Lecture Notes: Econ 203 Introductory Microeconomics Lecture/Chapter 1: 10 Economic Principles M. Cary Leahey Manhattan College Fall 2012

The nature of economics; what is economics all about Allocation of scarce resources Households; decisions to work, save and spend Firms: produce, hire/fire, and distribute those goods Society: dividing those resources

Principle 1: Tradeoffs Guns versus butter Equity versus efficiency

Principle 2: Opportunity costs What you give up to get Relevant “cost” of decisionmaking

Principle 3: Rational thinking is at the margin Rational people go the best they can with what they have Make incremental “marginal” decisions to existing plans “Marginal” returns outweigh the “marginal” costs

Principle 4: Incentives Rational people respond to incentives Internalize the externalities Incentives don’t always work according to plan (Mankiw’s seat belt example)

Principle 5: Trade Can Benefit All Self-sufficiency has its limits Absolute versus comparative advantage Winners pay off the losers

Principle 6: Markets work best Market, a group of buyers and sellers Organized activity in markets: what/how/how much/who gets Market economy, decentralized decisions of households and firms Reliance on price mechanism Smith’s invisible hand Markets better at production than distribution Private wealth/public squalor

Principle 7: Market problems/failure: the role for govt. Externalities/market power/market failure open role for government Govt. can: Enforce property rights (Chicago dictum) Govt. Can: Promote efficiency/distribute the pie “better” Internalize the externality

Principle 8: Standard of living is material well being Well being can be measured by GDP Wide variation in living standards across time and countries Standard of living depends on productivity-capital, labor, skills, and organization

Principle 9: Inflation is a monetary phenomenon Relative versus absolute prices Changes in relative prices (beef/chicken) Changes in absolute prices (inflation) Change in the change (change in inflation) Money/inflation link works with 10-year averages (Friedman)

Principle 10: Output inflation tradeoff In short-run, output (unemployment) and inflation can move in opposite directions—a tradeoff (the case for Keynesian “fine tuning”) In long-run, there is no tradeoff at full employment (the divine coincident according to Blanchard)