PowerPoint Lecture Notes for Chapter 1: Ten Principles of Economics Principles of Microeconomics 4th edition, by N.

Gregory Mankiw PowerPoint Slides by Ron Cronovich

Dear Colleague,

Ten Principles of Economics

PRINCIPLES OF

MICROECONOMICS
FOURTH EDITION

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 to update data, fix any typos, incorporate the best suggestions from users, and make improvements based on my experience using these 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. 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 that might be helpful in your teaching. So before you present a chapter in class, 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 twosemester sequence). If you are teaching a principles of microeconomics course, you might consider skipping Principles 810, as they deal with macroeconomics.

N. G R E G O R Y M A N K I W
Pow erPoint Slides by Ron Cronovich

2006 Thomson South-Western, all rights reserved

In this chapter, look for the answers to these 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 a
whole works?

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TEN PRINCIPLES OF ECONOMICS

What economics is all about Scarcity refers to the limited nature of societys
resources.

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 decide how much of our time to spend working? Theres a tradeoff: the more time we spend working, the higher our income, and therefore the more stuff we can buy. But, the more time we spend working, the less 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 it depends on how many classes they are taking, or the time requirements 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 more productive, 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 they sell. (Probably some will say it depends on whether theres a lot of demand for the product. To which you might respond and if theres a lot of demand for the product, what does that mean for the price that firms can get for the product?)

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 resources between national defense, consumer goods, protecting the environment, and other needs
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HOW PEOPLE MAKE DECISIONS Decision-making is

at the heart of economics.

The first four

principles deal with how people make decisions.

Decision-making is at the heart of economics. The individual must decide how much to save for retirement, how much to spend on different 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 national defense (guns) versus how much to spend on consumer goods (butter).
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HOW PEOPLE MAKE DECISIONS

Principle Principle #1: #1: People People Face Face Tradeoffs 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 might otherwise be used to produce consumer goods.
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HOW PEOPLE MAKE DECISIONS

Principle Principle #1: #1: People People Face Face Tradeoffs 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 safety net for people at the low end of the income distribution.
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Society faces an important tradeoff:

efficiency vs. equity

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

HOW PEOPLE MAKE DECISIONS

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

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.

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HOW PEOPLE MAKE DECISIONS

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 them to see that even things without an explicit monetary cost are not truly free, 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 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 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 incredible view probably means that land has been set aside for a national park that 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 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 hes the worlds 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. Thats true love, dont you think? And its certainly not free.

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

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HOW PEOPLE MAKE DECISIONS

Principle Principle #3: #3: Rational Rational People People Think Think at at the 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 by rational. In economics, a rational consumer makes decisions about the goods she buys (which ones and how much of each) with the goal of maximizing her well-being, subject to her income, the prices of the goods, and her preferences.
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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.
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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.

HOW PEOPLE MAKE DECISIONS

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.
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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.
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ACTIVE LEARNING

Exercise

1:

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
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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 the preceding slides. A good idea is to give students time to formulate their answers before asking for 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 participation: 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-PAIRSHARE. 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 theyre getting) which you can then correct before moving on to cover additional material. End of digression.

ACTIVE LEARNING

Answers

1:

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.
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ACTIVE LEARNING

Answers
Observations:

1:

If you wish, you can omit this slide and just give this information to the class verbally.

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.

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HOW PEOPLE INTERACT An economy is just

a group of people interacting with each other.

Whether were talking about the U.S. economy, or the local economy, the term economy simply means a group of people interacting with each other. These interactions play a critical role in the allocation of societys scarce resources. For example, the interaction of buyers and sellers determines the prices of goods and the amounts produced and sold. These interactions are an important part of what economists study.
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The next
three principles deal with how people interact.

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HOW PEOPLE INTERACT

Principle Principle #5: #5: Trade Trade Can Can Make Make Everyone Everyone Better Better Off Off

Rather than being self-sufficient, people can

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

If each person had to grow his own food, make his own clothes, cut his 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 a good or service, and then exchanging it with other people for the things they produce. The statement trade can make everyone better off should not be 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? 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 than they could produce at home. In addition, trade gives a countrys consumers access to a greater variety of goods including goods they might not be able to get at all. For example, U.S. consumers enjoy a variety of fresh produce year-round. This would not be possible without international trade.

Countries also benefit from trade & specialization:

get a better price abroad for goods they

produce

buy other goods more cheaply from abroad

than could be produced at home
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HOW PEOPLE INTERACT

Principle Principle #6: #6: Markets Markets Are Are Usually Usually A A Good Good Way Way to to Organize Organize Economic Economic Activity Activity

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
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A market economy is decentralized, meaning that there is no government committee that makes the decisions about what goods to produce and so forth. Instead, many households and firms make their own decisions: Each of many households decides who to work for and what goods to buy. Each of many firms decides whom to hire and what goods to produce.

HOW PEOPLE INTERACT

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.

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HOW PEOPLE INTERACT

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 goods 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 societys economic well-being.
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HOW PEOPLE INTERACT

Principle Principle #7: #7: Governments Governments Can Can Sometimes Sometimes Improve Improve Market Market Outcomes Outcomes

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.

Govt is an abbreviation for government. Throughout all of the PowerPoint chapters, I will try to use abbreviations the way a thoughtful instructor would use them if writing on a blackboard. If you 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 the transition from central planning because they have not developed institutions that protect and enforce property rights. The British news 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.

A restaurant wont serve meals if customers do not pay before they leave. A music company wont produce CDs if too many people avoid paying by making illegal copies.
TEN PRINCIPLES OF ECONOMICS 19

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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
societys 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.

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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 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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A C T I V E L E A R N I N G 2:

Discussion 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

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 (2025 minutes). Two would suffice. Pick your favorite two and delete the others. 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:
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a. Public 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 in schools, 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? Could the 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 firms provide 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, the higher 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. Public highways. The alternative would be toll highways operated by the 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 pay equally - 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?

HOW THE ECONOMY AS A WHOLE WORKS

The last three

principles deal with the economy as a whole.

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HOW THE ECONOMY AS A WHOLE WORKS

Principle Principle #8: #8: A A countrys countrys standard standard of of living living depends depends on on its its ability ability to to produce produce goods 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.

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.

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HOW THE ECONOMY AS A WHOLE WORKS

Principle Principle #8: #8: A A countrys countrys standard standard of of living living depends depends on on 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.
CHAPTER 1 TEN PRINCIPLES OF ECONOMICS 25

HOW THE ECONOMY AS A WHOLE WORKS

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.

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HOW THE ECONOMY AS A WHOLE WORKS

Principle Principle #10: #10: Society Society faces faces a a short-run short-run tradeoff tradeoff between between inflation inflation and and unemployment 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.

While the long-run effect of increasing the quantity of money is inflation, the short-run effects are more complicated - and controversial. However, most mainstream economists believe following: 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 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.

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FYI: How to read your textbook

1. Summarize, dont highlight. Highlighting is a passive activity that wont improve your 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 back of the book. If your answers are incorrect, review the section before moving on.
CHAPTER 1 TEN PRINCIPLES OF ECONOMICS 28

Most students, especially those in their first year of college, have not been taught good study skills. Yet, we professors expect them to know 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 box in the textbook, reproduced here in the PowerPoint presentation of chapter 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.

FYI: How to read your textbook

3. Practice, practice, practice. Work through the end-of-chapter review questions and 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 material more easily and effectively.
CHAPTER 1 TEN PRINCIPLES OF ECONOMICS 29

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 so will help them earn a higher score on the exam.

FYI: How to read your textbook

5. Study in groups. Get together with a few of your classmates to review each 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 in each 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 connections with what youre learning in the textbook.
CHAPTER 1 TEN PRINCIPLES OF ECONOMICS 30

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:

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CHAPTER SUMMARY The principles of decision-making are:

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

People face tradeoffs The cost of any action is measured in terms of

foregone opportunities.

Rational people make decisions by comparing

marginal costs and marginal benefits.

People respond to incentives.

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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.

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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.

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