In this chapter, look for the answers to these questions
• What kinds of questions does economics address?
• What are the principles of how people make decisions?
• What are the principles of how people interact?
• What are the principles of how the economy as
a whole works?
KEY POINTS:
• The fundamental lessons about individual decisionmaking are that people face trade-offs
among alternative goals, that the cost of any action is measured in terms of forgone
opportunities, that rational people make decisions by comparing marginal costs and
marginal benefits, and that people change their behavior in response to the incentives they
face.
• The fundamental lessons about interactions among people are that trade and
interdependence can be mutually beneficial, that markets are usually a good way of
coordinating economic activity among people, and that the government can potentially
improve market outcomes by remedying a market failure or by promoting greater economic
equality.
• The fundamental lessons about the economy as a whole are that productivity is the ultimate
source of improving living standards, that growth in the quantity of money is the ultimate
source of inflation, and that society faces a short-run trade-off between inflation and
unemployment.
NOTES
Decision-making is at the heart of economics. The individual must decide how much to save for
retirement, how much to spend on different goods and services, how many hours a week to
work. The firm must decide how much to produce, what kind of labor to hire. Society as a
whole must decide how much to spend on national defense (“guns”) versus how much to spend
on consumer goods (“butter”).
“How do people decide how much to work?” Time is scarce resource—there’s just not
enough time to do everything we’d like to do. How do we decide how much of our time to
spend working? There’s a tradeoff: the more time we spend working, the higher our income,
and therefore the more stuff we can buy. But, the more time we spend working, the less time
we have for leisure—hanging out with friends, going hiking, watching movies, etc.
This lesson will introduce you to the ten economic principles that will serve as building blocks
for the rest of the text.
PRINCIPLE 1
People Face Tradeoffs
All decisions involve tradeoffs. Society faces an important tradeoff:
Efficiency vs. Equality
Efficiency: when society gets the most from its scarce resources
Equality: when prosperity is distributed uniformly among society’s members
Tradeoff: To achieve greater equality, could redistribute income from wealthy to poor.
But this reduces incentive to work and produce, shrinks the size of the economic “pie.”
Other Examples:
Going to a party the night before your midterm leaves less time for studying.
Having more money to buy stuff requires working longer hours, which leaves less time
for leisure.
Protecting the environment requires resources that could otherwise be used to produce
consumer goods.
PRINCIPLE 2
The Cost of Something Is
What You Give Up to Get It
Making decisions requires comparing the costs and benefits of alternative choices.
The opportunity cost of any item is whatever must be given up to obtain it.
It is the relevant cost for decision making.
Examples:
The opportunity cost of going to college for a year is not just the tuition, books, and fees, but
also the foregone wages.
Seeing a movie is not just the price of the ticket, but the value of the time you spend in the
theater.
PRINCIPLE 3
Rational People Think at the Margin
