copyright © 2004 south-western/thomson learning 1 ten principles of economics
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Copyright © 2004 South-Western/Thomson Learning
11Ten Principles of Economics
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TEN PRINCIPLES OF ECONOMICS
Economics is the study of how society manages its scarce resources.
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Microeconomics and Macroeconomics
• Microeconomics focuses on the individual parts of the economy.• How households and firms make decisions and how
they interact in specific markets
• Macroeconomics looks at the economy as a whole.• Economy-wide phenomena, including inflation,
unemployment, and economic growth
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TEN PRINCIPLES OF ECONOMICS
• How people make decisions.• People face tradeoffs.• The cost of something is what you give up to get it.• Rational people think at the margin.• People respond to incentives.
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TEN PRINCIPLES OF ECONOMICS
• How people interact with each other.• Trade can make everyone better off.• Markets are usually a good way to organize
economic activity.• Governments can sometimes improve economic
outcomes.
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TEN PRINCIPLES OF ECONOMICS
• The forces and trends that affect how the economy as a whole works. • The standard of living depends on a country’s
production.• Prices rise when the government prints too much
money.• Society faces a short-run tradeoff between inflation
and unemployment.
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22Thinking Like an Economist
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Thinking Like an Economist
• Economics trains you to. . . . • Think in terms of alternatives.• Evaluate the cost of individual and social choices.• Examine and understand how certain events and
issues are related.
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The Scientific Method: Observation, Theory, and More Observation
• Uses abstract models to help explain how a complex, real world operates.
• Observe fact
• Devise theory
• Collect data
• Test Theory
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Economic Models
• Economists use models to simplify reality in order to improve our understanding of the world
• Focus on specific relationships between variables
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Figure 1 The Circular Flow
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Spending
Goods andservicesbought
Revenue
Goodsand servicessold
Labor, land,and capital
Income
= Flow of inputs and outputs
= Flow of dollars
Factors ofproduction
Wages, rent,and profit
FIRMS•Produce and sellgoods and services
•Hire and use factorsof production
•Buy and consumegoods and services
•Own and sell factorsof production
HOUSEHOLDS
•Households sell•Firms buy
MARKETSFOR
FACTORS OF PRODUCTION
•Firms sell•Households buy
MARKETSFOR
GOODS AND SERVICES
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The Circular-Flow Diagram
• Firms• Produce and sell goods and services• Hire and use factors of production
• Households• Buy and consume goods and services• Own and sell factors of production
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The Circular-Flow Diagram
• Markets for Goods and Services• Firms sell• Households buy
• Markets for Factors of Production• Households sell• Firms buy
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The Production Possibilities Frontier
• The production possibilities frontier is a graph that shows the combinations of output that the economy can possibly produce given the available factors of production and the available production technology.
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Figure 2 The Production Possibilities Frontier
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Productionpossibilitiesfrontier
A
B
C
Quantity ofCars Produced
2,200
600
1,000
3000 700
2,000
3,000
1,000
Quantity ofComputers
Produced
D
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Our Second Model: The Production Possibilities Frontier
• Concepts Illustrated by the Production Possibilities Frontier • Efficiency• Tradeoffs• Opportunity Cost• Economic Growth
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Figure 3 A Shift in the Production Possibilities Frontier
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E
Quantity ofCars Produced
2,000
700
2,100
7500
4,000
3,000
1,000
Quantity ofComputers
Produced
A
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POSITIVE VERSUS NORMATIVE ANALYSIS
• Positive statements are statements that attempt to describe the world as it is.• Called descriptive analysis
• Normative statements are statements about how the world should be.• Called prescriptive analysis
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• Positive or Normative Statements? • An increase in the minimum wage will cause a
decrease in employment among the least-skilled.
POSITIVE
• Higher federal budget deficits will cause interest rates to increase.
POSITIVE
?
?POSITIVE VERSUS NORMATIVE
ANALYSIS
?
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• Positive or Normative Statements? • The income gains from a higher minimum wage are
worth more than any slight reductions in employment.
NORMATIVE
• State governments should be allowed to collect from tobacco companies the costs of treating smoking-related illnesses among the poor.
NORMATIVE
?
?POSITIVE VERSUS NORMATIVE
ANALYSIS
?
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Table 2 Ten Propositions about Which Most Economists Agree
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