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Dear Colleague,
1 Ten Principles of Economics
Thank you for trying out the new Mankiw PowerPoints. I’ve put a lot
PRINCIPLES OF of effort into them and I’m very proud of them. I’m confident you
ECONOMICS will find them helpful.
FOURTH EDITION
N. G R E G O R Y M A N K I W
I will be updating these PowerPoints roughly every 12-18 months to
Pow erPoint®Slides update data, fix any typos, incorporate the best suggestions from
by Ron Cronovich
users, and make improvements based on my experience using these
© 2006 Thomson South-Western, all rights reserved
slides in my own classes. So I will welcome any comments or
suggestions you have. Please email them to me at
roncron@unlv.nevada.edu.
“How do firms decide what kind of labor to hire?” Firms can hire
unskilled or skilled workers. The skilled workers are more
productive, but cost more than the unskilled workers.
Principle
Principle #1:
#1: People
People Face
Face Tradeoffs
Tradeoffs
Principle
Principle #2:
#2: The
The Cost
Cost ofof Something
Something Is
Is What
What
You
You Give
Give Up
Up to
to Get
Get ItIt
§ Making decisions requires comparing the costs
and benefits of alternative choices.
§ The opportunity cost of any item is whatever
must be given up to obtain it.
§ It is the relevant cost for decision-making.
HOW PEOPLE MAKE DECISIONS Here’s a fun tangent, if you have the class time and are so inclined:
Principle
Principle #2:
#2: The
The Cost
Cost ofof Something
Something Is
Is What
What
You
You Give
Give Up
Up to
to Get
Get ItIt Ask your students about the saying “The best things in life are free.”
Examples: Ask them to name some of these things that supposedly are free. Ask
The opportunity cost of…
…going to college for a year is not just the tuition,
them what “free” means in this context. The idea here is to get them
books, and fees, but also the foregone wages. to see that even things without an explicit monetary cost are not truly
…seeing a movie is not just the price of the ticket,
but the value of the time you spend in the theater.
“free,” because they have an opportunity cost.
For example, when you ask them to name the “best things” that are
CHAPTER 1 TEN PRINCIPLES OF ECONOMICS 7
“free,” they will respond with answers like love, sitting at the top of a
mountain you just climbed and enjoying an awesome view, or maybe
witnessing the joy of a child who has just been given a new toy. In
each case, there is no explicit monetary cost, but there’s an
opportunity cost.
With love, it’s less obvious, but if prodded enough, your students will
be able to think of non-monetary costs associated with love. For
example, you might not want to see the latest Ashton Kutcher film,
you might think he’s the world’s worst actor. But your
boyfriend/girlfriend/teenaged daughter or other loved one is DYING
to see it, they are BEGGING you to take them. So you take them.
That’s true love, don’t you think? And it’s certainly not free.
HOW PEOPLE MAKE DECISIONS This definition of “rational” is new to the 4th edition of the textbook.
Principle
Principle #3:
#3: Rational
Rational People
People Think
Think at
at the
the You might want to elaborate a bit on what economists mean by
Margin
Margin “rational.”
§ A person is rational if she systematically and
purposefully does the best she can to achieve
her objectives. In economics, a rational consumer makes decisions about the goods
§ Many decisions are not “all or nothing,” she buys (which ones and how much of each) with the goal of
but involve marginal changes – incremental
adjustments to an existing plan. maximizing her well-being, subject to her income, the prices of the
§ Evaluating the costs and benefits of marginal goods, and her preferences.
changes is an important part of decision-making.
CHAPTER 1 TEN PRINCIPLES OF ECONOMICS 8
Another rational economic actor – the firm – decides how much
output to produce, what price to charge, and how many workers to
hire in order to maximize its profits.
Principle
Principle #3:
#3: Rational
Rational People
People Think
Think at
at the
the
Margin
Margin
Examples:
§ A student considers whether to go to college
for an additional year, comparing the fees &
foregone wages to the extra income he could
earn with an extra year of education.
§ A firm considers whether to increase output,
comparing the cost of the needed labor and
materials to the extra revenue.
HOW PEOPLE MAKE DECISIONS The definition of “incentive” is new to the 4th edition.
Principle
Principle #4:
#4: People
People Respond
Respond to
to Incentives
Incentives
§ incentive: something that induces a person to
act, i.e. the prospect of a reward or punishment.
§ Rational people respond to incentives because
they make decisions by comparing costs and
benefits. Examples:
• In response to higher gas prices,
sales of “hybrid” cars (e.g. Toyota Prius) rise.
• In response to higher cigarette taxes,
teen smoking falls.
When students have a bit of time to think through their answers, they are
more likely to be comfortable sharing their answers with you and the class.
Even better: try a simple, time-tested activity called “THINK-PAIR-
SHARE.” Pair students up. Pose a question or problem. Have students
work on the problem individually for a couple minutes. Then, allow a
couple minutes to work in pairs: each student tries to explain to the other
why his or her answer is correct, and the other offers feedback. In many
cases, they come up with better answers by working together. Finally, ask
for volunteers. Students are much more likely to participate since they have
had the opportunity to “test” their answers on a classmate. And those who
do not participate will at least have had the chance to share their answer
with, and get feedback from, one other student.
Activities like these are useful to break up a lecture every 20 minutes or so.
They help maintain students’ attention spans, and increase their
comprehension of the material you cover. These activities are also useful for
quick, informal assessment – often, they will alert you to problems (such as
students not getting what you think they’re getting) which you can then
correct before moving on to cover additional material.
End of digression.
ACTIVE LEARNING 1:
Answers
Cost of fixing transmission = $600
A. Blue book value is $6500 if transmission works,
$5700 if it doesn’t
Benefit of fixing the transmission = $800
($6500 – 5700).
It’s worthwhile to have the transmission fixed.
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
ACTIVE LEARNING 1: If you wish, you can omit this slide and just give this information to
Answers the class verbally.
Observations:
§ The $1000 you previously spent on repairs is
irrelevant. What matters is the cost and benefit
of the marginal repair (the transmission).
§ The change in incentives from scenario A
to scenario B caused your decision to change.
13
HOW PEOPLE INTERACT If each person had to grow his own food, make his own clothes, cut
Principle
Principle #5:
#5: Trade
Trade Can
Can Make
Make Everyone
Everyone Better
Better his own hair, we would have a world full of skinny, unfashionable
Off
Off poor people having bad hair days every day of the week.
§ Rather than being self-sufficient, people can
specialize in producing one good or service
and exchange it for other goods. It’s far more efficient for each person to specialize in producing a
§ Countries also benefit from trade & specialization: good or service, and then exchanging it with other people for the
• get a better price abroad for goods they
produce things they produce.
• buy other goods more cheaply from abroad
than could be produced at home
The statement “trade can make everyone better off” should not be
CHAPTER 1 TEN PRINCIPLES OF ECONOMICS 15
hard to understand, if you think about it for a moment: Each of two
parties would not voluntarily enter into an exchange if it made either
of them worse off, now would they?
Principle
Principle #6:
#6: Markets
Markets Are
Are Usually
Usually A
A Good
Good
Way
Way to
to Organize
Organize Economic
Economic Activity
Activity
§ In a market economy, these decisions result from
the interactions of many households and firms.
§ Famous insight by Adam Smith in
The Wealth of Nations (1776):
Each of these households and firms
acts as if “led by an invisible hand”
to promote general economic well-being.
Principle
Principle #6:
#6: Markets
Markets Are
Are Usually
Usually A
A Good
Good
Way
Way to
to Organize
Organize Economic
Economic Activity
Activity
§ The invisible hand works through the price system:
• The interaction of buyers and sellers
determines prices of goods and services.
• Each price reflects the good’s value to buyers
and the cost of producing the good.
• Prices guide self-interested households and
firms to make decisions that, in many cases,
maximize society’s economic well-being.
CHAPTER 1 TEN PRINCIPLES OF ECONOMICS 18
HOW PEOPLE INTERACT “Govt” is an abbreviation for government. Throughout all of the
Principle
Principle #7:
#7: Governments
Governments Can
Can Sometimes
Sometimes PowerPoint chapters, I will try to use abbreviations the way a
Improve
Improve Market
Market Outcomes
Outcomes thoughtful instructor would use them if writing on a blackboard. If
§ Important role for govt: enforce property rights you prefer to spell the word out, just use your mouse to highlight
(with police, courts)
§ People are less inclined to work, produce, invest, or “govt” and then type out the full word.
purchase if large risk of their property being stolen.
• A restaurant won’t serve meals if customers
do not pay before they leave. Many fledging market economies are struggling through the
• A music company won’t produce CDs if too many transition from central planning because they have not developed
people avoid paying by making illegal copies.
institutions that protect and enforce property rights. The British news
CHAPTER 1 TEN PRINCIPLES OF ECONOMICS 19
magazine The Economist has lots of current examples of this. An
older but still interesting example comes from a column that Mankiw
wrote in the June 12, 2000 issue of Fortune magazine entitled
“Ukraine: How Not To Run An Economy.”
HOW PEOPLE INTERACT
Principle
Principle #7:
#7: Governments
Governments Can
Can Sometimes
Sometimes
Improve
Improve Market
Market Outcomes
Outcomes
§ Govt may alter market outcome to promote efficiency
§ market failure, when the market fails to allocate
society’s resources efficiently. Causes:
• externalities, when the production or consumption
of a good affects bystanders (e.g. pollution)
• market power, a single buyer or seller has
substantial influence on market price (e.g. monopoly)
§ In such cases, public policy may increase efficiency.
CHAPTER 1 TEN PRINCIPLES OF ECONOMICS 20
Principle
Principle #7:
#7: Governments
Governments Can
Can Sometimes
Sometimes
Improve
Improve Market
Market Outcomes
Outcomes
§ Govt may alter market outcome to promote equity
§ If the market’s distribution of economic well-being
is not desirable, tax or welfare policies can change
how the economic “pie” is divided.
Here are some notes which might help guide the discussion:
22
d. Patent laws. I’ve kind of loaded the question with the wording on the
slide. If you wish, change it to just “Patent laws.” Is it fair that drug
companies charge such high prices for drugs that some people need to stay
alive? If drug prices are regulated, how might pharmaceutical firms
respond?
HOW THE ECONOMY AS A WHOLE WORKS
HOW THE ECONOMY AS A WHOLE WORKS On this slide, “rich countries” refers to countries like the U.S., Japan,
Principle
Principle #8:
#8: A A country’s
country’s standard
standard of
of living
living and Germany, “poor countries” refers to countries like India,
depends
depends onon its
its ability
ability to
to produce
produce goods
goods & & Indonesia, and Nigeria.
services.
services.
§ Huge variation in living standards across
countries and over time:
• Average income in rich countries is more than
ten times average income in poor countries.
• The U.S. standard of living today is about
eight times larger than 100 years ago.
Principle
Principle #8:
#8: A A country’s
country’s standard
standard of
of living
living
depends
depends onon its
its ability
ability to
to produce
produce goods
goods & &
services.
services.
§ The most important determinant of living standards:
productivity, the amount of goods and services
produced per unit of labor.
§ Productivity depends on the equipment, skills, and
technology available to workers.
§ Other factors (e.g. labor unions, competition from
abroad) have far less impact on living standards.
Principle
Principle #9:
#9: Prices
Prices rise
rise when
when the
the
government
government prints
prints too
too much
much money.
money.
§ Inflation: increases in the general level of prices.
§ In the long run, inflation is almost always caused
by excessive growth in the quantity of money,
which causes the value of money to fall.
§ The faster the govt creates money,
the greater the inflation rate.
Keep in mind, though, the lesson from Principle #9: In the long run,
changing the quantity of money only affects inflation. We will learn
in a later chapter what determines the rate of unemployment in the
long run, and we will see that it has nothing to do with the quantity of
money.
The second point on this slide – “Other factors can make this tradeoff
more or less favorable, but the tradeoff is always present” – addresses
the following point: In some decades, factors outside of the control
of policymakers make inflation and unemployment both high (e.g.
1970s) – or low (e.g. 1990s). Yet, given these other factors,
policymakers can always reduce unemployment temporarily by
creating more inflation, or vice versa.
FYI: How to read your textbook Most students, especially those in their first year of college, have not
1. Summarize, don’t highlight. been taught good study skills. Yet, we professors expect them to
Highlighting is a passive activity that won’t improve
your comprehension or retention. Instead, summarize
know how to study. Your university may offer free one-time
each section in a few sentences of your own words.
When you finish, compare your summary to the one
workshops for students on study skills; if so, you might announce
at the end of the chapter. them in class. In the meantime, we offer your students this FYI box
2. Test yourself.
Try the “QuickQuiz” that follows each section before
in the textbook, reproduced here in the PowerPoint presentation of
moving on to the next section. Write your answers chapter 1.
down, and compare them to the answers in the back
of the book. If your answers are incorrect, review the
section before moving on.
If you’re pressed for time, you can omit it from your presentation of
CHAPTER 1 TEN PRINCIPLES OF ECONOMICS 28
the chapter, and instead just refer students to it in the textbook.
Conclusion
§ Economics offers many insights about the
behavior of people, markets, and economies.
§ It is based on a few ideas that can be applied
in many situations.
§ Whenever we refer back to one of the
Ten Principles from this chapter,
you will see an icon like this one:
CHAPTER SUMMARY
§ The principles of interactions among people are:
• Trade can be mutually beneficial.
• Markets are usually a good way of
coordinating trade.
• Govt can potentially improve market
outcomes if there is a market failure
or if the market outcome is inequitable.
CHAPTER SUMMARY
§ The principles of the economy as a whole are:
• Productivity is the ultimate source of living
standards.
• Money growth is the ultimate source of
inflation.
• Society faces a short-run tradeoff between
inflation and unemployment.