“Ten 

Principles” of Economics: 
Intro
One Approach to Some of the Core 
Concepts in Economic Analysis

Ten Principles of Economics
Summary

Ten Principles of Economics
Summary

1
 Principle 1: People Face Trade‐Offs it is aka opportunity cost, which is more
• Fundamental Problem of Economics preffered alternative. a tradeoff involves a
• Scarcity Exists
– Limits sacrifice that must be made to get a certain
– Constraints
• Decisions Must be Made
Must be Made
product or exp. a person may give up gud"B" to
• London School of Economics Student, and 

– Choices
geriatric rocker, Mick Jagger
becauz they want to buy gud"A".
– Trade Offs  • “I can’t get no… 
…satisfaction…”
• Goods & Services • “You can’t always get what 
– Provide Satisfaction you want….”
• “But if you try sometimes 
– “Utility” …you just might find… you 
get what you need”
• Do It Right
– It Can Work Out OK

Principle 1: People Face Trade‐Offs
• Economics is Study of:
– Procedures & Institutions
– Answering Basic Questions
• WHAT ?
WHAT ?
• HOW ?
• FOR WHOM ?
• That is:
– Dealing with Scarcity
– Making Choices 

Principle 2: The Cost of Something is 
What You Give Up to Get It
• The Difficult Part of Trade‐Offs 
• Opportunity Cost
– A Reflection of Trade Offs
– A Measure of Costs
A Measure of Costs
– Cost of What is Given Up…Next Best Alternative
• Cost of EMBA?
– Family
– Work
– Leisure
– Sanity

2
 Principle 3: 
Rational People Think at the Margin
• Rational People: 
– Systematic & Purposeful Behavior
– Do the Best They Can to Achieve Objectives
• “Decision Making at the Margin”
“D i i M ki t th M i ”
– Small Adjustments to a Plan of Action 
– Marginal = Extra;  Additional;  Incremental
– Evaluate Marginal Benefits vs. Marginal Costs
• Rational Decision Maker = Take Action Only If:
– Marginal Benefits > Marginal Costs

Principle 3: 
Rational People Think at the Margin
• General Approach in Econ:
– Who is Decision Maker?
– What Does He/She Give Up & Get?
• Cash vs NonCash
Cash vs. NonCash
• Psychic Benefits/Costs
• Observing “Irrational” Behavior?
– Check Individual Level Incentive (MB vs. MC)
– Consider Informational or Other Limitations
– Acknowledge Quirks of Individual Human Behavior

Principle 4: People Respond to Incentives
• Market Signals  Price Signals
– Price Matters; Price Increase Means:
– Buyers ‐ Consume Less
– Sellers ‐ Produce More
• Public Policy 
y Affect Marg. Benefits/Costs
g /
– Gasoline/Carbon Tax; Cigarette Tax
– Fuel Efficiency Standards
– Mortgage & Business Interest Deductibility
– Tax Credits & Subsidies
• Aside: Unintended Consequences
– Failure to Consider How Policies Affect Incentives
– Second Round of Responses

3
 Principle 5: 
Trade Can Make Everyone Better Off 
• “Mutual Gains from Exchange”
• Trade: Voluntary Exchange  Mutual Benefits
– Marginal Benefits > Marginal Costs: Agree
– Marginal Benefits < Marginal Costs: Refuse
i l fi i lC f
• Exchange Among Individuals, Groups, Countries
– Specialization: Focus on What Each Does “Best”
– Total Productivity Increases: More Available
– Net Gains (Increases) Split Among Participants

Principle 6: Markets Usually a Good 
Way to Organize Economic Activity
• Market Economy Organization:
– Decentralized: Diffuse Bits of Information
– Individual Decision Makers: Firms/ Households
• General Procedures:
– Interaction in Markets Produces Market Signals
– Self Interested Behavior in Response to Prices
– Competition Constrains Self Interested Behavior 
• Outcome: 
– Resources Allocated Efficiently
– Marginal Benefits Matched Against Marginal Costs
– Adam Smith’s “Invisible Hand”

Principle 7: Governments Can 
Sometimes Improve Market Outcomes
• What is The Proper Role of Government?
• Set & Maintain Ground Rules 
– Establish Laws/Courts; Specify Property Rights
• Be A Buyer or Provider of Goods
Be A Buyer or Provider of Goods
– Private Goods
– Public Goods
• Fix "Market Failures"
– Lack of Competition
– "Externalities" or "3rd Party Effects“
– Alter Resource Allocation; Improve Efficiency

4
 Principle 7: Governments Can 
Sometimes Improve Market Outcomes
• Some Roles More Controversial
• Redistribution of Income?
– Improve “Equity” or “Fairness”
• Promote Economic Stability?
– Dampen Business Cycle
– Promote Price Stability & “Full” Employment

Principle 8: Standard of Living Depends 
on Ability to Produce Goods & Services
• Large differences in living standards
– Among countries
– Over time
• Explanation: Differences in Productivity
Explanation: Differences in Productivity
• Higher Productivity = Higher Standard of Living
• Growth Rate of Nation’s Productivity 
• Determines Growth Rate of Its Average Income
• Productivity
– Quantity of Goods & Services Produced from Each 
Unit of Labor Input

Principle 9: Prices Rise When the 
Government Prints Too Much Money
• Link Between Money Supply & Inflation
• Inflation: Broad Based Price Increases
– Rise in: “General Price Level” ‐ “Overall Price Level”
• Inflation: Decline in Value of Money
Inflation: Decline in Value of Money
– Purchasing Power of Money Falls
– “Money Doesn’t Buy What it Used to”
• Must be Connection Between:
– Inflation (Decline in Value of Money)
– Money Supply (Amount Available)
– Money Demand 

5
 Principle 9: Prices Rise When the 
Government Prints Too Much Money
• Milton Friedman‐‐Famous “Monetarist”
– “Inflation is always & everywhere a monetary 
phenomenon.”
– Inflation is “Too Much Money… Chasing Too Few 
Goods ”
Goods.
• Logic: 
– Money Exchanged for Goods
– How Much Money Does It Take:
• Given An Amount of Goods
• People Offer Money for Goods
• More Money Available  More Offered
• Prices Bid Up

Principle 10: The Short‐Run Trade‐Off 
Between Inflation & Unemployment
• The “Phillips Curve”
• Short‐Run Effects of Monetary Injections:
– More in Peoples’ Hands  More Spending
– Higher Demand for Goods & Services
– Firms Hire More; Produce More; Raise Prices
Firms Hire More Produce More Raise Prices
• Short‐Run Trade‐Off: 
– Hiring Increases  Unemployment Falls
– Prices Rise  Inflation Increases
• A Concern: Only a Temporary Effect?
– Depends on Expectations
– Eventually Everyone Comes to Anticipate
– Tends to Neutralize Effect

Ten Principles of Economics: Summary
Mostly Micro

Scarcity Exists 

Opportunity Cost

MB = MC

Laws of Supply/Demand
pp y/

Mutual Gains from Exchange
“Nice Outcome”
Constrained Self Interest
“Market Failures” 

Production  Goods  Satisfaction/Utility