Macroeconomics- Chapter 1

Principle #1 People Face Trade Offs

Having more of one thing means having less of another. "There ain't no such thing as a free lunch" because someone has to pay for it.

What are the goals/objectives of economic agents?

1. For consumes? Consumers want to purchase the goods and services that allow them the greatest level of satisfaction given their income and the prices they face. (want to get the best deal) 2. For firms? Firm managers want to produce the level of output that maximizes the profits the firms earn. (make the most money) 3. For governments? Keep the economy in good shape

Economics tries to answer these questions

1. How do individuals make decisions? (micro) 2. How do people interact in a market? (micro) 3. How the whole economy works? (macro)

Principle #2: The Cost of Something Is What You GIve Up to Get It

1. One must know how to properly account for the cost: The cost of something is what you give up to get it

Principles of Economics on how people make decisions

1. People face trade-offs 2. The cost of something is what you give up to get it 3. Rational people compare opportunity cost and benefit to make a decision 4. Rational people think at the margin 5. People respond to incentives

Principle #5: People Respond to Incentives

Because rational people make decisions by weighing costs and benefits, their decisions may change in response to incentives because incentives alter the cost or benefits. When the price of a good rises, consumers buy less. When the price of a good rises, producers will allocate more resources to the production of the good because the benefit from producing the good has risen.

Sunk Cost

Cost that are beyond recovery at the moment of decision. It is the irrelevent cost in making a rational decision at the margin. Ex. Dropping a class after refund time, you lose money.

Principle #3: Rational People Compare Opportunity Cost and Benefit to Make a Decision

Economists generally assume that people are rational.

An important trade-off that society faces is the trade-off between

Efficiency and Equality

Scarcity

Limited nature of resources. This is the fundamental economic problem. It can be labor, physical capital (trucks, factory), land

Incentives

Something that induces a person

Rational

Systematically and purposely do the best you can to achieve your objectives

Where does the word "economy" come from?

The Greek word "okionomia" meaning "one who manages a household. This makes sense because in the economy we are faced with many decisions (just as a household is).

Marginal Benefit

The benefit of an additional unit of activity

An individual takes action if and only if

The benefits from taking action are at least as great as the opportunity cost. Ex. A computer game nearby is $25 but a 30 minute walk away it is $15. The benefit of going downtown is $10 and exercise. If you could do an errand with a payment of $1,000 in that 30 minutes, then going downtown wouldn't make sense. If you could do an errand with a payment of $9 in that 30 minutes, it would make sense unless you think the walk isn't worth $1.

Marginal Cost

The cost of the additional unit of activity

The government with efficiency and eqaulity

The government has to decide whether to have a society that is efficient or equitable. Having a more efficient society means having a less equitable society. The achieve a more equitable society, they can increase taxes on business. A higher tax rate, however, is an additional cost to businesses and hence it can discourage business and may even stop foreign companies to invest. So tax rates can cause society to be inefficient or not to maximize benefits from its scarce resources. Tax dollars, however, paid by wealthy Americans can be distributed to those less fortunate may improve equality and so you would see a society with a smaller number of poor families.

A rational decision maker takes an action if an only if

The marginal benefit is at least as large as the marginal cost

A rational decision compares

The marginal benefit to the marginal cost, not to the average cost.

Equality

The property of distributing economic prosperity uniformly among the members of society. Can be done through taxes

Efficiency

The property of society getting the maximum benefits from it scarce resources

Economics

The study of how society manages its scarce resources

Principle #4: Rational People Think at the Margin

There are certain situations when people must choose the extent to which activity should be pursued (compared to choosing whether to pursue it at all): a. Should I remain in school this semester? b. Should I take another course this semester? c. Should I study another hour for tomorrow's exam? 2. To answer this, a rational economic agent would focus on the benefit and cost of an additional unit of activity (compare marginal cost and marginal benefit).

Average Cost

Total cost/# of units

What are the costs of going to college?

Tuition, books, housing, food, time to work

Opportunity Cost

Whatever must be given up in order to obtain something. Ex. Facebook isn't free because you spend time on it