Seven Principals of Economics
& Economic Systems
Seven Principles of Economic Thinking
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Scarcity forces trade-offs
Costs versus benefits
Thinking at the margin
Incentives matter
Trade makes people better off
Markets coordinate trade
Future consequences count
Scarcity forces trade-offs
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Scarcity is most basic problem of economics
It forces people to decide how to use limited
resources to fill unlimited needs/wants
Tradeoffs are what you give up to buy or do
something else
What was the scarcity forces tradeoff decision
you made this morning?
Costs vs. Benefits
People only choose something
when its expected costs are less
than it expected benefits.
Decisions require comparing
costs and benefits of alternatives.
Whether to buy Starbucks coffee
instead of brewing their own
coffee at home?
Whether to go to college or to
work?
Whether to study or go out on a
date?
Whether to go to class or sleep
in?
Thinking at the margin
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Similar to costs vs. benefits
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you are looking at if one more unit of input
improves/hurts my output
Deciding whether to do or use one additional unit
of some resource.
Basically, it is an analysis to find the optimal return
on actions.
Should you study one more hour for this test
or go to bed?
Incentives matter
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People respond to incentives in generally predictable ways.
There is evidence that people respond significantly to
incentives even in situations where we do not usually imagine
their behavior to be rational.
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Apparently psychologists have discovered by experiment that when
you hand a person an unexpectedly hot cup of coffee, he typically
drops the cup if he perceives it to be inexpensive but manages to hang
on if he believes the cup is valuable.
Why do you stand in line for hours at Christmas to buy newest video
game or electronic device?
Trade makes
people
better off
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We end up with more and better products by trading
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You trade your ham and cheese sandwich for a peanut butter
and jelly sandwich.
Suppose I am in the market for a new laptop computer. If I am
permitted to trade freely with anyone in the world, I will
choose the computer that best fits my preferences.
What if that trade made someone lose their job at HP?
Are both people involved in both situations happy?
Markets coordinate trade
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Markets are defined as anything where buyers and sellers
are brought together to do business with each other
 examples include flea markets, e-bay, stores, garage
sales
Buyers and sellers can trade with each other until both
parties leave satisfied. This leads to the efficient use of
market systems.
Adam Smith made the observation that households and
firms interacting in markets act as if guided by an “invisible
hand.”
Future consequences count
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Decisions made today have consequences in the future
Law of unintended consequences occurs when a
decision is made and the effects were not expected or
the opposite of what was expected.
Raising speed limit to 75 may “encourage” drivers to
drive even faster.
Economic goals
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Answers come from these goals and how they are
ranked:
 Freedom – make own economic decisions
 Security – provide less fortunate members with
basic needs
 Stability – goods/services we need are provided
 Equity – fair & just distribution of society's wealth
 Growth – improve standard of living
 Efficiency – makes most of resources (full
employment)
3 Basic Economic Questions
What are you going to make?
 Who are you making it for?
 How are you going to make it?
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Who answers the 3 questions?
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Traditional – based on
customs, traditions, culture
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Command – government
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Highest goals are economic
security & stability
Main goal was economic
stability & accumulation of
wealth
Market – millions of
individuals acting
independently
Market Economies
Also known as freemarket or capitalist
 What are the
benefits of living in
the United States?
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• Get to pick your own
job
• Competition
• Choices
Socialism & Communism
Founded by Karl Marx & Friederich
Engels
 Answer to working conditions in
capitalist countries
 Socialism – society owns property
 Communism – final phase of
socialism where government owns
property and wealth and no classes
are left
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Communism
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Economic planning –
government planned
all aspects of
economy
Did not allow for
private ownership
Led to shortages
and/or few choices
No incentives for
workers to produce
high quality
goods/services
Mixed Economies
Most economies in world today are mixed –
some government, some private
 How much government involvement depends
on country
 In United States – it is limited in some areas
and more involved in others
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• Child labor laws, OSHA
• Competition, choice in market, private property
Key Characteristics of
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Economic freedom
Competition
Equal Opportunity
Binding contracts
Property rights
Profit motive
Limited government