“Economy” – Greek word “Oikonomos” meaning one who manages a household managed who does what job and how much they will make, once society has managed the people they must manage land, buildings and machines; Society must also allocate the output of goods and services.
Scarcity – means that society has limited resources and therefore cannot produce all the goods and services people wish to have.
Economics – is the study of how society manages its scarce resources.
How people make decisions
1. People face trade-offs
Society faces an important trade-off efficiency vs. equality
Efficiency – that society is getting the maximum benefits from its scarce resources.
Equality – means that those benefits are distributed uniformly among society’s members.
2. The cost of something is what you give up to get it
Because people face trade-offs, making decisions requires comparing the costs and benefits of alternative courses of action.
Opportunity cost – of an item is what you give up to get that item.
3. Rational people think at the margin
Rational people – people whom systematically and purposefully do the best they can to achieve their objectives.
Marginal change – a small incremental adjustment to an existing plan of action.
4. People respond to incentives
Incentive – something that induces a person to act, such as the prospect of a punishment or a reward.
How people interact
5. Trade can make everyone better off
Rather than being self-sufficient people can specialize in producing one good or service and exchange it for other goods.
6. Markets are usually a good way to organize economic activity
Market Economy – an economy that allocates resources through the decentralized decisions of many firms and households as they interact in markets for good and services.
Market – a group of buyers and sellers organize economic activity – determining what goods to produce? How to produce them? How much of each to produce? And who buys them?
Adam Smith – Wealth of Nations 1776 – invisible hand
System – the interaction of buyers and sellers determines price.
7. Governments can sometimes improve market outcomes.
Property rights – the ability of an individual to own and exercise control over scare resources.
Market failure – a situation in which a market left on its own fails to allocate resources efficiently.
Externality – the impact of one person’s actions on the well being of a bystander.
Market power – is the ability of a single economic actor to have a substantial influence on market prices.
How the Economy as a whole works
8. A country’s standard of living depends on its ability to produce goods and services.
Productivity – the amount of goods and services produced from each unit of labor input.
9. Prices rise when the government prints too much money.
Inflation – is an increase in the over all levels of prices in the economy.
10. Society faces a short-run trade-off between inflation and unemployment
Business cycle – is the irregular and largely unpredictable fluctuations in economic activity, as measured by the production of goods and services or the number of people employed.
Chapter 2 Thinking Like an Economist
Economists play two roles: scientists trying to explain the world and policy advisors trying to improve it.
The economist as Scientist, economists try to address their subjects with a scientist’s objectivity.
The scientific method: observation, theory, and more observation. The dispassionate development and testing of theories about how the world works.
The role of Assumptions and models, assumptions simplify the complex world, make it easier to understand.
Model – a highly simplified representation of a more complicated reality. Economists use models to study economic issues.
Model 1: The circular-flow diagram – a visual model of the economy, shows how dollars flow through markets among households and firms.