1.1 How People Make Decisions

• People Face Trade-Offs

• In order to get one thing we like, we usually have to give up another thing we like in return

• EFFICIENCY V.S. EQUALITY (Societal Trade-Offs)

  • Efficiency- the property of society getting the most it can from its scarce resources

  • Equality- the property of distributing economic prosperity uniformly among the members of society

• In terms of government policies, such as the welfare system or unemployment insurance, it requires those who are financially successful to contribute more than others to support the government.

• This achieves greater equality but reduces efficiency. In order to make the best decisions when facing Trade-Offs, understanding the available options is most important.

• The Cost of Something Is What You Give Up to Get It

• Opportunity cost- the cost of an item that you would give up to retrieve that item

  • When making any decision, decision-makers should be aware of the opportunity cost

• Making decisions requires comparing the costs and benefits of the alternative choices

• Rational People Think at the Margin

• Rational people systematically and purposefully do the best they can to achieve their objectives when given the opportunity.

• Marginal change- a small increment adjustment to an existing plan of action

  • Rational people often make decisions by comparing marginal benefits and marginal costs

• People Respond to Incentives

• Incentive- something that reduces a person to act

  • An example would be the prospect of a punishment or a reward.

• Rational people make decisions by comparing costs and benefits, and they respond to incentives.

• Crucial to analyze how markets work.

• Public policies reflect on the public

• By altering its costs or benefits, which will influence their behavior.

• An example would be a tax on gasoline: encouraging people to drive smaller, more fuel-efficient cars, carpool, take public transportation, live closer to where they work, etc.

• Policymakers fail to consider how the policies affect incentives that may end up with unintended consequences

  • An example would be seat belts in automobiles.

• Its intended purpose was regarding the speed and care when drivers operate their cars.

• Though seat belts reduce deaths in car accidents, people are less cautious when driving. Driving slowly drains drivers’ time and energy. Therefore, it's considered that seat belts alter drivers’ cost-benefit calculations. People respond to seat belts as they would to an improvement in road conditions—by driving faster and less carefully. Pedestrians are more likely to be found in car accidents because they have no added protection.

1.2 How People Interact

• Trade Can Make Everyone Better Off

• The misinterpretation of different companies competing to be “better” and the “winner.”Companies benefit from each other in the economy rather than isolating themselves from its competitors. That would result in starting from nothing, requiring them to make their own resources.

• Trading allows each person to specialize in the activities they do best, while others can buy a greater variety of goods and services.

• Markets Are Usually A Good Way to Organize Economic Activity

• Market Economy- the decisions of a central planner are replaced by the decisions of millions of firms and households.

• Households and firms interacting in markets act as if they are guided by an “invisible hand” that leads them to desirable market outcomes

  • The invisible hand directs economic activity

• Buyers look at the price when determining how much to demand, and sellers look at the price deciding how much to supply.

  • Decisions that both the buyers and sellers make reflect on the value and cost to the society of making the good.

• Governments Can Sometimes Improve Market Outcomes

• The “invisible hand” can work its magic only if the government enforces the rules and maintains the institutions

  • Enforcing property rights

• The ability of an individual to own and exercise control over scarce resources

• We rely on government-provided police and courts to enforce our rights over the things we produce- and the invisible hand counts on our ability to enforce our rights

• The government intervenes in the economy to promote efficiency or to promote equality

• Most policies aim to enlarge or change how the pie is divided

• Market failure- a situation in which the market on its own fails to produce an efficient allocation of resources

• Possible: market power- the ability of a single economic actor (or small group of actors) to have a substantial influence on market prices

1.3 How the Economy as a Whole Works

• A Country’s Standard of Living Depends on Its Ability to Produce Goods and Services

• Variation in living standards depends on a country’s productivity

• The number of goods and services produced from each unit of labor input

• Some citizens from high-income countries may own more cars, have better nutrition, and better health care than citizens of low-income countries.

• Prices Rise When the Government Prints Too Much Money

• Inflation- an increase in the overall level of prices in the economy

  • High inflation imposes various costs on society

• Keeping inflation at a low level is a goal of all policymakers

• Inflation occurs when a government creates large quantities of the nation’s currency, which leads to the fall of value in the currency

• Society Faces a Short-Run Trade-Off between Inflation and Unemployment

• The long-run effect of higher levels of prices affects the quantity of money.

• Short-run effects

• Increasing the amount of money in the economy stimulates the overall level of spending and demand for goods and services

• Higher demands cause firms to raise prices while encouraging them to hire more workers that can produce more goods

• More hiring= low unemployment

• The business cycle- fluctuations in economic activity (employment and production)