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PowerPoint Lecture Notes for Chapter 1: Ten Principles of Economics

Pri nciples of Microeconomics4th

edition, by N. Gregory Mankiw

PowerPoint Slides by Ron Cronovich

2006 Thomson South-Western, all rights reserved

N. G R E G O R Y M A N K I W

PowerPointSlidesby Ron Cronovich

1

P R I N C I P L E S O F

F O U R T H E D I T I O N

MICROECONOMICS

Ten Principles of EconomicsTen Principles of Economics

Dear Colleague,

Thank you for trying out the new Mankiw PowerPoints. Ive put a lot

of effort into them and Im very proud of them. Im confident you

will find them helpful.

I will be updating these PowerPoints roughly every 12-18 months toupdate data, fix any typos, incorporate the best suggestions from

users, and make improvements based on my experience using theseslides in my own classes. So I will welcome any comments or

suggestions you have. Please email them to me [email protected].

In this area (the notes section), I will occasionally include notes

that will be visible only by you, and will not display during your

presentation in class. These notes contain additional information thatmight be helpful in your teaching. So before you present a chapter inclass, please take a quick scan of the notes area of all slides in that

chapter.

For chapter 1, most instructors try to cover this chapter in a single

class session (especially those that are teaching the second of a two-semester sequence). If you are teaching a principles ofmicroeconomics course, you might consider skipping Principles 8-

10, as they deal with macroeconomics.

CHAPTER 1 TEN PRINCIPLES OF ECONOMICS 1

In this chapter, look for the answers tothese questions:

What kinds of questions does economics

address?

What are the principles of how people make

decisions?

What are the principles of how people interact?

What are the principles of how the economy as awhole works?
mailto:[email protected]:[email protected]


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What economics is all about

Scarcity refers to the limited nature of societys

resources.

Economics is the study of how society manages

its scarce resources, including

how people decide how much to work, save,and spend, and what to buy

how firms decide how much to produce,how many workers to hire

how society decides how to divide its resourcesbetween national defense, consumer goods,protecting the environment, and other needs

You might want to elaborate a bit on some of the points made here.

Some examples are below:

How do people decide how much to work? Time is scarce

resource many of our students know this very well. Theres just not

enough time to do everything wed like to do. How do we decidehow much of our time to spend working? Theres a tradeoff: the

more time we spend working, the higher our income, and thereforethe more stuff we can buy. But, the more time we spend working, theless time we have for leisure hanging out with friends, going hiking,

watching movies, etc. (You might want to ask your students how

THEY decide how much time to spend working. Some will say itdepends on how many classes they are taking, or the timerequirements of the available jobs. But probably at least a few will

say the wage the higher the wage, the more worthwhile to work.)

How do firms decide what kind of labor to hire? Firms can hire

unskilled or skilled workers. The skilled workers are moreproductive, but cost more than the unskilled workers.

How do firms decide how much to produce? Ask your students,

and see if any of them say it depends on the price of the product theysell. (Probably some will say it depends on whether theres a lot of

demand for the product. To which you might respond and iftheres a lot of demand for the product, what does that mean for the

price that firms can get for the product?)


HOW PEOPLE MAKE DECISIONS

Decision-making is

at the heart of

economics.

The first fourprinciples deal with

how people make

decisions.

Decision-making is at the heart of economics. The individual mustdecide how much to save for retirement, how much to spend ondifferent goods and services, how many hours a week to work. The

firm must decide how much to produce, what kind of labor to hire.

Society as a whole must decide how much to spend on nationaldefense (guns) versus how much to spend on consumer goods(butter).



All decisions involve tradeoffs. Examples:

Going to a party the night before your midterm

leaves less time for studying.

Having more money to buy stuff requires working

longer hours, which leaves less time for leisure.

Protecting the environment requires resources

that might otherwise be used to produce

consumer goods.

Principle #1: People Face TradeoffsPrinciple #1: People Face Tradeoffs


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Society faces an important tradeoff:

eff ic iency vs. equi ty

efficiency: getting the most out of scarce

resources

equity: distributing prosperity fairly among

societys members

Tradeoff: To increase equity, can redistribute

income from the well-off to the poor.But this reduces the incentive to work and produce,

and shrinks the size of the economic pie.

Principle #1: People Face TradeoffsPrinciple #1: People Face Tradeoffs

The last point is expressed rather tersely on the slide; you may want

to elaborate verbally to insure that the point is clear.

Redistribute income from the rich to the poor is accomplished

through the progressive tax system, as well as social programs like

food stamps and unemployment insurance that try to provide a safetynet for people at the low end of the income distribution.

But this reduces the incentive to work hard the reward forworking hard is a high income. Taxes reduce this reward, and

therefore reduce the incentive to work hard.



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.

Principle #2: The Cost of Something Is What

You Give Up to Get It





Examples:

The opportunity cost of

going to college for a year is not just the tuition,

books, and fees, but also the foregone wages.

seeing a movie is not just the price of the ticket,

but the value of the time you spend in the theater.





Heres a fun tangent, if you have the class time and are so inclined:

Ask your students about the saying The best things in life are free.

Ask them to name some of these things that supposedly are free. Ask

them what free means in this context. The idea here is to get themto see that even things without an explicit monetary cost are not trulyfree, because they have an opportunity cost.

For example, when you ask them to name the best things that are

free, they will respond with answers like love, sitting at the top of a

mountain you just climbed and enjoying an awesome view, or maybewitnessing the joy of a child who has just been given a new toy. Ineach case, there is no explicit monetary cost, but theres an

opportunity cost.

For example, a day spent climbing a mountain represents a day of

foregone wages. And the fact that the mountain offers the incredibleview probably means that land has been set aside for a national parkthat might otherwise be used to produce industrial chemicals, or it

might be used for a subdivision of million-dollar homes.

With love, its less obvious, but if prodded enough, your students willbe 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 hes the worlds worst actor. But yourboyfriend/girlfriend/teenaged daughter or other loved one is DYING

to see it, they are BEGGING you to take them. So you take them.Thats true love, dont you think? And its certainly not free.


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A person is rational if she systematically and

purposefully does the best she can to achieve

her objectives.

Many decisions are not all or nothing,but involve marginal changes incremental

adjustments to an existing plan.

Evaluating the costs and benefits of marginal

changes is an important part of decision-making.

Principle #3: Rational People Think at the

Margin


Margin

This definition of rational is new to the 4th edition of the textbook.

You might want to elaborate a bit on what economists mean byrational.

In economics, a rational consumer makes decisions about the goods

she buys (which ones and how much of each) with the goal ofmaximizing her well-being, subject to her income, the prices of the

goods, and her preferences.

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.



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.


Margin


Margin



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.

Principle #4: People Respond to IncentivesPrinciple #4: People Respond to Incentives

The definition of incentive is new to the 4th

edition.


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AA CC TT IIVVE LE L EEAA RRNN II NN GG 11::

ExerciseExercise

You are selling your 1996 Mustang. You have

already spent $1000 on repairs.

At the last minute, the transmission dies. You can

pay $600 to have it repaired, or sell the car as is.

In each of the following scenarios, should you have

the transmission repaired?

A. Blue book value is $6500 if transmission works,

$5700 if it doesnt

B. Blue book value is $6000 if transmission works,

$5500 if it doesnt

11

Most of these PowerPoint chapters have two or three Active Learning

activities. They break up the lecture with a short in-class activity for

immediate reinforcement, application, or assessment of the material in thepreceding slides.

A good idea is to give students time to formulate their answers before askingfor volunteers to share their answers with the class. When the questions or

exercises are more complex, consider having them work in pairs.

Digression on class parti cipation:

In general, its not a good idea to try to solicit participation by saying Now

who can tell me the answer to.. The invariable result is regular

participation by very few students the quick thinkers that have the

confidence to answer spontaneously in front of the class while most

students remain silent.

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 otherwhy 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 answerwith, 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 theyre getting) which you can then

correct before moving on to cover additional material.End of di gression.


AnswersAnswers

Cost of fixing transmission = $600

A. Blue book value is $6500 if transmission works,

$5700 if it doesnt

Benefit of fixing the transmission = $800

($6500 5700).

Its worthwhile to have the transmission fixed.

B. Blue book value is $6000 if transmission works,

$5500 if it doesnt

Benefit of fixing the transmission is only $500.

Paying $600 to fix transmission is not worthwhile.12


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AnswersAnswers

Observations:

The $1000 you previously spent on repairs is

irrelevant. What matters is the cost and benefit

of the marginalrepair (the transmission).

The change in incentives from scenario A

to scenario B caused your decision to change.

13

If you wish, you can omit this slide and just give this information to

the class verbally.


HOW PEOPLE INTERACT

An economy is just

a group of people

interacting with

each other.

The next

three principles

deal with how people

interact.

Whether were talking about the U.S. economy, or the local economy,

the term economy simply means a group of people interacting witheach other.

These interactions play a critical role in the allocation of societys

scarce resources. For example, the interaction of buyers and sellersdetermines the prices of goods and the amounts produced and sold.

These interactions are an important part of what economists study.


HOW PEOPLE INTERACT

Rather than being self-sufficient, people can

specialize in producing one good or service

and exchange it for other goods.

Countries also benefit from trade & specialization:

get a better price abroad for goods theyproduce

buy other goods more cheaply from abroadthan could be produced at home

Principle #5: Trade Can Make Everyone Better

Off

Principle #5: Trade Can Make Everyone Better

Off

If each person had to grow his own food, make his own clothes, cuthis own hair, we would have a world full of skinny, unfashionable

poor people having bad hair days every day of the week.

Its far more efficient for each person to specialize in producing agood or service, and then exchanging it with other people for the

things they produce.

The statement trade can make everyone better off should not behard to understand, if you think about it for a moment: Each of two

parties would not voluntarily enter into an exchange if it made eitherof them worse off, now would they?

The same principles apply at the national and international level:

International trade allows countries to sell their exports abroad and

get a higher price, and to buy things from abroad more cheaply thanthey could produce at home.

In addition, trade gives a countrys consumers access to a greatervariety of goods including goods they might not be able to get at

all. For example, U.S. consumers enjoy a variety of fresh produceyear-round. This would not be possible without international trade.


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HOW PEOPLE INTERACT

A market is a group of buyers and sellers.

(They need not be in a single location.)

Organize economic activity means determining

what goods to produce how to produce them how much of each to produce who gets them

Principle #6: Markets Are Usually A Good

Way to Organize Economic Activity



A market economy is decentralized, meaning that there is no

government committee that makes the decisions about what goods toproduce and so forth. Instead, many households and firms make theirown decisions:

Each of many households decides who to work for and what goodsto buy.

Each of many firms decides whom to hire and what goods to

produce.


HOW PEOPLE INTERACT

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.






HOW PEOPLE INTERACT

The invisible hand works through the price system:

The interaction of buyers and sellersdetermines prices of goods and services.

Each price reflects the goods value to buyersand the cost of produc ing the good.

Prices guide self-interested households andfirms to make decisions that, in many cases,

maximize societys economic well-being.






HOW PEOPLE INTERACT

Important role for govt: enforce property rights

(with police, courts)

People are less inclined to work, produce, invest, or

purchase if large risk of their property being stolen.

A restaurant wont serve meals if customersdo not pay before they leave.

A music company wont produce CDs if too manypeople avoid paying by making illegal cop ies.

Principle #7: Governments Can Sometimes

Improve Market Outcomes



Govt is an abbreviation for government. Throughout all of the

PowerPoint chapters, I will try to use abbreviations the way athoughtful instructor would use them if writing on a blackboard. Ifyou prefer to spell the word out, just use your mouse to highlight

govt and then type out the full word.

Many fledging market economies are struggling through thetransition from central planning because they have not developed

institutions that protect and enforce property rights. The British newsmagazine The Economisthas 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 ofFortune magazine entitledUkraine: How Not To Run An Economy.


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HOW PEOPLE INTERACT

Govt may alter market outcome to promote efficiency

market failure, when the market fails to allocate

societys resources efficiently. Causes:

externalities, when the production or consumptionof 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.






HOW PEOPLE INTERACT

Govt may alter market outcome to promote equity

If the markets distribution of economic well-being

is not desirable, tax or welfare policies can change

how the economic pie is divided.






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AA CC TT IIVVE LE L EEAA RRNN II NN G 2G 2::

Discussion QuestionsDiscussion Questions

In each of the following situations, what is the

governments role? Does the governments

intervention improve the outcome?

a. Public schools for K-12

b. Workplace safety regulations

c. Public highways

d. Patent laws, which allow drug companies to

charge high prices for life-saving drugs

22

The items in this list are meant to get students thinking about Principles 6

and 7 in the context of specific examples, and to generate discussion rather

than arrive at definitive answers.

NOTE: Discussing the entire list would consume a lot of class time (20-

25 minutes). Two would suffice. Pick your favorite two and delete theothers. Of course, you can skip this slide entirely if you wish to get

through the chapter as quickly as possible.

Here are some notes which might help guide the discussion:

a. Publi c schools. The alternative would private schools. The cost of

education would be concentrated among those with school-aged children,

rather than spread over all taxpayers, so the price per child would likely be

high. Some families would not be able to afford to enroll their children inschools, and would either home-school the children or raise them without

education. Is the benefit to society of having an educated population large

enough to justify making people without children share in the cost? Couldthe private sector provide education more efficiently (either at lower cost or

higher quality) than the public sector?

b. Workplace safety regulations. Without such regulations, would firmsprovide a safe environment for their workers? Some students will say no

look at how bad working conditions are in poor countries which have no

safety regulations. Another view is dropping such regulations would make

workers better off. Workers may view the safety of their work environment

as part of their wage: the less safe the environment at a specific firm, thehigher the wage the firm will have to offer to make workers willing to work

there. If workers vary with respect to their tolerance for unsafe conditions,then workers with a high risk tolerance would be better off if given the

option to work for higher wages in factories that arent as safe. Such

workers would be worse off if the government required all firms to provide

equally safe conditions.

c. Publi c highways. The alternative would be toll highways operated bythe private sector. People who use highways more would pay more, and

people that use them less would pay less, which seems fairer than having

everyone pay equally for highways. (Actually, everyone does not payequally - people who use public roads more buy more gas, and therefore pay

more gas tax.) If there are external benefits to society of having a national

highway system, then the private sector would under-provide this good.

d. Patent laws. Ive 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?


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HOW THE ECONOMY AS A WHOLE WORKS

The last three

principles deal with

the economy as a

whole.



Huge variation in living standards across

countries and over time:

Average income in rich countries is more thanten times average income in poor countries.

The U.S. standard of living today is abouteight times larger than 100 years ago.

Principle #8: A countrys standard of living

depends on its ability to produce goods &

services.



services.

On this slide, rich countries refers to countries like the U.S., Japan,

and Germany, poor countries refers to countries like India,Indonesia, and Nigeria.



The most important determinant of living standards:productivity, the amount of goods and servicesproduced per unit of labor.

Productivity depends on the equipment, skills, andtechnology available to workers.

Other factors (e.g. labor unions, competition fromabroad) have far less impact on living standards.



services.



services.



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.

Principle #9: Prices rise when the

government prints too much money.

Principle #9: Prices rise when the

government prints too much money.


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In the short-run (1 2 years),

many economic policies push inflation and

unemployment in opposite directions.

Other factors can make this tradeoff more or less

favorable, but the tradeoff is always present.

Principle #10: Society faces a short-run

tradeoff between inflation and unemployment

Principle #10: Society faces a short-run

tradeoff between inflation and unemployment

While the long-run effect of increasing the quantity of money is

inflation, the short-run effects are more complicated - andcontroversial. However, most mainstream economists believefollowing: An increase in the quantity of money causes spending to

rise, which causes prices to rise, which induces firms to produce more

goods and services, which requires that they hire more workers.Hence, in the short-run, increasing the quantity of money causes

inflation to rise, but unemployment to fall.

Of course, REDUCING the quantity of money would have the

opposite effects (inflation would fall, while unemployment would

rise) in the short run.

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 thelong 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 tradeoffmore or less favorable, but the tradeoff is always present addresses

the following point: In some decades, factors outside of the controlof 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

1. Summarize, dont highlight.

Highlighting is a passive activity that wont improveyour comprehension or retention. Instead, summarize

each section in a few sentences of your own words.

When you finish, compare your summary to the one

at the end of the chapter.

2. Test yourself.

Try the QuickQuiz that follows each section before

moving on to the next section. Write your answers

down, and compare them to the answers in the backof the book. If your answers are incorrect, review the

section before moving on.

Most students, especially those in their first year of college, have notbeen taught good study skills. Yet, we professors expect them toknow how to study. Your university may offer free one-time

workshops for students on study skills; if so, you might announce

them in class. In the meantime, we offer your students this FYI boxin the textbook, reproduced here in the PowerPoint presentation ofchapter 1.

If youre pressed for time, you can omit it from your presentation of

the chapter, and instead just refer students to it in the textbook.



3. Practice, practice, practice.

Work through the end-of-chapter review questionsand problems. They are often good practice for the

exams. And the more you use your new knowledge,

the more solid it will become.4. Go online.

The book comes with excellent web resources,

including practice quizzes, tools to strengthen your

graphing skills, helpful video clips, and other

resources to help you learn the textbook materialmore easily and e ffectively.

If you do not like They are often good practice for the exams,please feel free to delete it. Ive found, though, that students are more

motivated to work practice problems when they think that doing sowill help them earn a higher score on the exam.


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5. Study in groups.

Get together with a few of your classmates to revieweach chapter, quiz each other, and help each other

understand the material in the chapter.

6. Dont forget the real world.

Read the Case Studies and In The News boxes ineach chapter. They will help you see how the new

terms, concepts, models, and graphs apply to the real

world. As you read the newspaper or watch the

evening news, see if you can find the connectionswith what youre learning 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 Princi plesfrom this chapter,

you will see an icon like this one:


CHAPTER SUMMARY

The principles of decision-making are:

People face tradeoffs

The cost of any action is measured in terms offoregone opportunities.

Rational people make decisions by comparingmarginal costs and marginal benefits.

People respond to incentives.

Many instructors do not use class time to cover the chaptersummaries. They appear in the textbook.


CHAPTER SUMMARY

The principles of interactions among people are:

Trade can be mutually beneficial.

Markets are usually a good way ofcoordinating trade.

Govt can potentially improve marketoutcomes if there is a market failureor if the market outcome is inequitable.


CHAPTER SUMMARY

The principles of the economy as a whole are:

Productivity is the ultimate source of livingstandards.

Money growth is the ultimate source ofinflation.

Society faces a short-run tradeoff betweeninflation and unemployment.

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