1 TEN PRINCIPLES OF ECONOMICS
WHAT’S NEW IN THE SIXTH EDITION:
There is a new Case Study on ―The Incentive Effects of Gasoline Prices.‖ Principle 10 on the Short-Run
Trade-off Between Inflation and Unemployment has been updated to reflect changes in the economy in
2008–2009 and some of the response from the Obama administration.
LEARNING OBJECTIVES:
By the end of this chapter, students should understand:
that economics is about the allocation of scarce resources.
that individuals face trade-offs.
the meaning of opportunity cost.
how to use marginal reasoning when making decisions.
how incentives affect people’s behavior.
why trade among people or nations can be good for everyone.
why markets are a good, but not perfect, way to allocate resources.
what determines some trends in the overall economy.
CONTEXT AND PURPOSE:
Chapter 1 is the first chapter in a three-chapter section that serves as the introduction to the text.
Chapter 1 introduces ten fundamental principles on which the study of economics is based. In a broad
sense, the rest of the text is an elaboration on these ten principles. Chapter 2 will develop how
economists approach problems while Chapter 3 will explain how individuals and countries gain from
trade.
The purpose of Chapter 1 is to lay out ten economic principles that will serve as building blocks for
the rest of the text. The ten principles can be grouped into three categories: how people make decisions,
how people interact, and how the economy works as a whole. Throughout the text, references will be
made repeatedly to these ten principles.
1
© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from
the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.
,2 ❖ Chapter 1/Ten Principles of Economics
KEY POINTS:
The fundamental lessons about individual decisionmaking are that people face trade-offs among
alternative goals, that the cost of any action is measured in terms of forgone opportunities, that
rational people make decisions by comparing marginal costs and marginal benefits, and that people
change their behavior in response to the incentives they face.
The fundamental lessons about interactions among people are that trade and interdependence can
be mutually beneficial, that markets are usually a good way of coordinating economic activity among
people, and that the government can potentially improve market outcomes by remeding a market
failure or by promoting greater economic equality.
The fundamental lessons about the economy as a whole are that productivity is the ultimate source
of living standards, that growth in the quantity of money is the ultimate source of inflation, and that
society faces a short-run trade-off between inflation and unemployment.
CHAPTER OUTLINE:
I. Introduction
Begin by pointing out that economics is a subject that students must confront in their
daily lives. Point out that they already spend a great deal of their time thinking about
economic issues: changes in prices, buying decisions, use of their time, concerns
about employment, etc.
A. The word ―economy‖ comes from the Greek word oikonomos meaning ―one who manages a
household.‖
B. This makes some sense because in the economy we are faced with many decisions (just as a
household is).
C. Fundamental economic problem: resources are scarce.
You will want to start the semester by explaining to students that part of learning
economics is understanding a new vocabulary. Economists generally use very precise
(and sometimes different) definitions for words that are commonly used outside of
the economics discipline. Therefore, it will be helpful to students if you follow the
definitions provided in the text as much as possible.
D. Definition of scarcity: the limited nature of society’s resources.
E. Definition of economics: the study of how society manages its scarce resources.
Because most college freshmen and sophomores have limited experiences with
viewing the world from a cause-and-effect perspective, do not underestimate how
challenging these principles will be for the student.
© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from
the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.
, Chapter 1/Ten Principles of Economics ❖ 3
As you discuss the ten principles, make sure that students realize that it is okay if
they do not grasp each of the concepts completely or find each of the arguments
fully convincing. These ideas will be explored more completely throughout the text.
II. How People Make Decisions
Table 1
A. Principle #1: People Face Trade-offs
1. ―There ain’t no such thing as a free lunch.‖ Making decisions requires trading one goal for
another.
2. Examples include how students spend their time, how a family decides to spend its income,
how the U.S. government spends tax dollars, and how regulations may protect the
environment at a cost to firm owners.
3. An important trade-off that society faces is the trade-off between efficiency and equality.
a. Definition of efficiency: the property of society getting the maximum benefits
from its scarce resources.
b. Definition of equality: the property of distributing economic prosperity
uniformly among the members of society.
c. For example, tax dollars paid by wealthy Americans and then distributed to those less
fortunate may improve equality but lower the return to hard work and therefore reduce
the level of output produced by our resources.
d. This implies that the cost of this increased equality is a reduction in the efficient use of
our resources.
4. Recognizing that trade-offs exist does not indicate what decisions should or will be made.
B. Principle #2: The Cost of Something Is What You Give Up to Get It
1. Making decisions requires individuals to consider the benefits and costs of some action.
2. What are the costs of going to college?
a. We cannot count room and board (at least all of the cost) because the student would
have to pay for food and shelter even if he was not in school.
b. We would want to count the value of the student’s time because he could be working for
pay instead of attending classes and studying.
3. Definition of opportunity cost: whatever must be given up in order to obtain some
item.
© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from
the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.
, 4 ❖ Chapter 1/Ten Principles of Economics
One of the hardest ideas for students to grasp is that ―free‖ things are not truly free.
Thus, you will need to provide students with numerous examples of such ―free‖
things with hidden costs, especially the value of time. Suggested examples include
the time students spend waiting in line for ―free‖ sporting event tickets at their
universities, time spent relaxing in the sun outside their residence halls, or dinner in
a restaurant with their parents.
C. Principle #3: Rational People Think at the Margin
1. Economists generally assume that people are rational.
a. Definition of rational: systematically and purposefully doing the best you can to
achieve your objectives.
b. Consumers want to purchase the goods and services that allow them the greatest level
of satisfaction given their incomes and the prices they face.
c. Firm managers want to produce the level of output that maximizes the profits the firms
earn.
2. Many decisions in life involve incremental decisions: Should I remain in school this semester?
Should I take another course this semester? Should I study another hour for tomorrow’s
exam?
a. Definition of marginal change: a small incremental adjustment to a plan of
action.
b. Example: Suppose that flying a 200-seat plane across the country costs the airline
$100,000, which means that the average cost of each seat is $500. Suppose that the
plane is minutes from departure and a passenger is willing to pay $300 for a seat. Should
the airline sell the seat for $300? In this case, the marginal cost of an additional
passenger is very small.
c. Another example: Why is water so cheap while diamonds are expensive? The marginal
benefit of a good depends on how many units a person already has. Because water is
plentiful, the marginal benefit of an additional cup is small. Because diamonds are rare,
the marginal benefit of an extra diamond is high.
3. A rational decision maker takes an action if and only if the marginal benefit is at least as
large as the marginal cost.
D. Principle #4: People Respond to Incentives
1. Definition of incentive: something that induces a person to act.
2. Because rational people make decisions by weighing costs and benefits, their decisions may
change in response to incentives.
a. When the price of a good rises, consumers will buy less of it because its cost has risen.
© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from
the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.
WHAT’S NEW IN THE SIXTH EDITION:
There is a new Case Study on ―The Incentive Effects of Gasoline Prices.‖ Principle 10 on the Short-Run
Trade-off Between Inflation and Unemployment has been updated to reflect changes in the economy in
2008–2009 and some of the response from the Obama administration.
LEARNING OBJECTIVES:
By the end of this chapter, students should understand:
that economics is about the allocation of scarce resources.
that individuals face trade-offs.
the meaning of opportunity cost.
how to use marginal reasoning when making decisions.
how incentives affect people’s behavior.
why trade among people or nations can be good for everyone.
why markets are a good, but not perfect, way to allocate resources.
what determines some trends in the overall economy.
CONTEXT AND PURPOSE:
Chapter 1 is the first chapter in a three-chapter section that serves as the introduction to the text.
Chapter 1 introduces ten fundamental principles on which the study of economics is based. In a broad
sense, the rest of the text is an elaboration on these ten principles. Chapter 2 will develop how
economists approach problems while Chapter 3 will explain how individuals and countries gain from
trade.
The purpose of Chapter 1 is to lay out ten economic principles that will serve as building blocks for
the rest of the text. The ten principles can be grouped into three categories: how people make decisions,
how people interact, and how the economy works as a whole. Throughout the text, references will be
made repeatedly to these ten principles.
1
© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from
the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.
,2 ❖ Chapter 1/Ten Principles of Economics
KEY POINTS:
The fundamental lessons about individual decisionmaking are that people face trade-offs among
alternative goals, that the cost of any action is measured in terms of forgone opportunities, that
rational people make decisions by comparing marginal costs and marginal benefits, and that people
change their behavior in response to the incentives they face.
The fundamental lessons about interactions among people are that trade and interdependence can
be mutually beneficial, that markets are usually a good way of coordinating economic activity among
people, and that the government can potentially improve market outcomes by remeding a market
failure or by promoting greater economic equality.
The fundamental lessons about the economy as a whole are that productivity is the ultimate source
of living standards, that growth in the quantity of money is the ultimate source of inflation, and that
society faces a short-run trade-off between inflation and unemployment.
CHAPTER OUTLINE:
I. Introduction
Begin by pointing out that economics is a subject that students must confront in their
daily lives. Point out that they already spend a great deal of their time thinking about
economic issues: changes in prices, buying decisions, use of their time, concerns
about employment, etc.
A. The word ―economy‖ comes from the Greek word oikonomos meaning ―one who manages a
household.‖
B. This makes some sense because in the economy we are faced with many decisions (just as a
household is).
C. Fundamental economic problem: resources are scarce.
You will want to start the semester by explaining to students that part of learning
economics is understanding a new vocabulary. Economists generally use very precise
(and sometimes different) definitions for words that are commonly used outside of
the economics discipline. Therefore, it will be helpful to students if you follow the
definitions provided in the text as much as possible.
D. Definition of scarcity: the limited nature of society’s resources.
E. Definition of economics: the study of how society manages its scarce resources.
Because most college freshmen and sophomores have limited experiences with
viewing the world from a cause-and-effect perspective, do not underestimate how
challenging these principles will be for the student.
© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from
the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.
, Chapter 1/Ten Principles of Economics ❖ 3
As you discuss the ten principles, make sure that students realize that it is okay if
they do not grasp each of the concepts completely or find each of the arguments
fully convincing. These ideas will be explored more completely throughout the text.
II. How People Make Decisions
Table 1
A. Principle #1: People Face Trade-offs
1. ―There ain’t no such thing as a free lunch.‖ Making decisions requires trading one goal for
another.
2. Examples include how students spend their time, how a family decides to spend its income,
how the U.S. government spends tax dollars, and how regulations may protect the
environment at a cost to firm owners.
3. An important trade-off that society faces is the trade-off between efficiency and equality.
a. Definition of efficiency: the property of society getting the maximum benefits
from its scarce resources.
b. Definition of equality: the property of distributing economic prosperity
uniformly among the members of society.
c. For example, tax dollars paid by wealthy Americans and then distributed to those less
fortunate may improve equality but lower the return to hard work and therefore reduce
the level of output produced by our resources.
d. This implies that the cost of this increased equality is a reduction in the efficient use of
our resources.
4. Recognizing that trade-offs exist does not indicate what decisions should or will be made.
B. Principle #2: The Cost of Something Is What You Give Up to Get It
1. Making decisions requires individuals to consider the benefits and costs of some action.
2. What are the costs of going to college?
a. We cannot count room and board (at least all of the cost) because the student would
have to pay for food and shelter even if he was not in school.
b. We would want to count the value of the student’s time because he could be working for
pay instead of attending classes and studying.
3. Definition of opportunity cost: whatever must be given up in order to obtain some
item.
© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from
the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.
, 4 ❖ Chapter 1/Ten Principles of Economics
One of the hardest ideas for students to grasp is that ―free‖ things are not truly free.
Thus, you will need to provide students with numerous examples of such ―free‖
things with hidden costs, especially the value of time. Suggested examples include
the time students spend waiting in line for ―free‖ sporting event tickets at their
universities, time spent relaxing in the sun outside their residence halls, or dinner in
a restaurant with their parents.
C. Principle #3: Rational People Think at the Margin
1. Economists generally assume that people are rational.
a. Definition of rational: systematically and purposefully doing the best you can to
achieve your objectives.
b. Consumers want to purchase the goods and services that allow them the greatest level
of satisfaction given their incomes and the prices they face.
c. Firm managers want to produce the level of output that maximizes the profits the firms
earn.
2. Many decisions in life involve incremental decisions: Should I remain in school this semester?
Should I take another course this semester? Should I study another hour for tomorrow’s
exam?
a. Definition of marginal change: a small incremental adjustment to a plan of
action.
b. Example: Suppose that flying a 200-seat plane across the country costs the airline
$100,000, which means that the average cost of each seat is $500. Suppose that the
plane is minutes from departure and a passenger is willing to pay $300 for a seat. Should
the airline sell the seat for $300? In this case, the marginal cost of an additional
passenger is very small.
c. Another example: Why is water so cheap while diamonds are expensive? The marginal
benefit of a good depends on how many units a person already has. Because water is
plentiful, the marginal benefit of an additional cup is small. Because diamonds are rare,
the marginal benefit of an extra diamond is high.
3. A rational decision maker takes an action if and only if the marginal benefit is at least as
large as the marginal cost.
D. Principle #4: People Respond to Incentives
1. Definition of incentive: something that induces a person to act.
2. Because rational people make decisions by weighing costs and benefits, their decisions may
change in response to incentives.
a. When the price of a good rises, consumers will buy less of it because its cost has risen.
© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from
the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.
