PRINCIPLES OF ECONOMICS
Lecturer: Jack Wu
WHAT IS ECONOMY?
The word economy originally comes from a Greek
word for “one who manages a household.”
Broader definition: household, society, and
Taiwan was called Newly Industrialized
Economy (NIE) or Country (NIC).
FUNDAMENTAL PROBLEM FACED
Fundamental economic problem: scarce resources.
-- Scarcity. . . means that society has limited
resources and therefore cannot produce all the
goods and services people wish to have.
WHAT IS ECONOMICS?
Economics is the study of how society manages
its scarce resources.
It comprises of Microeconomics and
Microeconomics: the study of how households and
firms make decisions and how they interact in
markets (Econ 101: introductory Microeconomics,
Econ 201: intermediate Microeconomics)
Macroeconomics: the study of economy-wide
phenomena including inflation, unemployment,
and economic growth (Econ 102: Introductory
Macroeconomics, Econ 202: Intermediate
EVERYBODY SHOULD LEARN
<Reason>. Economics is a subject that we must
confront in our everyday lives. As a matter of
fact, we already spend a great deal of our time
thinking about economic issues: prices(inflation),
incomes (economic growth), consumption
decisions, use of our time, job opportunity
(unemployment), and so on.
MICRO AND MACRO EFFECTS
Event: An increase in gasoline price
_ Micro effect: vehicle driver, bicycle market,
_Macro effect: inflation, unemployment
TEN PRINCIPLES OF ECONOMICS
How people make decisions. (4 principles)
How people interact with each other. (3
The forces and trends that affect how the
economy as a whole works. (3 principles)
How People Make
PRINCIPLE #1: PEOPLE FACE
There is no such thing as a free lunch.
To get one thing, we usually have to give up
Making decisions requires trading
off one goal against another.
EXAMPLES OF TRADE OFF
How a student spends her time
How a family decides to spend its income
How the Taiwanese government spends tax
How regulations may protect the environment at
a cost to firm owners
SPECIAL EXAMPLE OF TRADEOFF
Efficiency v. Equity
Efficiency means society gets the most that it can
from its scarce resources.
Equity means the benefits of those resources are
distributed fairly among the members of society.
Example: Tax paid by wealthy Taiwanese and then
distributed to those less fortunate.
Outcome: Increased equity and reduced efficiency
PRINCIPLE #2: THE COST OF
SOMETHING IS WHAT YOU GIVE UP
TO GET IT.
Decisions require comparing costs and benefits of
Whether to go to college or to work?
The opportunity cost of an item is what you give
up to obtain that item.
What are the costs of going to college?
_ Tuition costs?
_ Room and board?
_ Forgone pay?
What is the opportunity cost of seeing a movie?
_ cost of admission?
_ time cost of going to the theater?
_ time cost of attending the show?
Note: Time cost depends on what else you might do
with that time. Examples: staying at home and
watch TV, working an extra three hours at paid
PRINCIPLE #3: RATIONAL PEOPLE THINK
AT THE MARGIN
Many decisions in life involve incremental
decisions: should I take another course this
Marginal changes are small, incremental
adjustments to an existing plan of action.
People make decisions by comparing costs and
benefits at the margin.
PRINCIPLE #4: PEOPLE RESPONDS TO
Because people make decisions by weighing costs
and benefits, their decisions may change in
response to changes in costs and benefits.
Example: Seat Belt Laws increase use of seat
belts and lower the incentives of individuals to
How People Interact
PRINCIPLE #5: TRADE CAN MAKE
EVERYONE BETTER OFF
People gain from their ability to trade with one
Competition results in gains from trading.
Trade allows people to specialize in what they do
Examples: Most families do not build their own
homes, make their own clothes, or grow their own
PRINCIPLE #6: MARKETS ARE USUALLY
A GOOD WAY TO ORGANIZE ECONOMIC
A market economy is an economy that allocates
resources through the decentralized decisions of
many firms and households as they interact in
markets for goods and services.
Adam Smith made the observation that
households and firms interacting in markets act
as if guided by an “invisible hand”—Market
PRINCIPLE #7: GOVERNMENT CAN
SOMETIMES IMPROVE MARKET
Market failure occurs when the market fails to
allocate resources efficiently.
Market failure may be caused by
an externality, which is the impact of one person or
firm’s actions on the well-being of a bystander.
market power, which is the ability of a single
person or firm to unduly influence market prices.
When the market fails (breaks down) government
can intervene to promote efficiency and equity.
How the Economy as a
PRINCIPLE #8: THE STANDARD OF
LIVING DEPENDS ON A COUNTRY’S
Standard of living may be measured in different
By comparing personal incomes.
By comparing the total market value of a nation’s
production (GDP, Gross Domestic Product).
Almost all variations in living standards are
explained by differences in countries’
Productivity is 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
Inflation is an increase in the overall level of
prices in the economy.
One cause of inflation is the growth in the
quantity of money.
When the government creates large quantities of
money, the value of the money falls.
PRINCIPLE #10: SOCIETY FACES A
SHORT-RUN TRADEOFF BETWEEN
INFLATION AND UNEMPLOYMENT
The Phillips Curve illustrates the tradeoff
between inflation and unemployment:
Inflation is lower Unemployment is higher
It’s a short-run tradeoff!