Chapter 1 P 1 People face Trade-offs

Chapter 1

P 1. People face Trade-offs “There’s no such thing as free lunch” - N. G. Mankiw The act of giving up one thing to buy the other thing is called the “Trade-off”.

Efficiency & Equity People face trade-offs between efficiency and equity. Equity is when a resource is fairly allocated, whereas efficiency is when trying to get the most out of To put it into easy words, if you have a certain a resource. amount of money that you want to invest, you face two trade-offs considering two questions: 1. Are you going to give it to someone who is going to share it fairly among everyone? (Equity) 2. Or, are you going to give it to someone who is going to get the most out of the money? (Efficiency)

P 2. Opportunity cost If you have two things you want to buy, yet you have a limited amount of money (meaning you can only buy one) in order to buy one thing you must give up the other one. The thing you gave up is what you call opportunity cost. Video on the next slide

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P 3. Rational People? “Rational people know that decisions in life are rarely black and white but usually involve shades of gray” - N. G. Mankiw Everyone has their own goals. In order to achieve the goals, given with the limited amount of resources and choices, they plan and do what they think is the best for them. “They” are the rational people - finding what is the best for them.

Marginal changes “+/ –” Plus one or minus one, these small marginal changes affect the motivation, and the incentives of people. For example, When you are studying for a AP Economics test, you have a choice to sleep an hour and take a rest, or use that hour to study more. Which ever you give up, that becomes the marginal change of the trade off.

P 4. People responds to incentives “People respond to incentives. The rest is commentary” - N. G. Mankiw “Incentives” is a magical power that drags people in to do something due to the desire for more benefits. If price goes down, people respond to the change of the price. Thus because the product is cheaper, people will tend do buy more.

P 5. Trade Your friend might be good at something that you aren’t good at. Vice versa, your friend might be bad at something that you are good at. How will you solve this? By trading, you and your friend can be both satisfied. You can share what you are good at, and your friend can share what you are good at. Trade makes you concentrate and do what you are good at.

P 6. Market is a place where firms and households interact. Market is a place where trade occurs - they make decisions considering what will make the firms and households both better off. Invisible Hand pulls and pushes people to the way they respond to changes. For example, if something that you wanted to buy increase its price, the invisible hand will push you not to buy the thing because it is expensive.

P 7. What can governments do? Like when the government increased the price of the smoke to reduce people from smoking, government is a big part of the economy. Government uses the invisible hand to control firms and households.

Property rights are your rights to have when you own something. Market failure, literally when market fails when markets do not use the scarce at the efficiency level. - Externality is when one person affect many people around him/her (e. g. governmental; tax, tariff) - Market power is when one person’s ability to influence the whole market