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Chapter 1: First Principles

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Key Learning Objectives​

  • Understand the four principles that guide individual choices.
  • Learn the four principles that govern how individual choices interact.
  • Identify the three principles that illustrate economy-wide interactions.

I. Principles of Individual Choice​

1. Scarcity and Choice​

  • Resources are scarce, meaning there isn’t enough to satisfy all wants.
  • Scarcity forces choices about how resources are allocated.

2. Opportunity Cost​

  • The true cost of something is its opportunity cost (what is given up to get it).
  • Example: Mark Zuckerberg dropping out of Harvard to start Facebook.

3. Marginal Analysis​

  • "How much" decisions involve comparing marginal benefits vs. marginal costs.
  • Marginal decision-making means choosing to do a little more or less of an activity.

4. Incentives Matter​

  • People respond to incentives to make themselves better off.
  • Example: Companies are more likely to reduce pollution if given financial rewards rather than just educational information.

II. Interaction of Individual Choices​

5. Gains from Trade​

  • Trade allows individuals to consume more than they otherwise could.
  • Specialization: People focus on tasks they do best, increasing efficiency.

6. Markets Move Toward Equilibrium​

  • Equilibrium: No individual benefits from changing their behavior because market forces balance supply and demand.

7. Efficient Resource Use​

  • Efficiency occurs when an economy maximizes benefits without making others worse off.

8. Markets Lead to Efficiency (Most of the Time)​

  • Markets tend to allocate resources efficiently.
  • However, market failures can occur, requiring government intervention.

Equity vs. Efficiency​

  • Equity: Fair distribution of resources (subjective).
  • Often, achieving greater equity reduces efficiency.

III. Economy-Wide Interactions​

9. Spending Drives the Economy​

  • One person’s spending is another person’s income.
  • Recessions occur when reduced spending leads to layoffs and declining incomes.

10. Government Policy Can Influence Spending​

  • Recessions occur when overall spending is too low → government may step in.
  • Inflation happens when spending is too high → government may intervene.

11. Economic Growth Increases Living Standards​

  • Growth comes from technology, resource availability, and productivity improvements.
  • Growth benefits some more than others, creating winners (e.g., tech industries) and losers (e.g., coal miners).

Practice Questions​

  1. If Costco offers unlimited free samples, do customers who eat them face an opportunity cost?
    Answer: Yes, they give up alternative food choices or time.

  2. What is happening when workers in a fast-food chain specialize in different tasks?
    Answer: Specialization.

  3. What is a potential cause of income inequality in a market economy?
    Answer: Equity concerns—some full-time workers still earn below the poverty line.

  4. What happens during a recession when businesses cut spending?
    Answer: Less income, less spending, more layoffs.