LEC # 2 Ten Principles of Economics. (Mankiw Chapter No. 1)

Ten principles of Economics
Lecture # 2
(Chapter No. 1 of N. GREGORY MANKIW)
Faculty of Social Sciences
Department of Politics and International Relations
Subject: Introduction to Economics (PS 1833)
BS IR Fall 2022
Ten Principles of Economics
 At first glance, this might look peculiar. But in reality, there are many
similarities between households and economies.
 Household decide.. which household members do which tasks and

what each member receives in return.
 A household must allocate its scarce resources (time, car milage etc)
among its various members. (Cooking dinner, Laundry, driving etc.)
 Taking into account each member’s abilities, efforts, and desires.
 Similarly, society also faces many decisions. (growing food, cloth

making, designing computer software's etc.)
 The management of society’s resources is important because resources

are scarce.
 Scarcity is the limited nature of society’s resources.
 Economics is the study of how society manages its scarce resources.
 In most societies, resources are allocated not by an all-powerful dictator.
 But through the combined choices of millions of households and firms.

 Economists, therefore, study how people make decisions: how much
they work, what they buy, how much they save and how they invest
their savings.
 Economist also study how people interact with one another.
 Finally, economist analyze forces and trends that affect the economy as
a whole, growth, inflation, and unemployment.
 The study of economics has many facets, but it is unified by several

central ideas.
 In this chapter, we look at Ten Principles of Economics.

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 margin.
4. People respond to incentives.
How People Interact
5. Trade can make every one better off.
6. Market are usually a good way to organize economic activity.
7. Government can sometimes improve market outcomes.
How the economy as a whole works
8. A country’s standard of living depends on its ability to produce goods and
services.
9. Price rise when the government prints too much money.
10. Society faces a short-run trade-off between inflation and unemployment.
1. How People Make Decisions
 An economy is just a group of people dealing with one another as they

go about their lives.
 The behavior of an economy reflects the behavior of the individuals

who makeup the economy.
Principle 1: People Face Trade-offs
 An old saying “ There isn't no such thing as a free lunch”.
 To get something that we like, we usually have to give up something

else that we also like.
Principle 1: People Face Trade-offs
 To make a decision, we must trade off one goal against another.
 The student must decide how to allocate his most valuable resource, time.
 Consider parents deciding how to spend their family income.
 One classic trade-off is between “guns and butter.”
 Another trade-off society faces is between efficiency and equality.
 Efficiency means the society is getting the maximum benefits from its scarce
resources.
 Equality means that those benefits are distributed equally among society’s
members.
 Recognizing that people face trade-offs does not by it self tell us what decisions
they will or should make.
 However, people are like to make good decisions only if they understand the
options that are available to them.
 The study of economics therefore, starts by acknowledging life’s trade off.

Principle 2: The Cost of Something is What you Give Up to Get It
 Making decision requires comparing the costs and benefits of alternative

courses of action.
 Benefits and costs for a student to go to college.
 Main benefits are intellectual enrichment and a lifetime of better job

opportunities. But what are the costs?
 The Opportunity cost of an item is what you give up to get that item.
 Decision makers should be aware of the opportunity cost that accompany
each possible action.
 Opportunity cost of a college athletes.
Principle 3: Rational People Think at the Margin
 Rational people systematically and purposefully do the best they can to

achieve their objectives.
 Marginal change is a small incremental adjustment to a plan of action.
 Rational people often make decisions by comparing marginal benefits

and marginal costs.
 For example you are considering calling a friend on your cell phone.
 A rational decision maker takes an action if and only if M.B > M.C.
Principle 4: People Respond to Incentives
 An incentive is something that induces a person to act.
 Incentives are critical to analyzing how markets work.
 The influence of prices on the behavior of consumers and producers is

important for how a market economy allocate scarce resources.
 Public policy makers should never forget about incentives: Many policies
changes costs or benefits that people face and as a result, change their
behavior.
2. How People Interact

 Many of our decisions affect not only ourselves but other people as well.
 The next three principles concern how people interact with one another.
Principle 5: Trade Can Make Everyone Better Off
 Trade competition is distinct from a sporting event where one team wins
and another loses.
 Trade between two nations can make both better off.
 Consider how trade affects your family.

 Trade allows each person to specialize in the activities he does best.
 Trade allows countries to specialize in what they do best and to enjoy a

greater variety of goods and services.
Principle 6: Markets are Usually a Good way to Organize Economic Activity
 The centrally planned economies operate on the theory that government

officials were in best position to allocate the economy’s scarce resources.
 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.
 In a market economy, the prices and self-interest guide their decisions.
 Adam Smith most famous observation: Households and firms interacting in

markets acts as if they are guided by an “invisible hand” that leads them to
desirable market outcomes.
 Prices are the instrument with which the invisible hand directs economic
activity.
 Buyers demands and sellers supplies depend on the prices that exist in the
market.
 Market prices are determined by the decisions made by buyers and sellers,
reflecting both the value of a good to society and the cost of its production.
Principle7: Goverments can sometimes Improve Market Outcomes
 If the invisible hand of the market is so great, why do we need government?
 One reason for government intervention is to enforce the rules and

maintains the institution that are key to market economy.
 Most important, economies need institutions to enforce property rights.

 Property rights is the ability of an individual to own and exercise control
over scarce resources.
 Farmers, Restaurants and Entertainment company
 Government provided police and courts to enforce our rights over the things
we produce.
 Another two broad reasons for a government to intervene is to promote

efficiency or to promote equality.
 Policies aim either to enlarge economic pie or to change how the pie is divided.
 Market failure is a situation in which a market left on its own fails to allocate
resources efficiently.
 One possible cause of market failure is externality, which is the impact of one
person’s actions on the well-being of a bystander. (e.g. Pollution)
 Another possible cause is market power, which refers to the ability of a single
economic actor to have substantial influence on market price. (Tube well)
 A market economy rewards people according to their ability to produce things

that other people are willing to pay for.
 The invisible hand does not ensure that every one has sufficient food, decent
clothing, and adequate health care.
 This inequality may, depending on one’s political philosophy, call for

government intervention.
 Public policies is not made by angels but by a political process that is far from
perfect.
 Sometimes it is designed to reward the politically powerful, some times by well
intentioned leaders who are not fully informed.
3. How the Economy as a Whole Works
 All the decisions and interactions together make up “the economy”.
 The last three principles concern the workings of the economy as a whole.
Principle 8: A Country’s Standard of Living Depends on it’s Ability to
Produce Goods and Services
 There is too much difference in living standards around the world.
 Citizens of high-income countries have more better healthcare, and a longer

life expectancy than citizens of low-income countries.
 What explains these large differences in living standards among countries and
over time?
 All variation in living standards is attributable to differences in countries

productivity.
 Productivity is the quantity of goods and services produced from each unit of
labour input.
 Nations with higher productive workers can produce a large quantity of goods
and services per hour, most people enjoy a high standard of living.
 Similarly, the growth rate of a nation’s productivity determines the growth rate
of its average income.
Principle 9: Prices Rise When the Government Prints too Much Money
 The daily newspaper in Germany increased in price from 0.30 marks in

January 1921 to 70,000,000 marks in November 1922.
 Inflation is an increase in the overall level of prices in the economy.
 President Gerald Ford called inflation “Public enemy number one.”
 High inflation impose various costs on society, keeping inflation a low level
is a goal of economic policy makers.
 The large or persistent inflation is associated with rapid growth in the

quantity of money.
Principle 10: Society Faces a Short-Run Trade-off between Inflation
and Unemployment
 Inflation, in the long run, is mainly due to an increase in the quantity of

money.
 Most economist describe the short run effects of monetary injection as

follows:
o Increasing the amount of money in the economy increases the overall
level of spending and thus the demand for goods and services.
o Higher demand may over time cause firms to raise their prices, but in the
meantime, it also encourages them to hire more workers and produce a
larger quantity of goods and services.
o More hiring means lower unemployment.
 A short run trade-off between inflation and unemployment.
 Business cycle is the irregular and largely unpredictable fluctuations in

economic activity.
 It is measured by the production of goods and services or the number of

people employed.
 Fiscal policy tools are government expenditure and taxes.
 Monetary policy instruments are printing money and interest rate.
 2008-09 financial crisis (starts from real estate> spilled rest of the economy >
causing incomes to fall and unemployment to rise). Fiscal and monetary
Thank You

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Ten principles of Economics

 Household decide.. which household members do which tasks and

 Taking into account each member’s abilities, efforts, and desires.

 Similarly, society also faces many decisions. (growing food, cloth

 The management of society’s resources is important because resources

 Scarcity is the limited nature of society’s resources.

 Economics is the study of how society manages its scarce resources.

 In most societies, resources are allocated not by an all-powerful dictator.

 But through the combined choices of millions of households and firms.

 Economist also study how people interact with one another.

 The study of economics has many facets, but it is unified by several

 In this chapter, we look at Ten Principles of Economics.

 An economy is just a group of people dealing with one another as they

 The behavior of an economy reflects the behavior of the individuals

Principle 1: People Face Trade-offs

 An old saying “ There isn't no such thing as a free lunch”.

 To get something that we like, we usually have to give up something

Principle 1: People Face Trade-offs

 To make a decision, we must trade off one goal against another.

 Consider parents deciding how to spend their family income.

 One classic trade-off is between “guns and butter.”

 Another trade-off society faces is between efficiency and equality.

 The study of economics therefore, starts by acknowledging life’s trade off.

 Making decision requires comparing the costs and benefits of alternative

 Benefits and costs for a student to go to college.

 Main benefits are intellectual enrichment and a lifetime of better job

Principle 3: Rational People Think at the Margin

 Rational people systematically and purposefully do the best they can to

 Marginal change is a small incremental adjustment to a plan of action.

 Rational people often make decisions by comparing marginal benefits

Principle 4: People Respond to Incentives

 An incentive is something that induces a person to act.

 Incentives are critical to analyzing how markets work.

 The influence of prices on the behavior of consumers and producers is

2. How People Interact

Principle 5: Trade Can Make Everyone Better Off

 Trade between two nations can make both better off.

 Consider how trade affects your family.

 Trade allows each person to specialize in the activities he does best.

 Trade allows countries to specialize in what they do best and to enjoy a

Principle 6: Markets are Usually a Good way to Organize Economic Activity

 The centrally planned economies operate on the theory that government

 Market economy is an economy that allocates resources through the

 In a market economy, the prices and self-interest guide their decisions.

 Adam Smith most famous observation: Households and firms interacting in

Principle7: Goverments can sometimes Improve Market Outcomes

 If the invisible hand of the market is so great, why do we need government?

 One reason for government intervention is to enforce the rules and

 Most important, economies need institutions to enforce property rights.

 Another two broad reasons for a government to intervene is to promote

 A market economy rewards people according to their ability to produce things

 This inequality may, depending on one’s political philosophy, call for

 There is too much difference in living standards around the world.

 Citizens of high-income countries have more better healthcare, and a longer

 All variation in living standards is attributable to differences in countries

 The daily newspaper in Germany increased in price from 0.30 marks in

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

 President Gerald Ford called inflation “Public enemy number one.”

 The large or persistent inflation is associated with rapid growth in the

 Inflation, in the long run, is mainly due to an increase in the quantity of

 Most economist describe the short run effects of monetary injection as

 A short run trade-off between inflation and unemployment.