Chapter 1-Ten Principles of Economics-The Principles of How People Interact-Part 2 – Flashcards

-Whether we're talking about the U.S. economy or the local economy, the term "economy" simply means a group of people interacting with each other. -These interactions play a critical role in the allocation of society's scarce resources. -For example, the interaction of buyers and sellers determines the prices of goods and the amounts produced and sold. -These interactions play a critical role in the allocation of society's scarce resources -These interactions are an important part of what economists study.

-Rather than being self-sufficient, people can specialize in producing one good or service and exchange it for other goods. -Countries also benefit from trade and specialization: -Get a better price abroad for goods they produce -Buy other goods more cheaply from abroad than could be produced at home

-A group of buyers and sellers (need not be in single location) -A market economy is "decentralized," meaning that there is no government committee that makes the decisions about what goods to produce and so forth. -Instead, many households firms make their own decisions. -"Organize economic activity" means determining -What goods to produce -How to produce them -How much of each to produce -Who gets them

-A market economy allocates resources through the decentralized decisions of many households and firms as they interact in markets. -Famous insight by Adam Smith in The Wealth of Nations (1776): Each of these households and firms acts as if "led by an invisible hand" to promote general economic well-being.

-The invisible hand works through the price system: -The interaction of buyers and sellers determines prices. -Each price reflects the good's value to buyers and the cost of producing the good. -Prices guide self-interested households and firms to make decisions that, in many cases, maximize society's economic well-being.

-Important role for government: enforce property rights (with police, courts) -People are less inclined to work, produce, invest, or purchase if large risk of their property being stolen. -Two examples of the idea: -A restaurant won't serve meals if customers do not pay before they leave. -A record company won't produce CDs if too many people avoid paying by making illegal copies.

Market Failure: When the market fails to allocate society's resources efficiently

Externalities and Market power

When the production or consumption of a good affects bystanders (e.g. pollution)

A single buyer or seller has substantial influence on market price (e.g. monopoly)

-Public policy may promote efficiency -Government may alter market outcome to promote equity. -If the market's distribution of economic well-being is not desirable, tax or welfare policies can change how the economic "pie" is divided.