Lesson Plan # 2. Economic Thinking and Analytical Methods
I. Review of Prior Class: Ten Economic Principles
Questions or concerns on Course Administration ??
Syllabus and Text
Aplia and Quizzes How People Make Decisions.

Principle #1: People Face Tradeoffs.
Principle #2: The Cost of Something Is What You Give Up to Get It.
Principle #3: Rational People Think at the Margin.
Principle #4: People Respond to Incentives.

II. How People Interact

A. Principle #5: Trade Can Make Everyone Better Off

1. Trade is not like a sports competition where one side gains and the other side loses.

2. Consider trade that takes place inside your home. Certainly the family is involved in trade with other families on a daily basis. Most families do not build their own homes, make their own clothes, or grow their own food.

3. Just like families benefit from trading with one another so do countries.

4. This occurs because it allows for specialization in areas that countries (or families) can do best.
B. Principle #6: Markets Are Usually a Good Way to Organize Economic Activity

1. Many countries that once had centrally planned economies have abandoned this system and are trying to develop market economies.

2. Definition of market economy: an economy that allocates resources through the decentralized decisions of many firms and households as they interact in markets for goods and services.

3. Market prices reflect both the value of a product to consumers and the cost of the resources used to produce it. Therefore, decisions to buy or produce goods and services are made based on the cost to society of providing them.

4. When a government interferes in a market and restricts price from adjusting decisions that households and firms make are not based on the proper information. Thus, these decisions may be inefficient.

5. Centrally planned economies have failed because they did not allow the market to work.

6. FYI: Adam Smith and the Invisible Hand

a. Adam Smith’s 1776 work suggested that although individuals are motivated by self-interest, an invisible hand guides this self- interest into promoting society’s economic well-being.

b. Smith’s astute perceptions will be discussed more fully in the chapters to come.

C. Principle #7: Governments Can Sometimes Improve Market Outcomes

1. There are two broad reasons for the government to interfere with the economy: the promotion of efficiency and equity.

2. Government policy can be most useful when there is market failure.

Market failure: a situation in which a market left on its own fails to allocate resources efficiently. 3. Examples of Market Failure

a. Externality: the impact of one person’s actions on the well-being of a bystander.

b. Market power: the ability of a single economic actor (or small group of actors) to have a substantial influence on market prices.

c. Because a market economy rewards people for their ability to produce things that other people are willing to pay for, there will be an unequal distribution of economic prosperity.

4. Note that the principle states that the government can improve market outcomes. This is not saying that the government always does improve market outcomes.

III. How the Economy as a Whole Works

A. Principle #8: A Country’s Standard of Living Depends on Its Ability to Produce Goods and Services

1. Differences in living standards from one