Definitions- Introduction:
The economy: Well-functioning system for coordinating productive activities – the
activities that create the goods and services people want and get them to the people
who want them.
Economics: Social science that studies the production, distribution, and consumption
of goods and services.
A market economy: Market in which production and consumption are the result of
decentralized decisions by many firms and individuals. Each individual producer
makes what he or she thinks will be most profitable and each consumer buys what he
or she chooses.
A command economy: Economy in which there is a central authority making decisions
about production and consumption.
The term invisible hand: Used to refer to the way a market economy manages to
harness the power of self-interest for the good of society.
Microeconomics: Study of how individuals make decisions and how these decisions
interact.
Promoting: Individuals pursuing their own interests often do promote the interests of
society as a whole (Adam Smith).
A market failure: When the individual pursuit of one’s own interest, instead of
promoting the interests of society, can make society worse off.
A recession: Downturn in the economy.
Macroeconomics: Concerned with the overall ups and downs of the economy.
Economic growth: Growing ability of the economy to produce goods and services.
,Macroeconomics: Chapter 1
All economic analysis is based on a set of common principles that apply to many
different issues.
Although all economics at a basic level is about individual choices, to understand how
market economies, behave we must also understand economic interaction, how my
choices affect your choices.
Individual choice are decisions by an individual about what to do and what not to do.
All economic activities involve individual choice.
Principles of Individual Choice
1. Choices are necessary because resources are scarce
a. Limited income is something that keeps people from everything they want.
b. But time is also a limited supply(choosing to spend time on one activity also
means choosing not to spend time on a different activity).
c. People must make choices because resources are scarce.
d. A resource is anything that can be used to produce something else (land,
labour, capital, and human capital)
i. A resource is scarce when there’s not enough of the resource available
to satisfy all the ways a society wants to use it.
ii. Natural resources(minerals) and human resources(intelligence).
iii. The scarcity of resources means that society must make choices.
2. Opportunity Cost: The opportunity cost is what you must give up getting an item you
want.
a. The opportunity cost of an item- what you must give up getting it – is its true
cost.
b. In the end, all costs are opportunity costs.
c. The opportunity cost of a choice is what you forgo by not choosing your next
best alternative.
3. ‘How much’ is a decision at the margin
a. A trade-off is a comparison of costs and benefits.
b. Marginal decisions are decisions about whether to do a bit more or less of an
activity, like what you do with your next hour, your next dollar etc. The study
of such decisions is known as marginal analysis.
c. ‘How much’ decisions require making trade-offs at the margin, comparing the
costs and benefits of doing a little bit more of an activity versus doing a little
bit less.
4. People usually respond to incentives, exploiting opportunities to make themselves
better off
a. An incentive is anything that offers rewards to people who change their
behaviour, an opportunity to make themselves better off.
b. People usually respond to incentives, exploiting opportunities to make
themselves better off.
An economy is a system for coordinating the productive activities of many people.
Interaction of choices- my choices affect your choices and vice versa- is a feature of most
,economic situations. The results of this interaction are often quite different from what the
individuals intend.
Principles of the interaction of individual choices
5. There are gains from trade
a. The key for a much better standard of living is trade, in which people divide
tasks among themselves and each person provides a good or service that other
people want in return for different goods and services that he or she wants.
b. Gains from trade: by dividing tasks and trading, two people can each get more
of what they want than they could get by being self-sufficient.
c. There are gains from trade.
d. Gains from trade arise from this division of tasks called specialization, a
situation in which different people each engage in a different task, specializing
in those task that they are good at performing.
e. The economy can produce more when each person specializes in a task and
trades with others.
f. Markets are what allow a doctor and a pilot to specialize in their own fields
6. Markets move toward equilibrium: A situation in which individuals cannot make
themselves better off by doing something different.
a. People will exploit opportunities to make themselves better off
a. An economic situation is in equilibrium when no individual would be better off
doing something different.
b. Because people respond to incentives, markets move toward equilibrium.
c. Markets usually reach equilibrium via changes in prices, which rise or fall until
no opportunities for individuals to make themselves better remain.
d. The concept of equilibrium is extremely helpful in understanding economic
interactions because it provides a way of cutting through the sometimes
complex details of those interactions.
e. The fact that markets move toward equilibrium is why we can depend on them
to work in a predictable way.
7. Resources should be used efficiently to achieve society’s goals
a. An economy’s resources are used efficiently when they are used in a way that
has fully exploited all opportunities to make everyone better off.
b. An economy is efficient if it takes all opportunities to make some people better
off without making other people worse off.
c. When an economy is efficient, it is producing the maximum gains from trade
possible given the resources available.
d. Resources should be used as efficiently as possible to achieve society’s goals.
e. Equity means that everyone gets his or her fair share. Since people can
disagree about what’s fair, equity isn’t as well defined as a concept as
efficiency.
f. Policies that promote equity often come at a cost of decreased efficiency in the
economy.
8. Markets usually lead to efficiency
, a. In a market economy, in which individuals are free to choose what to consume
and what to produce, people normally take opportunities for mutual gain, gains
from trade.
i. Because people usually exploit gains from trade, markets usually lead
to efficiency.
b. In cases of market failure- the market income is inefficient.
9. When markets don’t achieve efficiency, government intervention can improve
society’s welfare
a. When markets go wrong, an appropriately designed government policy can
sometimes move society closer to an efficient outcome by changing how
society’s resources are used.
b. How society’s fail:
i. Individual actions have side effects that are not properly considered by
the market.
ii. One party prevents mutually beneficial trades from occurring to capture
a greater share of resources for itself.
iii. Some goods, by their very nature, are unsuited for efficient
management by markets.
10. One person’s spending is another person’s income
a. In a market economy, people make a living selling things- including their
labour to other people. If some group in the economy decides, for whatever
reason, to spend more, the income of other groups will arise. If some groups
decide to spend less, the income of other groups will fall.
b. Cut in business investment spending > reduced family incomes > reducing
consumer spending > income cuts > and so on.
11. Overall spending sometimes gets out of line with the economy’s productive capacity
c. The amount of goods and services that consumers and businesses want to but
sometimes doesn’t match the amount of goods and services the economy can
produce
d. Inflation is the rise in prices throughout the economy.
e. Refers to both inflation and depression
12. Government policies can change spending
f. Government policies can dramatically affect spending.
g. The government does a lot of spending on everything from military equipment
to education.
h. Government spending, taxes and control of money are the tools of
macroeconomics policy.
