Principles 9/13/2010
CHAPTER
1
Ten of Economics
Macroeonomics
N. Gregory Mankiw
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2009 South-Western, a part of Cengage Learning, all rights reserved
PRINCIPLES OF
What Economics Is All About
Scarcity: the limited nature of societys resources Economics: the study of how society manages its scarce resources, e.g. 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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The principles of HOW HOW PEOPLE MAKE DECISIONS
HOW PEOPLE MAKE DECISIONS
Principle #1: People Face Tradeoffs
All decisions involve tradeoffs. Examples:
Going to a party the night before your midterm leaves less time for studying. Having more money to buy stuff requires working longer hours, which leaves less time for leisure. Protecting the environment requires resources that could otherwise be used to produce consumer goods.
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HOW PEOPLE MAKE DECISIONS
Principle #1: People Face Tradeoffs
Society faces an important tradeoff: efficiency vs. equality Efficiency: when society gets the most from its scarce resources Equality: when prosperity is distributed uniformly among societys 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 the economic pie.
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HOW PEOPLE MAKE DECISIONS
Principle #2: The Cost of Something Is What You Give Up to Get It
Making decisions requires comparing the costs and benefits of alternative choices. The opportunity cost of any item is whatever must be given up to obtain it. It is the relevant cost for decision making.
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HOW PEOPLE MAKE DECISIONS
Principle #2: The Cost of Something Is What You Give Up to Get It
Examples: The opportunity cost of
going to college for a year is not just the tuition, books, and fees, but also the foregone wages. seeing a movie is not just the price of the ticket, but 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. make decisions by evaluating costs and benefits of marginal changes incremental adjustments to an existing plan.
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HOW PEOPLE MAKE DECISIONS
Principle #3: Rational People Think at the Margin
Examples: When a student considers whether to go to college for an additional year, he compares the fees & foregone wages to the extra income he could earn with the extra year of education. When a manager considers whether to increase output, she 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, i.e. the prospect of a reward or punishment. Rational people respond to incentives. 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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The principles of HOW HOW PEOPLE INTERACT
HOW PEOPLE INTERACT
Principle #5: Trade Can Make Everyone Better Off
Rather than being self-sufficient, people can specialize in producing one good or service and exchange it for other goods. Countries also benefit from trade & 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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HOW PEOPLE INTERACT
Principle #6: Markets Are A Usually 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 to produce how to produce them how much of each to produce who gets them
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HOW PEOPLE INTERACT
Principle #6: Markets Are Usually A Good Way to Organize Economic Activity
A market economy allocates resources through the decentralized decisions of many households and firms 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
The invisible hand works through the price system: The interaction of buyers and sellers determines prices. Each price reflects the goods value to buyers and the cost of producing the good. Prices guide self-interested households and firms to make decisions that, in many cases, maximize societys economic well-being.
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Principle #7: Governments Can Sometimes Improve Market Outcomes
Important role for govt: enforce property rights (with police, courts) 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
Market failure: when the market fails to allocate societys resources efficiently Causes:
Externalities, when the production or consumption of a good affects bystanders (e.g. pollution) Market power, a single buyer or seller has substantial influence on market price (e.g. monopoly)
In such cases, public policy may promote efficiency.
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HOW PEOPLE INTERACT
Principle #7: Governments Can Sometimes Improve Market Outcomes
Govt may alter market outcome to promote equity If the markets distribution of economic well-being is not desirable, tax or welfare policies can change how the economic pie is divided.
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The principles of HOW HOW THE ECONOMY AS A WHOLE WORKS
HOW THE ECONOMY AS A WHOLE WORKS
Principle #8: A countrys standard of living depends on its ability to produce goods & 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: A countrys standard of living depends on its ability to produce goods & services.
The most important determinant of living standards: productivity, the amount of goods and services produced per unit of labor. Productivity 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: increases in the general level of prices. 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 govt creates money, the greater the inflation rate.
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Principle #10: Society faces a short-run tradeoff between inflation and unemployment
In the short-run (1 2 years), 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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