CHAPTER 1 TEN PRINCIPLES OF ECONOMICS

Principles of Economics Arab World, 4e Gregory Mankiw, Mohamed Rashwan (Solu�ons Manual All Chapters, 100% Original Verified, A+ Grade) 1 / 4

Chapter 1/ Ten Principles of Economics ❖ 1

© Cengage EMEA. Only to be used with Mankiw/Rashwan Principles of Economics Arab World Edition, 4e (ISBN 9781473774926)

CHAPTER 1 TEN PRINCIPLES OF ECONOMICS

LEARNING OBJECTIVES:

By the end of this chapter, students should understand:

• that economics is about the allocation of scarce resources.• that individuals face trade-offs.• the meaning of opportunity cost.• how to use marginal reasoning when making decisions.• how incentives affect people’s behavior.• why trade among people or nations can be good for everyone.• why markets are a good, but not perfect, way to allocate resources.• what determines some trends in the overall economy.

CONTEXT AND PURPOSE:

Chapter 1 is the first chapter in a three-chapter section that serves as the introduction to the text. Chapter

• introduces ten fundamental principles on which the study of economics is based. In a broad sense, the

rest of the text is an elaboration on these ten principles. Chapter 2 will develop how economists approach problems while Chapter 3 will explain how individuals and countries gain from trade.The purpose of Chapter 1 is to lay out ten economic principles that will serve as building blocks for the rest of the text. The ten principles can be grouped into three categories: how people make decisions, how people interact, and how the economy works as a whole. Throughout the text, references will be made repeatedly to these ten principles.

KEY POINTS:

• 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 behavior 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.

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Chapter 1/ Ten Principles of Economics ❖ 2

© Cengage EMEA. Only to be used with Mankiw/Rashwan Principles of Economics Arab World Edition, 4e (ISBN 9781473774926)

CHAPTER OUTLINE:

1) Introduction Begin by pointing out that economics is a subject that students must confront in their daily lives. Point out that they already spend a great deal of their time thinking

about economic issues: changes in prices, buying decisions, use of their time,

concerns about employment, etc.

a) The word “economy” comes from the Greek word oikonomos meaning “one who manages a

household.”

b) This makes some sense because in the economy we are faced with many decisions (just as a

household is).

c) Fundamental economic problem: resources are scarce.

You will want to start the semester by explaining to students that part of learning economics is understanding a new vocabulary. Economists generally use very precise (and sometimes different) definitions for words that are commonly used outside of the economics discipline. Therefore, it will be helpful to students if you follow the definitions provided in the text as much as possible.

d) Definition of scarcity : the limited nature of society’s resources.

e) Definition of economics : the study of how society manages its scarce resources.

Because most first and second year university students have limited experiences with viewing the world from a cause-and-effect perspective, do not underestimate how challenging these principles will be for the student.

As you discuss the ten principles, make sure that students realize that it is okay if they do not grasp each of the concepts completely or find each of the arguments fully convincing. These ideas will be explored more completely throughout the text.2) How People Make Decisions

a) Principle #1: People Face Trade-offs

• “Nothing is for free.” Making decisions requires trading one goal for another.

ii) Examples include how students spend their time, how a family decides to spend its income, how the government spends tax collected, and how regulations may protect the environment at a cost to firm owners.iii) An important trade-off that society faces is the trade-off between efficiency and equality.(1) Definition of efficiency : the property of society getting the maximum benefits from its scarce resources.(2) Definition of equality : the property of distributing economic prosperity uniformly among the members of society. 3 / 4

Chapter 1/ Ten Principles of Economics ❖ 3

© Cengage EMEA. Only to be used with Mankiw/Rashwan Principles of Economics Arab World Edition, 4e (ISBN 9781473774926) (3) For example, tax paid by the wealthy and then distributed to those less fortunate may improve equality but lower the return to hard work and therefore reduce the level of output produced by our resources.(4) This implies that the cost of this increased equality is a reduction in the efficient use of our resources.iv) Recognizing that trade-offs exist does not indicate what decisions should or will be made.

b) Principle #2: The Cost of Something Is What You Give Up to Get It

i) Making decisions requires individuals to consider the benefits and costs of some action.

ii) What are the costs of going to university?(1) We cannot count room and board (at least all of the cost) because the student would have to pay for food and shelter even if the person was not in school.(2) We would want to count the value of the student’s time because the person could be working for pay instead of attending classes and studying.iii) Definition of opportunity cost : whatever must be given up in order to obtain some item.One of the hardest ideas for students to grasp is that “free” things are not truly free.Thus, you will need to provide students with numerous examples of such “free” things with hidden costs, especially the value of time. Suggested examples include the time students spend waiting in line for “free” event tickets at their universities, time spent relaxing in the sun, or dinner in a restaurant with their parents.

c) Principle #3: Rational People Think at the Margin

i) Economists generally assume that people are rational.

(1) Definition of rational : people who systematically and purposefully doing the best they can to achieve their objectives.(2) Consumers want to purchase the goods and services that allow them the greatest level of satisfaction given their incomes and the prices they face.(3) Firm managers want to produce the level of output that maximizes the profits the firms earn.(4) Many decisions in life involve incremental decisions: Should I stay at university this semester?ii) Should I take another course this semester? Should I study another hour for tomorrow’s exam?(1) Definition of marginal change : a small incremental adjustment to a plan of action.(2) Example: Suppose that flying a 200-seat plane from Amman to Cairo costs the airline (3) $100,000, which means that the average cost of each seat is $500. Suppose that the plane is minutes from departure and a passenger is willing to pay $300 for a seat. Should the airline sell the seat for $300? In this case, the marginal cost of an additional passenger is very small.(4) Another example: Why is water so cheap while diamonds are expensive? The marginal benefit of a good depends on how many units a person already has. Because water is plentiful, the marginal benefit of an additional cup is small. Because diamonds are rare, the marginal benefit of an extra diamond is high.iii) A rational decision maker takes an action if and only if the marginal benefit is at least as large as the marginal cost.

d) Principle #4: People Respond to Incentives

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