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8 ❖ Chapter 1/Ten Principles of Economics
© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
a. Definition of market failure: a situation in which a market left on its own fails to
allocate resources efficiently.
4. Examples of Market Failure
a bystander.
b. Definition of market power: the ability of a single economic actor (or small
c. Because a market economy rewards people for their ability to produce things that other
people are willing to pay for, there will be an unequal distribution of economic well-
being.
5. Note that the principle states that the government
can
improve market outcomes. This is not
saying that the government always
does
improve market outcomes.
IV. How the Economy as a Whole Works
A. Principle #8: A Country’s Standard of Living Depends on Its Ability to Produce Goods and
Services
4. Definition of productivity: the quantity of goods and services produced by each unit
of labor input.
6. Thus, policymakers must understand the impact of any policy on our ability to produce goods
and services.
7.
In the News: Why You Should Study Economics
consequences.
b. This is an excerpt from a commencement address by Robert D. McTeer, Jr., the former
economics.
B. Principle #9: Prices Rise When the Government Prints Too Much Money
2. When the government creates a large amount of money, the value of money falls, leading to
price increases.
Chapter 1/Ten Principles of Economics ❖ 9
3. Examples: Germany after World War I (in the early 1920s) and the United States in the
1970s.
1. Most economists believe that the short-run effect of a monetary injection is lower
unemployment and higher prices.
2. The short-run trade-off between inflation and unemployment plays a key role in the analysis
of the business cycle.
3. Definition of business cycle: fluctuations in economic activity, such as employment
and production.
4. Policymakers can exploit this trade-off by using various policy instruments, but the extent
5. This debate heated up during the early years of Obama’s presidency. The severe downturn in
the economy led policymakers to try to stimulate demand, but some feared that the end
result would be inflation.
10 ❖ Chapter 1/Ten Principles of Economics
SOLUTIONS TO TEXT PROBLEMS:
Quick Quizzes
1. There are many possible answers.
2. A country is better off by trading because trade allows more goods and services to be produced
failures are market power and externalities.
short-term ability to exploit this relationship using various policy instruments.
Activity 2—So Many Things to Do, So Little Time
Type: In-class assignment
Topics: Trade-offs, opportunity cost, thinking at the margin, incentives
Materials needed: None
Time: 10 minutes
Class limitations: Works in any class size
Give students a list of activities with corresponding time requirements: sleep, 8 hours; sleep,
6 hours; eat breakfast, 30 minutes; ride a bike, 1 hour; go hiking, 2 hours; study, 3 hours;
study, 2 hours; go to class, 4 hours; go to class, 6 hours; watch TV, 2 hours; watch TV, 6
hours; take a nap, 1 hour; work, 8 hours; work, 4 hours; etc.
Make sure that there are many choices and that there are many pleasurable experiences—too
much for a 24-hour period.
Ask students which Principles of Economics this activity illustrates.
If they do not say 1, 2, 3, and 4, help them see that this exercise has trade-offs in the choices
they make, that each choice has an opportunity cost, that deciding whether or not to sleep 4
more hours may depend on whether you have already slept for 6, and that choices may be
influenced by the incentives the student faces. For example, a student who is about to be
placed on academic probation has an incentive to study harder.
Chapter 1/Ten Principles of Economics ❖ 11
Questions for Review
1. Examples of trade-offs include time trade-offs (such as studying one subject over another or studying
2. To figure out the opportunity cost of a vacation to Disney World, you would include the monetary
3. The marginal benefit of a glass of water depends on your circumstances. If you have just run a
marathon or you have been walking in the desert sun for three hours, the marginal benefit is very
5. Trade among countries is not a game with some losers and some winners because trade can make
everyone better off. By allowing specialization, trade between people and trade between countries
can improve everyone’s welfare.
6. The “invisible hand” of the marketplace represents the idea that even though individuals and firms
society as a whole.
7. The two main causes of market failure are externalities and market power. An externality is the effect
8. Productivity is important because a country’s standard of living depends on its ability to produce
9. Inflation is an increase in the overall level of prices in the economy. Inflation is caused by increases
in the quantity of a nation’s money.
10. Inflation and unemployment are negatively related in the short run. Thus, reducing inflation entails
Quick Check Multiple Choice
© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Problems and Applications
1. a. A family deciding whether to buy a new car faces a trade-off between the cost of the car and
mean saving time by avoiding multiple trips.
b. For a member of Congress deciding how much to spend on national parks, one trade-off is
between parks and other spending items or tax cuts. If more money goes into the park
d. In deciding how much to prepare for class, a professor faces a trade-off between the value
of improving the quality of the lecture compared to other things she could do with her time,
such as working on additional research or enjoying some leisure time.
with a loan.
2. When the benefits of something are psychological, such as going on a vacation, it is not easy to
compare benefits to costs to determine if it is worth doing. But there are two ways to think about the
benefits. One is to compare the vacation with what you would do in its place. If you did not go on
3. If you are thinking of going skiing instead of working at your part-time job, the cost of skiing includes
is its monetary and time costs including the value of time spent studying.
Chapter 1/Ten Principles of Economics ❖ 13
5. The fact that you have already sunk $5 million is not relevant to your decision anymore, because that
money is gone. What matters now is the chance to earn profits at the margin. If you spend another
6. a. The provision of Social Security benefits lowers an individual’s incentive to save for retirement.
The benefits provide some level of income to the individual when she retires. This means that the
individual is not entirely dependent on savings to support consumption through the years in
retirement.
discourages work effort after age 65.
7. a. When welfare recipients have their benefits cut off after two years, they have a greater incentive
to find jobs than if their benefits were to last forever.
increases efficiency but reduces equality.
9. a. If everyone were guaranteed the best healthcare possible, much more of our nation’s output
would be devoted to medical care than is now the case. Would that be efficient? If you believe
that doctors have market power and restrict health care to keep their incomes high, you might
think efficiency would increase by providing more healthcare. But more likely, if the government
b. When workers are laid off, equality considerations argue for the unemployment benefits system
to provide them with some income until they can find new jobs. After all, no one plans to be laid
14 ❖ Chapter 1/Ten Principles of Economics
© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
off, so unemployment benefits are a form of insurance. But there is an efficiency problemwhy
work if you can get income for doing nothing? The economy is not operating efficiently if people
remain unemployed for a long time, and unemployment benefits encourage unemployment.
Thus, there is a trade-off between equality and efficiency. The more generous unemployment
benefits are, the less income is lost by an unemployed person, but the more that person is
encouraged to remain unemployed. So greater equality reduces efficiency.
10. Because average income in the United States has roughly doubled every 35 years, we are likely to
standard of living.
11. If Americans save more and it leads to more spending on factories, there will be an increase in
production and productivity, because the same number of workers will have more equipment to work
with. The benefits from higher productivity will go to both the workers, who will get paid more
12. When governments print money, they impose a “tax” on anyone who is holding money, because the
value of money is decreased.
