PRINCIPLES OFTen Principles of EconomicsTen Principles of EconomicsSlide 4How People Make DecisionsSlide 6Slide 7Slide 8Slide 9Slide 10How People InteractSlide 12Slide 13Slide 14Slide 15Slide 16Slide 17How the Economy as a Whole WorksSlide 19Slide 20Slide 21Slide 22Ten principles of economicsPRINCIPLES OFBy N. Gregory MankiwPowerPoint slides prepared by:Andreea ChiritescuEastern Illinois UniversityPrinciples of Economics5e N. Gregory Mankiw© 2009 CengageEconomicsChapter Ten Principles of Economics1Ten Principles of Economics•Economy – “oikonomos” (Greek)–“One who manages a household” •Household - many decisions–Allocate scarce resources•Ability, effort, and desire•Society - many decisions–Allocate resources–Allocate output•Resources are scarce3Ten Principles of Economics•Scarcity - limited nature of society’s resources•Economics–Study of how society manages its scarce resources•Economists study:–How people make decisions –How people interact with one another–Analyze forces and trends that affect the economy as a whole4How People Make DecisionsPrinciple 1: People face trade-offs•Making decisions–Trade off one goal against another–Student – time–Parents – income–Society•National defense vs. consumer goods•Clean environment vs. high level of income•Efficiency vs. equality 5How People Make DecisionsPrinciple 1: People face trade-offs•Efficiency–Society - maximum benefits from its scarce resources–Size of the economic pie•Equality–Benefits - uniformly distributed among society’s members–How the pie is divided into individual slices6How People Make DecisionsPrinciple 2: The cost of something is what you give up to get it•People face trade-offs–Make decisions•Compare cost with benefits of alternatives–Opportunity cost•Whatever most be given up to obtain one item7How People Make DecisionsPrinciple 3: Rational people think at the margin•Rational people–Systematically & purposefully do the best they can to achieve their objectives•Marginal changes–Small incremental adjustments to a plan of action•Rational decision maker – take action only if–Marginal benefits > Marginal costs8How People Make DecisionsPrinciple 4: People respond to incentives•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 behavior9How People Make DecisionsPrinciple 4: People respond to incentives–Gasoline tax•Car size & fuel efficiency; carpool; public transportation–Unintended consequences•Policymakers fail to consider how their policies affect incentives10How People InteractPrinciple 5: Trade can make everyone better off •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 cost11How People InteractPrinciple 6: Markets are usually a good way to organize economic activity•Communist countries – central planning–Government officials (central planners)•Allocate economy’s scarce resources–Decided»What goods & services were produced»How much was produced»Who produced & consumed these goods & services•Theory: only the government could organize economic activity to promote economic well-being for the country as a whole12How People InteractPrinciple 6: Markets are usually a good way to organize economic activity•Market economy - allocates resources–Decentralized decisions of many firms and households–As they interact in markets for goods and services –Guided by prices and self interest–Adam Smith’s “invisible hand”13How People InteractPrinciple 7: Governments can sometimes improve market outcomes•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 resources14How People InteractPrinciple 7: Governments can sometimes improve market outcomes•Government intervention–Change allocation of resources–To promote efficiency•Avoid market failure–To promote equality•Avoid disparities in economic wellbeing15How People Interact•Market failure–Situation in which the market on its own fails to produce an efficient allocation of resources•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 prices16How People Interact•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 perfect17How the Economy as a Whole WorksPrinciple 8: A country’s standard of living depends on its ability to produce goods and services•Large differences in living standards–Among countries–Over time•Explanation: differences in productivity18How the Economy as a Whole Works•Productivity–Quantity of goods & services produced from each unit of labor input•Higher productivity –Higher standard of living•Growth rate of nation’s productivity –Determines growth rate of its average income19How the Economy as a Whole WorksPrinciple 9: Prices rise when the government prints too much money•Inflation–An increase in the overall level of prices in the economy•Causes for large / persistent inflation–Growth in quantity of money•Value of money falls20How the Economy as a Whole WorksPrinciple 10: Society faces a short-run trade-off 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•Short-run tradeoff between inflation and unemployment21How the Economy as a Whole WorksPrinciple 10: Society faces a short-run trade-off between inflation and unemployment•Short-run trade-off between unemployment and inflation–Key role – analysis of business cycle•Business cycle–Fluctuations in economic activity•Employment•Production22TableTen principles of economics1How People Make Decisions1: People Face Trade-offs2: The Cost of Something Is What You Give Up to Get It3: Rational People Think at