ch01 Ten Principles .ppt

8/13/2019 ch01 Ten Principles .ppt

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Ten Principles of

Economics


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1CHAPTER 1 TEN PRINCIPLES OF ECONOMICS

In this chapter, look for the answers tothese questions:

What kinds of questions does economicsaddress?

What are the principles of how people makedecisions?

What are the principles of how people interact?

What are the principles of how the economy as awhole works?


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HOW PEOPLE MAKE DECISIONS

Decision making isat the heart ofeconomics.

The first fourprinciples deal withhow people makedecisions.


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Mini CasePioneer automobiles projected an increasing demand for

their cars in the country by 20% per annum. Currently alltheir plants are fully in operation up to in maximumcapacity. The firm intend to expand its output with anobjective of earning more profit. The management has

TWO option to choose for expanding output:Strategy I: construct two new additional plants

Strategy II: The rival firm is in financial trouble andwishes to sell out its two plants in the vicinity of thepioneer. Buy this and modify.

CHAPTER 1 TEN PRINCIPLES OF ECONOMICS


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AnswerDecision Process:

Objective: to increase profit(P) Analysis: Check relative cost and profit in case

of these two strategies i.e. PS1 and PS2

Decision rule: PS1 > PS2 choose S1 PS1 = PS2 choose S1

PS1 < PS2 choose S2



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All decisions involve tradeoffs. Examples:

Going to a party the night before your midterm

leaves less time for studying.Having more money to buy stuff requires workinglonger hours, which leaves less time for leisure.

Protecting the environment requires resourcesthat might otherwise be used to produceconsumer goods.

Principle #1: People Face Tradeoffs


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Society faces an important tradeoff:eff ic ienc y v s . equi ty

efficiency : getting the most out of scarce

resourcesequity : distributing prosperity(chadhati) fairly

(thik- thik) among societys members

Tradeoff: To increase equity, can redistributeincome from the well-off to the poor.But this reduces the incentive to work and produce,and shrinks the size of the economic pie.

Principle #1: People Face Tradeoffs


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Making decisions requires comparing the costsand benefits of alternative choices.

The opportunity cost of any item is whatevermust be given up to obtain it.

It is the relevant cost for decision making.

Principle #2: The Cost of Something Is What

You Give Up to Get It


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Examples: The opportunity cost of going to college for a year is not just the tuition,

books, and fees, but also the foregone(jatu karvu)wages.

seeing a movie is not just the price of the ticket,but the value of the time you spend in the theater.

Principle #2: The Cost of Something Is What

You Give Up to Get It


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A person is rational if she systematically andpurposefully does the best she can to achieveher objectives.Many decisions are not all or nothing,but involve marginal changes incremental

adjustments to an existing plan.Evaluating the costs and benefits of marginalchanges is an important part of decision making.

Principle #3: Rational People Think at the

Margin


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Examples:

A student considers whether to go to college

for an additional year, comparing the fees & foregonewages to the extra income he could earn with an extrayear of education.

Cost of Flight or train

A firm considers whether to increase output, comparingthe cost of the needed labor and materials to the extrarevenue.

Why water is so cheap and diamond are so expensive?

Principle #3: Rational People Think at the

Margin


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incentive: something that induces a person toact, i.e. the prospect of a reward or punishment.

Rational people respond to incentives becausethey make decisions by comparing costs andbenefits. Examples: In response to higher gas prices,

sales of hybrid cars ( e.g., Toyota Prius) rise. In response to higher cigarette taxes,teen smoking falls.

Principle #4: People Respond to Incentives


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Many public policies change the costs andbenefits that people face. Sometimespolicymakers fail to understand how policies alter

incentives and behavior.Example: Seat belt laws increase the use of seatbelts and lower the incentives of individuals todrive safely. This leads to an increase in thenumber of car accidents.


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Exercise

You are selling your 1996 Mercedes. You havealready spent $1000 on repairs.

At the last minute, the transmission dies. You canpay $600 to have it repaired, or sell the car as is.

In each of the following scenarios, should you havethe transmission repaired?A. Book value is $6500 if transmission works,

$5700 if it doesnt B. book value is $6000 if transmission works,

$5500 if it doesnt

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Answers

Cost of fixing transmission = $600A. Book value is $6500 if transmission works,

$5700 if it doesnt

Benefit of fixing the transmission = $800($6500 5700).Its worthwhile to have the transmission fixed.

B. Book value is $6000 if transmission works,$5500 if it doesnt Benefit of fixing the transmission is only $500.Paying $600 to fix transmission is not worthwhile.

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Answers

Observations:The $1000 you previously spent on repairs isirrelevant. What matters is the cost and benefit

of the marginal repair (the transmission).The change in incentives from scenario Ato scenario B caused your decision to change.

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HOW PEOPLE INTERACT

An economy is justa group of peopleinteracting witheach other.

The nextthree principlesdeal with how peopleinteract.


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HOW PEOPLE INTERACT

Rather than being self-sufficient, people canspecialize in producing one good or service

and exchange it for other goods.Countries also benefit from trade & specialization: get a better price abroad for goods they

produce buy other goods more cheaply from abroad

than could be produced at home

Principle #5: Trade Can Make Everyone Better

Off


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India's exports rise 34.42% in April 2011Exports jumped 34.42% in April 2011 to $ 23.8 billioncontinuing the fast paced growth of the previousfiscal.

Imports, too, continued to rise although at a lower

pace of 14/13% to $32.8 billion. The trade deficit for April 2011 was estimated at $ 8.98 billion which waslower than the deficit of $ 11.02 billion during April2010.

Oil imports during April, 2011 were valued at $ 10.18billion which was 7.7% higher than oil imports of $9.45 billion in the corresponding period last year.


di l


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Indian Exports Forecast to Escalate,Constraining Brazilian Expansion

Exports Strong export growth by India is expected to continue. Thisexpansion, paired with a significant upward revision in the2010 forecast, generates a substantially higher 2011 forecast.Comparatively low prices, a beneficial exchange rate, ample

supplies and robust Southeast Asian and Middle East demandare spurring shipments. In addition to benefiting fromincreased market access and growing demand in keymarkets, India is better able to compete with Brazil due to its

price competitiveness. As a result, India is expected tocapture some market share from Brazil, the worlds leadingexporter. Therefore, growth in Brazilian exports is revisedsignificantly downward.


h i f hi h


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The United States is forecast higher on acompetitive dollar, strong Asian demand, andtight Oceania supplies. Improved Asian market

access spurs an increase for Mexico . The EU isrevised upward on ample supplies enablingshipments to Russia and the short term sales toTurkey.

Lower than expected productionreduces Argentina , which are forecast less thanhalf of the volume achieved just two years ago.Despite ample supplies, high prices causeUruguay to struggle to expand shipments,generating a downward revision.



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Imports A downward revision in the United States is driven by

increased production, constrained consumption aseconomic recovery is slower than expected and aweaker dollar a relatively high-priced Oceania producthinders imports. Similarly, sluggish economic recoveryand elevated prices hinder Mexican and EU imports.The EU is also negatively impacted by furtherreductions in Argentine exportable supplies.

Korea is revised upward on lower production, reducedpork supplies and rising consumer confidence in USbeef.



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HOW PEOPLE INTERACT

A market is a group of buyers and sellers.(They need not be in a single location.)

Organize economic activity means determining what goods to produce how to produce them how much of each to produce who gets them

Principle #6: Markets Are Usually A Good Way

to Organize Economic Activity


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HOW PEOPLE INTERACT

In a market economy, these decisions result fromthe interactions of many households and firms.

Famous insight by Adam Smith inThe Wealth of Nations (1776):Each of these households and firms

acts as if led by an invisible hand to promote general economic well-being.




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HOW PEOPLE INTERACT

The invisible hand works through the price system:

The interaction of buyers and sellersdetermines prices of goods and services.

Each price reflects the goods value to buyersand the cost of producing the good.

Prices guide self-interested households andfirms to make decisions that, in many cases,maximize societys economic well -being.




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HOW PEOPLE INTERACT

Important role for govt: enforce property rights(with police, courts)

People are less inclined to work, produce, invest, orpurchase if large risk of their property being stolen. A restaurant wont serve meals if customers

do not pay before they leave. A music company wont produce CDs if too many

people avoid paying by making illegal copies.

Principle #7: Governments Can Sometimes

Improve Market Outcomes


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HOW PEOPLE INTERACT

Govt may alter market outcome to promote efficiency

market failure , when the market fails to allocatesocietys resources efficiently. Causes: externalities , when the production or consumption

of a good affects bystanders ( e.g. pollution)

market power , a single buyer or seller hassubstantial influence on market price ( e.g. monopoly)In such cases, public policy may increase efficiency.




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HOW PEOPLE INTERACT

Govt may alter market outcome to promote equity

If the markets distribution of economic well -beingis not desirable, tax or welfare policies can changehow the economic pie is divided.




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HOW THE ECONOMY AS A WHOLE WORKS

The last threeprinciples deal withthe economy as a

whole.


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Huge variation in living standards acrosscountries and over time: Average income in rich countries is more than

ten times average income in poor countries.

The U.S. standard of living today is abouteight times larger than 100 years ago.

Principle #8: A countrys standard of living

depends on its ability to produce goods &services.


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The most important determinant of living standards:

productivity , the amount of goods and servicesproduced per unit of labor.

Productivity depends on the equipment, skills, andtechnology available to workers.

Other factors ( e.g., labor unions, competition fromabroad) have far less impact on living standards.

Principle #8: A countrys standard of living

depends on its ability to produce goods &services.


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PPP growth ( in $)


Country 2011 2012 2013 2014 Australia 40,816 42,291 43,801 45,327

China 8,288 9,157 10,103 11,172

Denmark 37,585 38,778 40,002 41,323

India 3,608 3,892 4,213 4,571 Mauritius 14,746 15,483 16,257 17,119
http://en.wikipedia.org/wiki/Australiahttp://en.wikipedia.org/wiki/People%27s_Republic_of_Chinahttp://en.wikipedia.org/wiki/Denmarkhttp://en.wikipedia.org/wiki/Indiahttp://en.wikipedia.org/wiki/Mauritiushttp://en.wikipedia.org/wiki/Mauritiushttp://en.wikipedia.org/wiki/Indiahttp://en.wikipedia.org/wiki/Denmarkhttp://en.wikipedia.org/wiki/People%27s_Republic_of_Chinahttp://en.wikipedia.org/wiki/Australia


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Inflation : increases in the general level of prices.

In the long run, inflation is almost always causedby excessive growth in the quantity of money,which causes the value of money to fall.

The faster the govt creates money,the greater the inflation rate.

Principle #9: Prices rise when the

government prints too much money.


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ZIMBABWE INFLATIONOne 200,000 dollar note equals less than US $0.10

cents.December 22nd 2007, a new note of 500,000 dollarsintroduced to the market!

Next - 750,000 dollars.

January 2008 a new note of 10 million dollars.This US $10 dollar note is 10 times worth more than the10 million dollars Zimbabwe note.

This guy is going to a supermarket. The exchange rate is25 million Zimbabwe dollars for 1 US dollar.This mountain of cash is worth 100 US Dollars.


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Inflation in IndiaThe rising prices of food products, manufacturing products, and essentialcommodities have pushed inflation rate further in India.

This is how food prices have risen since 2007:Food articles: 7.02% (in 2007) to 17.41% in January 2010.Food products: 3.43% (in 2007) to 22.55% in January 2010.Food commodities: 5.60% (in 2007) to 19.42% in January 2010.Foodgrains: 6.27% (in 2007) to 17.89% in January 2010.Cereals: 6.27% (in 2007) to 13.69% in January 2010.Pulses: 2.14% (in 2007) to 45.62% in 2007 in January 2010.Rice: 6.05% (in 2007) to 12.02% in January 2010.Wheat: 6.77% (in 2007) to 14.86% in January 2010.

Dairy products: 6.08% (in 2007) to 12.87% in January 2010.Eggs, fish and meat: 6.38% (in 2007) to 30.71% in January 2010.Sugar: (-)14.69% (in 2007) to 58.94% in January 2010.


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CONCLUSIONEconomics offers many insights about the

behavior of people, markets, and economies.It is based on a few ideas that can be appliedin many situations.

Whenever we refer back to one of theTen Pr in cip les from this chapter,you will see an icon like this one:

ch01 Ten Principles .ppt

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