Topic #1: Economic Principles

Dr David Penn

Associate Professor of Economics and Director of the Business and Economic Research Center

Important Economic Principles

Several principles have a large influence on the way in which economists view the world.Examples of these principles will be encountered throughout the course.We will discuss them in two parts:1) Principles that underlie individual choice, and2) Principles having to do with how individuals interact

Principles related to choice

1) Scarcity2) Cost and tradeoffs3) Thinking at the margin4) Incentives matter

Principles related to choice 1) Scarcity –

Resources are limited but needs and wants are unlimited.

Consequently, we must make choices. Corollary: there is never enough resource to satisfy

needs and wants.

Principles related to choice 2) Opportunity cost and tradeoffs -

Since resources are limited, doing one thing means we can’t do something else.

We are constantly making tradeoffs. The cost of something is what we give up to get it

(opportunity cost).

Principles related to choice 3) Economists think at the margin –

A marginal change is a small adjustment. Rational decision-makers compare marginal costs

to marginal benefits.

Principles related to choice

4) Incentives matter – People typically exploit opportunities to make

themselves better off. If we want to change behavior, incentives must

change. Prices and wages are very important incentives.

Examples: which principle?

1) You are on your third trip to Chef Wang’s all-you-can-eat buffet and are nearly full. You choose just one dessert: chocolate cake instead of key lime pie.

Which principle is illustrated?

Examples: which principle?

2) Even if we increase the amount of resources in the world there still would not be enough to go around.

Which principle is illustrated?

Examples: which principle?

3) Wal-Mart shoppers typically shift to the line with the smallest number of people.

Which principle is illustrated?

Examples: which principle?

4) Instead of sinking a gift of money into my present selection of stocks, I search for the best possible stock for my additional investment.

Which principle is illustrated?

Principles related to interactions

5) We all gain from trade6) Markets move towards equilibrium7) Efficiency is an important goal8) Markets tend to allocate resources

efficiently9) Government is needed when markets fail

Principles related to interactions

5) We all gain from trade – Trade allows us to specialize. Specialization makes us more productive.

Principles related to interactions ) Markets move toward equilibrium -

Opportunities to benefit tend to be exploited. Imbalances in the market tend to self-correct.

Principles related to interactions 7) Resources should be used efficiently

Since needs and wants are unlimited, never enough resources to go around.

When the economy is efficient, we are getting all we can from our resources.

Efficiency must be balanced against equity.

Principles related to interactions 8) Markets tend to lead to efficiency

Market prices provide incentives for trade, and trade increases efficiency.

Goods and services flow where the gains are largest.

Principles related to interactions 9) Government intervention is needed when

markets don’t result in efficiency Sometimes markets fail to achieve efficiency Some necessary goods are not priced by the

marketplace Sometimes producers have too much power. Government can help to correct market failures.

Examples: which principle?

5) The Environmental Protection Agency severely restricts emissions of mercury from electric power generation plants.

Which principle is illustrated?

Examples: which principle?

6) Natural gas producers are actively seeking ways to export abundant natural gas from the United States.

Which principle is illustrated?

Examples: which principle?

7) I pay Firestone to change oil in my vehicles so I can focus my time on teaching and research.

Which principle is illustrated?

Examples: which principle?

8) Universities are rapidly moving to the MOOC model, teaching entire degree programs online.

Which principle is illustrated?