The Five Foundations of Economics Ch1 PDF

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The Five Foundations of Economics 

09/02/2015

What Is Economics  Economists study how decisions are made o Society as a whole must determine what to produce from its limited set of resources 

Scarcity o The term used to describe the limited nature of society’s resources

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Economics is the study of how people allocate their limited resources to satisfy their nearly unlimited wants

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Microeconomics & Macroeconomics o Microeconomics is the study of the individual units that make up the economy o Macroeconomics is the study of the overall aspects & workings of an economy, such as inflation, growth, employment, interest rates, & the productivity of the economy as a whole

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What Are the Five Foundations of Economics?  Incentive, trade-offs, opportunity cost, marginal thinking, & the principle that trade creates value o These are the key components of economics  Incentives o Incentives are factors that motivate you to act or to exert effort  Help you make decisions o 2 paired categories: positive & negative, direct & indirect  positive & negative  positive encourage action  end of the year bonuses  negative encourage action  the fear of a speeding ticket makes drivers drive slowly  

positive incentives usually need to be coupled with negative incentives in order to work

direct & indirect incentives  direct incentives are easy to recognize

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lowering gas prices may get more customers to stop

indirect incentives are harder to recognize  usually creates an unintended consequence

How Incentives Create Unintended Consequences o Australia created a “baby bonus” for all babies born after July 1, 2014  Couples would try to delay the birth of their children until after this date, potentially harming the baby & the mother o Incentives & Innovation  Incentives play a role in innovation, the engine of economic growth  The patent system & copyright laws guarantee inventors a specific period of time in which they can exclusively sell their work  Creates a power financial reward for creativity 

Illegal downloads reduce the incentive to produce new content o Incentives Are Everywhere  Financial gain almost always plays a prominent role  Watergate scandal 

Trade-Offs o Each & every decision incurs a cost o Trade-offs are an important part of policy decisions the cost of pollution control might cause strain on the economy

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Opportunity Cost o The highest-valued alternative that must be sacrificed in order to get something else  The key to making the best possible decision is to minimize your opportunity cost by selecting the option that gives you the largest benefit o Economists consider if the alternatives are better than what you are currently doing

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Marginal Thinking o Economic thinking

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The process of systematically evaluating a course of action

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Involves a purposeful evaluation of the available opportunities to make the best decision possible o Marginal analysis is used to break down decisions into smaller parts  Usually about doing more or less of something o Marginal thinking requires decision-makers to evaluate whether the benefit of one more unit of something is greater than its cost  People weigh the costs & benefits of their actions & chose to do the things with the greatest payoff 

Trade o Markets bring buyers & sellers together to exchnage involved trading goods & services for other goods & services , into more sophisticated systems that use cash, credit, & other financial instruments o Trade is the voluntary exchnage of goods & services between two or more parties  Voluntary trade among rational individuals creates value for everyone involved o Comparative advantage refers to the situation in which an individual, business, or country can produce at a lower opportunity cost than a competitor can  Harnesses the power of specialization  Trading of specialized services increases the welfare of everyone in society  Specialization happens at the country level too

09/02/2015 

09/02/2015 ...