Ch.1
Macroeconomics – Principles of Macroeconomics
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Economics: The study of how society manages its scarce resources
Scarcity: The limited nature of society’s resources.
Economists study how people make decisions…
o How much do they buy.
o What they buy.
o How much do they save.
o How they invest their savings.
Principle 1: Tradeoffs
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Everyone cannot have everything.
Efficiency: The property of society getting the most it can from its scarce resources.
Equity: The property of distributing economic prosperity fairly among the members of society.
Principle 2: The Cost of Something is What you Give up Getting it.
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Opportunity Cost: Whatever must be given up obtaining some item.
Principle 3: Rational People Think at the Margin.
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Rational People: Those who systematically and purposefully do the best they can to achieve
their objectives.
Marginal Changes: Small incremental adjustments to a plan of action.
Principle 4: People Respond to Incentives.
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Incentive: Something that induces a person to act.
Principle 5: Trade Can Make Everyone Better Off
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Trade allows countries to specialize in what they do best.
Allows countries to enjoy a greater variety of goods.
Trade between two countries both better off.
Principle 6: Markets Are Usually a Good Way to Organize Economic Activity
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Market Economy: An economy that allocates resources through the decentralized decisions of
many firms and households as they interact in markets for G/S.
Adam smith and the invisible hand, households acting in their own self interest led to the most
desirable outcomes.
Principle 7: Governments Can Sometimes Improve Market Outcomes.
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We need a government for two reasons…
o Enforce property rights.
 Property Rights: The ability of an individual to own ad exercise control over
scarce resources.
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o
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To intervene in the economy
 Promote efficiency where market failure and promote equity.
Market Failures: A situation in which a market left on its own fails to allocate resources
efficiently.
o Externality: The impact of one person’s actions on the well-being of a bystander.
(pollution)
o Market Power: the ability of a single economic actor (or small groups of actors to have a
substantial influence on market prices. (monopoly)
Principle 8: A Country’s Standard of Living Depends on Its Ability to Produce G/S.
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Productivity: The quantity of G/S produces from each hour of a worker’s time.
Principle 9: Prices Rise When the Government Prints Too Much Money
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Inflation: An increase in the overall level of prices in the economy.
Principle 10: Society Face a Short-Run Trade-off between Inflation and Unemployment.
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Business Cycle: Fluctuations in economic activity, such as employment and production.
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