Introduction to principles

Question 1

Principle 1: Choices are necessary because resources are scarce

Answer 1

Every society faces the problem of scarcity- limited resources but unlimited wants. Because scarcity exists, individuals, firms and governments must make choices on how to allocate these limited funds

Question 2

Resource

Answer 2

Anything that can be used to produce something else: land, labour capital, technology and even time

Question 3

Scarce

Answer 3

When it is not available in sufficient quantity to satisfy all the ways a society wants to use it

Question 4

Principle 2: The true cost of a choice is its opportunity cost

Answer 4

Every decision involves a trade-off. Choosing one option means forgoing another. The opportunity cost of any activity is the value of the next best alternative you give up by choosing it. Not always monetary- they include time, effort and foregone alternatives. Rational decision making requires accounting for opportunity costs, not just explicit costs. E.g. University has a monetary costs but the opportunity costs also includes the income you forgo by not working during that time

Question 5

Principle 3: “How much” is a decision made at the margin

Answer 5

Many economic decisions are not all or nothing, but involve choosing how much of an activity you do. These decisions are made by comparing the additional benefits and additional costs of consuming or producing one more unit- known as marginal analysis. A rational decision maker continues an activity as long as marginal benefit exceeds marginal cost

Question 6

Principle 4: People usually respond to incentives

Answer 6

When the costs or benefits of an activity change, people’s behaviour tends to change in predictable ways. Incentives are anything that motivates individuals to act- can be financial, social or moral. Rational agents adjust their decisions when incentives shift. E.g. Higher petrol prices may lead to people driving less or choosing more fuel efficient cars

Question 7

Principle 5: There are gains from trade, domestic and international

Answer 7

Trade allows people to specialise in activities they do best and to access goods and services that others produce more efficiently. Specialisation increases total production through division of labour. Individuals, firms and countries all benefit from voluntary exchange- both sides are better off
Markets exist because they facilitate mutually beneficial trades

Question 8

Principle 6: Markets move toward equilibrium

Answer 8

Equilibrium occurs when no individual has an incentive to change their behaviour- Supply equals demand. When markets are out of equilibrium (due to shortage or surplus), prices and quantities adjust. The movement towards equilibrium is often automatic- driven by individual responses to incentives. E.g. A rise in prices during a shortage encourages more production and reduces demand

Question 9

Principle 7: Resources should be used efficiently to achieve society’s goals

Answer 9

Efficiency means making the best possible use of scarce resources to meet people’s needs and wants. An allocation is efficient if no one can be made better off without making someone else worse off (Pareto efficiency). Efficiency is not the same as equity- society may also care about fairness which may require redistribution

Question 10

Principle 8: Markets usually lead to efficiency

Answer 10

In a well-functioning market system, individuals pursuing their own interests often promote general welfare. The invisible hand guides resources to their most valued uses through price signals and competition. Under certain assumptions (e.g. perfect information, no externalities), markets allocate resources efficiently, however failures still occur

Question 11

Principle 9: When markets don’t achieve efficiency, government intervention can improve society’s welfare

Answer 11

Market failure occurs when the pursuit of self-interest does not lead to an efficient outcome. Common causes include externalities, market power and asymmetric information
Government policies- taxes, subsidies, regulation- can correct market failure and improve efficiency, however government failure is also possible and interventions must be carefully designed and justified.

Question 12

Principle 10: One person’s spending is another person’s income

Answer 12

In a market economy , economic activity is interconnected- the flow of spending connects households, firms and workers. When one group increases its spending, it boosts income and output elsewhere in the economy. Conversely a drop in spending leads to income losses and potential recessions. This forms the basis of the circular flow model