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HOW PEOPLE MAKE DECISIONS
There is no mystery to what an “economy” is. Whether we are talking about the economy of Los Angeles, of the United States, or of the whole world, an economy is just a group of people interacting with one another as they go about their lives. Because the behavior of an economy reflects the behavior of the individuals who make up the economy, we start our study of economics with four principles of individual decisionmaking....
ef ficiency the property of society getting the most it can from its scarce resources equity the property of distributing economic prosperity fairly among the members of society...
market failure a situation in which a market left on its own fails to allocate resources efficiently externality the impact of one person’s actions on the well-being of a bystander...
productivity the amount of goods and services produced from each hour of a worker ’s time...
PRINCIPLE #9: PRICES RISE WHEN THE GOVERNMENT PRINTS TOO MUCH MONEY
In Germany in January 1921, a daily newspaper cost 0.30 marks. Less than two years later, in November 1922, the same newspaper cost 70,000,000 marks. All other prices in the economy rose by similar amounts. This episode is one of history’s most spectacular examples of inflation, an increase in the overall level of prices in the economy. Although the United States has never experienced inflation even close to that in Germany in the 1920s, inflation has at times been an economic problem. During the 1970s, for instance, the overall level of prices more than doubled, and President Gerald Ford called inflation “public enemy number one.” By contrast, inflation in the 1990s was about 3 percent per year; at this rate it would take more than...
Phillips curve a curve that shows the short-run tradeoff between inflation and unemployment...
Ta b l e 1 - 1
HOW PEOPLE MAKE DECISIONS #1: #2: #3: #4: HOW PEOPLE INTERACT #5: #6: #7: HOW THE ECONOMY AS A WHOLE WORKS #8: #9: #10: 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 Trade Can Make Everyone Better Off Markets Are Usually a Good Way to Organize Economic Activity Governments Can Sometimes Improve Market Outcomes A Country’s Standard of Living Depends on Its Ability to Produce Goods and Services Prices Rise When the Government Prints Too Much Money Society Faces a Short-Run Tradeoff between Inflation and Unemployment TEN PRINCIPLES
OF...
THE ECONOMIST AS SCIENTIST
Economists try to address their subject with a scientist’s objectivity. They approach the study of the economy in much the same way as a physicist approaches the study of matter and a biologist approaches the study of life: They devise theories, collect data, and then analyze these data in an attempt to verify or refute their theories. To beginners, it can seem odd to claim that economics is a science. After all, economists do not work with test tubes or telescopes. The essence of science,...
ECONOMIC MODELS
High school biology teachers teach basic anatomy with plastic replicas of the human body. These models have all the major organs—the heart, the liver, the kidneys, and so on. The models allow teachers to show their students in a simple way how the important parts of the body fit together. Of course, these plastic models...
circular-flow diagram a visual model of the economy that shows how dollars flow through markets among households and firms...
concepts mentioned briefly in Chapter 1: scarcity, efficiency, tradeoffs, opportunity cost, and economic growth. As you study economics, these ideas will recur in various forms. The production possibilities frontier offers one simple way of thinking about them....
THE ECONOMIST AS POLICY ADVISER
Often economists are asked to explain the causes of economic events. Why, for example, is unemployment higher for teenagers than for older workers? Sometimes economists are asked to recommend policies to improve economic outcomes. What, for instance, should the government do to improve the economic well-being of teenagers? When economists are trying to explain the world, they are scientists. When they are trying to help improve it, they are policy advisers....
work in order to help formulate labor-market policies. Economists at the Department of Justice help enforce the nation’s antitrust laws. Economists are also found outside the administrative branch of government. To obtain independent evaluations of policy proposals, Congress relies on the advice of the Congressional Budget Office, which is staffed by economists. The Federal Reserve, the quasi-governmental institution that sets the nation’s monetary policy, employs hundreds of economists to analyze economic developments in the United States and throughout the world. Table 2-1 lists the Web sites of some of these agencies. The influence of economists on policy goes beyond their role as advisers: Their research and writings often affect policy indirectly. Economist John Maynard Keynes offered this observation:
The ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly understood. Indeed, the world is ruled by little else. Practical men, who believe themselves to be quite exempt from intellectual influences, are usually the slaves of some defunct economist. Madmen in authority, who hear voices in the air, are distilling their frenzy from some academic scribbler of a few years back....
Questions for Review
1. 2. 3. 4. How is economics like a science? Why do economists make assumptions? Should an economic model describe reality exactly? Draw and explain a production possibilities frontier for an economy that produces milk and cookies. What happens to this frontier if disease kills half of the economy’s cow population? Use a production possibilities frontier to describe the idea of “efficiency.” 7. 8. 9. 6. What are the two subfields into which economics is divided? Explain what each subfield studies. What is the difference between a positive and a normative statement? Give an example of each. What is the Council of Economic Advisers? Why do economists sometimes offer conflicting advice to policymakers?...
Figure 2A-3
Price of Novels $11 (5, $10) 10 9 8 7 6 5 4 3 2 1 0 5 10 15 20 25 30 Quantity of Novels Purchased (9, $9) (13, $8) (17, $7) (21, $6) (25, $5) Demand, D1...
Figure 2A-4
S H I F T I N G D E M A N D C U RV E S . The location of Emma’s demand curve for novels depends on how much income she earns. The more she earns, the more novels she will purchase at any given price, and the farther to the right her demand curve will lie. Curve D1 represents Emma’s original demand curve when her income is $30,000 per year. If her income rises to $40,000 per year, her demand curve shifts to D2. If her income falls to $20,000 per year, her demand curve shifts to D3.
Price of Novels $11 10 9 8 7 6 5 4 3 2 1 0 5 10 13 15 16 20 25 30 Quantity of Novels Purchased When income decreases, the demand curve shifts to the left. (10, $8) (13, $8) (16, $8) When income increases, the demand curve shifts to the right....
where the Greek letter ∆ (delta) stands for the change in a variable. In other words, the slope of a line is equal to the “rise” (change in y) divided by the “run” (change in x). The slope will be a small positive number for a fairly flat upward-sloping line, a large positive number for a steep upward-sloping line, and a negative number for a downward-sloping line. A horizontal line has a slope of zero because in this case the y-variable never changes; a vertical line is defined to have an infinite slope because the y-variable can take any value without the x-variable changing at all. What is the slope of Emma’s demand curve for novels? First of all, because the curve slopes down, we know the slope will be negative. To calculate a numerical value for the slope, we must choose two points on the line. With Emma’s income at $30,000, she will purchase 21 novels at a price of $6 or 13 novels at a price of $8. When we apply the slope formula, we are concerned with the change between these two points; in other words, we are concerned with the difference between them, which lets us know that we will have to subtract one set of values from the other, as follows: slope = y first y-coordinate second y-coordinate 68 2 1 = = = = . x first x-coordinate second x-coordinate 21 13 8 4...
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