CHAPTER 1 TEN PRINCIPLES OF ECONOMICS Or consider parents deciding how to spend their family income. They can buy food, clothing, or a family vacation. Or they can save some of the family income for retirement or the children,'s college education. When they choose to spend an extra dollar on one of these goods, they have one less dollar to spend on some The classic tradeoff is between "guns and butter. The more we spend on national defense to protect our shores from foreign aggressors(guns), the less we can spend on consumer goods to raise our standard of living at home(butter). Also important in modern society is the tradeoff between a clean environment and a high level of income. Laws that require firms to reduce pollution raise the cost of pro oducing goods and services. Because of the higher costs, these firms end up earning smaller profits, paying lower wages, charging higher prices, or some combination of these three. Thus, while pollution regulations give us the benefit of a cleaner environ- ment and the improved health that comes with it, they have the cost of reducing the incomes of the firms' owners workers, and customers Another tradeoff society faces is between efficiency and equity. Efficiency efficiency means that society is getting the most it can from its scarce resources. Equity the property of society getting the means that the benefits of those resources are distributed fairly among societys most it can from its scarce resources members. In other words, efficiency refers to the size of the economic pie, and equity refers to how the pie is divided. Often, when government policies are being the property of distributing ecomomic Consider, for instance, policies aimed at achieving a more equal distribution of prosperity fairly among the members economic well-being. Some of these policies, such as the welfare system or unem- of society ployment insurance, try to help those members of society who are most in need Others, such as the individual income tax, ask the financially successful to con- tribute more than others to support the government. Although these policies have the benefit of achieving greater equity, they have a cost in terms of reduced effi- ciency. When the government redistributes income from the rich to the poor, it re- duces the reward for working hard; as a result, people work less and produce economic pie into more equal slices, the pie gets sma, government tries to cut the fewer goods and services. In other words, when the Recognizing that people face tradeoffs does not by itself tell us what decisions they will or should make A student should not abandon the study of psychology just because doing so would increase the time available for the study of econom- ics. Society should not stop protecting the environment just because environmen- tal regulations reduce our material standard of living. The poor should not be ignored just because helping them distorts work incentives. Nonetheless, ac knowledging life's tradeoffs is important because people are likely to make good decisions only if they understand the options that they have available PRINCIPLE 2: THE COST OF SOMETHING IS WHAT YOU GIVE UP TO GET IT Because people face tradeoffs, making decisions requires comparing the costs and enefits of alternative courses of action. In many cases, however, the cost of some action is not as obvious as it might first appear Consider, for example, the decision whether to go to college. The benefit is in- tellectual enrichment and a lifetime of better job opportunities. But what is the cost? To answer this question, you might be tempted to add up the money youCHAPTER 1 TEN PRINCIPLES OF ECONOMICS 5 Or consider parents deciding how to spend their family income. They can buy food, clothing, or a family vacation. Or they can save some of the family income for retirement or the children’s college education. When they choose to spend an extra dollar on one of these goods, they have one less dollar to spend on some other good. When people are grouped into societies, they face different kinds of tradeoffs. The classic tradeoff is between “guns and butter.” The more we spend on national defense to protect our shores from foreign aggressors (guns), the less we can spend on consumer goods to raise our standard of living at home (butter). Also important in modern society is the tradeoff between a clean environment and a high level of income. Laws that require firms to reduce pollution raise the cost of producing goods and services. Because of the higher costs, these firms end up earning smaller profits, paying lower wages, charging higher prices, or some combination of these three. Thus, while pollution regulations give us the benefit of a cleaner environ￾ment and the improved health that comes with it, they have the cost of reducing the incomes of the firms’ owners, workers, and customers. Another tradeoff society faces is between efficiency and equity. Efficiency means that society is getting the most it can from its scarce resources. Equity means that the benefits of those resources are distributed fairly among society’s members. In other words, efficiency refers to the size of the economic pie, and equity refers to how the pie is divided. Often, when government policies are being designed, these two goals conflict. Consider, for instance, policies aimed at achieving a more equal distribution of economic well-being. Some of these policies, such as the welfare system or unem￾ployment insurance, try to help those members of society who are most in need. Others, such as the individual income tax, ask the financially successful to con￾tribute more than others to support the government. Although these policies have the benefit of achieving greater equity, they have a cost in terms of reduced effi￾ciency. When the government redistributes income from the rich to the poor, it re￾duces the reward for working hard; as a result, people work less and produce fewer goods and services. In other words, when the government tries to cut the economic pie into more equal slices, the pie gets smaller. Recognizing that people face tradeoffs does not by itself tell us what decisions they will or should make. A student should not abandon the study of psychology just because doing so would increase the time available for the study of econom￾ics. Society should not stop protecting the environment just because environmen￾tal regulations reduce our material standard of living. The poor should not be ignored just because helping them distorts work incentives. Nonetheless, ac￾knowledging life’s tradeoffs is important because people are likely to make good decisions only if they understand the options that they have available. PRINCIPLE #2: THE COST OF SOMETHING IS WHAT YOU GIVE UP TO GET IT Because people face tradeoffs, making decisions requires comparing the costs and benefits of alternative courses of action. In many cases, however, the cost of some action is not as obvious as it might first appear. Consider, for example, the decision whether to go to college. The benefit is in￾tellectual enrichment and a lifetime of better job opportunities. But what is the cost? To answer this question, you might be tempted to add up the money you efficiency the property of society getting the most it can from its scarce resources equity the property of distributing economic prosperity fairly among the members of society