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1/11Chapter1TenPrincipalsofEconomicsHowpeoplemakedecisionsPrinciple1:peoplefacetradeoffsPrinciple2:thecostofsomethingiswhatyougiveuptogetitPrinciple3:rationalpeoplethinkatthemarginPrinciple4:peoplerespondtoincentivesHowpeopleinteractPrinciple5:tradecanmakeeveryonebetteroffPrinciple6:marketsareusuallyagoodwaytoorganizeeconomicactivityPrinciple7:governmentscansometimeimprovemarketoutcomesHowtheeconomyasawholeworksPrinciple8:acountry’sstandardoflivingdependsonitsabilitytoproducegoodsandservicesPrinciple9:pricesrisewhenthegovernmentprintstoomuchmoneyPrinciple10:societyfacesashort-termtradeoffbetweeninflationandunemployment1.Scarcity:societyhaslimitedresourcesandthereforecannotproduceallthegoodsandservicespeoplewishtohave2.Economics:thestudyofhowsocietymanagesitsscarceresources3.Classictradeoffs:gunsandbutter,efficiencyandequity4.Efficiency:thepropertyofthesocietygettingthemostitcanfromitsscarceresources5.Equity:thepropertyofdistributingeconomicprosperityfairlyamongthemembersofsociety6.Opportunitycost:whatevermustbegiventoobtainsomeitem7.Marginalchanges:smallincrementaladjustmentstoanexistingplanofaction8.Whenanalyzinganypolicy,wemustconsidernotonlythedirecteffectsbutalsotheindirecteffectsthatworkthroughincentives9.Centralplanning:thecentralplannersinthegovernmentwereinthebestpositiontoguideeconomicactivity10.Marketeconomy:aneconomythatallocatesresourcesthroughthedecentralizeddecisionsofmanyfirmsandhouseholdsastheinteractinmarketsforgoodsandservices11.Whenthegovernmentpreventspricesfromadjustingnormallytosupplyanddemand,itimpedestheinvisiblehand’sabilitytocoordinatethemillionsoffirmsandhouseholdsthatmakeuptheeconomy;buttheinvisiblehandneedsgovernmenttoprotectit.Thegovernmentcanalsopromoteefficiencyandequity.12.Marketfailure:asituationinwhichthemarketonitsownfailstoproduceanefficientallocationofresources13.Externality:theimpactofoneperson’sactionsonthewell-beingofabystander,whichmaycausemarketfailure14.Marketpower:theabilityofasingleeconomicactororsmallgroupofactorstohaveasubstantialinfluenceonmarketprices15.Productivity:thequantityofgoodsandservicesproducedfromeachhourofaworker’stime16.Similarly,thegrowthrateofanation’sproductivitydeterminesthegrowthrateofitsaverageincome17.Inflation:anincreaseintheoveralllevelofpricesintheeconomy18.Philipscurve:acurvethatshowstheshort-runtradeoffbetweeninflationandunemployment19.Businesscycle:fluctuationineconomicactivity,suchasemploymentandproductionSummary:1.Thefundamentallessonsaboutindividualdecisionmakingarethatpeoplefacetradeoffsamongalternativegoals,thatthecostofanyactionismeasuredintermsofforgoneopportunities,thatrationalpeoplemakedecisionsby2/11comparingmarginalcostandmarginalbenefits,andthatpeoplechangetheirbehaviorinresponsetotheincentivestheyface.2.Thefundamentallessonsaboutinteractionsamongpeoplearethattradecanbemutuallybeneficial,thatmarketsareusuallyagoodwayofcoordinatingtradeamongpeople,andthatthegovernmentcanpotentiallyimproveoutcomesifthereissomemarketfailureorifthemarketoutcomeisinequitable.3.Thefundamentallessonsabouttheeconomyasawholearethatproductivityistheultimatesourceoflivingstandards,thatthemoneygrowthistheultimatesourceofinflation,andthesocietyfacesashort-runtradeoffbetweeninflationandunemployment.Chapter2ThinkingLikeanEconomist1.Circular-flowdiagram:avisualmodeloftheeconomythatshowshowdollarsflowthroughmarketsamonghouseholdsandfirms2.Theproductionpossibilitiesfrontier:agraphthatshowsthecombinationofoutputthattheeconomycanpossiblyproducegiventheavailablefactorsofproductionandtheavailableproductiontechnology.Itshowstheopportunitycostofonegoodasmeasuredintermsoftheothergood.Itshowsthetradeoffbetweentheproductionofdifferentgoodsatagiventime,butthetradeoffcanchangeovertime3.Microeconomics:thestudyofhowhouseholdsandfirmsmakedecisionandhowtheinteractinmarkets4.Macroeconomics:thestudyofeconomy-widephenomena,includinginflation,unemployment,andeconomicgrowth5.Positivestatements:claimsthatattempttodescribetheworldasitis6.Normativestatements:claimsthatattempttoprescribehowtheworldshouldbe7.Normativestatementscannotcomefrompositiveanalysisalone,theyinvolvevaluejudgmentsaswellSummary:1.Economiststrytoaddresstheirsubjectwithascientificobjectivity.Likeallscientists,theymakeappropriateassumptionsandbuildsimplifiedmodelsinordertounderstandtheworldaroundthem.Twosimpleeconomicmodelsarethecircular-flowdiagramandtheproductionpossibilitiesfrontier2.Thefieldofeconomicsisdividedintotwosubfields:microeconomicsandmacroeconomics.Macroeconomistsstudydecision-makingbyhouseholdsandfirmsandtheinteractionamonghouseholdsandfirmsinthemarketplace.Macroeconomistsstudytheforcesandtrendsthataffecttheeconomyasawhole.3.Apositivestatementisanassertionabouthowtheworldis.Anormativestatementisanassertionabouthowtheworldoughttobe.Wheneconomistsmakenormativestatements,theyareactingmoreaspolicyadvisersthanscientists.4.Economistswhoadvisepolicymakersofferconflictingadviceeitherbecauseofdifferencesinscientificjudgmentsorbecauseofdifferencesinvalues.Atothertimes,economistsareunitedintheadvicetheoffer