1a ten principles

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PowerPoint® Lecture Presentationto accompany

Principles of Economics, Third EditionN. Gregory Mankiw

Prepared by Mark P. Karscig, Central Missouri State University.

1INTRODUCT ION

11Ten Principles of

Economics

Economy. . .

. . . The word economy comes from a Greek word for ³one who manages a household.´

FOUR BASIC Q U ESTI ON S I N EC ONOM ICS

A household and an economyface many decisions:

W ho will work? W hat goods and how many of them should be produced? W hat resources should be used in production?

A t what price should the goods be sold?

BASIC C ON CEPT I N EC ONOM ICS

S ociety and S carce Resources:The management of society¶s resources isimportant because resources are scarce.S carcity . . . means that society has limited resourcesand therefore cannot produce all the goods andservices people wish to have.

TE N P R IN CIPLES OF EC ONOM ICS

E conomics is the study of how society managesits scarce resources.

H ow people make decisions. People face tradeoffs.The cost of something is what you give up to get it.Rational people think at the margin.

People respond to incentives.

H ow people interact with each other.Trade can make everyone better off.

M arkets are usually a good way to organizeeconomic activity.Governments can sometimes improve economicoutcomes.

The forces and trends that affect how theeconomy as a whole works.

The standard of living depends on a country¶s production. Prices rise when the government prints too muchmoney.S

ociety faces a short-run tradeoff between inflationand unemployment.

Principle #1: People Fa ce Tr ad eoffs.

³There is no such thing as a free lunch!´

Mak ing d ecisions requires tr ad ingoff one go a l a ga inst a nother.

Principle #1: People Fa ce Tr ad eoffs.

To get one thing, we usually have to give upanother thing.

Food v. clothing Leisure time v. work

S leeping v. attending school Efficiency v. equity

Principle #1: People Fa ce Tr ad eoffs

Efficiency v. E quityEff iciency means society gets the most that it canfrom its scarce resources.Equ ity means the benefits of those resources aredistributed fairly among the members of society.

Principle #2: The Cost of Something Is Wh a tYou Give U p to Get It.

D ecisions require comparing costs and benefitsof alternatives.

W hether to go to college or to work? W hether to study or go out on a date? W hether to go to class or sleep in?

The opport unity cost of an item is what yougive up to obtain that item.

Principle #2: The Cost of Something Is Wh a tYou Give U p to Get It.

LA L akers basketballstar Kobe Bryant chose

to skip college and gostraight from highschool to the pros wherehe has earned millionsof dollars.

People m ak e d ecisions by comp a ringcosts a nd benefits a t the m a rgin.

Principle #3: Ra tion a l People Thin k a t theMa rgin.

M arginal changes are small, incrementaladjustments to an existing plan of action.

Principle #4: People R espon d to Incentives.

M arginal changes in costs or benefits motivate people to respond.The decision to choose one alternative over another occurs when that alternative¶s marginal

benefits exceed its marginal costs!

Principle #5: Tr ad e C a n Mak e EveryoneBetter O ff.

People gain from their ability to trade with oneanother.

Competition results in gains from trading.Trade allows people to specialize in what theydo best.

Principle #6: Ma r k ets Are U su a lly a Goo d Wa y to O rg a nize Economic Activity.

A market economy is an economy that allocatesresources through the decentralized decisions of many firms and households as they interact inmarkets for goods and services.

H ouseholds decide what to buy and who to work for.

Firms decide who to hire and what to produce.

Principle #6: Ma r k ets Are U su a lly a Goo d Wa y to O rg a nize Economic Activity.

A dam S mith made the observation thathouseholds and firms interacting in markets actas if guided by an ³invisible hand.´

Because households and firms look at prices whendeciding what to buy and sell, they unknowinglytake into account the social costs of their actions.

As a result, prices guide decision makers to reachoutcomes that tend to maximize the welfare of

society as a whole.

Principle #7: Governments C a n SometimesImprove Ma r k et O utcomes.

M arket f ail ure occurs when the market fails toallocate resources efficiently.

W hen the market fails (breaks down)government can intervene to promote efficiencyand equity.

Principle #7: Governments C a n SometimesImprove Ma r k et O utcomes.

M arket failure may be caused byan externality , which is the impact of one person or firm¶s actions on the well-being of a bystander.

market power , which is the ability of a single person or firm to unduly influence market prices.

Principle #8: The St a nda r d of Living Depen d son a Country¶s Pro d uction.

S tandard of living may be measured in differentways:

By comparing personal incomes.By comparing the total market value of a nation¶s

production.

Principle #8: The St a nda r d of Living Depen d son a Country¶s Pro d uction.

A lmost all variations in living standards areexplained by differences in countries¶

productivities.P rod uctivity is the amount of goods andservices produced from each hour of a worker¶stime.

Principle #9: Prices R ise When theGovernment Prints Too M uch M oney.

Inflation is an increase in the overall level of prices in the economy.

O ne cause of inflation is the growth in thequantity of money.

W hen the government creates large quantitiesof money, the value of the money falls.

Principle #10: Society Fa ces a Short-runTr ad eoff Between Infl a tion a nd U nemployment.

The P hillips C urve illustrates the tradeoff between inflation and unemployment:

I nflation UnemploymentI t¶s a short-run tradeoff!

Summ a ry

W hen individuals make decisions, they facetradeoffs among alternative goals.The cost of any action is measured in terms of foregone opportunities.Rational people make decisions by comparingmarginal costs and marginal benefits.

People change their behavior in response to theincentives they face.

Summ a ry

Trade can be mutually beneficial. M arkets are usually a good way of coordinatingtrade among people.Government can potentially improve marketoutcomes if there is some market failure or if the market outcome is inequitable.

Summ a ry

Productivity is the ultimate source of livingstandards.

M oney growth is the ultimate source of inflation.S ociety faces a short-run tradeoff betweeninflation and unemployment.

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