Principles of

Microeconomics

By N. Gregory Mankiw

Hafiz Muhammad Abubakar Siddique

GIFT Business School, GIFT University Gujranwala
 Chapter 1:

Ten Principles of Economics

Hafiz Muhammad Abubakar Siddique

 Introduction

• Adam Smith (1723–1790) considered to be the founding father of

Economics.

• He wrote a book “An Inquiry into the Nature and Causes of the Wealth of
Nations” in 1776. In the book Adam Smith defined economics as a
Science of Wealth.

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 Introduction

• Economics is a social science which studies the

human behavior.

• Economic theories seeks to predict and explain

economic behavior. It refers to microeconomics and
macroeconomics.

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 Conti…
• Microeconomics is the branch of economics that deals with the
behavior of individual economic units,
such as individual consumers, firms, workers and investors as well
as the markets that these units comprise.

• Macroeconomics is the branch of economics that deals with

aggregate economic variables,
such as the level and growth rate of national output, interest rates,
unemployment and inflation.
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 Conti…

• The word economy comes from a Greek word which means

“one who manages a household.”

• A household and an economy face many decisions:

• Who will work?
• What goods and how many of them should be produced?
• What resources should be used in production?
• At what price should the goods be sold?
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 Conti…

Society and Scarce Resources:

• The management of society’s resources is important
because resources are scarce.

• Scarcity means that society has limited resources and

therefore cannot produce all the goods and services
people wish to have.

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 Definition of Economics
• Economics is the study of how society manages its scarce
resources. For example
• how people decide what to buy, how much to work, save, and
spend
• how firms decide how much to produce, how many workers to
hire
• how society decides how to divide its resources between national
defense, consumer goods, protecting the environment, and other
needs

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 Ten Principles of Economics

A. How People Make Decisions

1. People face tradeoffs.
2. The cost of something is what you give up to get it.
3. Rational people think at the margin.
4. Rational People respond to incentives.

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 Principle 1: People face tradeoffs.

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 could
otherwise be used to produce consumer goods.

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 Principle 1: People face tradeoffs.
Society faces an important tradeoff
between Efficiency and Equality
• Efficiency: when society gets the most from its scarce resources
• Equality: when prosperity is distributed uniformly among the
members of society
• Tradeoff: To achieve greater equality, could redistribute income
from wealthy to poor. But this reduces the incentive to work and
produce, and also shrinks the size of the economic “pie.”
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 Principle 2: The Cost Of Something Is
What You Give Up To Get It

• Making decisions requires comparing the costs and benefits

of alternative choices.
• The opportunity cost of any item is what you give up to get
it.
• It is the relevant cost for decision making.

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 Principle 2:

For Example
• 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.

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 Principle 3: Rational People Think At The Margin
• Economists normally assume that people are rational.
• Rational people
• systematically and purposefully do the best they can, to
achieve their objectives.
• And make decisions by evaluating marginal costs and
marginal benefits
• Marginal changes: a small incremental adjustment to an existing
plan of actions.
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 Principle 3:

Examples
• When a student considers whether to go to college for an
additional year, he compares the fees & foregone wages to the
extra income he could earn with the extra year of education.

• When a manager considers whether to increase output, she

compares the cost of the needed labor and materials to the extra
revenue.

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 Principle 4:
Rational People Respond To Incentives
• An Incentive is something that induces a person to act, such as
the prospect of a punishment or reward.
• Rational people respond to incentives e.g.
• When the price of an apple rises, people decide to eat fewer
apples. At the same time apple orchards decide to hire more
workers and harvest more apples.

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 Ten Principles of Economics

B. How People Interact with each other

5. Trade can make everyone better off.
6. Markets are usually a good way to organize economic activity.
7. Governments can sometimes improve economic outcomes.

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 Principle 5:
Trade Can Make Everyone Better Off

• Rather than being self-sufficient, people can specialize in

producing one good or service and exchange it for other goods.

• Countries also get benefit from trade & specialization:

• Get a better price in abroad for goods they produce.
• Buy other goods more cheaply from abroad than could be
produced at home
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 Principle 6: Markets Are Usually A Good Way To
Organize Economic Activity
• Market: a group of buyers and sellers
(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
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 Principle 7: Governments Can Sometimes
Improve Economic Outcomes

• Important role for Government: To enforce property

rights

• People are less motivated to work, produce, invest, or

purchase if large risk of their property being stolen.

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 Principle 7:
• 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 promote efficiency.
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 Ten Principles of Economics

C. The forces and trends that affect how the economy as a

whole works.
8. The standard of living depends on a country’s production.
9. Prices rise when the government prints too much money.
10. Society faces a short-run tradeoff between inflation and
unemployment.

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 Principle 8: The Standard Of Living Depends On A
Country’s Production

• Standard of living may be measured in different ways:

• By comparing personal incomes.
• By comparing the total market value of a nation’s
production.

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 Principle 8:

• The most important determinant of living standards is

productivity:
• Productivity, the amount of goods and services produced
per unit of labor.

• Productivity depends on the equipment, skills, and

technology available to workers.

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 Principle 9: Prices Rise When The Government
Prints Too Much 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.
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 Principle 10: Society Faces A Short-run Tradeoff
Between Inflation And Unemployment

• 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.

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 Principle 10:

• The Phillips Curve illustrates the inverse tradeoff between inflation

and unemployment in the Short Run.

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 Thank You.

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