Ten Principles of Economics

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CHAPTER

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In this chapter, look for the answers to these questions:
What kinds of questions does economics address? What are the principles of how people make decisions? What are the principles of how people interact? What are the principles of how the economy as a whole works?

Ten Principles of Economics

Macroeconomics
N. Gregory Mankiw
Premium PowerPoint Slides by Ron Cronovich
© 2009 South-Western, a part of Cengage Learning, all rights reserved

PRINCIPLES OF

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What Economics Is All About
Scarcity: the limited nature of society’s 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 TEN PRINCIPLES OF ECONOMICS

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The principles of 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. TEN PRINCIPLES OF ECONOMICS

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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 society’s 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.” TEN PRINCIPLES OF ECONOMICS

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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.

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.

TEN PRINCIPLES OF ECONOMICS

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TEN PRINCIPLES OF ECONOMICS

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HOW PEOPLE MAKE DECISIONS
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.

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. 8

TEN PRINCIPLES OF ECONOMICS

TEN PRINCIPLES OF ECONOMICS

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HOW PEOPLE MAKE DECISIONS
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. 10

ACTIVE LEARNING

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Applying the principles
You are selling your 1996 Mustang. You have already spent $1000 on repairs. At the last minute, the transmission dies. You can pay $600 to have it repaired, or sell the car “as is.” In each of the following scenarios,...
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