Ten Principles of Economics People Face Tradeoffs Because resources are scarcely provided to us, we simply cannot make everything we want. When we devote resources towards one particular task, those resources cannot also be devoted to another task (at least not at the same time). Therefore, making a decision to do something carries with it the implication that you cannot also do something else.   The Cost of Something Is What You Give Up to Get It How much does it really cost you to see a concert? This may sound like a strange question, but economists will argue that the true cost of something is revealed by what people give up to get it. For example, suppose you want to see The Dave Matthews Band.   Q: How much does the ticket really cost? A: You might say, "I got the ticket for $30." However, economists want more information. How long did you wait in line in order to buy the ticket? Did you miss time at work when you were in line? What is the value of your time? Suppose you missed 6 hours of work while waiting in line and you currently hold a job that pays $8/hour.   Opportunity Cost of a Concert Ticket Ticket Price $30 Value of your time $48 (6 hrs. @ $8/hr)   Total $78   An economist would argue that you gave up $30 for the ticket, plus time that is worth $48. In other words, the true cost of the ticket to you is $78. This may seem like a lot of money for a concert ticket, but the fact that you paid $30 for the ticket and gave up $48 in wages reveals that the ticket was worth at least $78 to you - otherwise you would have decided NOT to buy the ticket.   Rational People Think at the Margin The word marginal appears often in economics. For economists, marginal is synonymous with 'incremental', or 'additional'. In general, when viewing economic decisions, it is the comparison of marginal benefit to marginal cost that is important.   Q: Should I pay for a $40/month on-campus parking space? A: It depends on the marginal benefit and marginal cost of buying the parking space. The marginal benefit of having an on-campus parking space is that you will have a shorter walk to and from class every day. The marginal cost is $40/month.   How much you benefit from parking on campus depends entirely on where you park when you park off campus. If you normally have to park a great distance away (say a half-mile on average), it's likely that the marginal benefit will exceed $40/month. If you normally can park for free right across the street from campus, the marginal benefit is likely less than $40/month.   The key to making any optimal decision is the relationship between marginal benefits and marginal costs. Whenever marginal benefit exceeds marginal cost, you'll be better off doing something. Whenever marginal benefit is less than marginal cost, you'll be worse off doing something.   People Respond to Incentives Marginal costs and benefits are not fixed forever. They change over time as economic and other conditions in the marketplace change. Because of these changes, you might make different decisions over time.   Remember the decision about whether or not to pay for an on-campus parking space? Lets suppose that you originally decided to buy the space for $40/month. Further suppose that six months later a free parking garage opens across the street from campus. The parking garage has reduced the average distance you'd have to walk whenever you park off campus. In other words, the parking garage has reduced the marginal benefit of paying for an on-campus parking space. If the marginal benefit is reduced to less than $40/month, you'll stop paying for that on-campus parking space.   Trade Can Make Everyone Better Off Trade allows all players in the market to specialize in what they do best. In this sense, all people are able to produce as much as possible, and trade some of their product away for things produced by other people. Think of everything you've purchased in the last year.   Q: Would you have been able to produce all of these items by yourself in the last year? A: Probably not.   This illustrates that trade allows ALL of us to consume more goods and services than we could individually produce. This notion holds true whether we look at trade within the United States or trade between the United States and other countries.   Markets Are Usually a Good Way to Organize Economic Activity Who, in the US economy, decides what (and how much) gets produced? Free markets. If you never gave this idea much thought, you should consider it now. Our economy is organized around the idea that markets, which are not controlled by anybody, are the best way to organize the interaction of buyers and sellers. As an example, think of all the times you've been to the grocery store in the last year.   Q: How often do you call the grocery store ahead of time to ensure that they'll have what you're coming to get? A: Never   Q: How often does the grocery store have what you're shopping for? A: Almost always.   On the surface, the first question sounds completely ridiculous. However, the fact that the grocery store has what you want, when you want it merely illustrates the point that free markets are the best way to organize economic activity. Grocery stores in the ex-USSR were often unable to supply the products their customers came in to buy. The reason for this is that economic activity in the ex-USSR was organized by a Central Planning Committee, not by free markets, and the Central Planning Committee was often wrong in deciding what should be produced.   Governments Can Sometimes Improve Market Outcomes While free markets are viewed by economists as the best way to organize economic activity, they are by no means perfect. There are times when the outcome of free market interactions of buyers and sellers leads to undesirable results. When this occurs, economists will look for ways to improve the problem that allows the market to continue to function as much as possible, rather than simply doing away with the market completely. Examples of market failures include pollution, monopoly and the fact that some goods will NOT be provided at all by free markets (like national defense).   A Country's Standard of Living Depends on Its Ability to Produce Goods and Services How much we can consume, whether it be TV sets or food or health care depends on our ability to produce the products we want to consume. Countries that are more productive will have higher per-capita consumption and consequently a higher standard of living. A major question that must be addressed by economists is: If living standards are linked to our productivity levels, then how do we continue to improve our productivity over time? Whether this involves education, capital accumulation or improving technology, our answer to the question will go a long way towards determining what type of life we will be able to live in the future.   Prices Rise When the Government Prints Too Much Money In our economy, the size of the money supply (e.g. the number of dollars circulating in the economy) is controlled by the Federal Reserve System. Inflation, or the rate of increase in prices, is related to the rate of growth of the money supply. When the Fed increases the money supply rapidly (as in the 1970's), inflation heats up. When the Fed increases the money supply slowly (as in the 1990's), inflation slows down. When the money supply is increased VERY rapidly (as in Germany in the 1920's, or more recently in Argentina or Bolivia) inflation can be simply out of control.   Society Faces a Short-Run Tradeoff between Inflation and Unemployment The idea that there is a tradeoff between inflation and unemployment, in the short-run, is illustrated in the figure below. Unemployment is the red series, and inflation is the blue series. Notice how they tend to move inversely. The implication of this relationship is that reducing one may cause the other to rise.   Source: Economic Report of the President, February, 1998 (Back to top)