N.

GREGORY MANKIW NINTH EDITION

PRINCIPLES OF
ECONOMICS

CHAPTER
Ten Principles of
1 Economics
Interactive PowerPoint Slides by:
V. Andreea Chiritescu
Eastern Illinois University
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 IN THIS CHAPTER
• What kinds of questions does economics
address?
• What are the principles of how people
make decisions?
• What are the principles of how people
interact?
• What are the principles of how the
economy as a whole works?

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 Ten Principles of Economics
Resources are scarce
• Scarcity: the limited nature of society’s
resources
– Society has limited resources and cannot
produce all the goods and services people wish
to have.
• Economics
– The study of how society manages its
scarce resources

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 Ten Principles of Economics
• Economists study:
– How people decide how much they work,
what they buy, how much they save, and
how they invest their savings
– How firms decide how much to produce
and how many workers to hire
– How society decides how to divide its
resources between national defense,
consumer goods, protecting the
environment, and other needs
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 How People Make Decisions

Principle 1: People face trade-offs

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

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 Principle 1: People Face Trade-Offs
To get something that we like, we have to give
up something else that we also like.
– Going to a party the night before an exam
• Less time for studying
– Having more money to buy stuff
• Working longer hours, less time for leisure
– Protecting the environment
• Resources could be used to produce
consumer goods.

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 Principle 2: The Cost of Something Is What You
Give Up to Get It
• Making decisions:
– Compare costs with benefits of
alternatives
– Need to include opportunity costs
• Opportunity cost
– Whatever must be given up to obtain
some item

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 Principle 3: Rational People Think at the Margin

• Rational people
– Systematically and purposefully do the
best they can to achieve their objectives
given the available opportunities
– Make decisions by evaluating costs and
benefits of marginal changes
• Small incremental adjustments to a plan of
action

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license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
 Principle 4: People Respond to Incentives
• Incentive
– Something that induces a person to act
– Can have unintended consequences
• People respond to incentives
– Because rational people make decisions
by comparing costs and benefits
• An increase in the price of doughnuts:
– Consumers buy fewer doughnuts.
– Sellers produce more doughnuts.
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 How People Interact

Principle 5: Trade can make everyone

better off.
Principle 6: Markets are usually a good way
to organize economic activity.
Principle 7: Governments can sometimes
improve market outcomes.

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 Principle 5: Trade Can Make Everyone Better Off

• People benefit from trade:

– People can buy a greater variety of goods
and services at lower cost.
• Countries benefit from trade:
– Allows countries to specialize in what they
do best
– Enjoy a greater variety of goods and
services

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 Principle 6: Markets Are Usually a Good Way to
Organize Economic Activity – 1
• Market
– A group of buyers and sellers (need not
be in a single location)
• “Organize economic activity” means
determining
– What goods and services to produce
– How to produce these goods and services
– How to allocate them to their final user

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 Principle 6: Markets Are Usually a Good Way to
Organize Economic Activity – 2
• Market economy
– Allocates resources through the
decentralized decisions of many firms and
households as they interact in markets
– Proven remarkably successful in
organizing economic activity to promote
overall prosperity

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 Principle 6: Markets Are Usually a Good Way to
Organize Economic Activity – 3
• Prices:
– Determined by the interaction of buyers
and sellers
– Reflect the good’s value to buyers
– Reflect the cost of producing the good
• Adam Smith’s “invisible hand”:
– Prices guide self-interested households
and firms to make decisions that maximize
society’s economic well-being.
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 Principle 7: Governments Can Sometimes
Improve Market Outcomes – 1
• Government: enforce property rights
– Enforce rules and maintain institutions that
are key to a market economy
• People are less inclined to work, produce,
invest, or purchase if there is a large risk of
their property being stolen.
• We rely on government-provided police and
courts to enforce our rights over the things we
produce.

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 Principle 7: Governments Can Sometimes
Improve Market Outcomes – 2
• Government: promote efficiency
– Avoid market failures: Market left on its
own fails to allocate resources efficiently.
– Externality – source of market failure
• Production or consumption of a good affects
bystanders (e.g. pollution).
– Market power – source of market failure
• A single buyer or seller has substantial
influence on market price (e.g., monopoly).

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 Principle 7: Governments Can Sometimes
Improve Market Outcomes – 3
• Government: promote equality
– Avoid disparities in economic well-being
– Use tax or welfare policies to change how
the economic “pie” is divided.
• To say that the government can improve
market outcomes
– Does not mean that it always will

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 How the economy as a whole works

Principle 8: A country’s standard of living

depends on its ability to produce goods and
services.
Principle 9: Prices rise when the
government prints too much money.
Principle 10: Society faces a short-run
trade-off between inflation and
unemployment.

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 Principle 8: Country’s Standard of Living Depends on Its
Ability to Produce Goods and Services – 1

• Huge variation in living standards across

countries and over time
– 2017 average income:
• $60,000 in the U.S.; $6,000 in Nigeria
– Average income in rich countries
• Is more than ten times average income in
poor countries
– The U.S. standard of living today
• Is about eight times greater than 100 years
ago
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 Principle 8: Country’s Standard of Living Depends on Its
Ability to Produce Goods and Services – 2

• Productivity: most important determinant

of living standards
– Quantity of goods and services produced
from each unit of labor input
– Depends on the equipment, skills, and
technology available to workers
• Other factors (e.g., labor unions, competition
from abroad) have far less impact on living
standards.

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 Principle 9: Prices Rise When the Government
Prints Too Much Money
• Inflation
– An increase in the overall level of prices in
the economy
• In the long run
– Inflation is almost always caused by
excessive growth in the quantity of money,
which causes the value of money to fall
– The faster the government creates money,
the greater the inflation rate

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license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
 Principle 10: Society Faces a Short-Run Trade-Off
between Inflation and Unemployment
• Short-run trade-off between inflation and
unemployment
– In the short-run, many economic policies
push inflation and unemployment in
opposite directions.
– Other factors can make this trade-off more
or less favorable, but the trade-off is
always present.

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 THINK-PAIR-SHARE
Your university decides to reduce the price of a
parking permit on campus from $250 per semester to
$10 per semester.
A. The number of students desiring to park their cars on
campus will .
B. The amount of time it would take to find a parking
place will .
C. Will the lower price of a parking permit necessarily
lower the true cost of parking? (Hint: opportunity cost)
D. Would the opportunity cost of parking be the same
for students with no outside employment and
students with jobs earning $15 per hour?
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license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
 CHAPTER IN A NUTSHELL
• Individual decision making:
• People face trade-offs among alternative goals.
• The cost of any action is measured in terms of
forgone opportunities.
• Rational people make decisions by comparing
marginal costs and marginal benefits.
• People change their behavior in response to the
incentives they face.

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license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
 CHAPTER IN A NUTSHELL
• Interactions among people:
• Trade and interdependence can be mutually
beneficial.
• Markets are usually a good way of coordinating
economic activity among people.
• Governments can potentially improve market
outcomes by remedying a market failure or by
promoting greater economic equality.

© 2021 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a 25
license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
 CHAPTER IN A NUTSHELL
• The economy as a whole:
• Productivity is the ultimate source of living
standards.
• Growth in the quantity of money is the ultimate
source of inflation.
• Society faces a short-run trade-off between
inflation and unemployment.

© 2021 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a 26
license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.