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EXAMPLES:

REVIEWER IN ECONOMICS
1. Student who must decide how to allocate
PART I: DEFINITION OF TERMS
her time either between studying 2 subjects
ECONOMY- comes from the Greek word
or with spending some time for leisure.
“oikonomos” which means, one who manages a
2. Parents deciding how to spend their family
household.
income
---management of society’s resources is important
SOCIETY FACES TRADE-OFFS:
because resources are scarce
3. The more it spends on national defense
SCARCITY- has limited resources and therefore,
(guns) to protect it shores
cannot produce all the goods and services
- The less it can spend on consumer
ECONOMICS – is the study of how society
goods (butter) to raise the standard of
manages its scarce resources.
living at home.
ECONOMISTS:
4. Pollution regulations: cleaner environment
 Study how people make decisions, how
and improved health
much they work, what they buy, how much
- But at the cost of reducing the incomes
they save, and how much they invest their
of the firms’ owners, workers, and
savings.
customers.
 Study how people interact with one another 5. Efficiency and Equality
i.e. they examine the multitude of buyers EFFICIENCY – society is getting the maximum
and sellers of a good together determine benefits from its scarce resources. (size of
the price at which the good is sold and the economic pie)
quantity that is sold. (MICRO) EQUALITY – the property of distributing economic
 Analyze the forces and trends that affect the prosperity uniformly among the members of the
economy as a whole, including the growth in society. (how the pie is divided into individual
average income, fraction of the population sizes)
that cannot find work, and the rate at which TRADEOFF:
prices are rising (MACRO) - To achieve greater quality, could
redistribute income from wealthy to poor
PART II: TEN PRINCIPLES OF ECONOMICS - But this reduces incentive to work and
produce, shrinks the size of economic
A. HOW PEOPLE MAKE DECISIONS pie.
PRINCIPLE 1: PEOPLE FACE TRADE-OFFS
 “There ain’t no such thing as a free lunch.” PRINCIPLE 2: THE COST OF SOMETHING IS
 To get something that we like, we usually WHAT YOU GIVE UP
have to give up something else that we also
like. MAKING DECISIONS:
 Making decisions requires taking off one - Compare costs with benefits or
goal against another. alternatives
- Need to include opportunity costs PRINCIPLE 4: PEOPLE RESPOND TO
2 TYPES OF COSTS: INCENTIVES
1. EXPLICIT COST – includes money INCENTIVE
2. IMPLICIT COST – salary plus foregone - Something that induces a person to act.
wages - Key to analysing how markets work.
OPORTUNITY COST – whatever must be given up Examples:
to obtain some item 1. When gas prices rise, consumers buy more
The opportunity cost of hybrid cars and fewer gas guzzling SUVs
1. Going to college for a year 2. When cigarette taxes increase, teen
- Tuition, books, and fees smoking falls
- PLUS foregone wages
2. Going to the movies
- The price of the movie ticket
- PLUS the value of the time you spend in
the theatre.

PRINCIPLE 3: RATIONAL PEOPLE THINK AT


THE MARGIN
RATIONAL PEOPLE:
- Systematically and purposefully do the
best that they can to achieve their
objectives given the available
opportunities.
- Make decisions by evaluating costs and
benefits of marginal changes
MARGINAL CHANGES – small incremental
adjustments to a plan of action
Examples:
1. Cell phone users with unlimited minutes
(the minutes are free at the margin)
• Are often prone to making long/frivolous calls
• Marginal benefit of the call > 0 – B. HOW PEOPLE INTERACT
2. A manager considers whether to PRINCIPLE 5: TRADE CAN MAKE EVERYONE
increase output BETTER OFF
• Compares the cost of the needed labor and TRADE – allows each person to specialize in the
materials to the extra revenue activities she does best
 People benefit from trade:
- People can buy a greater variety of - Reflect the good’s value to buyers
goods and services at lower cost - Reflect the cost of producing the good
 Countries benefit from trade and INVISIBLE HAND:
specialization - Prices guide self-interested households
- Get better price abroad for goods they and firms to make decisions that
produce maximize society’s economic well-being.
- Buy other goods more cheaply abroad
than could be produced at home PRINCIPLE 7: GOVERNMENTS CAN
SOMETIMES IMPROVE MARKET OUTCOMES
PRINCIPLE 6: MARKETS ARE USUALLY A  Government – enforce property rights
GOOD WAY TO ORGANIZE ECONOMIC - Enforce rules and maintain
ACTIVITY institutions that are key to a market
MARKET – a group of buyers and sellers (need not economy
in a single location) o People are less inclined to work,
CENTRAL PLANNING – only the government produce, invest, or purchase if
could organize economic activity large risk of their property being
 “Organize economic activity” means stolen
determining: PROPERTY RIGHTS – the ability of an individual
- What goods and services to produce to own and exercise control over scarce resources
- How much of each to produce  Government – promote efficiency
- Who produced and consumed these - Avoid market failures: market left on
 A market economy allocated resources its own fails to allocate resources
- Decentralized decisions of many firms efficiently
and households – as they interact in - Externality – source of market failure
markets. o Production or consumption of a
FIRMS – decide who to hire and what to make good affects bystanders (e.g.
HOUSEHOLDS – which firms to work for what to pollution)
buy “with their incomes” - Market power – source of market failure
FREE MARKETS – contain many buyers and o A single buyer or seller has
sellers; interested in their own well-being. substantial influence on market
 Famous insight by ADAM SMITH in The price (e.g. monopoly)
Wealth of Nations (1776)  Government – promote equality
- Each of these households and firms acts - Avoid disparities in economic well-
as if “led by an invisible hand” to being
promote general economic well-being - Use tax or welfare policies to change
PRICES: how the economic “pie” is divided
- Determined: interaction of buyers and
sellers
- The faster the government creates
money, the greater inflation rate.
-
PRINCIPLE 10: SOCIETY FACES A SHORT RUN
TRADE-OFF BETWEEN INFLATION AND
UNEMPLOYMENT
Short-run trade-off between unemployment and
inflation
- Over a period of a year or two, many
economic policies push inflation and
C. HOW THE ECONOMY AS A WHOLE
unemployment in opposite directions
WORKS
- Other factors can make this tradeoff
PRINCIPLE 8: A COUNTRY’S STANDARD OF
more or less favorable, but the tradeoff
LIVING DEPENDS ON ITS ABILITY TO
is always present.
PRODUCE GOODS AND SERVICES
Higher Inflation Rate, Lower Unemployment
PRODUCTIVITY: most important determinant of
Rate
living standards
BUSINESS CYCLE – fluctuations in economic
- Quantity of goods and services
activity such as employment and production.
produced from each unit of labor input
- Depends on the equipment, skills, and
technology available to workers
o Other factors (e.g., labor unions,
competition from abroad) have
far less impact on living
standards
GDP – Final market value
- Based on location
GNP – citizenship of the owner

PRINCIPLE 9: PRICE RISE WHEN THE


GOVERNMENT PRINTS TOO MUCH MONEY
INFLATION – an increase in the overall level of
prices in the economy
In the long run
- Inflation is almost always caused by
excessive growth in the quantity of
money which causes the value of money
to fall.