Download ten (10) principles of economics

TEN (10) PRINCIPLES OF ECONOMICS
Source: N. Gregory Mankiw, Principles of Economics. 4thed, (ThomsonSouth Western), 2007
HOW PEOPLE MAKE DECISIONS
1. People Face Trade-offs
There’s no “free lunch”. To get one thing, you have to give up something else.
Î Scarcity of Resources
Examples:
1. Students’ studying time vs. leisure time
2. Studying time between two subjects
3. Households deciding where and how to spend family income.
Î Society in general is faced with tradeoffs (Production Possibilities Frontier)
• “Guns and butter” trade-off
• Promotion of Services vs. Industry
• Growth vs. environmental protection
• Production Efficiency vs. equity (welfare benefits)
2. Opportunity Cost is Ever Present
The true cost of a good or service is the cost of another good or service you give up (best
alternative).
Cost of College: -
cost of tuition and books
value of wages lost (given up to attend college)
Î Not included in the opportunity cost of attending college are various living
expenses one would have had anyway whether he/she attends college or not.
3. Marginal Economics are Most Relevant
It is changes made “on the margin” (that is, small changes) that are relevant in economic
analysis and decision-making.
Examples:
-
airlines deciding to price stand-by tickets
off-peak pricing
Î incremental vs. average pricing
4. Incentives Matter
People respond to incentives (monetary and non-monetary).
Î Management-by-Objectives (MbO)
Dr. Savvas Savvides—School of Business, EUROPEAN UNIVERSITY CYPRUS
1
HOW PEOPLE INTERACT
5. Trade Makes Everybody Better Off
No man is an island.
Î Specialization and exchange increases production and welfare
Î Adam Smith and David Ricardo: Comparative Cost Advantage
6. Market Economy is Most Efficient System to Organize Economic Activity
Communism vs. Capitalism
Î Central Planning concept has failed because it leads to misallocation of resources,
corruption, inefficiencies etc
Î Adam Smith’s “Invisible Hand”: the Price System
How does the complex market system not fall apart?
1. Profits: Motivate economic activity
2. Price System: Directs and facilitates the market’s efficient functioning
3. Competition: Regulates the market players to stay within “the rules of the
game”
7. Governments Correct Market Externalities/Failures (sometimes!)
Too much government interference in the market is neither good (efficient), nor
desirable. Some intervention is a necessary evil and sometimes promotes social good.
The acceptable functions of government are:
• To provide for the legal system
• To promote efficiency and regulate competition
• To promote equity (equitable income distribution)
• To provide for public goods
• To facilitate and promote economic growth and development
Î correct for externalities (market failures) – pollution and environmental protection
Î regulate monopolies and protect consumers
HOW AN ECONOMIC SYSTEM WORKS
8. Standard of Living Depends on Productivity
Differences in income levels are very wide around the world. Why?
•
Availability of resources
Dr. Savvas Savvides—School of Business, EUROPEAN UNIVERSITY CYPRUS
2
•
•
Productivity of these resources
Level of technological know-how and usage
Productivity: the amount of goods and services produced per time period by each worker
Question: Are workers inherently more lazy in Africa than in Europe or America?
Of course not!! - the role of technology
- the level of education and training
- cultural, religious, social norms and customs
9. Prices are Affected by Monetary Policy
Nobel prize winner in Economics Milton Friedman said: “Inflation is always and everywhere
a monetary phenomenon.”
Î Prices rise when Demand exceeds Supply.
Î Too much money chasing too few goods
In Germany in January 1921 a newspaper cost 0.30 Deutschmarks. In November 1922 (20
months later!) it cost 70 million marks!!
Î Hyperinflation: Runaway inflation caused by the printing of money.
Joke (in Germany during the above period of hyperinflation): A worker gets paid in the
morning. He puts the millions of marks in paper notes he receives in a wheel barrel and rushes
to the market to buy goods. A thief robs the worker. He throws away the money (which are
already worthless!!) and keeps the wheel barrel: it was the only valuable thing the worker had.
10. Society Faces a Short-run Trade-off Between Inflation and Unemployment
Inflation
Phillips Curve
Unemployment
In the 1950s and 60s, the above-observed relationship was used in making policy decisions:
Policies to reduce inflation (higher taxes, less government projects, fewer loans, higher interest
rates etc) led to increased unemployment, or policies to reduce unemployment (expansionary
fiscal and monetary policies) led to increased economic activity but also to higher inflation.
Î In the long-run, there’s no evidence of inflation-unemployment trade-off.
Î The “stagflation” of the 1970s (co-existence of high inflation and high unemployment)
brought to an end the belief that the Phillips curve was a “theory”.
Dr. Savvas Savvides—School of Business, EUROPEAN UNIVERSITY CYPRUS
3