CHAPTER 1: INTRODUCTION
Dr. Widad Soufi


Economics is the study of choices that
economic agents (households, firms,
governments) must make as they use scarce
resources under the influence of incentives.
Large and complex subject to be understood
through ten principles
1. Every choice that people face involves a trade-off.
Definition:
Whenever we choose to get more of something or do
more of some activity, we have to forgo something
else.
Examples:
- Consumption vs. Saving
- Production vs. Research
- Work vs. Education
- Efficiency vs. Equity
Efficiency:
Noone in society can be made better off without
making someone else worse off.

Equity:
Everyone in society receives an equal share of
what the society produces

2. Every trade-off implies an opportunity cost.
Definition:
The opportunity cost is whatever needs to be forgone
when one gets more of something or does more of
some activity.
Examples:
What is the opportunity cost of a trip to NYC?
What is the opportunity cost of a cup of coffee?
What is the opportunity cost of studying?
3. When making choices, people think at the margin.
Definition:
People evaluate the effect of an incremental increase of
something or some activity before making a decision.
The benefit from getting more of something or doing
more of an activity is called the marginal benefit.
The opportunity cost of getting more of something or
doing more of an activity is the marginal cost.
Examples:
- Studying vs. Playing sports
- Producing cheese vs. Producing yogurt
4. People respond to incentives.
Definition:
When the marginal benefit is higher (lower) than the
marginal cost of an additional unit of some item, then
we have an incentive to get more (less) of the item.
Examples:
- Studying vs. Playing sports
- Producing cheese vs. Producing yogurt
5. Trade increases welfare.
Definition:
International trade of goods and services allows
countries to specialize, exchange, and buy more at
lower prices. So, countries are better off from
engaging in trade.
Example:
Household/plumber
6. Economic activity is better organized through the decentralized
decisions of many households and firms that interact in markets.
Adam Smith: « invisible hand »
How does the « invisible hand » work?
Rational interest
-
Utility maximization
Profit maximization
Conditions:
-
Voluntary exchange
Protection of property rights
The invisible hand produces efficiency (although not always), but it
does nothing about equity.
When does the invisible hand not work?
When the government intervenes in the market (e.g. to
improve equity), it prevents the price from adjusting in
response to a shortage or surplus.
Examples:
- Communist system where prices are set
- Government policies distording the market price:
- Taxes and subsidies
- Quotas
- Price floor or ceiling
7. Governments can improve market efficiency.
There are situations where resources are not allocated in the best possible
way, so the invisible hand does not work and the market fails to achieve an
efficient outcome.
Such situations are as follows:
- imperfect information
- externalities
- imperfect competition
- public goods
- commons
In these cases the government may intervene to improve efficiency.
The government may also intervene to improve equity (see above) because
the invisible hand does nothing about welfare distribution. It is only
concerned with efficiency.
8. A country’s living standard depends on its
workers’ productivity.
Definition:
The productivity is the amount of goods and services
produced by each unit of labor.
Productivity depends on:
Education
Capital
Technology.
9. Prices rise when the government supplies more
money.
Definition:
Inflation is the sustained increase in the average price
level.
Inflation is often caused by a rapid money growth.
Inflation is usually feared by governments as it
imposes costs on society and hence reduces efficiency.
10. There exists a short run trade-off between
inflation and unemployment.
Definition:
The Phillips curve describes the negative relationship
between inflation and unemployment.
There is a large agreement among economists that
this relationship only exists in the short-run.
Why?
The main reason for the short-run trade-off between
unemployment and inflation is the fact that in the
short-run prices are sticky (prices adjust slowly to
changes in government policies).
Thus, when money growth increases (so inflation
rises) and prices are sticky low, people spend more,
so firms sell more, so they hire more labor and
unemployment falls.
In the long-run, prices are flexible, so the long-run
effects of government policies are likely different
from their short-run effects.
1.
2.
3.
4.
What is the opportunity cost of seeing a movie
Why should policy makers think about
incentives?
What does the invisible hand of the market
place do?
Why is productivity important?

Solve the following problems: 3, 6, 9, 11, 15

Mankiw, Gregory. Principles of
Macroeconomics. Third edition.