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Ten Principles of Economics (Ch. 1)
ECON 103 – Principles of Microeconomic
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Topics Covered
• Scarcity and Trade-Off
• Opportunity Cost
• Marginal Reasoning
• Incentives
• Market and Government
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Suppose one of your friends rents a booth in Crystal Mall and
bubble tea there. In the past few months, your friend was actumoney. Here is the accounting: she pays a monthly rent of $2,0
booth, materials and labour cost $2,800 per month, and mont
revenues are $4,500.
Your friend does not think the sale will pick up in the near futu
decides to close her business. The only problem is that she stil
month lease remaining.
What suggestions do you have for her?
A Scenario…
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Fundamental economic problem: resources are scarce.
Scarcity: the limited nature of society’s resources.
Economics: the study of how society manages its scarce resou
For example:
• how people decide what to buy, how much to work, save, a
• how firms decide how much to produce, how many worker
• how society decides how to divide its resources between n
defense, consumer goods, protecting the environment, and
needs.
What Economics Is All About
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Making decisions requires trading off one goal against another
Trade-off = To get more of one thing, we have to give up anoth
All decisions involve trade-offs. Examples:
• Going to a party the night before your exam leaves less time
studying.
• Having more money to buy stuff requires working longer ho
leaves less time for leisure.
• Protecting the environment requires resources that could ot
be used to produce consumer goods.
“There is no such thing as a free lunch”
Principle #1: People Face Trade-Offs
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Society faces an important trade-off: efficiency vs. equity
• Efficiency = getting the most from scarce resources• Equity = distributing the benefits of those resources fairly am
members of society
There is a trade-off between efficiency and equity, which mean
increase in equity is associated with in a decrease in efficiency.
The reasons are …
Efficiency vs. Equity
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To achieve greater equity, the government needs to redistribut
from the rich to the poor. But this reduces incentive to work haa result, people would work less and less output will be produc
Efficiency refers to the size of economic pie, and equity refers t
pie is divided. How the pie is divided eventually affects the size
in the sense that when the government tries to cut the econom
more equal slices, the pie gets smaller.
Efficiency vs. Equity
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Opportunity cost: whatever must be given up to obtain some
Word of caution: Economists refer to cost as opportunity cost.
not expenditure or accounting costs, or historical cost, or “wha
for something”.
Opportunity cost is related to scarcity and trade-off. Because o
limited nature of resources, if you want to get more of one thihave to give up another. Whatever you must give up to get the
the opportunity cost of this item. If you have more than one a
the opportunity cost is the value of the best alternative.
Principle #2: The Cost of Something Is What Youto Get It
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• The opportunity cost of seeing a movie is not just the price
ticket, but also the value of the time you spend in the movtheatre.
• The opportunity cost of going to college or university inclu
tuition fees plus foregone income.
Food and rent are not cost of going to college or universit
Application: College dropout billionaires
Examples
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Rational people systematically and purposefully do the best th
achieve their objectives, given the opportunities available.
Rational people make decisions by comparing marginal benef
marginal costs.
Marginal benefit (MB) is the increase in total benefit that aris
additional unit of good, and marginal cost (MC) is the increasecost from an extra unit of good.
Rational people take an action if and only if the marginal bene
action exceeds the marginal cost.
Principle #3: Rational People Think at the Ma
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Notation: ∆ (delta) = “change in…”
Examples:
∆TB = change in total benefits
∆TC = change in total costs
∆ = change in quantity
MB =∆TB
∆
MC =∆TC
∆
Principle #3: Rational People Think at the Ma
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The company that you manage has invested $5 million in deve
new product, but the development is not quite finished. At a rmeeting, your salespeople report that the introduction of com
products has reduced the expected sales of your new product
million. If it would cost $1 million to finish development and m
product, should you complete this project or give up?
Exercise
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You should complete the project. The fact that you've already
million isn't relevant to your decision anymore, since that is a What matters now is the chance to earn profits at the margin.
spend another $1 million (MC = $1 million) and can generate s
million (MB = $3 million) , you'll earn $2 million in marginal pr
you should do so.
Alternatively, you can compare the profit or loss. If you spend additional $1 million, the project has lost a total of $3 million
in total costs and only $3 million in revenue). But if you don't s
additional $1 million, you won't have any sales and your losse
million. You should complete the project by minimizing the los
Answer
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Back to the question on slide 12. Now that you have already s
million in developing the product and you know you will expeanyway. What is the most amount that you should pay to com
project?
Answer: $3 million
A Follow-Up Question
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Diamond Water
Q
$
MV
Q
$
MV
10
$3,000
$0Q D
• Price = MV (marginal value)
• Importance to people’s life = TV (total value)
Example: The Water-Diamond Paradox
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Incentive = something that induces a person to act, such as th
prospect of a reward or punishment.Because people make decisions by comparing marginal costs
marginal benefits, and incentives change their calculation of b
and costs, so they respond to incentives.
Examples:• In response to higher gas prices, sales of hybrid cars rise.
• In response to higher cigarette taxes, the incidence of smok
Principle #4: People Respond to Incentive
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How does a seat belt law affect the number of deaths?
Total number of deaths = number of accidents X number of deaaccident
Seat belts change a driver’s cost-benefit calculation. Seat belts
accidents less costly because the number of deaths per acciden
decreases. As a result, drivers tend to drive faster than before, number of accidents to increase.
The net result is little change in the number of driver deaths an
increase in the number of pedestrian deaths.
Application: Seat Belt Laws
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The purpose of rent control is to help the poor by making ho
affordable. Can rent control really reduce homelessness?In the short run, rent control causes the quantity of rental ho
demanded to rise and the quantity supplied to fall. There is a
of rental housing. Over time, housing shortages caused by re
increases because the demand for and supply of housing are
elastic in the long run.
One economist argued that rent control is "the best way to d
city, other than bombing."
Application: Rent Control
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Rather than being self-sufficient, people can specialize in pro
things they are better at and exchange for other goods. Throspecialization and trade, people have more of all goods to co
To be covered in Chapter 3.
Principle #5: Trade Can Make Everyone Bette
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Principle #6: Markets Are Usually a Good Way to
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Market = a group of buyers and sellers of a particular good or
“Organize economic activity” means determining
• what to produce
• how to produce
• how much of each good to produce
• who receives which good
A market economy allocates resources through the decentraliz
decisions of many households and firms as they interact in ma
To be covered in Chapter 4.
Principle #6: Markets Are Usually a Good Way to Economic Activity
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Adam Smith and the invisible hand (1776)
•
Although individuals are motivated by self-interest, an invisibguides this self-interest into promoting society’s economic w
The invisible hand works through the price system:
• The interaction of buyers and sellers determines prices.
•
Each price reflects the good’s value to buyers and the cost ofthe good.
• Prices guide self-interested households and firms to make de
that, in many cases, maximize society’s economic well-being
Market Economy
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An economic system is the method that coordinates choices a
production with choices about consumption, and distributes gservices to the people who want them.
• Market Economy = Production and consumption are the re
decentralized decisions by firms and individuals.
• Command Economy = The central government makes all de
about the production and consumption of goods and servic
• Mixed Economy = Economic system that combines the free
with limited government intervention.
More on Economic Systems
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Principle #7: Governments Can Sometimes Im
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Important role for government: enforce property rights (with p
courts, etc.)
Property rights = the ability of an individual to own and exercis
over scarce resources.
• Market works only if property rights are enforced.
• We rely on the government to enforce our rights over the th
produce.
Principle #7: Governments Can Sometimes ImMarket Outcomes
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Government may alter market outcome to promote efficiency w
is market failure.
Market failure = the market fails to allocate society’s resources
• Externalities = the impact of one person’s actions on the we
bystander (e.g. pollution).
• Market power = the ability of a single person (or a small num
sellers) to have a substantial influence on the market prices
monopoly).
More on Government
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Government may also alter market outcome to promote equity
If the market’s distribution of economic well-being is not desira
tax or welfare policies can change how the economic pie is divi
More on Government
Junjie Liu – Econ 103
Principle #8: A Country’s Standard of Living Dep
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The standard of living in an economy depends on the economy
to produce goods and services. Productivity measures the abilproduce goods and services.
Productivity = the amount of goods and services produced fro
unit of a worker’s time
Principle #8: A Country s Standard of Living DepIts Ability to Produce Goods & Services
Junjie Liu – Econ 103
P i i l #9 P i Ri Wh T M h M
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Inflation = an increases in the overall level of prices in the eco
In the long run, inflation is almost always caused by excessive
the quantity of money, which causes the value of money to fa
Principle #9: Prices Rise When Too Much Money
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Principle #10: Society Faces a Short-Run Trad
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The short-run effects of monetary injection:
•
Increasing the amount of money in the economy stimulates level of spending and thus the demand for goods and servic
• Higher demand may over time cause firms to raise their pric
encourages them to increase the quantity of goods and serv
produce and to hire more workers to produce those goods a
services.• More hiring means lower unemployment.
Principle #10: Society Faces a Short Run Tradbetween Inflation and Unemployment
Junjie Liu – Econ 103
E i
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Assume you are selling your 10-year old car. You have already
$1,000 on repairs.At the last minute, the transmission fails. You can pay $600 to
repaired, or sell the car “as is.”
In each of the following scenarios, should you have the transm
repaired?1) Blue book value is $6,500 if transmission works, $5,700 if it
2) Blue book value is $6,000 if transmission works, $5,500 if it
Exercise
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A
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1) The benefits of repairing the transmission are $6,500 − $5
$800, whereas the costs of repairing the transmission are $
should repair it.
2) The benefits of repairing the transmission are $6,000 − $5
$500, whereas the costs of repairing the transmission are $
shouldn’t repair it.
Answer
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S
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• Economics is about the allocation of scarce resources.
• Individuals face trade-offs.• Opportunity cost is whatever must be given up to obtain so
• Rational people think at the margin.
• People make decisions by comparing costs and benefits; th
respond to incentives.
• Markets are a good, but not perfect, way to allocate resou
Governments can sometimes improve market outcomes.
Summary
Junjie Liu – Econ 103