Microeconomics (Chapters 1 – 5)

Study of how society manages its scarce resources

Limited nature of society's resources

1) How people make decisions
2) How people interact
3) How the economy as a whole works

People face tradeoffs: There is often a tradeoff between efficiency (the property of society getting the most it can from its scarce resources) and equity (property of distributing economic prosperity fairly among members of society)

The cost of something is what you give up to get it: Opportunity cost - whatever must be given up to obtain some item.

Rational people think at the Margin: Rational people make decisions by comparing marginal benefits and marginal costs.
Marginal changes - small incremental changes to a plan of action

People respond to incentives: something that induces a person to act

Trade can make everyone better off: allows people to specialize and allows access to a greater variety of goods and services.
Property rights - the ability of an individual to own and exercise control over a scarce resource

Markets are usually a good way to organize economic activity: Market economy - economy that allocates resources through the decentralized decisions of society. Most important element of market economy = competition. In 1776 Adam Smith observed that society interacts in markets as if they are guided by an invisible hand that leads them to a desirable market outcome

Governments can improve market outcomes: Governments exist for 2 reasons: (1) to enforce property rights; (2) because the invisible hand is powerful, but not omnipotent. Government may interfere in economy for the goal of efficiency or the goal of equity.

Market failure (when a market is left on its own and it fails to allocate resources efficiently) can be caused by an externality (impact of one persons actions on the well-being of a bystander) (ie. pollution). Another cause of market failure is market power (ability of a single economic actor to have a substantial influence on market prices) (ie. EPCOR).

Even when the invisible hand is yielding efficient outcomes it can leave disparities in economic well-being. A market economy rewards people according to their ability to produce something others are willing to pay for. However the invisible hand does not ensure everyone has adequate food, clothing, or healthcare. The government puts policies such as welfare and income tax in place to achieve equity.

A country's standard of living depends on its ability to produce goods and services: variation in standards of living can be explained by differences in countries productivity (quantity of goods and services produced from each hour of work).

Prices rise when the government prints too much money: Inflation - increase in the overall level of prices in the economy. If production is fixed but the government prints more money the value of G&S increases and the value of money decreases.

Society faces short-run tradeoff between inflation and unemployment: as unemployment decreases and more money is printed inflation increases