PowerPoint Slides

to accompany
Principles of Economics, An Asian Edition (2nd Edition)
N. Gregory Mankiw | Euston Quah | Peter Wilson
 1

TEN PRINCIPLES OF ECONOMICS

© 2013 Cengage Learning Asia

 Economy. . .
• . . . The word economy comes from a Greek word for
“one who manages a household.”
• A household and an economy face many decisions:
• Society and Scarce Resources:
– The management of society’s resources is important
because resources are scarce.
– Scarcity. . . means that society has limited resources and
therefore cannot produce all the goods and services
people wish to have.
• Economics is the study of how society manages its
scarce resources.
 Ten Principles of Economics
1) How people make decisions
2) How people interact
3) How the economy as a whole works
 HOW PEOPLE MAKE DECISIONS
1. People face trade-offs.
2. The cost of something is what you give up to
get it.
3. Rational people think at the margin.
4. People respond to incentives.
 Principle #1: People Face Trade-offs.
• “There is no such thing as a free lunch!”
 Principle #1: People Face Trade-offs.
• To get one thing, we usually have to give up
another thing.
– Your time (Leisure time vs work)
– Your money (consumption vs saving)
– Guns vs butter
– Efficiency vs equity

Making decisions requires trading

off one goal against another.
• Efficiency v. Equity
– Efficiency means society gets the most that it can
from its scarce resources.
– Equity means the benefits of those resources are
distributed fairly among the members of society.
Principle #2: The Cost of Something Is What You
Give Up to Get It.

• Because people face tradeoffs, making

decisions require comparing costs and
benefits of alternatives.
– Whether to go to college or to work?
– Comparing cost (including opportunity cost) and
benefit
• The opportunity cost of an item is what you
give up to obtain that item.
 “college dropout billionaires”

They chose to skip college and go straight to earns millions of dollars

 Principle #3: Rational People Think at the
Margin.
• Decisions in life are rarely black and white but
usually involve shades of gray
• People make decisions by comparing costs and
benefits at the margin.
**Marginal changes are small, incremental
adjustments to an existing plan of action.
• People compare marginal benefits and marginal
costs
• Example : airline (200 seat, TC =$100.000,
AC=$500, if there are 10 empty seats?? MC?)
Principle #4: People Respond to Incentives.

• Marginal changes in costs or benefits motivate

people to respond.
• Example : rising oil prices, Minimum wage, a
seat belt law in US
• The decision to choose one alternative over
another occurs when that alternative’s
marginal benefits exceed its marginal costs!
 HOW PEOPLE INTERACT
5. Trade can make everyone better off.
6. Markets are usually a good way to organize
economic activity.
7. Governments can sometimes improve
economic outcomes.
Principle #5: Trade Can Make Everyone
Better Off.
• Competition and collaboration
• People gain from their ability to trade with
one another.
• Trade allows people to specialize in what they
do best.
Principle #6: Markets Are Usually a Good
Way to Organize Economic Activity.
• Central planners, market economy and Mix
system
• A market economy is an economy that allocates
resources through the decentralized decisions of
many firms and households as they interact in
markets for goods and services.
– Households decide what to buy and who to work for.
– Firms decide who to hire and what to produce.
• Prices (invisible hand) and self interest guide
their decisions
Principle #6: Markets Are Usually a Good
Way to Organize Economic Activity.
• Adam Smith (1776) : “invisible hand”
– households and firms look at prices when deciding
what to buy and sell, they unknowingly take into
account the social costs of their actions.
– Price reflect both the value of good to society and
the cost to society
– prices guide decision makers to reach outcomes
that tend to maximize the welfare of society as a
whole.
 Principle #7: Governments Can
Sometimes Improve Market Outcomes.
Why we do need government?
1) Markets work only if property rights are
enforced.
 Property rights are the ability of an individual to own
and exercise control over a scarce resource
2) When the market fails (breaks down)
government can intervene to promote efficiency
and equity.
 Market failure occurs when the market fails to
allocate resources efficiently.
 Principle #7: Governments Can
Sometimes Improve Market Outcomes.
• Market failure may be caused by:
– an 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.
– Public goods
 HOW THE ECONOMY AS A WHOLE
WORKS

8. A country’s standard of living depends on its

ability to produce goods and services.
9. Prices rise when the government prints too
much money.
10.Society faces a short-run trade-off between
inflation and unemployment.
 Principle #8: A Country’s Standard of Living Depends on Its
Ability to Produce Goods and Services.

• Standard of living may be measured in

different ways:
– By comparing personal incomes. (GDP per
persons)
– By comparing the total market value of a nation’s
production (GDP) , $894.9 billion (2012)
– HDI Index :
– Happiness Index :
 Country GDP per persons 2012 Category
(USD)
India 1,489 Lower middle income
China 6,091 Upper middle income
Indonesia 3,557 Lower middle income
United States 49,965 High income
Norway 99,558 High income
United Kingdom 38,514 High income
Thailand 5,474 Upper middle income
Singapore 51,709 High income
Denmark 56,210 High income
Malaysia 10,381 Upper middle income

Note :
low income, $1,035 or less; lower middle income, $1,036 - $4,085; upper
middle income, $4,086 - $12,615; and high income,$12,616 or more.(
data.worldbank.org)
 HDI
• The Human Development Index (HDI) is a
comparative measure of life expectancy,
literacy, education, standards of living, and
quality of life for countries worldwide.
• Rank : (1) Norwegia (2) Australia (3) USA (10)
Japan (121) Indonesia (103) Thailand (136)
India (101) China (64) Malaysia (172)
Zimbabwe (undp, 2012)
GNH indicators :

GNH value is proposed to be an index function of the total

average per capita of the following measures:
1. Economic Wellness
2. Environmental Wellness:
3. Physical Wellness:
4. Mental Wellness:
5. Workplace Wellness
6. Social Wellness
7. Political Wellness
 THE STATISTICS SHOWS …

 The happiest countries in the world are all in Northern

Europe (Denmark, Norway, Finland, Netherlands). Their
average life evaluation score is 7.6 on a 0-to-10 scale.

 The least happy countries are all poor countries in Sub-

Saharan Africa (Togo, Benin, Central African Republic,
Sierra Leone) with average life evaluation scores of 3.4.

 Bhutan, the tiny Himalayan nation tops Asia in the

report, depicting a new economic model based on
principles of happiness and well being

(Global GNH Survey)

 Principle #8: A Country’s Standard of Living Depends on Its
Ability to Produce Goods and Services.

• Almost all variations in living standards are

explained by differences in countries’
productivities.
• Productivity is the amount of goods and
services produced from each hour of a
worker’s time.
• To boost living standards : the workers are
well educated, have the tools (capital) to
produce, have access to technology
 Principle #9: Prices Rise When the
Government Prints Too Much Money.
• Inflation is an increase in the overall level of
prices in the economy.
• Germany : newspaper cost 0.3 marks (jan1921),
later 70.000.000 marks (nov 1921)
• One cause of inflation is the growth in the
quantity of money.
• When the government creates large quantities
of money, the value of the money falls.
 Principle #10: Society Faces a Short-run Trade-off between
Inflation and Unemployment.

 The Phillips Curve illustrates the trade-off between

inflation and unemployment
 as more people work - the national output increases -
wages increase - consumers have more money to
spend - consumers demanding more goods and
services - prices of goods and services to increase.
 The trade-off plays a key role in the analysis of the
business cycle—fluctuations in economic activity, such
as employment and production
 Policymakers can exploit the short-run tradeoff
between inflation and unemployment using various
policy instruments : monetary and fiscal policy
 2

THINKING LIKE AN ECONOMIST

© 2013 Cengage Learning

THE ROLE OF ASSUMPTIONS

• Economists use different assumptions to

answer different questions.
– Assumptions can simplify the complex world and
make it easier to understand.
• The art in scientific thinking is deciding which
assumptions to make.
 Economic Models
• Economists use models to simplify reality in
order to improve our understanding of the
world.
• Two of the most basic economic models are:
– The Circular Flow Diagram
– The Production Possibilities Frontier
 Our First Model: The Circular-Flow
Diagram
• The circular-flow diagram is a visual model of
the economy that shows how dollars flow
through markets among households and
firms.
 The Circular Flow
MARKETS
Revenue FOR Spending
GOODS AND SERVICES
•Firms sell Goods and
Goods
•Households buy services
and services
sold bought

FIRMS HOUSEHOLDS
•Produce and sell •Buy and consume
goods and services goods and services
•Hire and use factors •Own and sell factors
of production of production

Factors of MARKETS Labor, land,

production FOR and capital
FACTORS OF PRODUCTION
Wages, rent, •Households sell Income
and profit •Firms buy
= Flow of inputs
and outputs
= Flow of dollars
 Our Second Model: The Production
Possibilities Frontier
• The production possibilities frontier is a graph
that shows the combinations of output that
the economy can possibly produce given the
available factors of production and the
available production technology.
Our Second Model: The Production
Possibilities Frontier
 Our Second Model: The Production
Possibilities Frontier
• Concepts illustrated by the production
possibilities frontier
– Efficiency
– Trade-offs
– Opportunity cost
– Economic growth
Microeconomics and Macroeconomics
• Microeconomics focuses on the individual
parts of the economy.
– How households and firms make decisions and
how they interact in specific markets
• Macroeconomics looks at the economy as a
whole.
– Economy-wide phenomena, including inflation,
unemployment, and economic growth
Positive Versus Normative Analysis

?
• Are the following positive or normative
statements?
– An increase in the minimum wage will cause a
?
decrease in employment among the least-skilled.
– POSITIVE

– Higher federal budget deficits will cause interest

?
rates to increase.
– POSITIVE ?
Positive Versus Normative Analysis
• Are the following positive or normative
statements?
?
– The income gains from a higher minimum wage are worth

? more than any slight reductions in employment.

– NORMATIVE

– State governments should be allowed to collect from

tobacco companies the costs of treating smoking-related
illnesses among the poor.
– NORMATIVE ?