Economics is the study of how society manages its scarce resources. The following are ten principles of economics. The first four concern how people make decisions, the next three concern how people interact, and the final three concern how the economy as a whole works.
- People face trade-offs. Making decisions requires trading off one goal against another.
- The cost of something is what you give up to get it. Making decisions requires comparing the costs and benefits of alternative course of action. The opportunity cost of an item is what you give up to get that item.
- Rational people think at the margin. A marginal change is a small incremental adjustment to an existing plan of action. Rational people (those who systematically and purposefully do the best they can to achieve their objectives) make decisions by comparing marginal benefits and marginal costs.
- People respond to incentives. An incentive is something that induces a person to act, such as the prospect of a punishment or reward.
- Trade can make everyone better off. Trade allows countries to specialize in what they do best and to enjoy a greater variety of goods and services at lower cost.
- Markets are usually a good way to organize economic activity. A market economy allocates resources through the decentralized decisions of many firms and households as they interact in markets for goods and services. Prices are the instrument with which the invisible hand directs economic activity. Prices adjust to guide buyers and sellers to reach out comes that, in many cases, maximize the well-being of society as a whole.
- Governments can sometimes improve market outcomes. The invisible hand works only if the government enforces the rules and maintains the institutions that are key to a market economy. Market economies need institutions to enforce property rights so individuals can own and control scarce resources. The invisible hand is powerful but not omnipotent. There are two broad rationales for a government to intervene in the economy and change the allocation of resources that people would choose on their own: to promote efficiency (enlarging the economic pie) and to promote equality (changing how the pie is divided).
- A country’s standard of living depends on its ability to produce goods and services. Almost all variation in living standards is attributable to differences in countries’ productivity (the amount of goods and services produced by each unit of labor input). Similarly, the growth rate of a nation’s productivity determines the growth rate of its average income.
- Prices rise when the government prints too much money. Inflation is an increase in the overall level of prices in the economy. In almost all cases of large or persistent inflation, the cause is growth in the quantity of money.
- Society faces a short-run trade-off between inflation and unemployment. Most economists describe the short-run effects of money growth as follows: increasing the amount of money in an economy stimulates demand; higher demand encourages firms to hire more workers; and more hiring means lower unemployment. Over a period of a year or two, many economic policies push inflation and unemployment in opposite directions.
—September 2020
Lance Jones 