Bicol University

College of Business Economics and Management

Daraga Campus,Daraga Albay
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MANAGERIAL ECONOMICS

Module on: Ten Principles of Economics

Adopted by: Imelda A. Siapno

Objectives:

a. To familiarize with the 10 principles of Economics

b. To relate the economic principles to day-to-day life in terms of how people make
decisions, interact with others and how the economy works.

Introduction:

Economics is the study of how to make the best possible use of the available resources, such as
capital, labor, land, etc., in the most profitable way. Resources or factors of production are
always scarce, and people must make the best possible use of these resources that will
maximize the utility they derive from them. Mr. N. Gregory Mankiw wrote the book “Principles
of Economics” in which he gave us ten principles of economics that guide the economy and its
participants.

Mr.Mankiw classifies all his ten principles of economics into three broad categories. And these
three categories are – How people make decisions, how they interact with each other, and how
the economy as a whole works. Let us look at these principles in detail.

Table of Contents
1. Ten Principles of Economics
1. How do People Make their Decisions?
1. Principle 1: People Face Trade-Offs
2. Principle 2: The Cost of an Item is What We Sacrifice to Get it
3. Principle 3: Rational People Look to Maximize their Utility
4. Principle 4: People Respond to Incentives
2. How People Interact with Each Other?
1. Principle 5: Trade Makes Everyone Better Off
2. Principle 6: Markets are a Good Way of Organizing Economic Activity
3. Principle 7: Government has the Resources to Improve the Outcomes of
the Market
3. How the Entire Economy Works?
 1. Principle 8: The Ability to Produce Goods & Services Decides the Standard
of Living of a Country
2. Principle 9: Excessive Printing of Money by the Government Results in
Rising Prices
3. Principle 10: Trade-Off between Unemployment & Inflation

How do People Make their Decisions?

The first four of the ten principles of economics fall into this category. These principles are based
upon the individual decision-making process.

Principle 1: People Face Trade-Offs

Trade-offs are something that we regularly face in our day-to-day lives. In order to take one thing,
we have to make choices and let go of something else. This is so because the resources that are
available to us have a limit and are scarce. Hence, it is not possible for us to have all products and
services as per our choice and quantity. Somewhere we all need to prioritize and leave off or let
go of something that can not be accommodated. This let-off is the trade-off that one makes every
time one is faced with alternatives.

On an individual level, people face the trade-off of sacrificing the consumption of one item over
another. Also, they may have to spend more time on one activity than another. As a nation, the
government faces a trade-off when choosing how much to spend on defense and how much to
spend on consumption. Also, societies face a trade-off between a pollution-free environment and
high-income levels and between efficiency and equity. Therefore, acknowledging that we have
to face trade-offs at each and every stage of our life is a guiding core principle of economics.

Principle 2: The Cost of an Item is What We Sacrifice to Get it

People have to regularly do a cost-benefit analysis of the choices they have before choosing or
preferring a particular course of action. There is an opportunity cost to everything. It is the cost
of the next best choice one foregoes while choosing between two or more alternatives. The
opportunity cost of spending money on buying a television is missing out on an opportunity to
buy some other household item or spending that money on vacation. People must always
consider the opportunity cost of any choice or item before taking the final decision.
Principle 3: Rational People Look to Maximize their Utility
Economists all over the world believe that people and businesses are rational. And therefore,
they all make the best possible decisions and have the most rational choice among the various
options available at their disposal. Moreover, it is also the underlying assumption that the people
are very much aware of the scarcity of resources in the economy. And all this prompts them to
maximize the utility or the outcome out of all these scarce resources. Consumers will go on
consuming a product only and only until its marginal utility is more than its marginal cost.
Producers, sellers, and service providers often face the dilemma of selling a product at a price
below their average cost. This is common in industries such as aviation, entertainment, cinema,
etc. Since people are rational, they should continue to sell the product till the marginal utility of
the product becomes equal to its marginal cost.

Principle 4: People Respond to Incentives

Participants in an economy are rational. Hence they respond to any extra benefit that they may
get from the consumption of a product or a service. Incentives are a sort of reward for promoting
the consumption of goods and services. And these may be in the form of free additional units of
the product, or increased quantity of the product at the same price, or giving price discounts on
the product.

Consumers react positively to incentives as it allows them to maximize their satisfaction levels.
Thus, manufacturers and sellers give incentives to buyers when the momentum in the economy
is low, and their sales are not up to the mark. Also, incentives are helpful as a fighting force
against the competition, luring gullible customers to consume their product and drive the
competition out of the market.

Principle 5: Trade Makes Everyone Better Off

Trade between people, businesses, and countries is essential for the betterment and well-being
of one and all. An individual cannot produce each, and everything for his consumption need
himself. He will be better off in producing a few things in which he specializes and leaves the rest
for others to produce in which they have an edge or are better off.

Through this concept and rational decision, all the individuals and entities will ultimately do what
is best for them. And in this way, they all can enjoy the benefits of specialization and economies
of scale and scope. One can trade with other people and buy everything that one does not
produce himself. When we see this on a broad scale, keeping in mind the entire economy, we
will find that everyone is producing goods or providing a service as per his specialized skills. The
same applies to big businesses and even countries. All have to depend upon each other for
trading activities, and this is beneficial for society as a whole.

Principle 6: Markets are a Good Way of Organizing Economic Activity

Free and fair markets are a must for the success of any economy. The market forces of demand
and supply should act on their own to give us the price and quantity equilibrium, where demand
and supplies are matched at a particular price point. It has been proven historically that any
government intervention in deciding the quantity or pricing of goods and services has been
always a failure in the long run. Moreover, the authoritative system of fixing a price of a product
or service without studying the consumer demand pattern, consumers’ tastes and preferences,
their willingness to pay, and the cost of production, etc., result in complete chaos and a crash of
the market.

A free-market economy is the best form of market. The participants have the upper hand in
deciding what, how, where, and how much to produce and sell at the best possible price.

Principle 7: Government has the Resources to Improve the Outcomes of the Market

Government is the most important form of institutional body that acts as an invisible hand to
control the market forces. It works day and night to ensure that the market participants follow
its regulations and play the game by its rules. The government enforces property rights in the
country. It encourages the people to produce and sell and participate in economic activities
without any fear of being cheated or of suffering unfair losses.

How the Entire Economy Works?

The last three of the ten principles tell us how an economy works.

Principle 8: The Ability to Produce Goods & Services Decides the Standard of Living of a Country

The countries of the world witness different standards of living. That, in turn, decides their access
to healthcare facilities, the standard of living, gadgets, housing, consumption patterns, and life
expectancy. The large variation in the standard of living of people is because of the difference in
their productivity levels.

More the people produce in each hour of their work results in higher income and standard of
living. Similarly, countries with low productivity levels are poor and still under-developed or
developing. Good and proper education, availability of adequate tools and infrastructure, and
access to modern technology are a must for a nation to improve its productivity levels and hence
its standard of living.

Principle 9: Excessive Printing of Money by the Government Results in Rising Prices

Excessive printing of money by the government of a nation results in the loss of value of that
currency. The purchasing power goes on reducing, resulting in a constant and spiraling price rise
of goods and services. The rise in prices results in inflation in the economy. And due to reduced
purchasing power, more and more money is required to buy the same quantity of goods and
services. Therefore, a government needs to have a strict control mechanism regarding printing
and the supply of money in the economy. And this is to ensure that inflationary trends in the
economy are temporary and stay under control.
Principle 10: Trade-Off between Unemployment & Inflation

Every country experiences a short-term trade-off between inflation and unemployment.

Inflationary trends in the economy result in higher demand for goods and services. This is due to
the excess money supply in the hands of the people. Higher demand results in a further increase
in prices as well as pressure on the producers to supply more. In order to supply more, they hire
more people. Therefore, the unemployment level goes down in the economy.

The level of demand for goods and services usually remains in the control of the government and
its policymakers. By tweaking various policies, they can alter the spending levels, taxation levels,
the money supply in the market, etc., to influence the demand for goods and services. A change
in demand will also affect the trade-off between inflation and unemployment.

To do Activity
Cite one example you personally experience that manifest any of the first four principles of
economics.