N.

GREGORY
MANKIW
PRINCIPLES OF
MICROECONOMICS
Eight Edition

CHAPTE
R
Ten Principles of
Economics
1 Premium PowerPoint Slides by:
V. Andreea CHIRITESCU
Eastern Illinois University

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Look for the answers to these questions:
• What kinds of questions does economics
address?
• What are the principles of how people
make decisions?
• What are the principles of how people
interact?
• What are the principles of how the
economy as a whole works?

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 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
• Economists 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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 How People Make Decisions

Principle 1: People face trade-offs

Principle 2: The cost of something is what
you give up to get it
Principle 3: Rational people think at the
margin
Principle 4: People respond to incentives

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 Principle 1: People Face Trade-offs
• To get something that we like, we have to
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
• Marginal benefit of the call > 0
– 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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 How People Interact

Principle 5: Trade can make everyone

better off
Principle 6: Markets are usually a good way
to organize economic activity
Principle 7: Governments can sometimes
improve market outcomes

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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
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
http://www.youtube.com/watch?v=4ERbC7JyCfU

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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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 How the economy as a whole works

Principle 8: A country’s standard of living

depends on its ability to produce goods and
services
Principle 9: Prices rise when the
government prints too much money
Principle 10: Society faces a short-run
trade-off between inflation and
unemployment
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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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