N.

Gregory Mankiw In this chapter,

look for the answers to these questions:

Economics
Principles of
What kinds of questions does economics
Sixth Edition
address?
What are the principles of how people make
decisions?
1 What are the principles of how people interact?
What are the principles of how the economy as
Ten Principles of a whole works?
Premium
Economics PowerPoint
Slides by
Ron Cronovich
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What Economics Is All About The principles of

Scarcity: the limited nature of societys HOW PEOPLE
resources MAKE DECISIONS
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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PRINCIPLE #1: PRINCIPLE #1:

People Face Tradeoffs People Face Tradeoffs
All decisions involve tradeoffs. Examples: Society faces an important tradeoff:
Going to a party the night before your midterm efficiency vs. equality
leaves less time for studying. Efficiency: when society gets the most from its
Having more money to buy stuff requires scarce resources
working longer hours, which leaves less time Equality: when prosperity is distributed
for leisure. uniformly among societys members
Protecting the environment requires resources Tradeoff: To achieve greater equality,
that could otherwise be used to produce could redistribute income from wealthy to poor.
consumer goods. But this reduces incentive to work and produce,
shrinks the size of the economic pie.
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 PRINCIPLE #2: PRINCIPLE #2:
The Cost of Something Is The Cost of Something Is
What You Give Up to Get It What You Give Up to Get It
Making decisions requires comparing the costs Examples:
and benefits of alternative choices. The opportunity cost of
The opportunity cost of any item is going to college for a year is not just the tuition,
whatever must be given up to obtain it. books, and fees, but also the foregone wages.

It is the relevant cost for decision making. 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: PRINCIPLE #3:

Rational People Think at the Margin Rational People Think at the Margin
Rational people Examples:
systematically and purposefully do the best they When a student considers whether to go to
can to achieve their objectives. college for an additional year, he compares the
make decisions by evaluating costs and benefits fees & foregone wages to the extra income
of marginal changes, incremental adjustments he could earn with the extra year of education.
to an existing plan. 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: ACTIVE LEARNING 1

People Respond to Incentives Applying the principles
Incentive: something that induces a person to You are selling your 1996 Mustang. You have already
act, i.e. the prospect of a reward or punishment. spent $1000 on repairs.
Rational people respond to incentives. At the last minute, the transmission dies. You can
Examples: pay $600 to have it repaired, or sell the car as is.
When gas prices rise, consumers buy more In each of the following scenarios, should you have
hybrid cars and fewer gas guzzling SUVs. the transmission repaired? Explain.
When cigarette taxes increase, A. Blue book value (what you could get for the car) is
teen smoking falls. $6500 if transmission works, $5700 if it doesnt
B. Blue book value is $6000 if transmission works,
$5500 if it doesnt

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 ACTIVE LEARNING 1 ACTIVE LEARNING 1
Answers Observations
Cost of fixing transmission = $600 The $1000 you previously spent on repairs is
A. Blue book value is $6500 if transmission works, irrelevant. What matters is the cost and benefit
$5700 if it doesnt of the marginal repair (the transmission).
Benefit of fixing the transmission = $800 The change in incentives from scenario A
($6500 5700). to scenario B caused your decision to change.
Its worthwhile to have the transmission fixed.
B. Blue book value is $6000 if transmission works,
$5500 if it doesnt
Benefit of fixing the transmission is only $500.
Paying $600 to fix transmission is not worthwhile.
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PRINCIPLE #5:
The principles of Trade Can Make Everyone Better Off
HOW PEOPLE Rather than being self-sufficient,
INTERACT people can specialize in producing one good or
service and exchange it for other goods.
Countries also 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: PRINCIPLE #6:

Markets Are Usually A Good Way to Markets Are Usually A Good Way to
Organize Economic Activity Organize Economic Activity
Market: a group of buyers and sellers A market economy allocates resources through
(need not be in a single location) the decentralized decisions of many households
and firms as they interact in markets.
Organize economic activity means determining
what goods to produce Famous insight by Adam Smith in
The Wealth of Nations (1776):
how to produce them
Each of these households and firms
how much of each to produce
acts as if led by an invisible hand
who gets them to promote general economic well-being.

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 PRINCIPLE #6: PRINCIPLE #7:
Markets Are Usually A Good Way to Governments Can Sometimes
Organize Economic Activity Improve Market Outcomes
The invisible hand works through the price Important role for govt: enforce property rights
system: (with police, courts)
The interaction of buyers and sellers People are less inclined to work, produce,
determines prices. invest, or purchase if large risk of their property
Each price reflects the goods value to buyers being stolen.
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: PRINCIPLE #7:

Governments Can Sometimes Governments Can Sometimes
Improve Market Outcomes Improve Market Outcomes
Market failure: when the market fails to allocate Govt may alter market outcome to
societys resources efficiently promote equity.
Causes of market failure: If the markets distribution of economic well-being
Externalities, when the production or consumption is not desirable, tax or welfare policies can
of a good affects bystanders (e.g. pollution) change how the economic pie is divided.
Market power, a single buyer or seller has
substantial influence on market price
(e.g. monopoly)
Public policy may promote efficiency.
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ACTIVE LEARNING 2 The principles of

Discussion Question
HOW THE
In each of the following situations, what is the
governments role? Does the governments
ECONOMY
intervention improve the outcome? AS A WHOLE
a. Public schools for K-12 WORKS
b. Workplace safety regulations
c. Public highways
d. Patent laws, which allow drug companies to
charge high prices for life-saving drugs

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 PRINCIPLE #8: PRINCIPLE #8:
A Countrys Standard of Living Depends A Countrys Standard of Living Depends
on Its Ability to Produce Goods & Services on Its Ability to Produce Goods & Services
Huge variation in living standards across The most important determinant of living
countries and over time: standards: productivity, the amount of goods
Average income in rich countries is more than and services produced per unit of labor.
ten times average income in poor countries. Productivity depends on the equipment, skills,
The U.S. standard of living today is about and technology available to workers.
eight times larger than 100 years ago. Other factors (e.g., labor unions, competition from
abroad) have far less impact on living standards.

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PRINCIPLE #9: PRINCIPLE #10:

Prices Rise When the Government Prints Society Faces a Short-run Tradeoff
Too Much Money Between Inflation and Unemployment
Inflation: increases in the general level of prices. In the short-run (12 years),
In the long run, inflation is almost always caused many economic policies push inflation and
by excessive growth in the quantity of money, unemployment in opposite directions.
which causes the value of money to fall. Other factors can make this tradeoff more or less
The faster the govt creates money, favorable, but the tradeoff is always present.
the greater the inflation rate.

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FYI: How to Read Your Textbook FYI: How to Read Your Textbook
1. Read before class. 3. Test yourself.
Youll get more out of class. Try the Quick Quiz that follows each section
before moving on to the next section.
2. Summarize, dont highlight. Write your answers down, compare them to the
Highlighting is a passive activity that wont answers in the back of the book. If your answers
improve your comprehension or retention. are incorrect, review the section before moving on.
Instead, summarize each section in your own
4. Practice, practice, practice.
words. Then, compare your summary to the one Work through the end-of-chapter review questions
at the end of the chapter. and problems. They are often good practice for
the exams. And the more you use your new
knowledge, the more solid it will become.

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 FYI: How to Read Your Textbook FYI: How to Read Your Textbook
5. Go online. 7. Teach someone.
The book comes with excellent web resources, The best way to learn something is to teach it to
including practice quizzes, tools to strengthen someone else, such as a study partner or friend.
your graphing skills, helpful video clips, and other 8. Dont skip the real world examples.
resources to help you learn the textbook material Read the Case Studies and In The News boxes
more easily and effectively. Visit: in each chapter. They will help you see how the
http://academic.cengage.com/economics/mankiw new terms, concepts, models, and graphs apply to
6. Study in groups. the real world. As you read the newspaper or
Get together with a few classmates to review each watch the evening news, see if you can find the
chapter, quiz each other, and help each other connections with what youre learning in the
understand the material. textbook.

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S U MMARY S U MMARY

The principles of decision making are: The principles of interactions among people are:
People face tradeoffs. Trade can be mutually beneficial.
The cost of any action is measured in terms of Markets are usually a good way of coordinating
foregone opportunities. trade.
Rational people make decisions by comparing Govt can potentially improve market outcomes if
marginal costs and marginal benefits. there is a market failure or if the market outcome
People respond to incentives. is inequitable.

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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

S U MMARY

The principles of the economy as a whole are:

Productivity is the ultimate source of living
standards.
Money growth is the ultimate source of inflation.
Society faces a short-run tradeoff between
inflation and unemployment.

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