ECONOMICS FOR MANAGER

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Chapter 1

Ten lessons from economics


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A household and an economyface many decisions :

Who will work? What goods and how many of them should

be produced? What resources should be used in

production? At what price should the goods be sold?


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Society and scarce resources: The management of societys resources

is important because resources are scarce. Scarcity means that society has limited

resources and therefore cannot produce allthe goods and services people want.



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Economics is the study of how societymanages its scarce resources.



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How people make decisions.1. People face trade-offs.

2. The cost of something is what you give upto get it.3. Rational people think at the margin.4. People respond to incentives.



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How people interact with each other.5. Trade can make everyone better off.

6. Markets are usually a good way to organiseeconomic activity.7. Governments can sometimes improve

market outcomes.



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How the economy as a whole works.8. A countrys standard of living depends on

its ability to produce goods and services.9. Prices rise when the government prints toomuch money.

10.Society faces a short-term trade-off

between inflation and unemployment.



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There is no such thing as a free lunch!

Lesson 1:

People face trade-offs


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To get one thing, we usually have togive up another thing.

guns v. butter clothing v. holidays leisure time v. work clean environment v. income

efficiency v. equity

Lesson 1:



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Making decisions requires trading off onegoal against another.

Lesson 1:



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Efficiency v. equity Efficiency means society gets the most that

it can from its scarce resources. Equity means the benefits of thoseresources are distributed fairly among themembers of society.

Lesson 1:



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Decisions require comparing costs andbenefits of alternatives. Whether to go to university or

to work? Whether to study or go to the movies? Whether to go to lectures or sleep in?

The opportunity cost of an item is whatyou give up to obtain that item.

Lesson 2:The cost of something is

what you give up to get it


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Marginal changes are small incrementaladjustments to an existing plan of action.

Lesson 3:Rational people think

at the margin


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People make decisions by comparingcosts and benefits at the margin.

Lesson 3:Rational people think

at the margin


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Marginal changes in costs or benefitsmotivate people to respond.

The decision to choose one alternativeover another occurs when thatalternatives marginal benefits exceedits marginal costs.

Lesson 4:

People respond to incentives


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People gain from their ability to tradewith one another.

Competition results in gains fromtrading.

Trade allows people to specialise in

what they do best.

Lesson 5:Trade can make everyone

better off


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A market economy is an economy thatallocates resources through thedecentralised decisions of many firmsand households as they interact inmarkets for goods and services. Firms decide who to hire and what to

produce. Households decide what to buy and who to

work for.

Lesson 6:Markets are usually a good way

to organise economic activity


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Adam Smith made the observation thathouseholds and firms interacting in

markets act as if guided by an invisiblehand. As households and firms look at prices

when deciding what to buy and sell, theyunknowingly take into account the socialcosts of their actions.

As a result, prices guide decision makers toreach outcomes that tend to maximise thewelfare of society as a whole.

Lesson 6:Markets are usually a good way

to organise economic activity


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Market failure occurs when the marketfails to allocate resources efficiently.

When the market fails (breaks down)government can intervene to promoteefficiency and equity.

Lesson 7:Governments can sometimes

improve market outcomes


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Market failure may be caused by: An externality , which is the impact of one

person or firms actions on the wellbeing of a bystander.

Market power , which is the ability of asingle person or firm to have a substantial

influence on market prices.

Lesson 7:Governments can sometimes

improve market outcomes


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A countrys standard of living may bemeasured in different ways: By comparing personal incomes. By comparing the total market value of a

nations production.

Lesson 8:The standard of living depends

on a countrys production


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Large differences exist in livingstandards: The average Australian in 2007 had an

annual income of $36 553 ($US). South Koreans had an average of $18 392

($US).

Indians had an average of $797.




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Large differences exist in livingstandards: But incomes may converge over time.

Growth rate in Korean incomes over the lasttwo decades has been much stronger thanAustralian growth rates.

Australian incomes double about every 35years, while Korean incomes have doubledin the last 15 years.




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Almost all variations in living standardsare explained by differences in

countries productivity. Productivity is the amount of goods and

services produced from each hour of aworkers time.




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Inflation is an increase in the overalllevel of prices in the economy.

One cause of inflation is the growth inthe quantity of money.

When the government creates large

quantities of money, the value of themoney falls.

Lesson 9: Prices rise when theGovernment prints too much

money


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The Phillips Curve illustrates the short-term trade-off between inflation and

unemployment.Inflation = Unemployment

Its a short -term trade-off!

Lesson 10: Society faces ashort-term trade-off betweeninflation and unemployment


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Summary When individuals make decisions, they

face trade-offs between alternativegoals.

The cost of any action is measured interms of foregone opportunities.

Rational people make decisions bycomparing marginal costs and marginalbenefits.

People change their behaviour inresponse to the incentives they face.


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Summary

Trade can be mutually beneficial. Markets are usually a good way of

coordinating trade among people. Government can potentially improve

market outcomes if there is marketfailure or if the market outcome isinequitable.


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Summary

Productivity is the ultimate source of living standards.

Money growth is the ultimate source of inflation. Society faces a short-term trade-off

between inflation and unemployment.

ECONOMICS FOR MANAGER

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