Chapter 1

Ten Principles of
Economics

Microeconomics
Ratna K. Shrestha
Overview
4 Scarcity and Economics
4 How People Make Decisions
4 How People Interact
4 How the Economy as a Whole Works

4 Who will work?
4 What good and how many to produce?
4 What resources to use?
4 Who will we sell it to and at what price?
Scarcity...
means that society has less to offer than people
wish to have.

Managing societys resources is important
because resources are scarce.
+Economics is the study of how society
manages its scarce resources.
how people make decisions.
...how people interact with each other.
the forces and trends that affect the
economy as a whole.

What is Economics?
How People Make Decisions?
C People face tradeoffs.
C The cost of something is what you
give up to get it.
C Rational people think at the margin.
C People respond to incentives.
1. People Face Tradeoffs
To get one thing, we usually have to
give up another thing
Food vs. Clothing
Leisure Time vs. Work
Efficiency vs. Equity
1. People Face Tradeoffs
4 Efficiency means . . .
getting the most you can from scarce
resources.

4 Equity means . . .
benefits of resources are distributed fairly
among society.
2. The Cost of Something Is What You
Give Up to Get It
4Decisions require comparing costs and benefits
of alternatives
Going to university vs. going to work
4Opportunity Cost is what you give up from one
alternative (choice) to get what you want (from
another choice)
What is the opportunity cost of going to
university for Hokey Star Joe Sakic?
What is the Opportunity Cost of Econ 310?
3. Rational People Think at the Margin
4Marginal means one more.
Would you consumer one more apple?
Your decision depends on:
+Marginal Benefits => MB
+Marginal Costs => MC of such a choice.
What are the MB and MC of a MA degree?
4. People Respond to Incentives
4 When your marginal cost or benefit from a
decision changes, that can change your
decision.
What would you do if the government
imposes a tax of $1/lit on gasoline?
Fertility rate went up in Quebec between
1988-1997 in response to baby bonus.
Should the bonus be higher for the first or
second baby ?
4. People Respond to Incentives.
LA Laker basketball star
Kobe Bryant chose to skip
college and go straight to
the NBA from high school
when offered a $10 million
contract.
How People Interact?
CTrade can make
everyone better off.
Markets are usually a
good way to organize
economic activity.
CGovernment can
sometimes improve
market outcomes.
5. Trade Can Make Everyone Better Off
4 Individuals gain from trading with others.
You cannot grow your own food, make your
own clothes, and build your own homes.
4 Trade allows one to specialize in what
he/she does best and enjoy a greater
variety of goods.
4 What does Canada specialize in and what
does Canada buy from others?
6. Markets Are Usually a Good Way to
Organize Economic Activity
4 In a Market Economy, households and bfirms
determine what to buy, who to work for, who
to hire and what to produce.
4 Interaction between households and firms is
guided by prices (invisible hand). They look
at prices when deciding what to buy and sell.
4 Puzzle: Although everybody is guided by
his/her own self- interest and it promotes
overall economic well being.
7. Governments Can Sometimes Improve
Market Outcomes
4 Market failure results in inefficiency - failure
of the invisible hand.
4 When the market fails the government can
intervene to promote Efficiency.
4 Government also intervenes to promote
Equity.
4 Oftentimes both efficiency and equity are not
obtainable simultaneously.
Causes of Market Failure
1) Externality: impact of one
persons actions on the
well-being of a bystander.
when you slow down on
a highway to have a
look at an accident, you
dont care if that causes
traffic jam behind you.
Other Examples:
Pollution, Research
2) Market Power is the ability of a single person
or a small group to unduly influence market
prices. Examples: monopoly, Cartel.
3) Asymmetric Information: one party (seller or
buyer) having more information than the other
about a product. Examples: In the auto
insurance market, drivers know whether they
are careful drivers, but ICBC does not.
In the used car market, who has more
information (on the condition of the car)?
Causes of Market Failure
How Can the Government Improve
Market Outcomes?
4 Government can tax or subsidize externality
creating activities. For example, Tax pollution,
subsidize research.
4 Government can control prices, prevent firms
from collusion, or break a big company into
smaller firms to foster competition. US
government split AT&T into smaller baby bells
to foster competition in mid 1970s.
How the Economy as a Whole Works?
A countrys standard of living
depends on its ability to produce
goods and services.
Prices rise when the government
prints too much money.
1Society faces a short-run tradeoff
between inflation and
unemployment.
8. Standard of Living Depends on a
Countrys Production.
4 Standard of Living depends on per capita
income, not total income of the country.
Canadas living standard is higher than that
of China (although Chinas GDP is close to
3 times higher than Canadas)
Differences in standard of living between
countries is attributable to the productivity.
8. Standard of Living Depends on a
Countrys Production.
4 Productivity is the amount of goods and
services produced from each hour of a
workers time.
4 Higher the Productivity, higher the Standard of
Living.
4 So when thinking about how a public policy will
affect living standards, the key question is how
it affects our ability to produce goods and
services.
9. Prices Rise When The Government
Prints Too Much Money
4 Inflation is an increase in the overall level of
prices in the economy.
One cause of inflation is the over supply of
money (notes and coins). This reduces the
value of money.
Germany (Jan 1921), Price of a daily
newspaper was 0.3 mark. By Nov 1922,
the price was 70,000,000 mark, why?
The high inflation in 1970s in Canada was
also associated with oversupply of money.
Inflation rate in Zimbabwe topped 2.2
million percent in 2008.
10. Society Faces a Short-Run Tradeoff
Between Inflation and Unemployment
4 When govt. reduces the quantity of money,
in the long run, prices go down. But in the
short run, prices remain the same. It takes
time for the stores to change their prices
and restaurants to change their menu etc
(sticky prices).
Inflation Unemployment
10. Society Faces a Short-Run Tradeoff
Between Inflation and Unemployment
+ With less money and unchanged prices,
people will buy less. As consumers buy less,
producers produce less and employ less
people, causing unemployment.
+ The central bank (Bank of Canada) can
increase money supply by printing more notes
and coins and using these notes and coin to
buy government bonds from the commercial
banks (such as TD, RBC and BMO) or the
public.