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C H A P T E R In this chapter, 1 In this chapter, look for the answers to these questions: look for the answers to these questions: Ten (Seven Micro-) Principles of Ten (Seven Micro-) Principles of What kinds of questions does economics address? Economics Economics What are the principles of how people make P R I N C I P L E S O F P R I N C I P L E S O F decisions? Microeonomics What are the principles of how people interact? N. Gregory Mankiw N. Gregory Mankiw What are the principles of how the economy as a whole works? Premium PowerPoint Slides by Ron Cronovich ©2009 South-Western, a part of Cengage Learning, all rights reserved 1 What Economics Is All About The principles of The principles of Scarcity: the limited nature of society’s HOW PEOPLE resources HOW PEOPLE MAKE DECISIONS Economics: the study of how society manages MAKE DECISIONS 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 2 1 HOW PEOPLE MAKE DECISIONS HOW PEOPLE MAKE DECISIONS Principle #1: People Face Tradeoffs Principle #1: People Face Tradeoffs Principle #1: People Face Tradeoffs Principle #1: People Face Tradeoffs All decisions involve tradeoffs. Examples: Society faces an important tradeoff: efficiency vs. equality Going to a party the night before your midterm Efficiency: when society gets the most from its leaves less time for studying. scarce resources Having more money to buy stuff requires working Equality: when prosperity is distributed uniformly longer hours, which leaves less time for leisure. among society’s 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.” TEN PRINCIPLES OF ECONOMICS 4 TEN PRINCIPLES OF ECONOMICS 5 HOW PEOPLE MAKE DECISIONS HOW PEOPLE MAKE DECISIONS Principle #2: The Cost of Something Is Principle #2: The Cost of Something Is Principle #2: The Cost of Something Is Principle #2: The Cost of Something Is What You Give Up to Get It What You Give Up to Get It 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. TEN PRINCIPLES OF ECONOMICS 6 TEN PRINCIPLES OF ECONOMICS 7 2 HOW PEOPLE MAKE DECISIONS HOW PEOPLE MAKE DECISIONS Principle #3: Rational People Think at the Principle #3: Rational People Think at the Principle #3: Rational People Think at the Principle #3: Rational People Think at the Margin Margin Margin 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. TEN PRINCIPLES OF ECONOMICS 8 TEN PRINCIPLES OF ECONOMICS 9 HOW PEOPLE MAKE DECISIONS A C T I V E L E A R N I N G 1 A C T I V E L E A R N I N G 1 Applying the principles Principle #4: People Respond to Incentives Applying the principles Principle #4: People Respond to Incentives Incentive: something that induces a person to You are selling your 1996 Mustang. You have act, i.e. the prospect of a reward or punishment. already 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 hybrid cars and fewer gas guzzling SUVs. have the transmission repaired? Explain. When cigarette taxes increase, A. Blue book value is $6500 if transmission works, teen smoking falls. $5700 if it doesn’t B. Blue book value is $6000 if transmission works, $5500 if it doesn’t TEN PRINCIPLES OF ECONOMICS 10 11 3 A C T I V E L E A R N I N G 1 A C T I V E L E A R N I N G 1 A C T I V E L E A R N I N G A C T I V E L E A R N I N G 1 1 Answers Answers Answers Answers Cost of fixing transmission = $600 Observations: A. Blue book value is $6500 if transmission works, The $1000 you previously spent on repairs is $5700 if it doesn’t irrelevant. What matters is the cost and benefit Benefit of fixing the transmission = $800 of the marginal repair (the transmission). ($6500 – 5700). The change in incentives from scenario A It’s worthwhile to have the transmission fixed. to scenario B caused your decision to change. B. Blue book value is $6000 if transmission works, $5500 if it doesn’t Benefit of fixing the transmission is only $500. Paying $600 to fix transmission is not worthwhile. 12 13 The principles of HOW PEOPLE INTERACT The principles of Principle #5: Trade Can Make Everyone HOW PEOPLE Principle #5: Trade Can Make Everyone HOW PEOPLE Better Off INTERACT Better Off INTERACT 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 TEN PRINCIPLES OF ECONOMICS 15 4
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