldbeworkingforpayinsteadofattendingclassesandstudying.
3.Definitionofopportunitycost:
whatevermustbegivenuptoobtainsomeitem.
Oneofthehardestideasforstudentstograspisthat“free”thingsarenottrulyfree.Thus,youwillneedtoprovidestudentswithnumerousexamplesofsuch“free”thingswithhiddencosts,especiallythevalueoftime.
C.Principle#3:
RationalPeopleThinkattheMargin
1.Manydecisionsinlifeinvolveincrementaldecisions:
ShouldIremaininschoolthissemester?
ShouldItakeanothercoursethissemester?
ShouldIstudyanadditionalhourfortomorrow’sexam?
2.Definitionofmarginalchanges:
smallincrementaladjustmentstoaplanofaction.
3.Example:
Youaretryingtodecidehowmanyyearsyoushouldstayinschool.ComparingthelifestyleofanindividualwithaPh.D.tothatofanindividualwhohasdroppedoutofgradeschoolwouldbeinappropriate.Youarelikelydecidingwhetherornottoremaininschoolforanadditionalyearortwo.Thus,youneedtocomparetheadditionalbenefitsofanotheryearinschool(themarginalbenefit)withtheadditionalcostofstayinginschoolforanotheryear(themarginalcost).
4.Anotherexample:
Supposethatflyinga200-seatplaneacrossthecountrycoststheairline$100,000,whichmeansthattheaveragecostofeachseatis$500.Supposethattheplaneisminutesfromdepartureandapassengeriswillingtopay$300foraseat.Shouldtheairlineselltheseatfor$300?
Inthiscase,themarginalcostofanadditionalpassengerisverysmall.
D.Principle#4:
PeopleRespondtoIncentives
1.Becausepeoplemakedecisionsbyweighingcostsandbenefits,theirdecisionsmaychangeinresponsetochangesincostsandbenefits.
a.Whenthepriceofagoodrises,consumerswillbuylessofitbecauseitscosthasrisen.
b.Whenthepriceofagoodrises,producerswillallocatemoreresourcestotheproductionofthegoodbecausethebenefitfromproducingthegoodhasrisen.
2.Sometimespolicymakersfailtounderstandhowpoliciesmayalterincentivesandbehavior.
3.Example:
Seatbeltlawsincreaseuseofseatbeltsandlowertheincentivesofindividualstodrivesafely.Thisleadstoanincreaseinthenumberofcaraccidents.Thisalsoleadstoanincreasedriskforpedestrians.
Ifyouincludeanyincentive-basedcriteriaonyoursyllabus,discussitnow.Forexample,ifyourewardclassattendance(orpenalizestudentswhodonotattendclass),explaintostudentshowthischangeinthemarginalbenefitofattendingclasscanbeexpectedtoaltertheirbehavior.
III.HowPeopleInteract
A.Principle#5:
TradeCanMakeEveryoneBetterOff
1.Tradeisnotlikeasportscompetitionwhereonesidegainsandtheothersideloses.
2.Considertradethattakesplaceinsideyourhome.Certainlythefamilyisinvolvedintradewithotherfamiliesonadailybasis.Mostfamiliesdonotbuildtheirownhomes,maketheirownclothes,orgrowtheirownfood.
3.Justlikefamiliesbenefitfromtradingwithoneanothersodocountries.
4.Thisoccursbecauseitallowsforspecializationinareasthatcountries(orfamilies)candobest.
Activity1—GettingDressedintheGlobalEconomy
Type:
In-classassignment
Topics:
Specialization,interdependence,self-interest,consumerchoice,internationaltrade
Materialsneeded:
None
Time:
20minutes
Classlimitations:
Worksinanyclasssize
Purpose
Theadvantagesofspecializationanddivisionoflaborareveryclearinthisexample.Theworldwidelinksofthemoderneconomyarealsoillustrated.Wedependonthousandsofpeoplewedon’tknow,won’tsee,anddon’tthinkofinordertogetdressedeachmorning.Self-interestfollowsnaturallyfrominterdependence.Wages,profits,andrentsgivepeopletheincentivetoperformthesevariedtasks.Wedependonthemtoclotheusandtheydependonourpurchasesfortheirincomes.
Instructions
Asktheclasstoanswerthefollowingquestions.Givethemtimetowriteananswertoeachquestion,thendiscusstheiranswersbeforemovingontothenextquestion.Thefirstq
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