1/13/2025

N. GREGORY MANKIW NINTH EDITION

IN THIS CHAPTER
PRINCIPLES OF • What kinds of questions does economics
address?
ECONOMICS • What are the principles of how people
make decisions?
CHAPTER
• What are the principles of how people
Ten Principles of interact?

1 Economics • What are the principles of how the

economy as a whole works?
Interactive PowerPoint Slides by:
V. Andreea Chiritescu
Eastern Illinois University
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Ten Principles of Economics Ten Principles of Economics

Resources are scarce • Economists study:
• Scarcity: the limited nature of society’s – How people decide how much they work,
resources what they buy, how much they save, and
– Society has limited resources and cannot how they invest their savings
produce all the goods and services people wish – How firms decide how much to produce
to have. and how many workers to hire
• Economics – How society decides how to divide its
– The study of how society manages its resources between national defense,
scarce resources consumer goods, protecting the
environment, and other needs
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How People Make Decisions Principle 1: People Face Trade-Offs

To get something that we like, we have to give
Principle 1: People face trade-offs up something else that we also like.
Principle 2: The cost of something is what – Going to a party the night before an exam
• Less time for studying
you give up to get it
– Having more money to buy stuff
Principle 3: Rational people think at the
• Working longer hours, less time for leisure
margin
– Protecting the environment
Principle 4: People respond to incentives
• Resources could be used to produce
consumer goods.

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EXAMPLE 1A: Society faces trade-offs EXAMPLE 1B: Society faces trade-offs
• The more it spends on national defense • Efficiency: Society gets the maximum
(guns) to protect from foreign aggressors benefits from its scarce resources.
– The less it can spend on consumer goods • Equality: Prosperity is distributed uniformly
(butter) to raise its standard of living among society’s members.
• Pollution regulations: cleaner environment • Trade-off:
and improved health
– To achieve greater equality, we could
– But at the cost of reducing the well-being redistribute income from wealthy to poor.
of the firms’ owners, workers, and
– But this reduces incentive to work and
customers
produce, shrinking the size of economic
“pie”.
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Principle 2: The Cost of Something Is What You

EXAMPLE 2: Opportunity cost
Give Up to Get It
• Making decisions: • What is the opportunity cost of going to
college for a year?
– Compare costs with benefits of
• Tuition, books, and fees
alternatives
• NOT: room and board
– Need to include opportunity costs
• PLUS foregone earnings
• Opportunity cost • What is the opportunity cost of going to the
– Whatever must be given up to obtain movies?
some item • 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 Active Learning 1: Thinking at the margin
A. As the manager at the local Save-a-lot, you
• Rational people
are thinking of hiring one more cashier that
– Systematically and purposefully do the would increase sales revenues by $400 per
best they can to achieve their objectives week. The new cashier would earn $300 per
given the available opportunities week. Should you hire the new cashier? Why?
– Make decisions by evaluating costs and
benefits of marginal changes B. You pay $12/month for access to Netflix,
• Small incremental adjustments to a plan of regardless of how many movies or TV shows
action you watch in a month. Should you watch one
more movie (or episode)? Why?

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Active Learning 1: Answers, A Active Learning 1: Answers B

A. Manager at the local Save-a-lot: B. Netflix:
– Marginal benefit of hiring one more cashier: – Marginal benefit of watching one more movie:
• Sales would increase by $400 per week. • The enjoyment you get from watching the
– Marginal cost of hiring one more cashier: movie
• The new cashier would earn $300. – Marginal cost of watching one more movie:
– Decision: Because the marginal benefit exceeds • Monetary cost = $0
the marginal cost, the manager should hire the • Opportunity cost of time
additional cashier – Decision: If the marginal benefit exceeds the
marginal cost, watch the movie.

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Principle 4: People Respond to Incentives EXAMPLE 3: Incentives

• Incentive The government increases the gasoline tax by
$1 per gallon.
– Something that induces a person to act
• How do consumers respond?
– Can have unintended consequences
– Drive smaller or more fuel-efficient cars
• People respond to incentives – Carpool
– Because rational people make decisions – Use public transportation
by comparing costs and benefits
– Move closer to work
• An increase in the price of doughnuts: • How do businesses respond?
– Consumers buy fewer doughnuts.
– Sellers produce more doughnuts.
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Active Learning 2: Applying the principles Active Learning 2: Answers

You are selling your black 1967 Chevy Impala. Cost of fixing the transmission = $1,400
You have already spent $2,000 on repairs. At the A. Blue book value is $14,500 if transmission works,
last minute, the transmission dies. You can pay $11,200 if it doesn’t.
$1,400 to have it repaired, or sell the car “as is.” – Benefit of fixing transmission = $3,300
In each of the following scenarios, should you (= 14,500 – 11,200)
have the transmission repaired? Explain. – Get the transmission fixed.
A. Blue book value (what you could get for the car) B. Blue book value is $12,300 if transmission works,
is $14,500 if transmission works, $11,200 if it $11,000 if it doesn’t.
doesn’t. – Benefit of fixing the transmission = $1,300
B. Blue book value is $12,300 if transmission (= 12,300 – 11,000)
works, $11,000 if it doesn’t.
– Do not pay $1,400 to fix it.
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How People Interact Principle 5: Trade Can Make Everyone Better Off

• People benefit from trade:

Principle 5: Trade can make everyone – People can buy a greater variety of goods
better off. and services at lower cost.
Principle 6: Markets are usually a good way • Countries benefit from trade:
to organize economic activity. – Allows countries to specialize in what they
Principle 7: Governments can sometimes do best
improve market outcomes. – Enjoy a greater variety of goods and
services

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Principle 6: Markets Are Usually a Good Way to Principle 6: Markets Are Usually a Good Way to
Organize Economic Activity – 1 Organize Economic Activity – 2
• Market • Market economy
– A group of buyers and sellers (need not – Allocates resources through the
be in a single location) decentralized decisions of many firms and
• “Organize economic activity” means households as they interact in markets
determining – Proven remarkably successful in
– What goods and services to produce organizing economic activity to promote
overall prosperity
– How to produce these goods and services
– How to allocate them to their final user

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Principle 6: Markets Are Usually a Good Way to Principle 7: Governments Can Sometimes
Organize Economic Activity – 3 Improve Market Outcomes – 1
• Prices: • Government: enforce property rights
– Determined by the interaction of buyers – Enforce rules and maintain institutions that
and sellers are key to a market economy
– Reflect the good’s value to buyers • People are less inclined to work, produce,
invest, or purchase if there is a large risk of
– Reflect the cost of producing the good
their property being stolen.
• Adam Smith’s “invisible hand”: • We rely on government-provided police and
– Prices guide self-interested households courts to enforce our rights over the things we
and firms to make decisions that maximize produce.
society’s economic well-being.
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Principle 7: Governments Can Sometimes Principle 7: Governments Can Sometimes

Improve Market Outcomes – 2 Improve Market Outcomes – 3
• Government: promote efficiency • Government: promote equality
– Avoid market failures: Market left on its – Avoid disparities in economic well-being
own fails to allocate resources efficiently. – Use tax or welfare policies to change how
– Externality – source of market failure the economic “pie” is divided.
• Production or consumption of a good affects • To say that the government can improve
bystanders (e.g. pollution).
market outcomes
– Market power – source of market failure – Does not mean that it always will
• A single buyer or seller has substantial
influence on market price (e.g., monopoly).

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Active Learning 3: The government How the economy as a whole works

In each of the following situations, what is the
government’s role? Principle 8: A country’s standard of living
Does the government’s intervention improve depends on its ability to produce goods and
the outcome? services.
A. Public schools for K-12 Principle 9: Prices rise when the
B. Workplace safety regulations government prints too much money.
C. Public highways Principle 10: Society faces a short-run
D. Patent laws, which allow drug companies trade-off between inflation and
to charge high prices for life-saving drugs unemployment.
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Principle 8: Country’s Standard of Living Depends on Its Principle 8: Country’s Standard of Living Depends on Its
Ability to Produce Goods and Services – 1 Ability to Produce Goods and Services – 2

• Huge variation in living standards across • Productivity: most important determinant

countries and over time of living standards
– 2017 average income: – Quantity of goods and services produced
• $60,000 in the U.S.; $6,000 in Nigeria from each unit of labor input
– Average income in rich countries – Depends on the equipment, skills, and
• Is more than ten times average income in technology available to workers
poor countries • Other factors (e.g., labor unions, competition
– The U.S. standard of living today from abroad) have far less impact on living
standards.
• Is about eight times greater than 100 years
ago
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Principle 9: Prices Rise When the Government Principle 10: Society Faces a Short-Run Trade-Off
Prints Too Much Money between Inflation and Unemployment
• Inflation • Short-run trade-off between inflation and
– An increase in the overall level of prices in unemployment
the economy – In the short-run, many economic policies
• In the long run push inflation and unemployment in
– Inflation is almost always caused by opposite directions.
excessive growth in the quantity of money, – Other factors can make this trade-off more
which causes the value of money to fall or less favorable, but the trade-off is
– The faster the government creates money, always present.
the greater the inflation rate
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THINK-PAIR-SHARE CHAPTER IN A NUTSHELL

Your university decides to reduce the price of a
parking permit on campus from $250 per semester to • Individual decision making:
$10 per semester. • People face trade-offs among alternative goals.
A. The number of students desiring to park their cars on • The cost of any action is measured in terms of
campus will _________. forgone opportunities.
B. The amount of time it would take to find a parking
• Rational people make decisions by comparing
place will ___________.
marginal costs and marginal benefits.
C. Will the lower price of a parking permit necessarily
lower the true cost of parking? (Hint: opportunity cost)
• People change their behavior in response to the
incentives they face.
D. Would the opportunity cost of parking be the same
for students with no outside employment and
students with jobs earning $15 per hour?
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CHAPTER IN A NUTSHELL CHAPTER IN A NUTSHELL

• Interactions among people: • The economy as a whole:
• Trade and interdependence can be mutually • Productivity is the ultimate source of living
beneficial. standards.
• Markets are usually a good way of coordinating • Growth in the quantity of money is the ultimate
economic activity among people. source of inflation.
• Governments can potentially improve market • Society faces a short-run trade-off between
outcomes by remedying a market failure or by inflation and unemployment.
promoting greater economic equality.

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