Ten Principles Of Economics

TEN PRINCIPLES OF ECONOMICS

A) How people make decisions: 1. People face trade offs 2. Cost of something is what you give up to get it 3. Rational people think at margins 4. People respond to incentives B) How people interact: 1. Trade can make everyone better off 2. Market is a good way to/or gauge economic activities 3. Governments can improve market outcomes C) How economy works as a whole: 1. Countries standard of living depends on its ability to produce goods and services 2. Price rise when government prints too much of money 3. Short-run trade off between inflation and unemployment

P 1: People Face Trade offs 1. Family vacations Vs college education for the child 2. Guns or bread?? 3. More on national defence – less on primary education 4. High industrialization/income /profits-environment 5. ‘No free lunch’ 6. Society faces trade-offs between efficiency &equity

1.Society is getting maximum benefit from the resource 2. ‘size of pie’ taxes ??

1. How the benefit is divided 2. How the pie is divided

P 2: Cost of Something is what you give up to get it 1.

Decision making: cost vs. benefits

e.g. of being at CEPT

1. 2. 3. 4. 5. 6.

Tuition fees Books Room Food Etc Wages earned if not at CEPT

OPPOURTINITY COST is what you give up to get that item

P 3: Rational People think at the Margin People are rational  An extra hour of studying everyday change in grades from

C to A or C to C+  MARGINAL COST: MARGINAL BENEFIT  Delhi to Ahmedabad (SASTA JET) : 200 passengers: Rs 10 lakh  Av. Cost –Rs 5000  Marginal cost /passenger??  Diamonds vs. water

P 4: People Respond to Incentive  Tax incentives for saving  Less cost for early registration  Direct benefit vs indirect benefits  Sam Peltzman , 1975  Auto safety

P 5: Trade can make everyone better off  American vs Japanese firms

Ford vs. Toyota  Apple vs Sony 

 People compete for jobs  People compete in market to buy more goods at least

cost

P 6: Markets are usually good way to organize economic activity

 Buyers  Sellers  Produce  Controlled markets : centrally planned economics  Market economies : firms and households  Free markets: many buyers and sellers  Adam smith- invisible hand

P 7: Governments can sometimes improve Market outcomes  Invisible

hand is powerful, but not omnipotent. Invisible hand does not ensure that everyone has sufficient food, health care etc.  Govt. needs to intervene in the economy- to promote efficiency and to promote equity.  Enlarge the economic pie  Market economy rewards people accordingly to their ability to produce things that others are willing to pay  Public policies , such as income tax and welfare system, aim to achieve an equitable distribution of economic well being.

P 8: Countries Standard of living depends on its ability to produce goods and services  Productivity has a profound impact on living standards  Average income  USA $ 37,000  Mexico $ 10,000  India $ 9000  In USA incomes have grown at the rate of 2% per year.  India –Growth Rate 9%

Expected 8.5%  High growth rate –better standard of living  Inflation ?? 



P 9: Prices Rise when Governments Prints too much Money

 More money chasing less goods 

Price rise

value of money falls

 Multiple causes of inflation

global oil prices  Poor rainfall  Poor harvest  Slow growth of manufacturing sector 

P 10:Soceity faces trade off between Inflation &unemployment  More money in circulation  Increase in overall spending  More demand  More production  Hire more  Short run inflation vs long run employment.

Various Economic Models Model 1 Circular flow Diagram

Market for good and services

Revenue

Spending

Firms Sell HH buy

Firms

Households Produce & sell Hire &use factor of production

Consume & buy Own & sell factors of production

Income Wages, Rents, Profits

Markets for factors of Productions

Model 2 : Production Possibilities Frontiers

 Decisions for various combinations of goods and services

to be made.  Suppose two industries make cars and computers use all the resources in the economy.  We have various combinations of production possible.

 Economy can produce any

combination on or inside the curve.  Inside means less production  Outside not possible  Opportunity

cost of manufacturing is more for computers

Utility Theory  Consumers and society make choice , which depends

on the utility of good/services.  Define ‘Utility’  Subjective pleasure /usefulness of consuming a good/service  By consuming more of a good we increase the utility ??  Second/third cup of tea, ice-cream gives a little less satisfaction as compared to first cup.  Additional satisfaction is marginal utility is decreasing.  Law of diminishing marginal utility

Relationship between T.U and M.U Qt. Consumed

T.U

M.U

0

-

-

1

4

4

2

7

3

3

9

2

4

10

1

5

10

0