Notes on Principles of Economics, 6th ed.(Mankiw) - 1
Economics
Economics is the study of how society manages its scarce resources.
Ten Principles of Economics
The first four priciples are related to inidvidual decision making.
Principle 1: People Face Trade-offs
- "No Free Lunch"
- One classic trade-off is betweeen "guns and butter". Also important in modern society is the trade-off between a clean environment and a high level of income.
- Another trade-off society faces is between efficiency and equality. Efficiency refers to the size of the economic pie, and equality refers to how the pie is divided into individual slices. These two goals often conflict - when the govenment tries to cut the economic pie into more equal slices, the pie gets smaller.
Principle 2: The cost of something is what you give up to get it.
- opportunity cost: whatever must be given up to obtain some item.
Principle 3: Rational people think at the margin
- rational people: people who systematically and purposefully do the best they can to achieve their objectives.
- marginal change: a small incremental adjustment to a plan of action.
- rational people often make decisions by comparing marginal benefits and marginal costs
(Definition from wikipedia) In economics, marginal cost is the change in the total cost that arises when the quantity produced is incremented by one unit, that is, it is the cost of producing one more unit of a good.)
- A rational decision maker takes an action iff the marginal benefit of the action exceeds the marginal cost.
Principle 4: People Respond to Incentives
An incentive is something that induces a person to act.
How does a seat belt law affect auto safety? Consider how a seat belt law alters a driver's cost-benefit calculation -- the result of a seat belt law is a larger number of accidents. At first, this discussion of incentive s and seat belts might seem like idle speculation. Yet in a classic 1975 study, economist Sam Peltzman argued that auto-safety laws have had many of these effects: fewer deaths per accident and more accidents, an increase in the number of pedestrian deaths.
Case Study The Incentive Effects of Gasoline Prices
How People Interact
Principle 5: Trade can make everyone better off
Principle 6: Markets are usually a good way to organize economic activity
- market economy: an economy that allocates resources through the decentralized decisions of many firms and households as they interact in markets for goods and services.
- An Inquiry into the Nature and Causes of the Wealth of Nations, Adam Smith, famous observation in all of economics: Households and firms interacting in markets as if they are guided by an inivisible hand.
- Corollary: When the govenment prevents prices from adjusting naturally to supply and demand, it impedes the invisible hand's ability to coordinate the decisions of the households and firms that make up the economy. (e.g.: Why taxes adversely affect the allocation of resources, for they distort prices and thus the decisions of households and firms)
Principle 7: Governments can sometimes improve market outcomes
- One reason: need institutions to enforce property rights
- Another reason: market failure, externality, market power
How the Economy as a Whole Works
Principle 8: A country's standard of living depends on its ability to produce goods and services
Principle 9: Prices Rise When the Government Prints Too Much Money
Principle 10: Society Faces a Short-Run Trade-off between Inflation and Unemployment
- Increasing the amount of money in the economy stimulates the overall level of spending and thus the demand for goods and services.
- Higher demand may over time cause firms to raise their prices, but in the meantime, it also encourages them to hire more workers and produces a larger quantity of goods and services.
- More hiring means lower unemployment.
