Mankiw: Brief Principles of Macroeconomics, Second Edition (Harcourt, 2001) Ch. 1: Ten Principles of Economics

Econ 202 Dr. Ugur Aker 2 What Is Economics? Economics tries to capture the rules of rational choice. If choice is to be made then there must be scarcity. –Examples of scarcity are limited income, limited resources, limited time… “So many books, so little time!” is an economic problem.

Econ 202 Dr. Ugur Aker 3 Ten Principles of Economics How People Make Decisions. –Principles 1-4. How People Interact. –Principles 5-7. How the Economy as a Whole Works. –Principles 8-10.

Econ 202 Dr. Ugur Aker 4 Principle #1: People Face Tradeoffs Choices usually require giving up something else. This is true for individual and community decisions. Sometimes tradeoffs involve a choice between fairness and more wealth (equity vs. efficiency).

Econ 202 Dr. Ugur Aker 5 Principle #2: Opportunity Cost The cost of something is not only the payment but also what one has to give up. Opportunity cost is the true cost of an action. Opportunity cost includes the hypothetical cost of sacrificing the best alternative.

Econ 202 Dr. Ugur Aker 6 Principle #3: Thinking at the Margin Improvement to one’s condition can usually take place by making marginal decisions. Marginal here means additional, extra. It is easier to identify and calculate the costs and benefits of an additional work/leisure. This is the source of the maximization rule: – Marginal benefit > Marginal cost => increase the activity. –Marginal benefit reduce the activity.

Econ 202 Dr. Ugur Aker 7 Principle #4: People Respond to Incentives When prices change, when new laws and regulations are put in practice, costs and benefits of actions also change forcing different actions and behavior. Unintended consequences of legislation may be more important because of the changed incentives.

Econ 202 Dr. Ugur Aker 8 Principle #4: Trade Can Make Everyone Better Off Self-sufficiency forces families, countries to use their resources to produce a number of goods and services that they are not suited for. The cost of those activities are very high. By concentrating on activities they are suited for and produce cheaply, they can increase the ability to obtain a higher amount of goods that are costly to produce. Trade also increases the variety of choice.

Econ 202 Dr. Ugur Aker 9 Principle #6: Markets Are Usually More Efficient Than Government Individual producers and individual consumers know the costs and benefits of their actions best. When prices are determined through the interaction of buyers and sellers, each price reflects the cost and benefit of the last unit produced and consumed.

Econ 202 Dr. Ugur Aker 10 Principle #7: Governments Can Sometimes Improve Markets Externalities lead to market failure. The allocation of resources becomes non-optimal. –Government (collective action) can improve the outcome. Market power (monopoly) also leads to market failure. Public goods may not be provided by the market unless governments intervene.

Econ 202 Dr. Ugur Aker 11 Principle #8: Standard of Living in A Country Depends on Productivity Productivity is the value of goods and services produced in an hour by average worker. Increasing the amount of labor, amount of capital or technology all increase the total amount of goods and services produced, raising the standard of living. Investment (increasing capital stock) and improving technology both increase productivity.

Econ 202 Dr. Ugur Aker 12 Principle #9: Inflation Is The Result of Fast Increase of Money An increase in the overall level of prices is called inflation. Growth in the money supply is the culprit for persistent inflation. Money is defined as any payment accepted in exchange for goods, services, assets. –In US it is currency outside the banks plus checking account deposits.

Econ 202 Dr. Ugur Aker 13 Principle #10: Only in the Short-run There Is a Trade-off Between Inflation and Unemployment Because prices may not adjust to upward pressure immediately, in the short-run, output may increase because of higher demand in the economy. Likewise, during high inflation, efforts to lower the total demand in the economy may first result in increasing unemployment and after a while, in reducing inflation.