Joson Ten Eco Principles

Principles of Economics
Third Edition
N. Gregory Mankiw
1
INTRODUCTION
…and sometimes it feels
like you are just going about
your life
Copyright © 2004 South-Western/Thomson Learning

It’s not so tough to understand. After all,
you live economics every day of your life
Sometimes it
feels like
economics…

Our goal is to help you
integrate economics
into your life. Like the
climbing wall, this is an
effort to give you a
toehold on economic
understanding. We
hope it will provide
enough to get you
started, and a desire to
learn more.

Back to Basics:
1
Definition of
Economics
How Do We Define Economics?
• The study of the allocation of scarce

resources
• Allocation: deciding who gets it?

• Scarce : wants exceed resources
• Resources : human, natural, capital, and
entrepreneurial. These productive resources are
used to create the goods and services people
want.

ALLOCATION
• Different from “distribution”
• Allocation prioritizes the needs of

the individual, community or country.
• To allocate: Who gets what?

SCARCITY
• When wants exceed resources
• Scarcity is not poverty
• Scarcity is not “out of stock”
• Scarcity is not shortage.

Scarcity
Society and Scarce Resources:
• The management of society’s resources is

important because resources are scarce.
• Scarcity. . . means that society has limited

resources and therefore cannot produce all the
goods and services people wish to have.

Definition of Economics
Economics is the study of how
The individual….
family…..
society…..
country……
manages its scarce resources
to maximize human wants.
Definition of Economics
HUMAN WANTS
• Needs
• To economists, the term need is
not definable.
• Wants
• Goods and services on which we place a
positive value
• People have unlimited wants.
Two Facts of Economics
Limited
RESOURCES
Unlimited
HUMAN WANTS

Two Branches of Economics:
Micro: The study of decision making undertaken

by individuals (or households) and by firms
Macro: The study of the behavior of the

economy as a whole

• Microeconomics
• The study of decision making undertaken by
individuals (or households) and by firms
• Like looking though a microscope to focus on
the smaller parts of the economy
• Decision of a worker to work overtime or not
• A family’s choice of having a baby
• An individual firm advertising

• Macroeconomics
• The study of the behavior of the economy as a
whole
• Deals with economy wide phenomena
• The national unemployment rate
• The rate of growth in the money supply
• The national government’s budget deficit

Positive vs. Normative Economic
Statements
Positive Eco statements: …..claims that attempt
to describe the world as it is.
….. Statements that are based on facts.
Normative Eco statements: …..claims that

attempt to prescribe how the world should be.
…… statements that are based on values and
beliefs.

Positive vs. Normative Statements
Why is helpful for us to understand

the difference between positive and
normative statements?

Economists have found the positive-normative
distinction useful because it helps people with
very different views about what is desirable to
communicate with each other. Libertarians and
socialists, Christians and atheists may have very
different ideas about what is desirable. When
they disagree, they can try to learn whether their
disagreement stems from different normative
views or from different positive views.

If their disagreement is on normative grounds,

they know that their disagreement lies outside
the realm of economics, so economic theory
and evidence will not bring them together.
However, if their disagreement is on positive
grounds, then further discussion, study, and
testing may bring them closer together.

SUMMARY – PART 1
• Microeconomics versus macroeconomics

• Economics is the study of how individuals
make choices to satisfy wants.
• Microeconomics is the study of decision
making by individual households and
individual firms.
• Macroeconomics is the study of nationwide
phenomena, such as inflation and
unemployment levels.
SUMMARY – PART 1
• Macroeconomics deals with aggregates, or

totals—such as total output in an economy.
• Modern economic theory blends

micro and macro concepts.

SUMMARY – PART 1
• Economics as a science
• Economists use models, or theories, that are

simplified representations of the real world to
analyze and make predictions about the real
world.

SUMMARY – PART 1
• The difference between positive and

normative economics
• Positive economics deals with what is, whereas
normative economics deals with what ought to
be.
• Positive statements are of the “if…then”
variety, while normative ask what “should, or
could” be.

Ten Principles of
Economics
1
Ten Principles of Economics
How People Make Decisions

1. People face tradeoffs.
2. The cost of something is what you give up
to get it.
3. Rational people think at the margin.
4. People respond to incentives.

How People Interact

5. Trade can make everyone better off.
6. Markets are usually a good way to
organize economic activity.
7. Governments can sometimes improve
economic outcomes.

How the Economy as a Whole Works
8. The standard of living depends on a

country’s production.
9. Prices rise when the government
prints too much money.
10. Society faces a short-run tradeoff
between inflation and unemployment.

How People
Make
Economic Decisions

1. People face trade-offs.
30
We All Make Choices
• Scarcity forces us to choose

• Unlimited wants, limited
resources
• Not making a choice is itself a
choice
• Active, not passive
• Young people need a framework
for making choices that is best
begun early
• Factors driving choices can be
material, behavioral, moral, or
some combination of all three.
We ALL Make Choices
Most of us
want to BENEFITS
maximize
our benefits
While
minimizing COSTS
our
costs.
1. People face trade-offs.“T
• To get one thing, we usually have to give

up another thing.
 Subject A v. Subject B.
 To party v. studying for an exam
 Leisure time v. work
 Attendance in other classes or to join an On
Board Training
Making decisions requires trading

off one goal against another.
Principle #1: People Face Trade
Offs
What could be a synonym of

Trade Off?
What are your everyday
trade off decisions?
34
2. The cost of something is what
you give up to get it.
35
•All costs should be recognized.
•You often have many initial alternatives from

which you can choose, but in the moment of
choice, you choose between only two things.
•That next best choice you didn’t pick is called

your opportunity cost.

Most choices are not choices

between desirable and
undesirable options. We
usually choose between two
desirable options.

• Decisions require comparing costs and benefits
of alternatives.
• Whether to go with the field trip or not?
• Whether to study full time or work part time?
• Whether to go to class or sleep in?
• The opportunity cost of an item is what you

give up to obtain that item.

LA Laker basketball star
Kobe Bryant chose to
skip college and go
straight from high
school to the pros where
he has earned millions
of dollars.

The road
You
Did
Not
Take
Is
“The
Opportunity
Cost”

2. The cost of something is
what you give up to get it.
Choices Have Consequences
• Consequences lie in the

future
• Predictability improves
decision-making
• Observe patterns to
make predictions
• Unpredictability leads
to inconsistent decision-
making
2. The cost of something is
what you give up to get it.
Choices Have Consequences
• Theory of unintended
consequences
• Our character is the
consequence of thousands of
choices made throughout our
lives.
• Understanding the past can
help us start in the present to
make choices that can change
the future!
Applying Costs, Choices, and Consequences to
make sound decisions
1. Identify the problem

2. Analyze alternative solutions and select the
two best
3. Make a list of the foreseeable positive and
the negative consequences of each choice
Be sure to differentiate between the short-
run and long run when evaluating
consequences
4. Select the best choice

What is your opportunity cost in the
following situations?
1.Eating lunch in school instead of going home

which is one ride from school?
2. When you decided to take the taxi instead of
the jeep because you were late for your class?
3. When you decide to be absent from class?

Scarcity, Choice,
and Opportunity Cost
Limited Resources & Unlimited Wants
Scarcity
Choices
Opportunity Cost
3. Rational people think at the
margin.
46
margin.
• The Economic Person: Rational Self-Interest
• Economists assume that individuals

act as if motivated by self-interest and
respond predictably to opportunities
for gain.

margin.
“It is not from the benevolence of the butcher,

the brewer, or the baker that we expect our
dinner, but from their regard to their own
interest.”
—Adam Smith, An Inquiry into the Nature and
Causes of the Wealth of Nations, 1776

margin.
• Rationality Assumption
• The assumption that people do not
intentionally make decisions that would
leave them worse off

margin.
• Rational people
• Systematically & purposefully do the best they
can to achieve their objectives
• Rational decision maker – take action only if

• Marginal benefits > Marginal costs

margin.
In thinking economically, economists coined the
term “marginal” to describe the cost or benefit of
attaining one more unit of something.
Marginal changes are small, incremental

adjustments to an existing plan of
action.

margin.
People make decisions by comparing

costs and benefits at the margin.
margin.
“Neuroeconomics” Explores the
Rationality Assumption
• Economists want to know which parts of the

brain play the greatest role in determining an individual’s
choices.
• Brain scans reveal considerable coordination between the
limbic system (governing emotions) and the prefrontal cortex
(associated with reason and calculation).
• There is evidence the brain attempts to factor in reasoned
calculations aimed at making a choice consistent with the
“best” overall outcome.
margin.
Question:
Does the fact that some people make
apparently irrational choices
invalidate the rationality assumption
in economics?

55
• Incentive
• Something that induces a person to act
• Higher price
• Buyers - consume less
• Sellers - produce more
• Public policy
• Change costs or benefits
• Change people’s behavior

• Incentives may be monetary and non-monetary.

• That which is subsidized or rewarded will increase,
and that which is taxed or penalized will decrease.
• To change behavior, change the incentive.
• Sometimes it is only with hindsight that
“predictability” becomes obvious!

• What kind of incentives are you receiving from

your parents? For what behavior?

• What kind of incentives are you getting from

your teachers?

• Which is more important? Instilling discipline in

children to act in a certain way or giving them
incentives for them to behave in a certain way?

• Questions:
• 1. What incentives do sellers give to encourage

buyers to buy MORE?
• 2. What incentives do companies give for
people to patronize their products or services?
• 3. If you open a restaurant in the future, what
incentives will you give to attract more
customers?
REVIEW of the first 4 Principles
How People Make Decisions

1. People face tradeoffs.
2. The cost of something is what you give up
to get it.
3. Rational people think at the margin.

How People
Interact

64
Trade
•Specialization
Allows each person/country to
specialize in the activities
he/she does best
•People/countries can buy a
greater variety of goods and
services at lower cost
Do What You Do Best, Trade for the Rest.
66
Do What You Do Best, Trade for the Rest.

•Trying to produce everything
yourself limits both production
and consumption
• What do you “do best”?
•Sell what you produce at
low opportunity cost.
•Buy what you would
produce at a high opportunity
cost.

• Trade works best when

there is: Honesty;
Transparency; Expected Gain
for both parties
• The gain for both parties
does not need to be equal
in order to be valuable.
• Trade allows people
to specialize in what
they do best.
6. Markets are usually a good way
to organize economic activity.
69
There are three basic systems. Most
economies have some elements of all
three.
These basic market systems are:
1.Traditional economy
2.Market economy
3.Command economy
Traditional Economies
– A system that
answers the what,
how, and for whom
questions by
following what has
always been done in
the past. These
economies are
usually
characterized by
subsistence living
and limited trade. Copyright © 2004 South-Western/Thomson Learning
• Command
Economies – The
answers to the
economic
questions above
are made by a
central authority,
usually “the
state.”
Problems with Centrally Planned Economies
• Consumers get low priority

• Little freedom of choice
• Central planning can be inefficient
• Resources owned by the state are
sometimes wasted
• Environmental damage

• Market Economies
– Decision-
making carried out
by buyers and
sellers at mutually
agreeable terms.
Such economies
are characterized
by the
decentralization of
decision-making.
Problems with Market Economies
• Difficulty enforcing property rights

• Some people have few resources to sell
• Some firms try to monopolize markets
• No public goods
• Externalities

7. Governments can sometimes
improve market outcomes.
76
Do you (REALLY) believe

that the government can
help improve market
outcome? If yes, how?
If no, why?
•We need government
Enforce the rules
Maintain institutions - key to market
economy
Enforce property rights
•Property rights
Ability of an individual to own and
exercise control over scarce
resources
•Government intervention
Change allocation of resources
To promote efficiency
Avoid market failure
To promote equality
Avoid disparities in economic wellbeing

In what situations will be need
government interventions?
•Market failure
Situation in which the market on its
own fails to produce an efficient
allocation of resources

In what situations will be need government
interventions?
•Causes for market failure

Externality
Impact of one person’s actions on the
well-being of a bystander
Market power
Ability of a single person (or small group)
to unduly influence market prices

In what situations will be need government
interventions?
•Disparities in economic wellbeing
Market economy
Rewards people - ability to produce things
that other people are willing to pay for
Government intervention
Public policies
May diminish inequality
Process far from perfect

“Put more public money and resources into

infrastructure and building up the
foundations of the market, IE education
and technology. This will allow faster flow
of resources around the economy, the
workforce, and the ability for markets to
connect with each other.”
Yahoo Answers

“Decrease taxes, stop out of control
government spending, restore faith in the
private economy (non government) to
correct itself and allow the people to vote
with their dollars. Mostly, keep the
government off our backs. They were the
ones to blame for this current recession or
depression.
Source(s):”
M.A. Economics 1968
Yahoo Answers
How The Economy
Works as a Whole

8. A country’s standard of living depends on
its ability to produce goods and services.
86
• Standard of living may be measured

in different ways:
• By comparing personal incomes.
• By comparing the total market value of
a nation’s production.
• Almost all variations in living standards
are explained by differences in
countries’ productivities.
•Large differences in living standards
Among countries
Over time
•Explanation: differences in productivity
•Productivity is the amount of goods and services

produced from each hour of a worker’s time.
Higher productivity,
Higher standard of living
Quantity and Quality of Resources Impact
Living Standards.
The four factors of production

o Natural Resources (Land)
o Human Resources (Labor)
o Capital Resources (Equipment)
o Entrepreneurial Resources (risk, profit
motive)

Here are some ways we can grow our

resources:
• To increase capital resources–
technological changes
• To increase human resources – better
education, better skills, higher birth rate,
removal of age, race, gender and other
barriers to employment

Here are some ways we can grow our

resources:
• To increase natural resources –

environmental controls, land management
• To increase entrepreneurial resources –
establishment of private property, patent
and copyright laws, access to financial
markets, friendly tax and regulatory policy

9. Prices rise when the government
prints too much money.

Principle #9: Prices Rise When the
Government Prints Too Much Money.
• Inflation is an increase in the overall level of
prices in the economy.
• One cause of inflation is the growth in the
quantity of money.
• When the government creates large quantities
of money, the value of the money falls.

Principle #10: Society Faces a Short-run
Tradeoff Between Inflation and Unemployment.
• Short-run effects of monetary

injections:
• Stimulates - overall level of spending
• Higher demand for goods and services
• Firms – raise prices; hire more workers;
produce more goods and services
• Lower unemployment

Principle #10: Society Faces a Short-run
Tradeoff Between Inflation and Unemployment.
• The Phillips Curve illustrates the tradeoff
between inflation and unemployment:
Inflation  Unemployment
It’s a short-run tradeoff!

10. Society faces a short-run tradeoff
between inflation and unemployment.

Summary
• When individuals make decisions, they face
tradeoffs among alternative goals.
• The cost of any action is measured in terms of
foregone opportunities.
• Rational people make decisions by comparing
marginal costs and marginal benefits.
• People change their behavior in response to the
incentives they face.

Summary
• Trade can be mutually beneficial.
• Markets are usually a good way of coordinating
trade among people.
• Government can potentially improve market
outcomes if there is some market failure or if
the market outcome is inequitable.

Summary
• Productivity is the ultimate source of living
standards.
• Money growth is the ultimate source of
inflation.
• Society faces a short-run tradeoff between
inflation and unemployment.

Joson Ten Eco Principles

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Principles of Economics

Copyright © 2004 South-Western/Thomson Learning

Copyright © 2004 South-Western/Thomson Learning

Copyright © 2004 South-Western/Thomson Learning

• The study of the allocation of scarce

• Allocation: deciding who gets it?

Copyright © 2004 South-Western/Thomson Learning

• Different from “distribution”

• Allocation prioritizes the needs of

• To allocate: Who gets what?

Copyright © 2004 South-Western/Thomson Learning

• When wants exceed resources

• Scarcity is not poverty

• Scarcity is not “out of stock”

• Scarcity is not shortage.

Copyright © 2004 South-Western/Thomson Learning

Society and Scarce Resources:

• The management of society’s resources is

• Scarcity. . . means that society has limited

Copyright © 2004 South-Western/Thomson Learning

Copyright © 2004 South-Western/Thomson Learning

Micro: The study of decision making undertaken

Macro: The study of the behavior of the

Copyright © 2004 South-Western/Thomson Learning

Copyright © 2004 South-Western/Thomson Learning

Copyright © 2004 South-Western/Thomson Learning

Normative Eco statements: …..claims that

Copyright © 2004 South-Western/Thomson Learning

Why is helpful for us to understand

Copyright © 2004 South-Western/Thomson Learning

Copyright © 2004 South-Western/Thomson Learning

If their disagreement is on normative grounds,

Copyright © 2004 South-Western/Thomson Learning

• Microeconomics versus macroeconomics

• Macroeconomics deals with aggregates, or

• Modern economic theory blends

Copyright © 2004 South-Western/Thomson Learning

• Economists use models, or theories, that are

Copyright © 2004 South-Western/Thomson Learning

• The difference between positive and

Copyright © 2004 South-Western/Thomson Learning

How People Make Decisions

Copyright © 2004 South-Western/Thomson Learning

How People Interact

Copyright © 2004 South-Western/Thomson Learning

How the Economy as a Whole Works

8. The standard of living depends on a

Copyright © 2004 South-Western/Thomson Learning

Copyright © 2004 South-Western/Thomson Learning

• Scarcity forces us to choose

• To get one thing, we usually have to give

Making decisions requires trading

What could be a synonym of

•All costs should be recognized.

•You often have many initial alternatives from

•That next best choice you didn’t pick is called

Copyright © 2004 South-Western/Thomson Learning

Most choices are not choices

Copyright © 2004 South-Western/Thomson Learning

• The opportunity cost of an item is what you

Copyright © 2004 South-Western/Thomson Learning

Copyright © 2004 South-Western/Thomson Learning

Copyright © 2004 South-Western/Thomson Learning