Chapter 1

Ten Principles of Economics

2002 by Nelson, a division of Thomson Canada Limited

In this chapter you will

Learn Learn that that economics economics is is about about the the allocation allocation of of scarce scarce resources. resources. Examine Examine some some of of the the tradeoffs tradeoffs that that people people face. face. Learn Learn the the meaning meaning of of opportunity opportunity cost. cost. See See how how to to use use marginal marginal reasoning reasoning when when making making decisions. decisions.

Chapter 1: edition Mankiw et al.: Principles of Microeconomics, 2nd Canadian

In this chapter you will

Discuss Discuss how how incentives incentives affect affect peoples peoples behaviour. behaviour. Consider Consider why why trade trade among among people people or or nations nations can can be be good good for for everyone. everyone. Discuss Discuss why why markets markets are are a a good, good, but but not not perfect, perfect, way way to to allocate allocate resources. resources. Learn Learn what what determines determines some some trends trends in in the the overall overall economy. economy.

Chapter 1: edition Mankiw et al.: Principles of Microeconomics, 2nd Canadian

The Word Economy Comes From the Greek word for one who manages a household.

Chapter 1: edition Mankiw et al.: Principles of Microeconomics, 2nd Canadian

TEN PRINCIPLES OF ECONOMICS

A A household household and and an an economy economy face face many many decisions: decisions: Who Who will will work? work? What What goods goods and and how how many many of of them them should should be be produced? produced? What What resources resources should should be be used used in in production? production? At At what what price price should should the the goods goods be be sold? sold?

Chapter 1: edition Mankiw et al.: Principles of Microeconomics, 2nd Canadian

TEN PRINCIPLES OF ECONOMICS

Society Society and and Scarce Scarce Resources: Resources: The The management management of of societys societys resources resources is is important important because because resources resources are are scarce. scarce. .. .. .. means Scarcity Scarcity means that that society society has has limited limited resources resources and and therefore therefore cannot cannot produce produce all all the the goods goods and and services services people people wish wish to to have. have.

Chapter 1: edition Mankiw et al.: Principles of Microeconomics, 2nd Canadian

TEN PRINCIPLES OF ECONOMICS

Economics Economics is is the the study study of of how how society society manages manages its its scarce scarce resources. resources. Economists Economists study study how how people people make make decisions: decisions: How How much much they they work work What What they they buy buy How How much much they they save save How How they they invest invest their their savings savings

Chapter 1: edition Mankiw et al.: Principles of Microeconomics, 2nd Canadian

TEN PRINCIPLES OF ECONOMICS

Economists Economists also also study study how how people people interact interact such such as as buyers buyers and and sellers. sellers. Price Price determination. determination. Economists Economists also also analyze analyze forces forces and and trends trends that that affect affect the the economy economy as as a a whole. whole. Growth Growth in in average average income income The The rate rate of of price price increase. increase.

Chapter 1: edition Mankiw et al.: Principles of Microeconomics, 2nd Canadian

HOW PEOPLE MAKE DECISIONS

There There is is no no mystery mystery to to what what an an economy economy is. is. Its Its a a group group people people interacting interacting with with one one another another as as they they go go about about their their lives. lives. We We start start the the study study of of economics economics with with four four principles principles of of individual individual decision decision making: making:

People Peopleface facetradeoffs tradeoffs The Thecost costof ofsomething somethingis iswhat what you yougive giveup upto to get get it. it. Rational Rational people peoplethink think at atthe the margin. margin. People Peoplerespond respond to to incentives. incentives. Chapter 1: edition Mankiw et al.: Principles of Microeconomics, 2nd Canadian

Principle 1: People Face Tradeoffs

There There is is no no such such thing thing as as a a free free lunch lunch To To get get something something we we like like we we usually usually have have to to give give up up something something we we dont dont like. like. A A student student and and her her time: time: Studying Studying vs. vs. napping napping or or cycling. cycling. Societys Societys tradeoffs: tradeoffs: Guns Guns vs. vs. Butter Butter Clean Clean environment environment and and higher higher income income

Chapter 1: edition Mankiw et al.: Principles of Microeconomics, 2nd Canadian

Principle 1: People Face Tradeoffs

Societys Societys tradeoffs tradeoffs (contd): (contd): Efficiency Efficiency vs. vs. Equity Equity Efficiency: Efficiency: Society Society getting getting the the most most it it can can from from its its scarce scarce resources. resources. Equity: Equity: Distributing Distributing economic economic prosperity prosperity fairly fairly among among the the members members of of society. society.

Chapter 1: edition Mankiw et al.: Principles of Microeconomics, 2nd Canadian

Principle 2: The Cost of Something is what You Give Up

Making Making decisions decisions requires requires comparing comparing the the costs costs and and benefits benefits of of alternative alternative courses courses of of actions. actions.
To Togo goto touniversity universityor ornot not to to go? go?

Opportunity Opportunity cost: cost: Whatever Whatever must must be be given given up up to to obtain obtain some some item. item.

Chapter 1: edition Mankiw et al.: Principles of Microeconomics, 2nd Canadian

Principle 3: Rational People Think at the Margin

Marginal Marginal changes: changes: Small Small incremental incremental adjustments adjustments to to marginal marginal changes. changes. Individuals Individuals and and firms firms can can make make better better decisions decisions by by thinking thinking at at the the margin. margin. By By comparing comparing the the marginal marginal benefits benefits (MB) (MB) with with the the associated associated marginal marginal costs costs (MC) (MC) of of a a decision. decision.

Chapter 1: edition Mankiw et al.: Principles of Microeconomics, 2nd Canadian

Principle 4: People Respond to Incentive

Marginal Marginal changes changes in in costs costs or or benefits benefits motivate motivate people people to to respond. respond. When When the the price price of of apples apples rise rise The The decision decision to to choose choose one one alternative alternative over over another another occurs occurs when when that that alternatives alternatives marginal marginal benefits benefits exceed exceed its its marginal marginal costs! costs!

Chapter 1: edition Mankiw et al.: Principles of Microeconomics, 2nd Canadian

HOW PEOPLE INTERACT

The The first first four four principles principles discussed discussed how how individuals individuals make make decisions. decisions. The The next next three three principles principles concern concern how how people people interact interact with with one one another. another.

Chapter 1: edition Mankiw et al.: Principles of Microeconomics, 2nd Canadian

Principle 5: Trade can Make Everyone Better Off

People People gain gain from from their their ability ability to to trade trade with with one one another. another. Competition Competition results results in in gains gains from from trading. trading. Trade Trade allows allows people people to to specialize specialize in in what what they they do do best. best.

Chapter 1: edition Mankiw et al.: Principles of Microeconomics, 2nd Canadian

Principle 6: Markets are Usually a Good Way to Organize Economic Activity

Market Market economy: economy: An An economy economy that that allocates allocates resources resources through through the the decentralized decentralized decisions decisions of of many many firms firms and and households households as as they they interact interact in in markets markets for for goods goods and and services. services. Firms Firms decide decide whom whom to to hire hire and and what what to to make. make. Households Households decide decide which which firms firms to to work work for for and and what what to to buy buy with with their their incomes. incomes.

Chapter 1: edition Mankiw et al.: Principles of Microeconomics, 2nd Canadian

Principle 6: Markets are Usually a Good Way to Organize Economic Activity

Market Market economy: economy: An An economy economy that that allocates allocates resources resources through through the the decentralized decentralized decisions decisions of of many many firms firms and and households households as as they they interact interact in in markets markets for for goods goods and and services. services. Firms Firms decide decide whom whom to to hire hire and and what what to to make. make. Households Households decide decide which which firms firms to to work work for for and and what what to to buy buy with with their their incomes. incomes.

Chapter 1: edition Mankiw et al.: Principles of Microeconomics, 2nd Canadian

Principle 7: Governments can Sometimes Improve Market Outcomes

When When the the invisible invisible hand hand does does not not work. work.
Market Market failure: failure: A Asolution solution in in which which a amarket market left lefton onits itsown ownfails failsto to allocate allocateresources resources efficiently. efficiently. Externality: Externality:The Theimpact impactof ofone onepersons persons actions actionson onthe thewell-being well-beingof ofa abystander. bystander. Market Market power: power:The The ability ability of of a asingle single economic economic actor actor(or (orsmall smallgroup groupof ofactors) actors) to tohave havea a substantial substantialinfluence influenceon onmarket marketprices. prices.

Chapter 1: edition Mankiw et al.: Principles of Microeconomics, 2nd Canadian

HOW THE ECONOMY AS A WHOLE WORKS

The Thelast lastthree threeprinciples principlesconcern concernthe theworkings workingsof of the theeconomy economyas asa a whole. whole.

Chapter 1: edition Mankiw et al.: Principles of Microeconomics, 2nd Canadian

Principle 8: A Countrys Standard of Living Depends on its Ability to Produce Goods and Services
Standard Standard of of Living Living may may be be measured measured in in different different ways ways (e.g. (e.g. personal personalincome incomeor ortotal total
market marketvalue valueof of a anations nationsproduction.) production.) Differences Differencesin in standard standard of of living livingbetween between countries countriesor oreven evenprovinces provincesis isattributable attributableto to the theproductivity productivity of of the thecountry countryor orprovince. province.

:: The Productivity Productivity The amount amount of of goods goods and and services services produced produced from from each each hour hour of of a a workers workers time. time. Productivity => Standard of Living

Chapter 1: edition Mankiw et al.: Principles of Microeconomics, 2nd Canadian

Principle 9: Prices Rise when the Government Prints Too Much Money
In In Germany Germany

In InJanuary January1921, 1921,a adaily dailynewspaper newspapercost cost0.30 0.30 marks. marks. In InNovember November 1922, 1922,the thesame samepaper papercost cost70 70000 000 000 000marks. marks. Inflation: Inflation:An An increase increasein in the theoverall overalllevel levelof of prices pricesin in the the economy. economy. One Onecause causeof ofinflation inflationis isthe thegrowth growthin inthe the quantity quantityof of money. money. When Whenthe thegovernment government creates createslarge largequantities quantitiesof of money, money,the thevalue valueof of the themoney moneyfalls. falls. Chapter 1: edition Mankiw et al.: Principles of Microeconomics, 2nd Canadian

Principle 10: Society Faces a Short-Run Tradeoff Between Inflation and Unemployment.
Phillips Phillips curve: curve: A A curve curve that that shows shows the the short-run short-run tradeoff tradeoff between between inflation inflation and and unemployment. unemployment.

Chapter 1: edition Mankiw et al.: Principles of Microeconomics, 2nd Canadian

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

Chapter 1: edition Mankiw et al.: Principles of Microeconomics, 2nd Canadian

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

Chapter 1: edition Mankiw et al.: Principles of Microeconomics, 2nd Canadian

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

Chapter 1: edition Mankiw et al.: Principles of Microeconomics, 2nd Canadian

The End

Chapter 1: edition Mankiw et al.: Principles of Microeconomics, 2nd Canadian