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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
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