Principles of Eco

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1N.G.Mankiw

Principles of Economics

Principles of how people make decisions

Principles of how people interact

Principles of how the economy as a whole works



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HOW PEOPLE MAKE DECISIONS

Decision making is at

the heart of economics.

The first four principles

deal with how people

make decisions.



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ll decisions in!ol!e tradeoffs.Trade-off is a situation that in!ol!es losing one

"uality or aspect of something in return for gaining

another "uality or aspect.

Examples:

Student – how to allocate time # Going to a party the

night $efore e%am lea!es less time for studying.

Parent – how to spend income & 'hen they spend

an e%tra dollar on one good( they ha!e less to spend

on some other.

)ontd*..

Principle #1: People Face Tradeoffs

Principle #1: People Face Tradeoffs



+


)ontd*..

,ociety faces some tradeoffs-1. Guns !s. utter

2. )lean en!ironment !s. /igh income

3. 0fficiency !s. 0"uity

efficiency- getting the most out of scarce resources

equity- distri$uting prosperity fairly among societys

mem$ers

To increase e"uity( can redistri$ute income from thewell#off to the poor.

ut this reduces the incenti!e to work and produce(

and reduces efficiency.




Making decisions re"uires comparing the costs

and $enefits of alternati!e choices.

t is the rele!ant cost for decision making.

Example:

College atletes can earn millions if they drop out & play professional sports.

But may decide that benefit of college education is

greater than its opportunity cost.

Principle #!: Te Cost of Someting "s at

$ou %i&e 'p to %et "t ( opportunity cost

Principle #!: Te Cost of Someting "s at

$ou %i&e 'p to %et "t ( opportunity cost



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person is rational if she systematically and

purposefully does the $est she can to achie!e her

o$5ecti!es.

Decisions depend on marginal canges &

incremental ad5ustments to an e%isting plan.

0!aluate the costs and $enefits of marginal

changes.

6ational people make decisions $y comparing

marginal $enefits and marginal costs.

)ontd**.

Principle #): *ational People Tin+ at te

,argin

Principle #): *ational People Tin+ at te

,argin



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)ontd**.

Examples: Case of an airline firm- o muc tocarge passengers o fly stand.y/

a 288 seat plane

)osts 9 1(88(888 per lap of tra!el to the airline.

)ost of each seat :); < 988

irline should not sell ticket less than 988

***imagine*.

Plane is a$out to take off with 18 empty seats

,tand$y passenger offers to pay 9388

,hould the airline issue ticket to the stand$y passenger=



>


incenti&e: something that induces a person toact( i.e. the prospect of a reward or punishment.

6ational people respond to incenti!es $ecause

they make decisions $y comparing costs and$enefits.

0%ample-

? n response to higher cigarette taxes(teen smoking falls.

? n response to higher price of apple( market

discourages $uyers from $uying more @

induces producers to produce @ sell more.

Principle #0: People *espond to "ncenti&esPrinciple #0: People *espond to "ncenti&es



A

Case Study: Incentive Efects o GasoineP!ices

Bil price skyrocketed during 288#8> in the world market.

6easons&limited supplies @ surging demand from ro$ustgrowth.

n C, price of gasoline rose from 92 to 9 +gallon.

o people responded2 uyers shifted to small cars

6ise in scooter sales

6ise in $icycle sales ncreased use of pu$lic transport

)amel demand up in 6a5asthan

Dri!e students to online courses



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HOW PEOPLE IN"E#AC"

n EeconomyF is 5usta group of people

interacting with

each other.

The ne%t

three principles

deal with how people

interact.



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HOW PEOPLE IN"E#AC"

Peoplecountry can specialie in producing one

good or ser!ice in which heit has ad!antage.

Hater( e%change it for other goods others.

oth the trading partiescountries $enefit from

trade @ specialiation-

? get a $etter price a$road for goods theyproduce.

? $uy other goods more cheaply from a$roadthan could $e produced at home.

Principle #3:Trade Can ,a+e E&eryone 4etter 5ff Principle #3:Trade Can ,a+e E&eryone 4etter 5ff



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HOW PEOPLE IN"E#AC"

mar+et is a group of $uyers and sellers.

:They need not $e in a single location.;

EBrganie economic acti!ityF means determining

? what goods to produce? how to produce them

? how much of each to produce

? who gets them

"n a mar+et economy6 tese decisions result from te

interactions of many ouseolds and firms/

dam ,miths insight# 0ach of these households and

firms acts as if Eled $y an in&isi.le andF to promote

general economic well#$eing.

Principle #7: ,ar+ets 8re 'sually 8 %ood ay to

5rgani9e Economic 8cti&ity

Principle #7: ,ar+ets 8re 'sually 8 %ood ay to

5rgani9e Economic 8cti&ity



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HOW PEOPLE IN"E#AC"Principle #: %o&ernments Can Sometimes

"mpro&e ,ar+et 5utcomes

4y tree ays:

0nforcing property rights.

Promoting efficiency to tackle market failures.

Promoting e"uity



1+

HOW PEOPLE IN"E#AC"

)ontd*..

Go!t. enforce property rights:with police( courts;

People are less inclined to work( produce( in!est( or

purchase if large risk of their property $eing stolen.? restaurant wont ser!e meals if customers

do not pay $efore they lea!e.

? music company wont produce )Ds if too many

people a!oid paying $y making illegal copies.

)ontd*..



1

HOW PEOPLE IN"E#AC"

)ontd*..

Go!t promote efficiency

mar+et failure( when the market fails to allocate

societys resources efficiently. )auses-

? externalities( when the production or consumption

of a good affects $ystanders :e.g. pollution;? mar+et poer ( a single $uyer or seller has

su$stantial influence on market price :e.g. monopoly;

n such cases( pu$lic policy may promote efficiency.

)ontd*..



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HOW PEOPLE IN"E#AC"

)ontd*..

Go!t promote e"uity

Markets lea!e disparities in economic well#$eing.

t doesnt ensure e!eryone has sufficient food( decent

clothing( ade"uate health care etc.

Pu$lic :Go!t.; policies for more e"ual distri$ution

Ta%es

'elfare schemes



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HOW "HE ECONOM$ AS A WHOLE WO#KS

The last threeprinciples deal with

the economy as a

whole.



1>


/uge !ariation in li!ing standards across

countries and o!er time-

? !erage income in rich countries is more thanten times a!erage income in poor countries.

? The C.,. standard of li!ing today is a$outeight times larger than 188 years ago.

)ontd*..

Principle #;: 8 country<s standard of li&ing

depends on its a.ility to produce goods =ser&ices/

Principle #;: 8 country<s standard of li&ing

depends on its a.ility to produce goods =ser&ices/



1A


)ontd*..

The most important determinant of li!ing standards-producti&ity( the amount of goods and ser!icesproduced per unit of la$or.

Producti!ity depends on the e"uipment( skills( andtechnology a!aila$le to workers.

Pu$lic policy makers to $oost std. of li!ing $y

ensuring workers are educated( ha!e tools( ha!eaccess to the $est a!aila$le technology.

.



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"nflation- increases in the general le!el of prices.

0%cessi!e growth in the "uantity of money

causes.

The faster the go!t. creates money(

the greater the inflation rate.

Principle #>: Prices rise en te

go&ernment prints too muc money/

Principle #>: Prices rise en te

go&ernment prints too muc money/



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n the short#run :1 & 2 years;(

many economic policies push inflation and

unemployment in opposite directions. Go!t. policy instruments- change e%penditure( ta%es(

money prints etc.

*eal case: 0conomic downturn in C., economy during

288>#8A.

Principle #1?: Society faces a sort-run

tradeoff .eteen inflation and unemployment

Principle #1?: Society faces a sort-run

tradeoff .eteen inflation and unemployment



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CONCL%SION

0conomics offers many insights a$out the

$eha!ior of people( markets( and economies.

t is $ased on a few ideas that can $e applied

in many situations.

'hene!er we refer $ack to one of the

Ten Principles from this chapter(

you will see an icon like this one-



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C8PTE* S',,8*$

The principles of decision making are-? People face tradeoffs.

? The cost of any action is measured in terms of

foregone opportunities.? 6ational people make decisions $y comparing

marginal costs and marginal $enefits.

? People respond to incenti!es.



2+

C8PTE* S',,8*$

The principles of interactions among people are-? Trade can $e mutually $eneficial.

? Markets are usually a good way of

coordinating trade.? Go!t can potentially impro!e market

outcomes if there is a market failureor if the market outcome is ine"uita$le.



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C8PTE* S',,8*$

The principles of the economy as a whole are-? Producti!ity is the ultimate source of li!ing

standards.

? Money growth is the ultimate source ofinflation.

? ,ociety faces a short#run tradeoff $etweeninflation and unemployment.

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Principles of Eco