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WHAT’S NEW IN THE SEVENTH EDITION:
There is an additional example about marginal benefits and marginal costs.
LEARNING OBJECTIVES:
By the end of this chapter, students should understand:
that economics is about the allocation of scarce resources.
that individuals face trade-offs.
the meaning of opportunity cost.
how to use marginal reasoning when making decisions.
how incentives affect people’s behavior.
why markets are a good, but not perfect, way to allocate resources.
what determines some trends in the overall economy.
CONTEXT AND PURPOSE:
trade.
The purpose of Chapter 1 is to lay out ten economic principles that will serve as building blocks for
the rest of the text. The ten principles can be grouped into three categories: how people make decisions,
how people interact, and how the economy works as a whole. Throughout the text, references will be
made repeatedly to these ten principles.
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TEN PRINCIPLES OF ECONOMICS
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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
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.
CHAPTER OUTLINE:
I. Introduction
household.”
B. This makes some sense because in the economy we are faced with many decisions (just as a
household is).
C. Fundamental economic problem: resources are scarce.
E. Definition of economics: the study of how society manages its scarce resources.
Because most college freshmen and sophomores have limited experiences with
viewing the world from a cause-and-effect perspective, do not underestimate how
challenging these principles will be for the student.
You will want to start the semester by explaining to students that part of learning
economics is understanding a new vocabulary. Economists generally use very precise
(and sometimes different) definitions for words that are commonly used outside of
the economics discipline. Therefore, it will be helpful to students if you follow the
definitions provided in the text as much as possible.
Begin by pointing out that economics is a subject that students must confront in their
daily lives. Point out that they already spend a great deal of their time thinking about
economic issues: changes in prices, buying decisions, use of their time, concerns
about employment, etc.
Chapter 1/Ten Principles of Economics ❖ 3
II. How People Make Decisions
A. Principle #1: People Face Trade-offs
1. “There ain’t no such thing as a free lunch.” Making decisions requires trading one goal for
another.
2. Examples include how students spend their time, how a family decides to spend its income,
3. An important trade-off that society faces is the trade-off between efficiency and equality.
scarce resources.
b. Definition of equality: the property of distributing economic prosperity
uniformly among the members of society.
d. This implies that the cost of this increased equality is a reduction in the efficient use of
our resources.
4. Recognizing that trade-offs exist does not indicate what decisions should or will be made.
B. Principle #2: The Cost of Something Is What You Give Up to Get It
2. What are the costs of going to college?
not in school.
instead of attending classes and studying.
3. Definition of opportunity cost: whatever must be given up in order to obtain some
item.
As you discuss the ten principles, make sure that students realize that it is okay if
they do not grasp each of the concepts completely or find each of the arguments
fully convincing. These ideas will be explored more completely throughout the text.
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1. Economists generally assume that people are rational.
b. Consumers want to purchase the goods and services that allow them the greatest level
of satisfaction given their incomes and the prices they face.
earn.
2. Many decisions in life involve incremental decisions: Should I remain in school this semester?
Should I take another course this semester? Should I study another hour for tomorrow’s
exam?
action.
b. Example: Suppose that you are considering calling a friend on your cell phone and the
cost of the call is only $5.00 so the marginal benefit of the call does outweigh its
marginal cost. Cell phone users who have unlimited minutes (free at the margin) often
make long and frivolous phone calls.
small.
3. A rational decision maker takes an action if and only if the marginal benefit is at least as
large as the marginal cost.
D. Principle #4: People Respond to Incentives
One of the hardest ideas for students to grasp is that “free” things are not truly free.
Thus, you will need to provide students with numerous examples of such “free”
things with hidden costs, especially the value of time. Suggested examples include
the time students spend waiting in line for “free” sporting event tickets at their
universities, time spent relaxing in the sun outside their residence halls, or dinner in
a restaurant with their parents.
Chapter 1/Ten Principles of Economics ❖ 5
2. Because rational people make decisions by weighing costs and benefits, their decisions may
change in response to incentives.
b. When the price of a good rises, producers will allocate more resources to the production
3. Many public policies change the costs and benefits that people face. Sometimes policymakers
unintended consequences.
4. Example: Seat belt laws increase the use of seat belts but lower the incentives of individuals
increased risk for pedestrians.
5.
Case Study: The Incentive Effects of Gasoline Prices
III. How People Interact
A. Principle #5: Trade Can Make Everyone Better Off
1. Trade is not like a sports contest, where one side gains and the other side loses.
2. Consider trade that takes place inside your home. Your family is likely to be involved in trade
with other families on a daily basis. Most families do not build their own homes, make their
own clothes, or grow their own food.
3. Countries benefit from trading with one another as well.
4. Trade allows for specialization in products that countries (or families) can do best.
If you include any incentive-based criteria on your syllabus, discuss it now. For
example, if you reward class attendance (or penalize students who do not attend
class), explain to students how this change in the marginal benefit of attending class
(or marginal cost of missing class) can be expected to alter their behavior.
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Activity 1—Getting Dressed in the Global Economy
Type: In-class assignment
Topics: Specialization, interdependence, self-interest, consumer choice,
international trade
Materials needed: None
Time: 20 minutes
Class limitations: Works in any class size
Purpose
The advantages of specialization and division of labor are very clear in this example. The
worldwide links of the modern economy are also illustrated. We depend on thousands of
people we don’t know, won’t see, and don’t think of in order to get dressed each morning.
Self-interest follows naturally from interdependence. Wages, profits, and rents give people
the incentive to perform these varied tasks. We depend on them to clothe us and they
question, then discuss their answers before moving on to the next question. The first question
can be answered with a brief phrase. The second question is the core of the assignment and
takes several minutes. Ask them to list as many categories of workers as possible. The third
question introduces demand concepts; most of the determinants of demand can be
introduced during this discussion. For the fourth question, ask the class to look at the
country-of-origin tags sewn in their garments.
3. What things do you consider when buying a garment?
4. Where were your clothes produced (what countries)?
Common Answers and Points for Discussion
1. Where did your clothes come from?
There are many possible ways to answer, but many students will say “the mall” or another
retail outlet. Some may say “a factory,” “a sweatshop,” or “a foreign country.”
Mention the importance of markets here (this can be emphasized by asking, “Is anyone
wearing something made by themselves, a friend, or a relative?”) and discuss distribution
2. Who worked to produce your clothes?
will also list workers dealing with raw materials, transportation, management, design, or
machinery. Some may think more broadly to investors, road crews, bankers, engineers, or
accountants.
Most answers focus on preferences (fit, style, quality, color). Price is cited less frequently. Ask
about the importance of price until someone volunteers that income is important. Prices of
substitute goods should also be discussed. Expectations of price changes may also be
mentioned.
Chapter 1/Ten Principles of Economics ❖ 7
B. Principle #6: Markets Are Usually a Good Way to Organize Economic Activity
are trying to develop market economies.
2. Definition of market economy: an economy that allocates resources through the
decentralized decisions of many firms and households as they interact in markets
for goods and services.
used to produce it.
firm decisions become distorted.
5. Centrally planned economies failed because they did not allow the market to work.
6.
FYI: Adam Smith and the Invisible Hand
a. Adam Smith’s 1776 work suggested that although individuals are motivated by self–
being.
b. Smith’s insights are at the center of modern economics and will be analyzed more fully in
the chapters to come.
1. The invisible hand will only work if the government enforces property rights.
promotion of efficiency and equality.
3. Government policy can improve efficiency when there is market failure.
Explain to students that when households and firms do what is best for themselves,
they often end up doing what is best for society, as if guided by market forces—or an
invisible hand. Spend some time and emphasize the magic of the market. Use
numerous examples to show students that the market most often allocates resources
to their highest valued use.
4. Where were your clothes produced (what countries)?
A large number of countries will be represented, even in small classes. Asia is always well
represented. Latin American and European goods appear in smaller numbers. African
products are conspicuously absent.
This pattern shows the limits of simple explanations such as “cheap labor.” Briefly di