AP Macro/Micro Economics Lesson 1 AP Macro/Micro Economics

Economics The study of how society manages its scarce resources Society must answer 3 economic questions: What is to be produced? How will it be produced? For whom will it be produced?

#1: People face tradeoffs. Scarcity Not being able to have all the goods and services one wants. Limited resources, unlimited wants Every economic resource is scarce What resources did you use to produce the triangles and squares? Economic Resources Land Labor Capital – Goods used to produce other goods Entrepreneurial Ability

Tradeoffs Should a student… Should a family… Should a government… Study economics or work? Should a family… Save for retirement or college? Should a government… Seek efficiency or equity? Spend more on “guns” or “butter”?

#2: The cost of something is what you give up to get it. What is the cost of attending college? The opportunity cost of an item is the next highest valued item forgone (given up) when an economic choice is made. The opportunity cost of using a resource in a particular way is the next-best use of that resource. Whenever someone makes a personal decision to use limited resources, an opportunity cost is incurred

#3: Rational people think at the margin. “Marginal” means “additional” People will take an action if the Marginal Benefit of that action exceeds the Marginal Cost of that action

Marginal Analysis How long should you stay in college? What are the additional benefits of an extra year in college? What are the additional costs of an extra year in college?

#4: People respond to incentives. Behavior changes when costs and benefits change What incentives are created or changed by… Higher gasoline taxes? Offering cash payments for higher grades? Seat belt laws?

#5: Trade can make everyone better off. Voluntary trade only occurs if both sides think they’ll be better off Specialization and trade improves efficiency

#6: Markets are usually a good way to organize economic activity. Market (capitalist) economies historically outperform command (socialist, communist) economies Markets allocate resources and products through the decentralized interaction of many firms and households

Adam Smith The Wealth of Nations, 1776 An “invisible hand” seems to guide households and firms to desirable economic outcomes

#7: Government can sometimes improve market outcomes. Government can correct… Market Failure: situation in which the market does not manage resources efficiently Externality: impact of a market transaction on the well-being of a bystander (e.g. pollution) Market Power: an economic actor’s substantial influence on market prices “CAN” does not mean “WILL”

A Few More… #8: A Country’s Standard of Living Depends on Its Ability to Produce Goods & Services #9 Prices Rise When the Government Prints Too Much Money #10 Society Faces a Short-Run Tradeoff between Inflation and Unemployment

In short… Scarcity creates tradeoffs. Tradeoffs mean opportunity cost. Always compare MB and MC. Incentives affect behavior. Trade is good. Markets are good… …but not perfect. Government can help.