WHATS NEW IN THE NINTH EDITION:

1 © 2018 Cengage Learning®. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.

WHAT’S NEW IN THE NINTH EDITION:

There are no major changes to this chapter.

LEARNING OBJECTIVES:

By the end of this chapter, students should understand:

➢ Explain how scarcity influences decisions.

➢ Explain how individuals evaluate opportunity costs to make decisions.

➢ Explain how marginal analysis influences decision making.

➢ Apply basic, economic principles of individual decision making that determine how an economy generally works.

➢ Explain how the terms of trade can lead to gains.

CONTEXT AND PURPOSE:

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

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TEN PRINCIPLES OF ECONOMICS

(Essentials of Economics, 9e Gregory Mankiw) (For Complete File, Download link at the end of this File) 1 / 4

• ❖ Chapter 1/Ten Principles of Economics

© 2018 Cengage Learning®. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.

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 improving 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.

CHAPTER OUTLINE:

• Introduction

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

household.”

• Both households and economies face many decisions about how to allocate resources.

• Resources are scarce so they must be managed carefully.

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

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

Because most college freshmen and sophomores 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.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.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.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 / 4

Chapter 1/Ten Principles of Economics ❖ 3 © 2018 Cengage Learning®. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.II. How People Make Decisions

A. Principle #1: People Face Trade-offs

• “There ain’t no such thing as a free lunch.” To get something that we like, we usually have to

give up, or trade for, something else that we also like.

• Examples include how students spend their time, how a family decides to spend its income,

how the U.S. government spends tax dollars, and how regulations may protect the environment at a cost to firm owners.

• An important trade-off that society faces is the trade-off between efficiency and equality.

• Definition of efficiency: the property of society getting the most it can from its

scarce resources.

b. Definition of equality: the property of distributing economic prosperity

uniformly among the members of society.

• For example, tax dollars paid by wealthy Americans 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.

• This implies that the cost of this increased equality is a reduction in the efficient use of

our resources.

• 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

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

• What are the costs of going to college?

• We should not count room and board (unless they are more expensive at college than

elsewhere) because the student would have to pay for food and shelter even if she were not in school.

• We should count the value of the student’s time because she could be working for pay

instead of attending classes and studying.

• 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. Provide students with many 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” sporting event tickets at their universities, time spent relaxing in the sun outside their residence halls, or driving on a road with no tolls but lots of congestion. 3 / 4

• ❖ Chapter 1/Ten Principles of Economics

© 2018 Cengage Learning®. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.

C. Principle #3: Rational People Think at the Margin

• Economists generally assume that people are rational.

• Definition of rational people: people who systematically and purposefully do the

best they can to achieve their objectives.

• Consumers want to purchase the goods and services that allow them the greatest level

of satisfaction given their incomes and the prices they face.

• Firm managers want to produce the level of output that maximizes the profits the firms

earn.

• Many decisions in life involve incremental decisions: Should I remain in school this semester?

Should I take another course this semester? Should I study another hour for tomorrow’s exam?

a. Definition of marginal change: a small incremental adjustment to a plan of

action.

• Example: Suppose that you are considering watching a movie tonight. You pay $40 a

month for a streaming service that gives you unlimited access to its film library. If you typically watch 8 movies a month, the average cost of a movie is $5. The marginal cost, however, is zero because you pay the same $40 regardless how many movies you stream. At the margin, streaming is free. When deciding whether to watch a movie, a rational person would compare the marginal benefit of watching a movie to the marginal cost. In this case, the only cost is the value of your time.

• Suppose that flying a 200-seat plane across the country costs the airline $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.

• 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.

• 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

1. Definition of incentive: something that induces a person to act.

• Because rational people make decisions by weighing costs and benefits, their decisions may

change in response to incentives.

• When the price of a good rises, consumers will buy less of it because its cost has risen.

• When the price of a good rises, producers will allocate more resources to the production

of the good because the benefit from producing the good has risen.

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