Page 8 The four principles of economic decision making are: (1) people face trade-offs; (2) the cost of something is what you give up to get it; (3) rational people think at the margin; and (4) people respond to incentives. People face trade-offs because to get one thing that they like, they usually have to give up another thing that they like. The cost of something is what you give up to get it, not just in terms of monetary costs but all opportunity costs. Rational people think at the margin by taking an action if and only if the marginal benefit exceeds the marginal cost. People respond to incentives because they choose activities by comparing benefits to costs; therefore, a change in these benefits or costs may cause their behavior to change.
Page 11 The three principles concerning people's economic interactions are: (1) trade can make everyone better off; (2) markets are usually a good way to organize economic activity; and (3) governments can sometimes improve market outcomes. Trade can make everyone better off because it allows countries to specialize in what they do best and to enjoy a wider variety of goods and services. Markets are usually a good way to organize economic activity because the invisible hand leads markets to desirable outcomes. Governments can sometimes improve market outcomes because markets may fail to allocate resources efficiently due to an externality or market power.
Page 14 The three principles that describe how the economy as a whole works are: (1) a country's standard of living depends on its ability to produce goods and services; (2) prices rise when the gov ernment prints too much money; and (3) society faces a short-run trade-off between inflation and unemployment. A country's standard of living depends largely on the productivity of its workers, which in turn depends on the education of its workers and the access its workers have to the necessary tools and technology. Prices rise when the government prints too much money because more money in circulation reduces the value of money, causing inflation. Society faces a short-run trade-off between inflation and unemployment that is only temporary. Policymakers have some short-term ability to exploit this relationship using various policy instruments.
Page 28 Economics is like a science because economists devise theories, collect data, and analyze the data in an attempt to verify or refute their theories. In other words, economics is based on the scientific method.
Figure 2-1 shows the production possibilities frontier for a society that produces food and clothing. Point A is an efficient point (on the frontier), point B is an inefficient
Quantity of Food Produced point (inside the frontier), and point C is an infeasible point (outside the frontier).
The effects of a drought are shown in Figure 2-2. The drought reduces the amount of food that can be produced, shifting the production possibilities frontier inward.
Quantity of Food Produced
Microeconomics is the study of how households and firms make decisions and how they interact in markets. Macroeconomics is the study of economy-wide phenomena, including inflation, unemployment, and economic growth.
Page 32 An example of a positive statement is "higher taxes discourage work effort." It is a positive statement because it is a claim that describes the world as it is. An example of a normative statement is "the government should reduce tax rates." It is a normative statement because it is a claim that prescribes how the world should be. Many other examples are possible.
Parts of the government that regularly rely on advice from economists are the Department of the Treasury in designing tax policy, the Department of Labor in analyzing data on the employment situation, the Department of Justice in
858 APPENDIX: QUICK QUIZ ANSWERS
enforcing the nation's antitrust laws, the Congressional Budget Office in evaluating policy proposals, and the Federal Reserve in analyzing economic developments. Many other answers are possible.
Page 34 Economic advisers to the president might disagree about a question of policy because of differences in scientific judgments or differences in values.
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