Economics, 3rd Edition

HOW PEOPLE MAKE DECISIONS

There is no mystery to what an ‘economy’ is. Whether we are talking about the economy of a group 

of countries such as the European Union (EU), or the economy of one particular country, such as India, 

or of  the whole world, an economy is just a group of people interacting with one another as they go 

about their lives. 

The economy

 refers to all the production and exchange activities that take place every 

day – all the buying and selling. The level of 

economic activity

 is how much buying and selling goes on in 

the economy over a period of time.

---

CHAPTER 1  TEN PRINCIPLES OF ECONOMICS  3

Consider, for instance, policies aimed at achieving a more equal distribution of economic well-being. 

Some of these policies, such as the social security system or unemployment insurance, try to help those 

members of society who are most in need. Others, such as income tax, ask the financially successful to 

contribute more than others to support government spending. Although these policies have the benefit of 

achieving greater equity, they have a cost in terms of reduced efficiency. When the government redistrib-

utes income from the rich to the poor, it reduces 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 

cake into more equal slices, the cake gets smaller.

Recognizing that people face trade-offs does not by itself tell us what decisions they will or should 

make. A student should not abandon the study of economics just because doing so would increase the 

time available for leisure. Society should not stop protecting the environment just because environmental 

regulations reduce our material standard of living. The poor should not be ignored just because helping 

Because the behaviour of an economy reflects the behaviour of the individuals who make up the eco-

nomy, we start our study of economics with four principles of individual decision making.