N.

GREGORY MANKIW
PRINCIPLES OF
MICROECONOMICS
Eighth Edition

Basic Principles of Economics

&
Economic Way of Thinking
Premium PowerPoint Slides by:
V. Andreea CHIRITESCU
Eastern Illinois University

1
 Ten Principles of Economics
• Resources are scarce
• Scarcity: the limited nature of society’s
resources
– Society has limited resources
• Cannot produce all the goods and services
people wish to have
• Economics
– The study of how society manages its
scarce resources
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 Ten Principles of Economics
• Economist study:
– How people decide what to buy,
how much to work, save, and spend
– How firms decide how much to produce,
how many workers to hire
– How society decides how to divide its
resources between national defense,
consumer goods, protecting the
environment, and other needs

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 Principle 1: People Face Trade-offs
• To get something that we like, we “must”
give up something else that we also like
– Going to a party the night before an exam
• Less time for studying
– Having more money to buy stuff
• Working longer hours, less time for leisure
– Protecting the environment
• Resources could be used to produce
consumer goods

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 Principle 1: People Face Trade-offs
• Society faces trade-offs:
– The more it spends on national defense
(guns) to protect its shores
• The less it can spend on consumer goods
(butter) to raise the standard of living at home
– Pollution regulations: cleaner environment
and improved health
• But at the cost of reducing the incomes of the
firms’ owners, workers, and customers

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 Principle 1: People Face Trade-offs
• Efficiency: society gets the most from its
scarce resources
• Equality: prosperity is distributed uniformly
among society’s members
• Tradeoff:
– To achieve greater equality, could
redistribute income from wealthy to poor
– But this reduces incentive to work and
produce, shrinks the size of economic “pie”
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 Principle 2: The Cost of Something Is
What You Give Up to Get It
• Making decisions:
– Compare costs with benefits of
alternatives
– Need to include opportunity costs
• Opportunity cost
– Whatever must be given up to obtain
some item

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 Principle 2: The Cost of Something Is
What You Give Up to Get It
• The opportunity cost of:
– Going to college for a year
• Tuition, books, and fees
• PLUS foregone wages
– Going to the movies
• The price of the movie ticket
• PLUS the value of the time you spend in the
theater

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 Principle 3: Rational People Think at the
Margin
• Rational people
– Systematically and purposefully do the
best they can to achieve their objectives
– Given the available opportunities
– Make decisions by evaluating costs and
benefits of marginal changes
• Small incremental adjustments to a plan of
action

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 Principle 3: Rational People Think at the
Margin
• Examples:
– Cell phone users with unlimited minutes
(the minutes are free at the margin)
• Are often prone to making long/frivolous calls

– A manager considers whether to increase

output
• Compares the cost of the needed labor and
materials to the extra revenue

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 Principle 4: People Respond to Incentives

• Incentive
– Something that induces a person to act
• Examples:
– When gas prices rise, consumers buy
more hybrid cars and fewer gas guzzling
SUVs
– When cigarette taxes increase,
teen smoking falls

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 Active Learning 1
You are selling your 2007 BMW. You have
already spent $1,000 on repairs. At the last
minute, the transmission dies. You can pay
$900 to have it repaired, or sell the car “as is.”
In each of the following scenarios, should you
have the transmission repaired? Explain.
A. Blue book value (what you could get for the
car) is $7,500 if transmission works, $6,200 if it
doesn’t.
B. Blue book value is $6,300 if transmission
works, $5,500 if it doesn’t.
• ………………………………………………
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Active Learning 1 Answers
Cost of fixing the transmission = $900
A. Blue book value is $7,500 if transmission works,
$6,200 if it doesn’t
– Benefit of fixing transmission = $1,300
(= 7500 – 6200)
– Get the transmission fixed
B. Blue book value is $6,300 if transmission works,
$5,500 if it doesn’t
– Benefit of fixing the transmission = $800
(= 6300 – 5500)
– Do not pay $900 to fix it
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 Principle 5: Trade Can Make Everyone
Better Off
• People benefit from trade:
– People can buy a greater variety of goods
and services at lower cost
• Countries benefit from trade and
specialization
– Get a better price abroad for goods they
produce
– Buy other goods more cheaply from
abroad than could be produced at home
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 Principle 6: Markets Are Usually a Good
Way to Organize Economic Activity
• Market
– A group of buyers and sellers (need not to
be in a single location)
• “Organize economic activity” means
determining
– What goods and services to produce
– How much of each to produce
– Who produced and consumed these

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 Principle 6: Markets Are Usually a Good
Way to Organize Economic Activity
• A market economy allocates resources
– Decentralized decisions of many firms and
households – as they interact in markets
• Famous insight by Adam Smith in
The Wealth of Nations (1776):
– Each of these households and firms acts
as if “led by an invisible hand” to promote
general economic well-being

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 Principle 6: Markets Are Usually a Good
Way to Organize Economic Activity
• Prices:
– Determined: interaction of buyers and
sellers
– Reflect the good’s value to buyers
– Reflect the cost of producing the good
• Invisible hand:
– Prices guide self-interested households
and firms to make decisions that maximize
society’s economic well-being
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 Principle 7: Governments Can Sometimes
Improve Market Outcomes
• Government - enforce property rights
– Enforce rules and maintain institutions that
are key to a market economy
• People are less inclined to work, produce,
invest, or purchase if large risk of their
property being stolen

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 Principle 7: Governments Can Sometimes
Improve Market Outcomes
• Government - promote efficiency
– Avoid market failures: market left on its
own fails to allocate resources efficiently
– Externality – source of market failure
• Production or consumption of a good affects
bystanders (e.g. pollution)
– Market power – source of market failure
• A single buyer or seller has substantial
influence on market price (e.g. monopoly)

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 Principle 7: Governments Can Sometimes
Improve Market Outcomes
• Government - promote equality
– Avoid disparities in economic wellbeing
– Use tax or welfare policies to change how
the economic “pie” is divided

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 Active Learning 2
In each of the following situations, what is the
government’s role?
Does the government’s intervention improve
the outcome?
a. Workplace safety regulations
b. Public transportation
c. High tax on junk food

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

• Huge variation in living standards

– Across countries and over time
– Average income in rich countries
• Is more than ten times average income in
poor countries
– The U.S. standard of living today
• Is about eight times larger than 100 years ago

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

• Productivity: most important determinant

of living standards
– Quantity of goods and services produced
from each unit of labor input
– Depends on the equipment, skills, and
technology available to workers
• Other factors (e.g., labor unions, competition
from abroad) have far less impact on living
standards

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 Principle 9: Prices Rise When the
Government Prints Too Much Money
• Inflation
– An increase in the overall level of prices in
the economy
• In the long run
– Inflation is almost always caused by
excessive growth in the quantity of money,
which causes the value of money to fall
– The faster the government creates money,
the greater the inflation rate

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 Principle 10: Society Faces a Short-run Trade-
off between Inflation and Unemployment
• Short-run trade-off between
unemployment and inflation
– Over a period of a year or two, many
economic policies push inflation and
unemployment in opposite directions
– Other factors can make this tradeoff more
or less favorable, but the tradeoff is
always present

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 N. GREGORY MANKIW
PRINCIPLES OF

ECONOMICS
Eighth Edition

CHAPTER Thinking Like an

2 Economist
Premium PowerPoint Slides by:
V. Andreea CHIRITESCU
Eastern Illinois University
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as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning
26
management system for classroom use.
 The Economist as a Scientist
• Economists play two roles:
1. Scientists: try to explain the world
2. Policy advisors: try to improve it
• As scientists, economists employ the
scientific method
– Dispassionate development and testing of
theories about how the world works

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 The Economist as a Scientist
• Assumptions
– Simplify the complex world and make it
easier to understand
– Example: to study international trade,
assume two countries and two goods
• Economists use models to study
economic issues
– Highly simplified representation of
a more complicated reality
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 The Economist as a Scientist
• Examples of models:
– The model teeth at the dentist’s office
– A model of human anatomy from high
school biology class Don’t forget
to floss!
– A road map

©ittipon/Shutterstock.com

©wavebreakmedia/Shutterstock.com

©Accord/Shutterstock.com

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 The Economist as a Scientist
• Circular-flow diagram
– Visual model of the economy
– Shows how dollars flow through markets
among households and firms
• Two decision makers
– Firms and Households
• Interacting in two markets
– Market for goods and services
– Market for factors of production (inputs)
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Figure 1 The circular flow
Households:
▪ Own the factors of production,
sell/rent them to firms for income
▪ Buy and consume goods & services

Households
Firms

Firms:
▪ Buy/hire factors of production,
use them to produce goods and
services
▪ Sell goods & services

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Figure 1 The circular flow

Revenue Spending
Markets for
G&S Goods &
G&S
sold Services bought

Firms Households

Factors of Labor, land,

production Markets for capital
Factors of
Wages, rent, Production Income
profit
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 The PPF
• Production possibilities frontier
– A graph: combinations of output that the
economy can possibly produce
– Given the available
• Factors of production and technology
– Example:
• Two goods: computers and wheat
• One resource: labor (measured in hours)
• Economy has 50,000 labor hours per month
available for production
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PPF Example
Producing one computer requires 100 hours labor.
Producing one ton of wheat requires 10 hours labor.
Employment of
Production
labor hours
Computers Wheat Computers Wheat
A 50,000 0 500 0
B 40,000 10,000 400 1,000
C 25,000 25,000 250 2,500
D 10,000 40,000 100 4,000
E 0 50,000 0 5,000

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 PPF Example
Wheat
Point Production (tons)
on Com- 6,000
graph puters Wheat E
5,000
A 500 0 D
4,000
B 400 1,000
3,000 C
C 250 2,500
2,000
D 100 4,000 B
1,000
E 0 5,000 A
0
0 100 200 300 400 500 600
Computers

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as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning 35
Active Learning 1 Points off the PPF
On the graph above, find the point that
represents (100 computers, 3000 tons of
wheat), label it F.
– Would it be possible for the economy to
produce this combination of the two goods?
Why or why not?
Next, find the point that represents (300
computers, 3500 tons of wheat), label it G.
– Would it be possible for the economy to
produce this combination of the two goods?
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Active Learning 1 Answers
• Point F: 100 Wheat
computers, 3000 (tons)
tons wheat 6,000
• Requires 40,000 5,000
hours of labor 4,000
• Possible but not 3,000
F
efficient: could
2,000
get more
1,000
of either good
without 0
0 100 200 300 400 500 600
sacrificing any of
the other Computers

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Active Learning 1 Answers
• Point G: 300 Wheat
computers, 3500 (tons)
tons wheat 6,000
• Requires 65,000 5,000
hours of labor. 4,000
G
• Not possible 3,000
because the
2,000
economy only
has 50,000 1,000
hours 0
0 100 200 300 400 500 600
Computers

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 The PPF: What We Know So Far
• Points on the PPF (like A – E): possible
– Efficient: all resources are fully utilized
• Points under the PPF (like F): possible
– Not efficient: some resources are
underutilized (e.g., workers unemployed,
factories idle)
• Points above the PPF (like G)
– Not possible

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 The PPF
• Moving along a PPF
– Involves shifting resources from the
production of one good to the other
• Society faces a tradeoff
– Getting more of one good requires
sacrificing some of the other
• The slope of the PPF
– The opportunity cost of one good in terms
of the other
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Economic Growth and the PPF
With additional Wheat
resources or an (tons)
Economic
improvement in 6,000
growth shifts
technology, 5,000 the PPF
the economy can 4,000 outward.
produce more 3,000
computers,
2,000

more wheat, 1,000

0
0 100 200 300 400 500 600
or any combination in
between. Computers

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 The Shape of the PPF
• Shape of the PPF
– Straight line: constant opportunity cost
• Previous example: the opportunity cost of 1
computer is 10 tons of wheat
– Bowed outward: increasing opportunity
cost
• As more units of a good are produced, we
need to give up increasing amounts of the
other good produced

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as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning 42
management system for classroom use.
 Why the PPF Might Be Bowed Outward

• The PPF is bowed outward

when:
– Different workers have different skills
– Different opportunity costs of producing
one good in terms of the other
– There is some other resource, or mix of
resources with varying opportunity costs
• E.g., different types of land suited for different
uses

43
 The Economist as a Scientist

Microeconomics
• The study of how households and
firms make decisions and how they
interact in markets
Macroeconomics
• The study of economy-wide
phenomena, including inflation,
unemployment, and economic growth
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 The Economist as Policy Adviser
• Positive statements: descriptive
– Attempt to describe the world as it is
– Confirm or refute by examining evidence:
“Minimum-wage laws cause
unemployment”
• Normative statements: prescriptive
– Attempt to prescribe how the world should
be: “The government should raise the
minimum wage”
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Active Learning 3 Positive vs. Normative
Which of these statements are “positive” and
which are “normative”? How can you tell the
difference?
a. Prices rise when the government increases the
quantity of money.
b. The government should print less money.
c. A tax cut is needed to stimulate the economy.
d. An increase in the price of burritos will cause an
increase in consumer demand for music
downloads.

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 Active Learning 3 Answers
a. Prices rise when the government increases
the quantity of money.
Positive – describes a relationship, could use
data to confirm or refute.

b. The government should print less money.

Normative – this is a value judgment, cannot be
confirmed or refuted.

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as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning 47
management system for classroom use.
 Active Learning 3 Answers
c. A tax cut is needed to stimulate the
economy.
Normative – another value judgment.

d. An increase in the price of burritos will cause

an increase in consumer demand for music
downloads
Positive – describes a relationship.

Note that a statement need not be true to be positive.

© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use
as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning 48
management system for classroom use.
"The key is in not spending time, but in
investing it." -- Stephen R. Covey

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