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Fundamental Principles of Economics


There are ten fundamental principles of economics. These principles have been divided under three categories i.e. how people make decisions, how people interact and how the economy as a whole works.

1-How people make decisions


Under this category of how people make decisions, there lie four fundamental principles of economics i.e. people face trade-offs, the cost of something is what you give up to get it, rational people think at margin and people respond to incentives. These four principles are mentioned here as;

1.1- People face trade-offs


In an economic point of view, taking a rational decision is not a joke because making decisions requires trading off one goal against another in which we usually have to give up one thing that we like, to get another thing that we like. For instance, we have twelve hours in a day, we can divide some of the hours for working hours and other for leisure hours. If we spend more hours for working to ensure higher income, we will have to enjoy only a few hours for leisure, and on the contrary if we enjoy more leisure time, then we can have only a few hours for work and earn less income. This way people face trade-offs in every step of their lives. So acknowledging life's trade-offs is important because people likely to make good decisions only if they understand the options that they have available.


1.2- The cost of something is what you give up to get it


People face trade-offs while making decisions so it requires to compare costs and benefits between alternatives. However, the cost of something is not as obvious as it might first appear. For instance, if a student admits in a college, she will have to buy books, uniform, pay tuition fees etc. Only all these costs appear to be the cost for going to college. But what you think about the time she spends while she is in the college. Don't you think she could do a job during that? So it is obvious that going to college means she is giving up the wages, she could get if she did not go to college. Here, the cost for going to college is giving up the job opportunity. So the job opportunity, in this case, is also known an opportunity cost for going to college. The opportunity cost of an item is what we give up to get that item. This is, what the cost of something is what you give up to get another thing.

1.3- Rational people think at the margin


In economics, it is assumed that the laws of of economics are applicable when people act rationally while utilizing limited resources. It is because rational people make the best decisions by thinking at the margin (edge) or comparing additional costs for extra benefits. For instance, you have been to the market for shopping from your house by bus paying off $10 bus-fare. There is also a circus-show at one corner in the market. You like to watch it but whether to watch it today or come to the next day, to decide it you compare the costs for coming the next day. If not today, extra $10 will be paid off as a bus-fare and the extra time against the utility for enjoying the circus today. This is, individuals and firms can make better decisions by thinking at the margin. A rational decisionmaker takes an action if and only if the marginal benefit of the action exceeds the marginal cost.


1.4- People responds to incentives


Incentive is something that induces a person to perform better. As rational people make decisions by comparing costs and benefits, they respond to incentives. Their behavior change with the change in costs and benefits. For instance, when the price of apple rises, people by a few of apples but buy more of its substitute because the cost of buying an apple is higher. At the same time, owners of apple orchards hire more workers and harvest more apples because the benefit of selling an apple is also higher. Thus, people respond incentives.

2-How people interact


Under this category of how people interact, there lie three fundamental principles of economics i.e. trade can make everyone better off, markets are usually a good way to organize economic activity and governments can sometimes improve market outcomes. These three principles are mentioned here as;

2.1- Trade can make everyone better off


Either we talk about individuals, society or countries, trade can make everyone better off. If there were no trade, we would make everything that we need  by ourselves. Perhaps we would lack to get much that we require but it is trade that allows individuals, firms or countries to specialize in what they do best and enjoy a wider variety of goods. Therefore, trade is the one that can make everyone better off.

2.2- Markets are usually a good way to organize economic activity


Markets are usually a good way to organize economic activity. Today, most countries that once had centrally planned economies have abandoned this system and are trying to develop market economies. In a market economy, the decisions of a central planner are replaced by the decisions of millions of firms and households. Firms decide whom to hire and what to make. Households decide which firms to work for and what to buy with their incomes. These firms and households interact in the marketplace, where prices and self-interest guide their decisions of making economic activities. Thus markets are usually a good way to organize economic activities.

2.3- Governments can sometimes improve market outcomes


Markets are usually a good way to organize economic activity. It is true if only the government play a crucial role to settle markets. Govt. provide legal safety to the economic agents i.e. producers, firms and consumers. Importantly, markets work only if property rights are enforced.  For example, a farmer won’t grow food if he expects his crops to be stolen, a restaurant won’t serve meals unless it is assured that customers will pay before they leave. We will rely on the government provided police & courts to enforce our rights over the things we produce. And sometimes markets fail to work due to some external effects. There is less efficiency, less equality, lack of efficient allocation of resources. In such a condition, the government can intervene and improve market outcomes by its public policy.

3-How the economy as a whole works


Under this category of how the economy as a whole works, there lie three fundamental principles of economics i.e. a country's standard of living depends on its ability to produce goods and services, prices rise when the government prints too much money and society faces a short-run trade-off between inflation and unemployment. These three principles are mentioned here as;

3.1- A country's standard of living depends on its ability to produce goods and services


The living standard of a country or its people primarily depends on its ability to produce goods and services. The more the ability to produce goods and services, the more people can enjoy required goods and services and maintain a high standard of living. Conversely, when there is a low productivity, most of the people are compelled to spend a miserly life.

3.2- Prices rise when the government prints too much money


The variation in prices of goods and services also depends on the quantity of money supply in the economy. When the government prints large amounts of money and lets it go in circulation, the value of money goes down and the price of goods and services rises. The continuous and sustained  rise in price level is called inflation. If such a situation is not timely checked, it brings an adverse effect in the entire economy.


3.3- Society faces a short-run trade-off between inflation and unemployment


There is a short-run trade off between inflation and unemployment. With the increase in the quantity of money supply, the demand for goods and services goes up. It is because there is more money in the hands of the buyers. Consequently, there is an increase in the price level (inflation) and in the meantime it also encourages producers to increase the quantity of goods and services they produce. So the producers employ more workers to produce more goods and services and supply them. It is, employing more workers means lower unemployment. Thus there is a short-run trade off between inflation and unemployment.

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