PRINCIPLES OF ECONOMICS Lecturer: Jack Wu Economics 101 WHAT IS ECONOMY (經濟，經濟體)? The word economy originally comes from a Greek word for “one who manages a household.” Broader definition: household, society, and country. Taiwan was called Newly Industrialized Economy (NIE) or Country (NIC). FUNDAMENTAL PROBLEM FACED BY ECONOMY Fundamental economic problem: scarce resources. -- Scarcity. . . means that economy has limited resources and therefore cannot produce all the goods and services people wish to have. -- Resources : physical resource, financial resource, human resource, natural resource WHAT IS ECONOMICS (經濟學)? Economics is the study of how society or economy manages its scarce resources. It comprises of Microeconomics and Macroeconomics. MICROECONOMICS 個體經濟學(台灣)， 微觀經濟學(大陸) Microeconomics: the study of how households and firms make decisions and how they interact in markets (Econ 101: introductory Microeconomics, Econ 201: intermediate Microeconomics) Examples: mobile phone consumption choice decision, mobile phone production decision, and mobile phone market MACROECONOMICS 總體經濟學(台灣)， 宏觀經濟學(大陸) Macroeconomics: the study of economy-wide phenomena including inflation, unemployment, and economic growth (Econ 102: Introductory Macroeconomics, Econ 202: Intermediate Macroeconomics) Examples: Quantitative Easing (QE) Policy, Euro Zone Crisis, Abenomics, China Economy Soft Landing, Sluggish Income Growth of Taiwan EVERYBODY SHOULD LEARN ECONOMICS <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, electricity _Macro effect: inflation, unemployment TEN PRINCIPLES OF ECONOMICS How people make decisions. (4 principles) How people interact with each other. (3 principles) The forces and trends that affect how the economy as a whole works. (3 principles) How People Make Decisions PRINCIPLE #1: PEOPLE FACE TRADEOFFS. There is no such thing as a free lunch. To get one thing, we usually have to give up another thing. 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 dollars 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 alternatives. Whether to go to college or to work? The opportunity cost of an item is what you give up to obtain that item. Opportunity cost comprises of both explicit cost and implicit cost. QUICK QUIZ What are the opportunity costs of going to college? _ Tuition costs? _ Room and board? _ Forgone pay? QUICK QUIZ 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 job. PRINCIPLE #3: RATIONAL PEOPLE THINK AT THE MARGIN Many decisions in life involve incremental decisions: should I take another course this semester? 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 INCENTIVES 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 drive safely. How People Interact PRINCIPLE #5: TRADE CAN MAKE EVERYONE BETTER OFF People gain from their ability to trade with one another. Competition results in gains from trading. Trade allows people to specialize in what they do best. Examples: Most families do not build their own homes, make their own clothes, or grow their own food. PRINCIPLE #6: MARKETS ARE USUALLY A GOOD WAY TO ORGANIZE ECONOMIC ACTIVITY 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 Prices. PRINCIPLE #7: GOVERNMENT CAN SOMETIMES IMPROVE MARKET OUTCOMES 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 Whole Works PRINCIPLE #8: THE STANDARD OF LIVING DEPENDS ON A COUNTRY’S PRODUCTION Standard of living may be measured in different ways: 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’ productivities. 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 MONEY 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!