Chapter 1: Ten Principles of Economics


People face trade offs for achieving alternative goals; cost is measured in foregone opportunity; rational people compare marginal costs+benefits; and people act on incentives.

Trade is good; markets are good; governments can improve market outcomes.

Productivity begets living standards; inflation means a surplus of money; and society faces trade offs between inflation and unemployment.


  1. Trade-offs (“guns and butter”)
  2. Cost is what you give up to get it
  3. Rational people, marginal benefits & costs (water vs diamonds)
  4. People respond to incentives (but think Freakonomics)
  5. Trade can be good for everyone
  6. Markets are (usually) a good way to organise economic activity - Adam Smith, invisible hand
  7. Governments can (sometimes) improve market outcomes
  8. A country’s standard of living depends on its ability to produce goods and services (but what is “standard of living”??)
  9. Society faces a short-run trade-off between inflation and unemployment

In 2008 and 2009, the U.S. economy, as well as many other economies around the world, experienced a deep economic downturn. Problems in the financial system, caused by bad bets on the housing market, spilled over into the rest of the economy, causing incomes to fall and unemployment to soar. Policymakers responded in various ways to increase the overall demand for goods and services. President Obama’s first major initiative was a stimulus package of reduced taxes and in- creased government spending. At the same time, the nation’s central bank, the Federal Reserve, increased the supply of money. The goal of these policies was to reduce unemployment. Some feared, however, that these policies might over time lead to an excessive level of inflation.


  • Is it possible to talk and reason about post-scarcity economics?
  • Markets and the invisible hand: isn’t that busted?
  • What does “standard of living” actually mean? What is the interaction between “societal” levels of production and individuals?

And from the text:

  1. Give three examples of important trade-offs that you face in your life.

  2. Work-life “balance” (i.e. time)

  • Rent and location (more rent for better location)
  • Savings vs spending
  1. What items would you include to figure out the opxportunity cost of a vacation to Disneyworld?
  2. Water is necessary for life. Is the marginal benefit of a glass of water large or small?
  3. Why should policymakers think about incentives?
  4. Why isn’t trade among countries like a game with some winners and some losers?
  5. What does the “invisible hand” of the marketplace do?
  6. Explain the two main causes of market failure and give an example of each.
  7. Why is productivity important?
  8. What is inflation and what causes it?
  9. How are inflation and unemployment related in the short run?


  1. Economics is best defined as the study of
  • how society manages its scarce resources.
  • how to run a business most profitably.
  • how to predict inflation, unemployment, and stock prices.
  • how the government can stop the harm from un-checked self-interest.
  1. Your opportunity cost of going to a movie is
  • the price of the ticket.
  • the price of the ticket plus the cost of any soda and popcorn you buy at the theater.
  • the total cash expenditure needed to go to the movie plus the value of your time.
  • zero, as long as you enjoy the movie and consider it a worthwhile use of time and money.
  1. A marginal change is one that
  • is not important for public policy.
  • incrementally alters an existing plan.
  • makes an outcome inefficient.
  • does not influence incentives.
  1. Adam Smith’s “invisible hand” refers to
  • the subtle and often hidden methods that businesses use to profit at consumers’ expense.
  • the ability of free markets to reach desirable outcomes, despite the self-interest of market participants.
  • the ability of government regulation to benefit con- sumers, even if the consumers are unaware of the regulations.
  • the way in which producers or consumers in unregulated markets impose costs on innocent bystanders.
  1. Governments may intervene in a market economy in order to
  • protect property rights.
  • correct a market failure due to externalities.
  • achieve a more equal distribution of income.
  • All of the above.
  1. If a nation has high and persistent inflation, the most likely explanation is
  • the central bank creating excessive amounts of money.
  • unions bargaining for excessively high wages.
  • the government imposing excessive levels of taxation.
  • firms using their monopoly power to enforce excessive price hikes.

Chapter 2: Thinking Like an Economist

Economists try to address their subject with a scientist’s objectivity. Like all scientists, they make appropriate assumptions and build simplified models to understand the world around them. Two simple economic models are the circular-flow diagram and the production possibilities frontier.

The field of economics is divided into two subfields: microeconomics and macroeconomics. Microeconomists study decision making by households and firms and the interaction among households and firms in the marketplace. Macroeconomists study the forces and trends that affect the economy as a whole.

A positive statement is an assertion about how the world is. A normative statement is an assertion about how the world ought to be. When economists make normative statements, they are acting more as policy advisers than as scientists.

Economists who advise policymakers sometimes offer conflicting advice either because of differences in scientific judgments or because of differences in values. At other times, economists are united in the advice they offer, but policymakers may choose to ignore the advice because of the many forces and constraints imposed by the political process.


  1. An economic model is:
  • a mechanical machine that replicates the functioning of the esconomy.
  • a fully detailed, realistic description of the economy.
  • a simplified representation of some aspect of the economy.
  • a computer program that predicts the future of the economy.

Chapter 3: Interdependence and the Gains from Trade

It is a maxim of every prudent master of a family, never to attempt to make at home what it will cost him more to make than to buy. The tailor does not attempt to make his own shoes, but buys them of the shoemaker. The shoemaker does not attempt to make his own clothes but employs a tailor. The farmer attempts to make neither the one nor the other, but employs those different artificers. All of them find it for their interest to employ their whole industry in a way in which they have some advantage over their neighbors, and to purchase with a part of its produce, or what is the same thing, with the price of part of it, whatever else they have occasion for.

An Inquiry into the Nature and Causes of the Wealth of Nations by Adam Smith (1776)

The “law of comparative advantage” refers

Chapter 4: The Market Forces of Supply and Demand

  • Economists use the model of supply and demand to analyze competitive markets. In a competitive market, there are many buyers and sellers, each of whom has little or no influence on the market price.
  • The demand curve shows how the quantity of a good demanded depends on the price. According to the law of demand, as the price of a good falls, the quantity demanded rises. Therefore, the demand curve slopes downward.
  • In addition to price, other determinants of how much consumers want to buy include income, the prices of substitutes and complements, tastes, expectations, and the number of buyers. If one of these factors changes, the demand curve shifts.
  • The supply curve shows how the quantity of a good supplied depends on the price. According to the law of supply, as the price of a good rises, the quantity sup- plied rises. Therefore, the supply curve slopes upward.
  • In addition to price, other determinants of how much producers want to sell include input prices, technol- ogy, expectations, and the number of sellers. If one of these factors changes, the supply curve shifts.
  • The intersection of the supply and demand curves determines the market equilibrium. At the equilibrium price, the quantity demanded equals the quantity supplied.
  • The behavior of buyers and sellers naturally drives markets toward their equilibrium. When the market price is above the equilibrium price, there is a surplus of the good, which causes the market price to fall. When the market price is below the equilibrium price, there is a shortage, which causes the market price to rise.
  • To analyze how any event influences a market, we use the supply-and-demand diagram to examine how the event affects the equilibrium price and quantity. To do this, we follow three steps. First, we decide whether the event shifts the supply curve or the demand curve (or both). Second, we decide in which direction the curve shifts. Third, we compare the new equilibrium with the initial equilibrium.
  • In market economies, prices are the signals that guide economic decisions and thereby allocate scarce re- sources. For every good in the economy, the price ensures that supply and demand are in balance. The equilibrium price then determines how much of the good buyers choose to consume and how much sellers choose to produce.

Chapter 5: Elasticity and its Application

Chapter 6: Supply, Demand, and Government Policies

Chapter 13: The Costs of Production