Principles of Economics

The word economy comes from the Greek word oikonomos, which means one who manages a household. At first, this origin might seem peculiar. But in fact, households and economies have much in common.

A household faces many decisions. It must decide which members of the household do which tasks and what each member gets in return: Who cooks dinner? Who does the laundry? Who gets the extra dessert at dinner? Who gets to choose what TV show to watch? In short, the household must allocate its scarce resources among its various members, taking into account each member’s abilities, efforts, and desires.

Like a household, a society faces many decisions. A society must decide what jobs will be done and who will do them. It needs some people to grow food, other people to make clothing and still others to design computer software. Once society has allocated people (as well as land, buildings and machines) to various jobs, it must also allocate the output of goods and services that they produce. It must decide who will eat caviar and who will eat potatoes. It must decide who will drive a Ferrari and who will take the bus.

The management of society’s resources is important because resources are scarce. Scarcity means that society has limited resources and therefore cannot produce all the goods and services people wish to have. Just as a household cannot give every member everything he or she wants, a society cannot give every individual the highest standard of living to which he or she might aspire.

Economics is the study of how society manages its scarce resources. In most societies, resources are allocated not by an all powerful dictator but through the combined actions of millions of households and firms. Economists therefore study how people make decisions: how much they work, what they buy, how much they save, and how the invest their savings. Economists also study how people interact with one another. For instance, they examine how the multitude of buyers and sellers of a good together determine the price at which the good is sold and the quantity that is sold. Finally, economists analyze forces and trends that affect the economy as a whole, including the growth in a average income, the fraction of the population that cannot find work, and the rate at which prices are rising.

Although the study of economies has many facets, the field is unified by several central ideas. We look at some principles of Economics.

How people make decisions

There is no mystery to what an economy is. Whether we are talking about the economy of Los Angeles, of the United States, or of the whole world, an economy is just a group of people interacting with one another as they go about their, lives. Because the behavior of an economy reflects the behavior of the individuals who make up the economy, we start our study of economies with four principles of individual decision making.

People face Trade offs>

The firs lesson about making decisions is summarized in the adage. There is no such thing as a free lunch. To get one thing that we like, we usually have to give up another thing that we like. Making decisions requires trading off one goal against another.

Consider a student who must decide how to allocate her most valuable resource – her time. She can spend all of her time studying economies; she can spend all of her time studying psychology; or she can divide her time between the two fields. For every hour she studies one subject, she gives up an hour she could have used studying the other. And for every hour she spends studying, she gives up an hour that she could have spent napping, bike riding, watching TV, or working at her part time job for some extra spending money.

Considering parents deciding how to spend their family income, they can buy food, clothing or a family vacation. Or they can save some of the family income for retirement or the children’s college education. When they chose to spend an extra dollar on one of these goods, they have one less dollar to spend on some other good. —