lOMoARcPSD|9847496 Summary Principles of Economics N. Gregory Mankiw lOMoARcPSD|9847496 Contents 1. Ten principles of Economics. How people make decisions.
How people interact. How the Economy as a whole works. Thinking like an Economist. The economist as a Scientist.
The economist as a policy advisor. Interdependence and the gains from Trade. A parable for the modern Economy. Comparative advantage: The driving force of Specialization.
The market forces of supply and demand. Markets and competition. Supply and demand together. Elasticity and its Applications.
The Elasticity of Demand. The Elasticity of Supply. Supply, Demand and government policies. Control on prices.
Consumers, Producers, and the Efficiency of Markets. Application: The costs of taxation. The Deadweight loss of Taxation. The determinants of the deadweight loss.
Deadweight loss and tax revenue as taxes vary. Application: International trade. The determinants of trade. The winners and losers from trade.
The arguments for restricting trade. Externalities and market inefficiency. 58 lOMoARcPSD|9847496 Public policies towards externalities. Private solutions to externalities.
Public goods and common resources. The different kinds of goods. The design of the tax system. A financial overview of the US government.
Taxes and efficieny. Taxes and equity. The costs of production. What are costs?.
Production and costs. The various measures of costs. Costs in the short run and in the long run. Firms in competitive markets.
What is a competitive market?. Profit maximization and the competitive firm's supply. The supply curve in a competitive market. Why monopolies arise.
How monopolies make production and pricing. The welfare cost of monopolies. Public policy toward monopolies. Between monopoly and perfect competition.
Competition with differentiated products. Markets with only a few sellers. The economics of cooperation. Public policy toward oligopolies.
The markets for the factors of production. The demand for labor. The supply of labor. 106 lOMoARcPSD|9847496 Equilibrium in the labor market.
The other factors of production: Land and capital. Earnings and discrimination. Some determinants of equilibrium wages. The economics of discrimination.
Income inequality and poverty. The measurement of inequality. The political philosophy of redistributing income. Policies to reduce poverty.
The theory of consumer choice. The budget constraint: What the consumer can afford. Preferences: What the consumer wants. Optimization: What the consumer chooses.
Frontiers of microeconomics. Measuring a nation's income. The economy's income and expenditure. The measurement of gross domestic product.
The components of GDP. Real versus nominal GDP. Is GDP a good measure of economic well-being?. Measuring the cost of living.
The Consumer price index. Correcting economic variables for the effects of inflation. Production and growth. Economic growth around the world.
Productivity: Its role and determinants. Economic growth and public policy. Saving, investment and the financial system. Financial institutions in the US economy.
Saving and Investment in the national income accounts. The market for loanable funds. The basic tools of finance. 166 lOMoARcPSD|9847496 Present value: measuring the time value of money.
Minimum-wage laws. Unions and collective bargaining. The theory of efficiency wages. The monetary system.
The meaning of money. The Federal Reserve System. Banks and the money supply. The Fed's tools of monetary control.
Money Growth and Inflation. The classical theory of inflation. The costs of inflation. Open-economy macroeconomics: Basic concepts.
The international flows of goods and capital. The prices for international transactions: Real and nominal. A first theory of exchange rate determination. A macroeconomic theory of the open economy.
Supply and demand for loanable funds and for foreign-currency. Equilibrium in the open economy. How policies and events affect an open economy. Aggregate demand and aggregate supply.
Three key facts about economic fluctuations. Explaining short-run economic fluctuations. The aggregate demand curve. The aggregate supply curve.
Two causes of economic fluctuations. The influence of monetary and fiscal policy on aggregate demand. How monetary policy influences aggregate demand. How fiscal policy influences aggregate demand.
Using policy to stabilize the economy. The short-run trade-off between inflation and unemployment. The Phillips curve. Shifts in the Phillips curve: The role of expectations.
Shifts in the Phillips curve: The role of supply shocks. The cost of reducing inflation. Six debates over macroeconomic policy. Should monetary and fiscal policymakers try to stabilize the economy.
Should the government fight recessions with spending hikes rather than tax cuts. Should monetary policy be made by rule rather than by discretion. Should the central bank aim for zero inflation. Should the government balance its budget.
Should the tax laws be reformed to encourage saving. 241 lOMoARcPSD|9847496 Ten principles of Economics A society faces many decisions in real life. Like a household, a society as a whole must decide how to allocate its resources. Because there is only a limited amount of resources, we say that resources are scarce.
Economics is the study of how society manages its scarce resources. In this chapter we will study how people make decisions and why. The fundamental lessons about individual decision making are that people face trade- offs among alternative goals, that the cost of any action is measured in terms of forgone opportunities, that rational people make decisions by comparing marginal costs and marginal benefits, and that people change their behaviour in response to the incentives they face. • The fundamental lessons about interactions among people are that trade and interdependence can be mutually beneficial, that markets are usually a good way of coordinating economic activity among people, and that the government can potentially improve market outcomes by remedying a market failure or by promoting greater economic equality.
• The fundamental lessons about the economy as a whole are that productivity is the ultimate source of living standards, that growth in the quantity of money is the ultimate source of inflation, and that society faces a short-run trade-off between inflation and unemployment. How people make decisions The four principles of individual decision making are: (1) People face trade-offs (2) The cost of something is what you give up to get it (3) Rational people think at the margin (4) People respond to incentives lOMoARcPSD|9847496 People face trade-offs: To get one thing we like, we usually have to give up another thing that we like. For example you have to choose between going to the cinema with a friend or work in a supermarket for money. The cost of something is what you give up to get it: Suppose you’re going to college and you want to calculate your costs.
It is tempting to only include tuition, books, room and board. This is a bit misleading, because even if you weren’t going to school you had to pay for food and housing. Second, this calculation ignores the largest cost of going to college; your time! During the time you were studying, making homework or attend classes you could have earned money with a job. These costs are called opportunity costs.
The opportunity cost of an item is what you give up to get that item. Rational people think at the margin: first of all we have to define what rational people are. People are considered rational if they consistently do their best they can to achieve their objectives. Second, we will always assume that people or firms think at the margin.
The marginal change is an incremental adjustment to a plan of action. If a firm decides whether to produce an extra unit of some good, it will always look at the cost of producing 1 extra unit versus the benefit of producing 1 extra unit. If the benefit/revenue is higher than the cost, it will decide to produce an extra unit. People respond to incentives: An incentive is something that induces a person to act.
Consider, for example a government which imposes a higher tax on cigarettes. This causes people to stop smoking. How people interact As we go about our lives, many of our decisions affect not only ourselves but other people as well. The next three principles concern how people interact with one another: (5) trade can make everyone better off (6) Markets are usually a good way to organize economic activity (7) Governments can sometimes improve market outcomes lOMoARcPSD|9847496 5.
Trade can make everyone better off: Countries as well as families benefit from trade by specializing in the things they are good at. This results in lower prices for goods and a more efficient production process. Markets are usually a good way to organize economic activity: In a market economy decisions are made by millions of firms and household. A firm decides how many workers to hire and household decide what to buy for their income.
Governments Can Sometimes Improve Market Outcomes: The government can impose important laws to stimulate economic activity. One way to establish this goal is by means of property rights. Property rights are defined as: the ability of an individual to own and exercise control over scarce resources. A singer wouldn’t produce any music if he knew everybody could get an illegal copy of his music.
Another reason why government can be important is in the case of a market failure. This occurs when a market fails to allocate recourses efficiently. Consider the case when you are the only one who is able to produce and sell eggs in a town. You can basically ask any price for your eggs, since you have a lot of market power.
In this case a government can choose to intervene and to set a maximum price for your eggs. Another possible cause of market failure is an externality, which is the impact of one person’s actions on the well-being of a bystander. Suppose your firm is producing a lot of pollution, which has a negative effect on the region, the government can choose to set rules for the maximum amount of pollution. How the Economy as a whole works The last three principles concern the workings of the economy as a whole: (8) A country's standard of living depends on its ability to produce goods and services (9) Prices rise when the government prints too much money (10) A Country’s Standard of Living Depends on Its Ability to Produce Goods and Services: Society Faces a Short-Run Trade-off between Inflation and Unemployment.
A Country’s Standard of Living Depends on Its Ability to Produce Goods and Services: There is a big difference between annual incomes for countries around world. Why is there such a big difference? The answer is that some countries can lOMoARcPSD|9847496 much more with 1 unit of labour input than other countries. We call this a difference in productivity, which is the quantity of goods and services produced from each unit of labour input. In western-Europe we can make a lot more with 1 unit of labour compared to Nigeria.
Prices rise when the government prints too much money: Almost every year we see that prices rise, but in some countries much faster than in other countries. The general term to indicate an increase in the overall price level is inflation. What causes inflation? In almost all cases of large or persistent inflation, the culprit is growth in the quantity of money. When a government creates large quantities of the nation’s money, the value of the money falls.
A Country’s Standard of Living Depends on Its Ability to Produce Goods and Services: Society Faces a Short-Run Trade-off between Inflation and Unemployment.