TEN PRINCIPLES OF ECONOMICS Chapter 1 1

The word Economy . . . Comes from a Greek word for “one who manages a household.” Here are some questions that need answers Who will work? What goods and how many of them should be produced? What resources should be used in their production? At what price should the goods be sold? Who should get the goods produced? 2

Scarcity . . . Scarcity is a key word to understand economics It means that society has less to offer than people wish to have Managing the resources of society is important because resources are scarce Economics is the study of how society manages its scarce resources How people make decisions How people interact with each other The forces and trends that affect the economy as a whole 5

Ten Principles of Economics The first group of principles look at the individuals in the society Our aim is to understand how people make decisions of economic nature We divide this group into four principles 1. People face tradeoffs 2. The cost of something is what you give up to get it. 3. Rational people think at the margin. 4. People respond to incentives. 7

Ten Principles of Economics The second group of principles look at the interaction of individuals in the society Our aim is to show the effects of the way people interact with one another 5. Trade can make everyone better off. 6. Markets are usually a good way to organize economic activity. 7. Governments can sometimes improve economic outcomes. 7

Ten Principles of Economics The third group of principles look at the behaviour of the whole society What happens at the whole economy has an effect on individuals and their interaction How the Economy as a Whole Works 8. The standard of living depends on a country’s production 9. Prices rise when the government prints too much money 10. Society faces a short-run tradeoff between inflation and unemployment 7

1. People face tradeoffs To get one thing, we usually have to give up another thing Guns vs. butter Food vs. clothing Leisure time vs. work Efficiency vs. equity Efficiency means society gets the most it can from its scarce resources. Equity means the benefits of those resources are distributed fairly among the members of society.

2. The cost of something is what you give up to get it. Decisions require comparing costs and benefits of alternatives College vs. work Sleeping vs. studying Cinema vs. football game Opportunity cost is what you give up to obtain some item The final real cost of everthing is its oportunity cost 10

3. Rational people think at the margin. Marginal thinking plays a crucial role in economic actions By “marginal” we mean small changes to an existing plan of action The word “incremental” ise also used Individuals make decisions by comparing the costs and benefits at the margin The last item therefore becomes very important 11

4. People respond to incentives. Marginal changes in costs or benefits motivate people to respond The decision to choose one alternative over another occurs when MB > MC MB = Marginal Benefits MC = Marginal Costs When they realise that the incentives have changed, economic actors take different decisions 12

5. Trade can make everyone better off People gain from their ability to trade with one another If there is competition in trading, then every party gains from trade Trade allows people to specialize in what they do best Specialisation is the key to modern society And the high levels of income that modern societies enjoy 15

6. Markets are usually a good way to organize economic activity. Specialisation requires the exchange of products of specialised producers One way of doing it is caled the market economy In a market economy Households decide what to buy and who to work for Firms decide who to hire and what to produce Households and firms interact is as if guided by an “invisible hand” 16

7. Governments can sometimes improve market outcomes. If markets fail (break down), government can intervene to promote efficiency and equity Market failure occurs when the market can not allocate resources efficiently Market failure may be caused by an externality, which is the impact of one person or firm’s actions on the well-being of a bystander Market failure may also be caused by market power, which is the ability of a single person or firm to unduly influence market prices 17

8. The standard of living depends on a country’s production. Standard of living may be measured in different ways: By comparing personal incomes By comparing the total market value of a nation’s production Almost all variations in living standards are explained by differences in the productivity level of different countries Productivity is the amount of goods and services produced from each hour of a worker’s time 21

9. Prices rise when the government prints too much money. Inflation is an increase in the overall level of prices in the economy Some countries in some periods have high levels of inflation Turkey has the highest inflation among comparable countries in the world Usually the growth in the quantity of money is the major cause of inflation In other words inflation happens because government prints too much money 23

òInflation ð ñUnemployment 10. Society faces a short-run tradeoff between inflation and unemployment. For many economies there exist a strong relation between the change in the level of unemployment and change in inflation The Phillips Curve summarises the relation òInflation ð ñUnemployment It’s a short-run tradeoff that applies to normal situations Higher inflation becomes the opportunity cost of lower inflation At other times the relationship may break down 24

Conclusion When individuals make decisions, they face tradeoffs Rational people make decisions by comparing marginal costs and marginal benefits People can benefit by trading with each other. Markets are usually a good way of coordinating trades Government can potentially improve market outcomes Inflation results from increases in the quantity of money