Chapter 1
1 TEN PRINCIPLES OF ECONOMICS
WHAT’S NEW IN THE EIGHTH EDITION:
There is a new case study “Adam Smith Would Have Loved Uber.”
LEARNING OBJECTIVES:
By the end of this chapter, students should understand:
that economics is about the allocation of scarce resources.
that individuals face trade-offs.
the meaning of opportunity cost.
how to use marginal reasoning when making decisions.
how incentives affect people’s behavior.
why trade among people or nations can be good for everyone.
why markets are a good, but not perfect, way to allocate resources.
what determines some trends in the overall economy.
CONTEXT AND PURPOSE:
Chapter 1 is the first chapter in a three-chapter section that serves as the introduction to the text.
Chapter 1 introduces ten fundamental principles on which the study of economics is based. In a broad
sense, the rest of the text is an elaboration on these ten principles. Chapter 2 will develop how
economists approach problems while Chapter 3 will explain how individuals and countries gain from
trade.
The purpose of Chapter 1 is to lay out ten economic principles that will serve as building blocks for
the rest of the text. The ten principles can be grouped into three categories: how people make decisions,
how people interact, and how the economy works as a whole. Throughout the text, references will be
made repeatedly to these ten principles.
1
© 2018 Cengage Learning®. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part,
except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning
management system for classroom use.
,2 ❖ Chapter 1/Ten Principles of Economics
KEY POINTS:
The fundamental lessons about individual decision making are that people face trade-offs among
alternative goals, that the cost of any action is measured in terms of forgone opportunities, that
rational people make decisions by comparing marginal costs and marginal benefits, and that people
change their behavior in response to the incentives they face.
The fundamental lessons about interactions among people are that trade and interdependence can
be mutually beneficial, that markets are usually a good way of coordinating economic activity among
people, and that the government can potentially improve market outcomes by remedying a market
failure or by promoting greater economic equality.
The fundamental lessons about the economy as a whole are that productivity is the ultimate source
of improving living standards, that growth in the quantity of money is the ultimate source of inflation,
and that society faces a short-run trade-off between inflation and unemployment.
CHAPTER OUTLINE:
I. Introduction
Begin by pointing out that economics is a subject that students must confront in their
daily lives. Point out that they already spend a great deal of their time thinking about
economic issues: changes in prices, buying decisions, use of their time, concerns
about employment, etc.
A. The word “economy” comes from the Greek word oikonomos meaning “one who manages a
household.”
B. Both households and economies face many decisions about how to allocate resources.
C. Resources are scarce so they must be managed carefully.
You will want to start the semester by explaining to students that part of learning
economics is understanding a new vocabulary. Economists generally use very precise
(and sometimes different) definitions for words that are commonly used outside of
the economics discipline. Therefore, it will be helpful to students if you follow the
D. Definition of provided
definitions scarcity:inthe
thelimited nature
text as much as of society’s resources.
possible.
E. Definition of economics: the study of how society manages its scarce resources.
Because most college freshmen and sophomores have limited experiences with
viewing the world from a cause-and-effect perspective, do not underestimate how
challenging
As these
you discuss theprinciples will bemake
ten principles, for the student.
sure that students realize that it is okay if
they do not grasp each of the concepts completely or find each of the arguments fully
convincing. These ideas will be explored more completely throughout the text.
II. How People Make Decisions
A. Principle #1: People Face Trade-offs
1. “There ain’t no such thing as a free lunch.” To get something that we like, we usually have to
give up, or trade for, something else that we also like.
© 2018 Cengage Learning®. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part,
except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning
management system for classroom use.
, Chapter 1/Ten Principles of Economics ❖ 3
2. Examples include how students spend their time, how a family decides to spend its income,
how the U.S. government spends tax dollars, and how regulations may protect the
environment at a cost to firm owners.
3. An important trade-off that society faces is the trade-off between efficiency and equality.
a. Definition of efficiency: the property of society getting the most it can from its
scarce resources.
b. Definition of equality: the property of distributing economic prosperity
uniformly among the members of society.
c. For example, tax dollars paid by wealthy Americans and then distributed to those less
fortunate may improve equality but lower the return to hard work and therefore reduce
the level of output produced by our resources.
d. This implies that the cost of this increased equality is a reduction in the efficient use of
our resources.
4. Recognizing that trade-offs exist does not indicate what decisions should or will be made.
B. Principle #2: The Cost of Something Is What You Give Up to Get It
1. Making decisions requires individuals to consider the benefits and costs of some action.
2. What are the costs of going to college?
a. We should not count room and board (unless they are more expensive at college than
elsewhere) because the student would have to pay for food and shelter even if she were
not in school.
b. We should count the value of the student’s time because she could be working for pay
instead of attending classes and studying.
3. Definition of opportunity cost: whatever must be given up in order to obtain some
item.
One of the hardest ideas for students to grasp is that “free” things are not truly free.
Provide students with many examples of such “free” things with hidden costs,
especially the value of time. Suggested examples include the time students spend
waiting in line for “free” sporting event tickets at their universities, time spent
relaxing in the sun outside their residence halls, or driving on a road with no tolls
but lots of congestion.
© 2018 Cengage Learning®. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part,
except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning
management system for classroom use.
, 4 ❖ Chapter 1/Ten Principles of Economics
C. Principle #3: Rational People Think at the Margin
1. Economists generally assume that people are rational.
a. Definition of rational people: people who systematically and purposefully do the
best they can to achieve their objectives.
b. Consumers want to purchase the goods and services that allow them the greatest level
of satisfaction given their incomes and the prices they face.
c. Firm managers want to produce the level of output that maximizes the profits the firms
earn.
2. Many decisions in life involve incremental decisions: Should I remain in school this semester?
Should I take another course this semester? Should I study another hour for tomorrow’s
exam?
a. Definition of marginal change: a small incremental adjustment to a plan of
action.
b. Example: Suppose that you are considering calling a friend on your cell phone and the
marginal benefit of the 10-minute call is $7.00. Your cell phone costs you $40 per month
plus an additional $0.50 per minute. You typically talk for 100 minutes and have a
monthly bill of $90. If you consider the average cost of a call, you would decide that the
benefit of this 10-minute call does not exceed its cost ($9.00). However, the marginal
cost of the call is only $5.00 so the marginal benefit of the call does outweigh its
marginal cost. Cell phone users who have unlimited minutes (free at the margin) often
make long and frivolous phone calls.
c. Suppose that flying a 200-seat plane across the country costs the airline $100,000, which
means that the average cost of each seat is $500. Suppose that the plane is minutes
from departure and a passenger is willing to pay $300 for a seat. Should the airline sell
the seat for $300? In this case, the marginal cost of an additional passenger is very
small.
d. Another example: Why is water so cheap while diamonds are expensive? The marginal
benefit of a good depends on how many units a person already has. Because water is
plentiful, the marginal benefit of an additional cup is small. Because diamonds are rare,
the marginal benefit of an extra diamond is high.
3. A rational decision maker takes an action if and only if the marginal benefit is at least as
large as the marginal cost.
D. Principle #4: People Respond to Incentives
1. Definition of incentive: something that induces a person to act.
2. Because rational people make decisions by weighing costs and benefits, their decisions may
change in response to incentives.
a. When the price of a good rises, consumers will buy less of it because its cost has risen.
© 2018 Cengage Learning®. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part,
except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning
management system for classroom use.
1 TEN PRINCIPLES OF ECONOMICS
WHAT’S NEW IN THE EIGHTH EDITION:
There is a new case study “Adam Smith Would Have Loved Uber.”
LEARNING OBJECTIVES:
By the end of this chapter, students should understand:
that economics is about the allocation of scarce resources.
that individuals face trade-offs.
the meaning of opportunity cost.
how to use marginal reasoning when making decisions.
how incentives affect people’s behavior.
why trade among people or nations can be good for everyone.
why markets are a good, but not perfect, way to allocate resources.
what determines some trends in the overall economy.
CONTEXT AND PURPOSE:
Chapter 1 is the first chapter in a three-chapter section that serves as the introduction to the text.
Chapter 1 introduces ten fundamental principles on which the study of economics is based. In a broad
sense, the rest of the text is an elaboration on these ten principles. Chapter 2 will develop how
economists approach problems while Chapter 3 will explain how individuals and countries gain from
trade.
The purpose of Chapter 1 is to lay out ten economic principles that will serve as building blocks for
the rest of the text. The ten principles can be grouped into three categories: how people make decisions,
how people interact, and how the economy works as a whole. Throughout the text, references will be
made repeatedly to these ten principles.
1
© 2018 Cengage Learning®. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part,
except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning
management system for classroom use.
,2 ❖ Chapter 1/Ten Principles of Economics
KEY POINTS:
The fundamental lessons about individual decision making are that people face trade-offs among
alternative goals, that the cost of any action is measured in terms of forgone opportunities, that
rational people make decisions by comparing marginal costs and marginal benefits, and that people
change their behavior in response to the incentives they face.
The fundamental lessons about interactions among people are that trade and interdependence can
be mutually beneficial, that markets are usually a good way of coordinating economic activity among
people, and that the government can potentially improve market outcomes by remedying a market
failure or by promoting greater economic equality.
The fundamental lessons about the economy as a whole are that productivity is the ultimate source
of improving living standards, that growth in the quantity of money is the ultimate source of inflation,
and that society faces a short-run trade-off between inflation and unemployment.
CHAPTER OUTLINE:
I. Introduction
Begin by pointing out that economics is a subject that students must confront in their
daily lives. Point out that they already spend a great deal of their time thinking about
economic issues: changes in prices, buying decisions, use of their time, concerns
about employment, etc.
A. The word “economy” comes from the Greek word oikonomos meaning “one who manages a
household.”
B. Both households and economies face many decisions about how to allocate resources.
C. Resources are scarce so they must be managed carefully.
You will want to start the semester by explaining to students that part of learning
economics is understanding a new vocabulary. Economists generally use very precise
(and sometimes different) definitions for words that are commonly used outside of
the economics discipline. Therefore, it will be helpful to students if you follow the
D. Definition of provided
definitions scarcity:inthe
thelimited nature
text as much as of society’s resources.
possible.
E. Definition of economics: the study of how society manages its scarce resources.
Because most college freshmen and sophomores have limited experiences with
viewing the world from a cause-and-effect perspective, do not underestimate how
challenging
As these
you discuss theprinciples will bemake
ten principles, for the student.
sure that students realize that it is okay if
they do not grasp each of the concepts completely or find each of the arguments fully
convincing. These ideas will be explored more completely throughout the text.
II. How People Make Decisions
A. Principle #1: People Face Trade-offs
1. “There ain’t no such thing as a free lunch.” To get something that we like, we usually have to
give up, or trade for, something else that we also like.
© 2018 Cengage Learning®. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part,
except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning
management system for classroom use.
, Chapter 1/Ten Principles of Economics ❖ 3
2. Examples include how students spend their time, how a family decides to spend its income,
how the U.S. government spends tax dollars, and how regulations may protect the
environment at a cost to firm owners.
3. An important trade-off that society faces is the trade-off between efficiency and equality.
a. Definition of efficiency: the property of society getting the most it can from its
scarce resources.
b. Definition of equality: the property of distributing economic prosperity
uniformly among the members of society.
c. For example, tax dollars paid by wealthy Americans and then distributed to those less
fortunate may improve equality but lower the return to hard work and therefore reduce
the level of output produced by our resources.
d. This implies that the cost of this increased equality is a reduction in the efficient use of
our resources.
4. Recognizing that trade-offs exist does not indicate what decisions should or will be made.
B. Principle #2: The Cost of Something Is What You Give Up to Get It
1. Making decisions requires individuals to consider the benefits and costs of some action.
2. What are the costs of going to college?
a. We should not count room and board (unless they are more expensive at college than
elsewhere) because the student would have to pay for food and shelter even if she were
not in school.
b. We should count the value of the student’s time because she could be working for pay
instead of attending classes and studying.
3. Definition of opportunity cost: whatever must be given up in order to obtain some
item.
One of the hardest ideas for students to grasp is that “free” things are not truly free.
Provide students with many examples of such “free” things with hidden costs,
especially the value of time. Suggested examples include the time students spend
waiting in line for “free” sporting event tickets at their universities, time spent
relaxing in the sun outside their residence halls, or driving on a road with no tolls
but lots of congestion.
© 2018 Cengage Learning®. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part,
except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning
management system for classroom use.
, 4 ❖ Chapter 1/Ten Principles of Economics
C. Principle #3: Rational People Think at the Margin
1. Economists generally assume that people are rational.
a. Definition of rational people: people who systematically and purposefully do the
best they can to achieve their objectives.
b. Consumers want to purchase the goods and services that allow them the greatest level
of satisfaction given their incomes and the prices they face.
c. Firm managers want to produce the level of output that maximizes the profits the firms
earn.
2. Many decisions in life involve incremental decisions: Should I remain in school this semester?
Should I take another course this semester? Should I study another hour for tomorrow’s
exam?
a. Definition of marginal change: a small incremental adjustment to a plan of
action.
b. Example: Suppose that you are considering calling a friend on your cell phone and the
marginal benefit of the 10-minute call is $7.00. Your cell phone costs you $40 per month
plus an additional $0.50 per minute. You typically talk for 100 minutes and have a
monthly bill of $90. If you consider the average cost of a call, you would decide that the
benefit of this 10-minute call does not exceed its cost ($9.00). However, the marginal
cost of the call is only $5.00 so the marginal benefit of the call does outweigh its
marginal cost. Cell phone users who have unlimited minutes (free at the margin) often
make long and frivolous phone calls.
c. Suppose that flying a 200-seat plane across the country costs the airline $100,000, which
means that the average cost of each seat is $500. Suppose that the plane is minutes
from departure and a passenger is willing to pay $300 for a seat. Should the airline sell
the seat for $300? In this case, the marginal cost of an additional passenger is very
small.
d. Another example: Why is water so cheap while diamonds are expensive? The marginal
benefit of a good depends on how many units a person already has. Because water is
plentiful, the marginal benefit of an additional cup is small. Because diamonds are rare,
the marginal benefit of an extra diamond is high.
3. A rational decision maker takes an action if and only if the marginal benefit is at least as
large as the marginal cost.
D. Principle #4: People Respond to Incentives
1. Definition of incentive: something that induces a person to act.
2. Because rational people make decisions by weighing costs and benefits, their decisions may
change in response to incentives.
a. When the price of a good rises, consumers will buy less of it because its cost has risen.
© 2018 Cengage Learning®. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part,
except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning
management system for classroom use.
