Ten Principles of Economics and How Markets Work

Ten Principles of Economics and How Markets Work

ECO/365

Ten Principles of Economics and How Markets Work

Introduction

Ten fundamental principles of economics are used to help study economics,

how people make decisions and interact, how the economy works, and how society manages its scarce resources. Using demand curves can help explain why the demand curve slopes downward, the supply curve slopes upward, and the point of equilibrium. The demand curve helps to show the impact of price controls, taxes, and elasticity on changes in supply, demand and equilibrium prices. These are some of the ways that we can determine what controls the price of goods and what can affect those prices.

Ten Principles of Economics Lessons

The Ten Principles of Economics teach us how people make decisions, how people

interact, and how the economy works as a whole. How do people make decisions?

Trade-offs. To get something we want, something else we want has to be given up.

Cost. Cost is more than just money. Whatever you give up to get something is part of the cost (opportunity cost). It includes things such as expenses, time, and lost income.

Think at the margin. (Economists assume people are rational and rational people think at the margin). When making a decision, a rational person will only take action if the marginal benefit (the benefit of increasing by one unit) is more than the marginal cost (the added cost of producing one more unit).

Incentives. An incentive is something that encourages a person to do something. People respond to being awarded or punished for something. When a policy changes the cost or benefit, people change their behavior.

Many of the decisions we make affect not only ourselves but others as well.

What is an interaction? Interaction is the communication or reaction between two or more people or things. How do people interact?

Trade. Trade creates competition for customers. Trading allows individuals or companies to produce the goods or services they are best at which provides a higher variety at a lower cost. If we did not have trade, we would have to provide everything for ourselves.

Market economy. A market economy distributes resources through the decisions of many companies and households as they interact in markets for goods and services. As buyers and sellers, we determine the cost and supply and demand for the goods that are produced.

Government policy. The government enforces the rules and maintains the establishments in the market. They enforce property rights, promote efficiency, and promote equality. Without government intervention and policy, the market would fail due to market power and externalities (the effect of one’s actions on the well-being of another).

People interact through trade in the market that is governed by government policies to create a more equal distribution of economic well-being.

How does the economy work as a whole?

Ability to produce goods and services. The standard of living in a country is dependent on its being able to produce goods and services. A country that can produce large amounts of a good or service has a higher standard of living than one that produces less.

Too much money. When the government prints too much money, prices rise which leads to inflation (an increase in the price of goods and services and a decrease in the purchasing value of money in an economy).

Short-run trade-off between inflation and unemployment. Increasing the amount of money leads to higher spending/demand. The higher demand raises prices, production, and employment. The rise in employment leads to a decrease in unemployment.

Many factors contribute to the economy as a whole. All of these lessons show how people make decisions, interact with others, and contribute to how the economy works as a whole.

Scarce Resource Management and Benefits from Economic Interdependence

Economics is the study of scarce resources are managed by society. Scarce resources are resources that are limited in society. A society manages its scarce resources by allocating them through the choices that households and firms make, markets, and trade. The ability to trade with other nations through markets creates economic interdependence which provides many benefits to society. Economic interdependence is a relationship between two or more people, nations, regions, or entities where each is dependent on the other for goods or services that they can produce more efficiently. These goods or services exchanged through trade. Trade encourages economic growth, higher standards of living, advances in technology, and efficiency. How society manages its scarce resources and benefits from economic interdependence are what economics is all about.

Downward Demand Curve, Upward Supply Curve, and Equilibrium Point

The demand curve represents the buyers (households) willingness to purchase, and the supply curve represents the sellers (firms) quantity of products on the market. The demand curve slopes downward because when a price decreases, consumers are more willing and able to buy the product. The supply curve slopes upward because when a price increases, sellers are more willing to supply their goods and able to cover the higher marginal costs. The equilibrium point is the one point where the supply and demand curves intersect. The equilibrium point determines where the quantity of a good that buyers are willing and able to purchase and the quantity that sellers are willing and able to sell are balanced exactly. Whenever there is a shift in supply or demand (or both), there is a change in the equilibrium point. Economics includes the study of supply and demand curves and the equilibrium point to understand what products and in what quantities households are willing to buy and firms are willing to supply.

Impact of Price Controls, Taxes, and Elasticity

Price controls, taxes, and elasticity have an impact on the changes in supply, demand, and equilibrium prices. Price controls—price ceilings and price floors—are policies imposed by the government to maintain prices at other than equilibrium levels. When the price ceiling is below the equilibrium price, the demand exceeds the supply causing a shortage. When the price floor is

above the equilibrium price, the supply exceeds the demand causing a surplus. It depends on whether the tax is imposed on the buyer or the seller as to the impact on supply, demand, and equilibrium price. If the tax is imposed on seller, the supply curve shifts upward (or to the left) by the size of the tax, the initial demand curve does not change, and the equilibrium price rises. If the tax is imposed on the buyer, the initial supply curve does not change, the demand curve shifts downward (or to the left) by the size of the tax, and the equilibrium price falls. Regardless of whether the tax is imposed on the seller or the buyer, they both share the burden of the tax. The elasticity of the supply and demand determine how a tax burden is divided. When the supply is more elastic, the more substantial tax burden falls on the buyer. When the demand is more elastic, the more substantial tax burden falls on the seller. When price controls and taxes are imposed by the government, it depends on who they are levied on and the elasticity of the market as to how they change the supply, demand, and equilibrium prices.

Conclusion

How people make decisions, how they interact, and how the economy works help to determine how society manages its scarce resources and benefit from economic interdependence. The price buyers are willing to pay, and the quantity sellers are willing to supply determine the slopes of the demand and supply curves and the equilibrium price. When the government imposes price controls and taxes, it burdens both the buyers and sellers creating changes in the supply, demand and equilibrium price depending on who they are levied. The amount of elasticity of supply and demand determines whether the buyer or the seller takes on more of the burden of the taxes. Many factors can change the outcomes of supply, demand, and equilibrium price.