1

WHATS NEW:

T01 P2'1*'P30S 45 0*4146'*S

The discussions of Principle #3, People think at the margin, Principle #4, People respond to incentives, and Principle #10, Societ faces a short!run tradeoff "et#een inflation and unemplo ment are no# more clear$ The FYI "o% on &dam Smith and the 'nvisi"le (and has "een moved to this chapter )from *hapter +,$

LEARNING OBJECTIVES:
By the end of this cha te!" st#dents sho#$d #nde!stand: that economics is a"out the allocation of scarce resources$ that individuals face tradeoffs$ the meaning of opportunit cost$ ho# to use marginal reasoning #hen making decisions$ ho# incentives affect people-s "ehavior$ #h trade among people or nations can "e good for ever one$ #h markets are a good, "ut not perfect, #a to allocate resources$ #hat determines some trends in the overall econom $

%E& 'OINTS:
1$ The fundamental lessons a"out individual decision making are that people face tradeoffs among alternative goals, that the cost of an action is measured in terms of foregone opportunities, that rational people make decisions " comparing marginal "enefits and marginal costs, and that people change their "ehavior in response to the incentives the face$ .$ The fundamental lessons a"out interactions among people are that trade can "e mutuall "eneficial, that markets are usuall a good #a of coordinating trades among people, and that the government can potentiall improve market outcomes if there is some sort of market failure or if the market outcome is ine/uita"le$

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Chapter 1 TEN PRINCIPLES OF ECONOMICS

3$ The fundamental lessons a"out the econom as a #hole are that productivit is the ultimate source of living standards, that mone gro#th is the ultimate source of inflation, and that societ faces a short!run tradeoff "et#een inflation and unemplo ment$

CHA'TER O(TLINE:
'$ 'ntroduction 8egin " pointing out that economics is a su"9ect that students must confront in their ever da lives$ Point out that the alread spend a great deal of their time thinking &$a"out The #ord A econom @ comes from the 7reek #ord meaning one #ho manages economic issues: prices, "u ing decisions, use of their time, A etc$ a household$ 8$ *$ This makes some sense, since in the econom #e are faced #ith man decisions )9ust as a household is,$ 5undamental economic pro"lem: resources are scarce$

=ou #ill #ant to start the semester " e%plaining to students that part of learning economics is understanding a ne# voca"ular $ 0conomists generall use ver precise )and sometimes different, definitions for #ords that are commonl used outside of the economics discipline$ Therefore, it #ill "e helpful to students if ou ;$follo# ;efinition of Sca!city: the $i)ited nat#!e of societys the definitions provided in the te%t as much as possi"le$!eso#!ces* 0$ ;efinition of Econo)ics: the st#dy of ho+ society )ana,es its sca!ce !eso#!ces*

8ecause most college freshmen and sophomores have limited e%periences #ith vie#ing the #orld from a cause!and!effect perspective, do not underestimate ho# challenging these principles #ill "e for the student$ ''$ (o# People 6ake ;ecisions Table 1-1 &$ Principle #1: People 5ace Tradeoffs 1$ .$ AThere is no such thing as a free lunch$@ 6aking decisions re/uires trading off one goal for another$ 0%amples include ho# a student spends her time, ho# a famil decides to spend its income, ho# the <$S$ government spends ta% dollars, ho# regulations ma protect the environment at a cost to firm o#ners$ & special e%ample of a tradeoff is the tradeoff "et#een efficienc and e/uit $ a$ ;efinition of Efficiency: the !o e!ty of society ,ettin, the )ost it can f!o) its sca!ce !eso#!ces*

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Chapter 1 TEN PRINCIPLES OF ECONOMICS

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;efinition of E-#ity: the !o e!ty of dist!i.#tin, econo)ic !os e!ity fai!$y a)on, the )e).e!s of society* 5or e%ample, ta% dollars paid " #ealth &mericans and then distri"uted to those less fortunate ma improve e/uit "ut lo#er the return to hard #ork and therefore reduce the level of output produced " our resources$ This implies that the cost of this increased e/uit is a reduction in the efficient use of our resources$

d$ 8$

Principle #.: The *ost of Something 's >hat =ou 7ive <p to 7et 't 1$ .$ 6aking decisions re/uires individuals to consider the "enefits and costs of some action$ >hat are the costs of going to college? a$ >e cannot count room and "oard )at least all of the cost, "ecause the person #ould have to pa for food and shelter even if he #as not in school$ >e #ould #ant to count the value of the student-s time since he could "e #orking for pa instead of attending classes and stud ing$ o!t#nity Cost: +hate/e! )#st .e ,i/en # to o.tain

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3$

;efinition of O so)e ite)*

4ne of the hardest ideas for students to grasp is that free things are not trul free$ Thus, ou #ill need to provide students #ith numerous e%amples of such free things #ith hidden costs, especiall the value of time$ *$ Principle #3: 2ational People Think at the 6argin 1$ .$ 3$ 6an decisions in life involve incremental decisions: should ' remain in school this semester? Should ' take another course this semester? ;efinition of 0a!,ina$ Chan,es: s)a$$ inc!e)enta$ ad1#st)ents to a $an of action* 0%ample: =ou are tr ing to decide on ho# man ears to sta in school$ *omparing the lifest le of an individual #ith a Ph$;$ to one of an individual #ho has dropped out of grade school #ould "e inappropriate$ =ou are likel deciding #hether or not to remain in school for an additional ear or t#o$ Thus, ou need to compare the additional "enefits of another ear in school )the marginal benefit, #ith the additional cost of sta ing in school for another ear )the marginal cost,$ &nother e%ample: Suppose that fl ing a .00!seat plane across the countr costs the airline @100,000 #hich means that the average cost of each seat is @A00$ Suppose that the plane is minutes from departure

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Chapter 1 TEN PRINCIPLES OF ECONOMICS and a passenger is #illing to pa @300 for a seat$ Should the airline sell the seat for @300? ;$ Principle #4: People 2espond to 'ncentives 1$ .$ 3$ 8ecause people make decisions " #eighing costs and "enefits, their decisions ma change in response to changes in costs and "enefits$ Sometimes polic makers fail to understand ho# policies ma alter incentives and "ehavior$ 0%ample: Seat "elt la#s increase use of seat "elts and lo#er the incentives of individuals to drive safel $ This leads to an increase in the num"er of car accidents$

'''$

(o# People 'nteract &$ Principle #A: Trade *an 6ake 0ver one 8etter 4ff 1$ *onsider trade that takes place inside our home$ *ertainl the famil is involved in trade #ith other families on a dail "asis$ 6ost families do not "uild their o#n homes, make their o#n clothes, or gro# their o#n food$ Bust like families "enefit from trading #ith one another so do countries$ This occurs "ecause it allo#s for specialiCation in areas that countries )or families, can do "est$

.$ 3$ 8$

Principle #D: 6arkets &re <suall a 7ood >a to 4rganiCe 0conomic &ctivit 1$ ;efinition of 0a!2et Econo)y: an econo)y that a$$ocates !eso#!ces th!o#,h the decent!a$i3ed decisions of )any fi!)s and ho#seho$ds as they inte!act in )a!2ets fo! ,oods and se!/ices* 6arket prices reflect "oth the value of a product to consumers and the cost of the resources used to produce it$ Therefore, decisions to "u or produce goods and services are made "ased on the cost to societ of providing them$

.$

0%plain to students that #hen households and firms do #hat is "est for themselves, the often end up doing #hat is "est for societ , as if guided " market forces E or an invisi"le hand$ Spend some time and emphasiCe the magic of the market$ <se numerous e%amples to sho# students that the market most often allocates resources 3$ >hen a government interferes in a market and restricts price from to their highest valued use$ ad9usting, decisions are not "ased on the proper information and ma "e inefficient$ 4$ A$ This helps to e%plain #h centrall planned economies have failed )such as the former Soviet <nion,$ FYI: The Invisible Hand of the Marketplace

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Chapter 1 TEN PRINCIPLES OF ECONOMICS a$

&dam Smith-s 1++D #ork suggested that although individuals are motivated " self!interest, an invisi"le hand guides this self! interest into promoting societ -s economic #ell!"eing$ Smith-s astute perceptions #ill "e discussed more full in the chapters to come$

"$ *$

Principle #+: 7overnments *an Sometimes 'mprove 6arket 4utcomes 1$ .$ 7oals of most government policies: promotion of efficienc and e/uit $ 7overnment polic can "e most useful #hen there is market failure$ a$ 3$ ;efinition of 0a!2et 4ai$#!e: a sit#ation in +hich a )a!2et $eft on its o+n fai$s to a$$ocate !eso#!ces efficient$y*

0%amples of 6arket 5ailure a$ "$ ;efinition of E5te!na$ity: the i) act of one e!sons actions on the +e$$6.ein, of a .ystande!* ;efinition of 0a!2et 'o+e!: the a.i$ity of a sin,$e econo)ic acto! 7o! s)a$$ ,!o# of acto!s8 to ha/e a s#.stantia$ inf$#ence on )a!2et !ices*

4$

1ote that the principle states that the government can improve market outcomes$ This is not sa ing that the government al#a s does improve market outcomes$

'F$

(o# the 0conom as a >hole >orks &$ Principle #G: & *ountr -s Standard of 3iving ;epends on 'ts &"ilit to Produce 7oods and Services 1$ .$ 3$ 4$ A$ D$ ;ifferences in living standards from one countr to another are /uite large$ *hanges in living standards over time are also great$ 0%planation: Productivit $ ;efinition of '!od#cti/ity: the -#antity of ,oods and se!/ices !od#ced f!o) each ho#! of a +o!2e!s ti)e* (igh productivit implies a high standard of living$ Thus, polic makers must understand the impact of an polic on our a"ilit to produce goods and services$ a$ "$ ;uring the 1HG0s and 1HH0s, much concern #as generated over the effects of large federal government "udget deficits$ >hen the government "orro#s, it lo#ers the /uantit of funds availa"le for other "orro#ers including those that #ould have "een used to finance a student-s education or "uild ne# factories$

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Chapter 1 TEN PRINCIPLES OF ECONOMICS

c$ 8$

Therefore, "udget deficits are generall "elieved to lo#er the count -s standard of living$

Principle #H: Prices 2ise >hen the 7overnment Prints Too 6uch 6one 1$ .$ 3$ ;efinition of Inf$ation: an inc!ease in the o/e!a$$ $e/e$ of !ices in the econo)y* >hen the government creates a large amount of mone , the value of mone falls$ 0%amples: 7erman after >orld >ar ' )in the earl 1H.0s,, the <nited States in the 1H+0s$

*$

Principle #10: Societ 5aces a Short!2un Tradeoff "et#een 'nflation and <nemplo ment 1$ .$ 3$ 4$ ;efinition of 'hi$$i s C#!/e: the sho!t6!#n t!adeoff .et+een inf$ation and #ne) $oy)ent* This is a controversial topic among economists$ This tradeoff e%ists "ecause some prices are assumed to "e slo# to ad9ust to market changes$ 0%ample: The government reduces the amount of mone in the econom to reduce inflation$ People respond " spending less, lo#ering the /uantit of goods that firms sell$ 5irms respond to lo#er sales " la ing off #orkers, increasing the unemplo ment rate$ This tradeoff is onl temporar "ut often used as an argument for government polic to control inflation or unemplo ment$

A$

A9J(NCT TEACHING TI'S AN9 WAR06(' ACTIVITIES:

1$ 6ake sure that students understand that this is 9ust an introduction to these Ten Principles$ Students should not feel as if the must understand each of these Ten Principles completel at this time$ 'nstead, point out that the students #ill "e seeing these Principles in action throughout the semesterI therefore, the #ill gain additional understanding as the semester progresses$ .$ 7ive students a list of activities #ith corresponding time re/uirements$ 5or e%ample: sleep, G hoursI sleep, D hoursI eat "reakfast, 30 minutesI ride a "ike, 1 hourI go hiking, . hoursI stud , 3 hoursI stud , . hoursI go to class, 4 hoursI go to class, D hoursI #atch TF, . hoursI #atch TF, D hoursI take a nap, 1 hourI #ork, G hoursI #ork, 4 hoursI etc$ 6ake sure that there are man choices and that there are man pleasura"le e%periences E too much for a .4!hour period$ &sk students #hich Principle of 0conomics this illustrates$ 'f the do not sa 1, ., 3, and 4, help them see that this e%ercise has tradeoffs in the choices the make, that each choice has an opportunit cost, that deciding #hether or not to sleep 4 more hours ma depend on #hether ou have alread slept for D, and that choices ma "e influenced " the incentives the student faces$ 5or e%ample, a student #ho is a"out to "e placed on academic pro"ation has an incentive to stud harder$

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Chapter 1 TEN PRINCIPLES OF ECONOMICS

3$ ;ivide the students into groups of four$ &ssign each group the definition of economics or one or t#o of the Principles of 0conomics$ (ave each group dra# the definition or principle, no #ords allo#ed$ &llo# time for classroom discussion of the dra#ings$ 5or e%ample, ou ma #ant the other mem"ers of the class to tr and guess #hat the dra#ing sho#s$ 4r, ou ma 9ust #ant the group to e%plain their dra#ing to the class$ 6ake sure that ou fill in an conceptual gaps$ 0ncourage students to keep thinking a"out the pictures throughout the semester as the cover the remaining chapters, and allo# them to modif or dra# ne# pictures if the choose$

SOL(TIONS TO TE:T 'ROBLE0S:

;#ic2 ;#i33es 1$ The four principles of economic decisionmaking are: )1, people face tradeoffsI )., the cost of something is #hat ou give up to get itI )3, rational people think at the marginI and )4, people respond to incentives$ People face tradeoffs "ecause to get one thing that the like, the usuall have to give up another thing that the like$ The cost of something is #hat ou give up to get it, not 9ust in terms of monetar costs "ut all opportunit costs$ 2ational people think at the margin " taking an action if and onl if the marginal "enefits e%ceed the marginal costs$ People respond to incentives "ecause as the compare "enefits to costs, a change in incentives ma cause their "ehavior to change$ The three principles concerning economic interactions are: )1, trade can make ever one "etter offI )., markets are usuall a good #a to organiCe economic activit I and )3, governments can sometimes improve market outcomes$ Trade can make ever one "etter off "ecause it allo#s countries to specialiCe in #hat the do "est and to en9o a #ider variet of goods and services$ 6arkets are usuall a good #a to organiCe economic activit "ecause the invisi"le hand leads markets to desira"le outcomes$ 7overnments can sometimes improve market outcomes "ecause sometimes markets fail to allocate resources efficientl "ecause of an e%ternalit or market po#er$ The three principles that descri"e ho# the econom as a #hole #orks are: )1, a countr -s standard of living depends on its a"ilit to produce goods and servicesI )., prices rise #hen the government prints too much mone I and )3, societ faces a short! run tradeoff "et#een inflation and unemplo ment$ & countr -s standard of living depends on its a"ilit to produce goods and services, #hich in turn depends on its productivit , #hich is a function of the education of #orkers and the access #orkers have to the necessar tools and technolog $ Prices rise #hen the government prints too much mone "ecause more mone in circulation reduces the value of mone , causing inflation$ Societ faces a short!run tradeoff "et#een inflation and unemplo ment "ecause some prices are stick , so that a change in polic can affect spending, causing unemplo ment to change in the opposite direction of a change in inflation$

.$

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;#estions fo! Re/ie+ 1$ 0%amples of tradeoffs include time tradeoffs )such as stud ing one su"9ect over another, or stud ing at all compared to engaging in social activities, and spending tradeoffs )such as #hether to use our last ten dollars on piCCa or on a stud guide for that tough economics course,$ The opportunit cost of seeing a movie includes the monetar cost of admission plus the time cost of going to the theater and attending the sho#$ The time cost depends on #hat

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Chapter 1 TEN PRINCIPLES OF ECONOMICS else ou might do #ith that timeI if itJs sta ing home and #atching TF, the time cost ma "e small, "ut if itJs #orking an e%tra three hours at our 9o", the time cost is the mone ou could have earned$

3$

The marginal "enefit of a glass of #ater depends on our circumstances$ 'f ouJve 9ust run a marathon, or ouJve "een #alking in the desert sun for three hours, the marginal "enefit is ver high$ 8ut if ouJve "een drinking a lot of li/uids recentl , the marginal "enefit is /uite lo#$ The point is that even the necessities of life, like #ater, donJt al#a s have large marginal "enefits$ Polic makers need to think a"out incentives so the can understand ho# people #ill respond to the policies the put in place$ The te%tJs e%ample of seat "elts sho#s that polic actions can have /uite unintended conse/uences$ 'f incentives matter a lot, the ma lead to a ver different t pe of polic I for e%ample, some economists have suggested putting knives in steering columns so that people #ill drive much more carefull K >hile this suggestion is sill , it highlights the importance of incentives$ Trade among countries isnJt a game #ith some losers and some #inners "ecause trade can make ever one "etter off$ 8 allo#ing specialiCation, trade "et#een people and trade "et#een countries can improve ever oneJs #elfare$ The invisi"le hand of the marketplace represents the idea that even though individuals and firms are all acting in their o#n self!interest, prices and the marketplace guide them to do #hatJs good for societ as a #hole$ The t#o main causes of market failure are e%ternalities and market po#er$ &n e%ternalit is the impact of one person-s actions on the #ell!"eing of a " stander, such as from pollution or the creation of kno#ledge$ 6arket po#er refers to the a"ilit of a single person )or small group of people, to undul influence market prices, such as in a to#n #ith onl one #ell or onl one ca"le television compan $ Productivit is important "ecause a countr Js standard of living depends on its a"ilit to produce goods and services$ The greater a countr Js productivit )the amount of goods and services produced from each hour of a #orkerJs time,, the greater #ill "e its standard of living$ 'nflation is an increase in the overall level of prices in the econom $ 'nflation is caused " increases in the /uantit of a nationJs mone $ 'nflation and unemplo ment are negativel related in the short run$ 2educing inflation entails costs to societ in the form of higher unemplo ment in the short run "ecause it takes time for all prices to ad9ust full $ $ications

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& famil deciding #hether to "u a ne# car faces a tradeoff "et#een the cost of the car and other things the might #ant to "u $ 5or e%ample, "u ing the car might mean the must give up going on vacation for the ne%t t#o ears$ So the real cost of the car is the famil Js opportunit cost in terms of #hat the must give up$ 5or a mem"er of *ongress deciding #hether to increase spending on national parks, the tradeoff is "et#een parks and other spending items or ta% cuts$ 'f more mone goes into the park s stem, that ma mean less spending on national defense or on the police force$ 4r, instead of spending more mone on the park

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Chapter 1 TEN PRINCIPLES OF ECONOMICS s stem, ta%es could "e reduced$ c$

>hen a compan president decides #hether to open a ne# factor , the decision is "ased on #hether the ne# factor #ill increase the firmJs profits compared to other alternatives$ 5or e%ample, the compan could upgrade e%isting e/uipment or e%pand e%isting factories$ The "ottom line is: >hich method of e%panding production #ill increase profit the most? 'n deciding ho# much to prepare for class, a professor faces a tradeoff "et#een the value of improving the /ualit of the lecture compared to other things she could do #ith her time, such as #orking on additional research$

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>hen the "enefits of something are ps chological, such as going on a vacation, it isnJt eas to compare "enefits to costs to determine if itJs #orth doing$ 8ut there are t#o #a s to think a"out the "enefits$ 4ne is to compare the vacation #ith #hat ou #ould do in its place$ 'f ou didnJt go on vacation, #ould ou "u something like a ne# set of golf clu"s? Then ou can decide if ouJd rather have the ne# clu"s or the vacation$ & second #a is to think a"out ho# much #ork ou had to do to earn the mone to pa for the vacationI then ou can decide if the ps chological "enefits of the vacation #ere #orth the ps chological cost of #orking$ 'f ou are thinking of going skiing instead of #orking at our part!time 9o", the cost of skiing includes its monetar and time costs, plus the opportunit cost of the #ages ouJre giving up " not #orking$ 'f the choice is "et#een skiing and going to the li"rar to stud , then the cost of skiing is its monetar and time costs plus the cost to ou of getting a lo#er grade in our course$ 'f ou spend @100 no# instead of investing it for a ear and earning A percent interest, ou are giving up the opportunit to spend @10A a ear from no#$ The idea that mone has a time value is the "asis for the field of finance, the su"field of economics that has to do #ith prices of financial instruments like stocks and "onds$ The fact that ouJve alread sunk @A million isnJt relevant to our decision an more, since that mone is gone$ >hat matters no# is the chance to earn profits at the margin$ 'f ou spend another @1 million and can generate sales of @3 million, ouJll earn @. million in marginal profit, so ou should do so$ =ou are right to think that the pro9ect has lost a total of @3 million )@D million in costs and onl @3 million in revenue, and ou shouldnJt have started it$ ThatJs true, "ut if ou donJt spend the additional @1 million, ou #onJt have an sales and our losses #ill "e @A million$ So #hat matters is not the total profit, "ut the profit ou can earn at the margin$ 'n fact, ouJd pa up to @3 million to complete developmentI an more than that, and ou #onJt "e increasing profit at the margin$ (arr suggests looking at #hether productivit #ould rise or fall$ Productivit is certainl important, since the more productive #orkers are, the lo#er the cost per gallon of potion$ (arr #ants to look at average cost$ 8ut "oth (arr and 2on are missing the other side of the e/uationrevenue$ & firm #ants to ma%imiCe its profits, so it needs to e%amine "oth costs and revenues$ Thus, (ermione is right it-s "est to e%amine #hether the e%tra revenue #ould e%ceed the e%tra costs$ 'n addition, (ermione is the onl one #ho-s thinking at the margin$ a$ Since a person gets fe#er after!ta% Social Securit "enefits the greater is his or her income, thereJs an incentive not to save for retirement$ 'f ou save a lot, our income #ill "e higher, and ou #onJt get as much after!ta% Social Securit income as someone #ho didnJt save as much$ The unintended conse/uence of the ta%ation of Social Securit "enefits is to reduce savingI et the Social Securit s stem arose "ecause of #orries that people #ouldn-t save enough for

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Chapter 1 TEN PRINCIPLES OF ECONOMICS retirement$ "$ 5or the same reason, ouJll tend not to #ork )or not #ork as much, after age DA$ The more ou #ork, the lo#er our after!ta% Social Securit "enefits #ill "e$ Thus the ta%ation of Social Securit "enefits discourages #ork effort after age DA$ >hen #elfare recipients #ho are a"le to #ork have their "enefits cut off after t#o ears, the have greater incentive to find 9o"s than if their "enefits #ere to last forever$ The loss of "enefits means that someone #ho canJt find a 9o" #ill get no income at all, so the distri"ution of income #ill "ecome less e/ual$ 8ut the econom #ill "e more efficient, since #elfare recipients have a greater incentive to find 9o"s$ Thus the change in the la# is one that increases efficienc "ut reduces e/uit $

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8 specialiCing in each task, ou and our roommate can finish the chores more /uickl $ 'f ou divided each task e/uall , it #ould take ou more time to cook than it #ould take our roommate, and it #ould take him more time to clean than it #ould take ou$ 8 specialiCing, ou reduce the total time spent on chores$ Similarl , countries can specialiCe and trade, making "oth "etter off$ 5or e%ample, suppose it takes Spanish #orkers less time to make clothes than 5rench #orkers, and 5rench #orkers can make #ine more efficientl than Spanish #orkers$ Then Spain and 5rance can "oth "enefit if Spanish #orkers produce all the clothes and 5rench #orkers produce all the #ine, and the e%change some #ine for some clothes$

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8eing a central planner is toughK To produce the right num"er of *;s " the right artists and deliver them to the right people re/uires an enormous amount of information$ =ou need to kno# a"out production techni/ues and costs in the *; industr $ =ou need to kno# each personJs musical tastes and #hich artists the #ant to hear$ 'f ou make the #rong decisions, ouJll "e producing too man *;s " artists that people donJt #ant to hear, and not enough " others$ =our decisions a"out ho# man *;s to produce carr over to other decisions$ =ou have to make the right num"er of *; pla ers for people to use$ 'f ou make too man *;s and not enough cassette tapes, people #ith cassette pla ers #ill "e stuck #ith *;s the canJt pla $ The pro"a"ilit of making mistakes is ver high$ =ou #ill also "e faced #ith tough choices a"out the music industr compared to other parts of the econom $ 'f ou produce more sports e/uipment, ouJll have fe#er resources for making *;s$ So all decisions a"out the econom influence our decisions a"out *; production$ 0fficienc : The market failure comes from the monopol " the ca"le TF firm$ 0/uit 0fficienc : &n e%ternalit arises "ecause secondhand smoke harms nonsmokers$ 0fficienc : The market failure occurs "ecause of Standard 4ilJs monopol po#er$ 0/uit 0fficienc : ThereJs an e%ternalit "ecause of accidents caused " drunk drivers$ 'f ever one #ere guaranteed the "est health care possi"le, much more of our nationJs output #ould "e devoted to medical care than is no# the case$ >ould that "e efficient? 'f ou think that currentl doctors form a monopol and restrict health care to keep their incomes high, ou might think efficienc #ould increase " providing more health care$ 8ut more likel , if the government mandated increased spending on health care, the econom #ould "e less efficient "ecause

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Chapter 1 TEN PRINCIPLES OF ECONOMICS

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it #ould give people more health care than the #ould choose to pa for$ 5rom the point of vie# of e/uit , if poor people are less likel to have ade/uate health care, providing more health care #ould represent an improvement$ 0ach person #ould have a more even slice of the economic pie, though the pie #ould consist of more health care and less of other goods$ "$ >hen #orkers are laid off, e/uit considerations argue for the unemplo ment "enefits s stem to provide them #ith some income until the can find ne# 9o"s$ &fter all, no one plans to "e laid off, so unemplo ment "enefits are a form of insurance$ 8ut there-s an efficienc pro"lem#h #ork if ou can get income for doing nothing? The econom isn-t operating efficientl if people remain unemplo ed for a long time, and unemplo ment "enefits encourage unemplo ment$ Thus, there-s a tradeoff "et#een e/uit and efficienc $ The more generous are unemplo ment "enefits, the less income is lost " an unemplo ed person, "ut the more that person is encouraged to remain unemplo ed$ So greater e/uit reduces efficienc $

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Since average income in the <nited States has roughl dou"led ever 3A ears, #e are likel to have a "etter standard of living than our parents, and a much "etter standard of living than our grandparents$ This is mainl the result of increased productivit , so that an hour of #ork produces more goods and services than it used to$ Thus incomes have continuousl risen over time, as has the standard of living$ 'f &mericans save more and it leads to more spending on factories, there #ill "e an increase in production and productivit , since the same num"er of #orkers #ill have more e/uipment to #ork #ith$ The "enefits from higher productivit #ill go to "oth the #orkers, #ho #ill get paid more since the Jre producing more, and the factor o#ners, #ho #ill get a return on their investments$ ThereJs no such thing as a free lunch, though, "ecause #hen people save more, the Jre giving up spending$ The get higher incomes at the cost of "u ing fe#er goods$ a$ "$ 'f people have more mone , the Jre pro"a"l going to spend more on goods and services$ 'f prices are stick , and people spend more on goods and services, then output ma increase, as producers increase output to meet the higher demand rather than raising prices$ 'f prices can ad9ust, then peopleJs higher spending #ill "e matched #ith increased prices, and output #onJt rise$

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c$ 1D$

To make an intelligent decision a"out #hether to reduce inflation, a polic maker #ould need to kno# #hat causes inflation and unemplo ment, as #ell as #hat determines the tradeoff "et#een them$ 8ecause prices are stick , an attempt to reduce inflation #ill lead to higher unemplo ment$ & polic maker thus faces a tradeoff "et#een the "enefits of lo#er inflation compared to the cost of higher unemplo ment$

(arcourt, 'nc$ items and derived items cop right .001 " (arcourt, 'nc$