10 Principles of Economics
Economics, Investment, and Taxation
Overview
• Defining economics and its subject matter
• Ten Principles of Economics
• How people make decisions (1-4)
• How people interact (5-7)
• How the economy as whole works (8-10)
• 10 Commandments for non-economists
Defining economics and its subject matter
• The word economy comes from the Greek word oikonomos, which
means “one who manages a household” (Mankiw, 2008).
• Economics – the study of how individuals and societies choose to
allocate scarce resources to produce and distribute goods and
services (Gissy, 2008).
• Physicians : Illnesses Lawyers : Injustices Economists : Scarcity
Why study Economics?
• Physicians: Illnesses
• Lawyers: Injustices
• Economists: Scarcity
• We study economics because there is scarcity.
• Scarcity – the limited nature of society’s resources.
• It leads to inflation, poverty, inequality,
unemployment, and economic crises.
• Shortage – Quantity Demand > Quantity Supplied
PRINCIPLE 1:
PEOPLE FACE
TRADE-OFFS
PRINCIPLE 1: Key Concepts
Efficiency
• It refers to the ability to maximize the use of available
resources to produce the maximum amount of output
possible.
• In other words, an economy is efficient when it
produces the greatest amount of goods and services
using the least amount of inputs, such as labor, capital,
and natural resources.
• An efficient economy is able to create more wealth and
improve living standards for its citizens.
PRINCIPLE 1: Key Concepts
Equality
• It refers to the fair distribution of resources,
opportunities, and benefits among members of a
society.
• It implies that all individuals are entitled to the same
basic rights and opportunities, regardless of their
background or circumstances.
• Inequality arises when some individuals or groups have
access to more resources, opportunities, or benefits
than others, leading to disparities in income,
education, healthcare, and other areas.
PRINCIPLE 2:
THE COST OF
SOMETHING
IS WHAT
YOU GIVE UP
TO GET IT
PRINCIPLE 2: Key Concepts
Opportunity Cost
• It refers to the potential benefits or opportunities that are
given up when choosing one option over another.
• In other words, when you choose to do something, you also
choose not to do something else, and the benefits of that
other option represent the opportunity cost of your decision.
• For example, if you decide to spend money on a vacation,
the opportunity cost is the other things you could have done
with that money, such as paying off debt, investing, or
buying a car.
• Similarly, if you choose to spend time watching a movie, the
opportunity cost is the other things you could have done
with that time, such as studying, exercising, or spending time
with friends and family.
PRINCIPLE 3:
RATIONAL
PEOPLE THINK
AT THE MARGIN
PRINCIPLE 3: Key Concepts
• A rational person is someone who makes
decisions based on a systematic and logical
evaluation of the costs and benefits of different
options, with the aim of maximizing their own
self-interest.
• According to this perspective, rational people
are assumed to have well-defined preferences,
and they choose the option that they perceive
to be the most beneficial, given their
constraints and available information.
• Rational individuals are not motivated by
emotions, biases, or social norms, but rather by
a desire to optimize their own well-being.
PRINCIPLE 4:
PEOPLE
RESPOND TO
INCENTIVES
PRINCIPLE 4: Key Concepts
• An incentive is a reward or benefit that is offered to
encourage a particular behavior.
• For example, a company might offer its employees a
bonus for meeting certain performance targets, or a
government might offer tax credits for individuals who
purchase electric cars.
• Incentives are designed to motivate people to act in a
certain way by offering them something they value.
PRINCIPLE 4: Key
Concepts
• On the other hand, a disincentive is a
penalty or punishment that is imposed
to discourage a particular behavior.
• For example, a government might
impose fines for littering, or a
company might withhold bonuses for
employees who fail to meet
performance targets.
• Disincentives are designed to
discourage people from acting in a
certain way by making the
consequences of their actions less
desirable.
PRINCIPLE 5: TRADE CAN MAKE EVERYONE BETTER OFF
PRINCIPLE 5: Key Concepts
• Specialization in trade refers to the concept of
countries or individuals focusing their production on a
narrow range of goods or services in which they have a
comparative advantage.
• In economics, comparative advantage refers to the
ability of a country or an individual to produce a good
or service at a lower opportunity cost than other
countries or individuals.
PRINCIPLE 5:
Key Concepts
• When countries specialize in
producing goods or services in
which they have a comparative
advantage, they can trade with
other countries for the goods
and services they do not
produce efficiently.
• This leads to increased efficiency
and productivity, as each
country can focus on producing
the goods or services they are
most efficient at, and trade for
the others.
PRINCIPLE 6:
MARKETS ARE
USUALLY A
GOOD WAY
TO ORGANIZE
ECONOMIC
ACTIVITY
PRINCIPLE 6: Key Concepts
Market Economy
• It is an economic system in which the production and
distribution of goods and services is primarily driven by
supply and demand in the marketplace.
• In a market economy, individuals and businesses own
and control the factors of production, such as land,
labor, and capital, and are free to produce and sell
goods and services in a competitive environment.
PRINCIPLE 7: GOVERNMENTS CAN SOMETIMES
IMPROVE MARKET OUTCOMES
PRINCIPLE 7: Key Concepts
• Property rights refer to the legal and social rights that
individuals or firms have to use, control, and dispose of
resources and assets, such as land, buildings,
intellectual property, and other forms of capital.
• They are a crucial aspect of a market economy, as they
provide incentives for individuals and firms to invest in
and use resources in productive ways.
• They enable individuals and firms to make investments
and take risks, knowing that they will be able to enjoy
the benefits of their investments and retain control
over their assets.
PRINCIPLE 7:
Key Concepts
• Market failure refers to a situation in which the market
mechanism fails to allocate resources efficiently,
resulting in an inefficient or suboptimal outcome for
society as a whole. In other words, market failure occurs
when the market fails to produce the socially optimal
level of goods or services, or when the distribution of
these goods or services is not equitable.
• Externalities: They occur when the production or
consumption of a good or service imposes costs or
benefits on others who are not involved in the
transaction. For example, pollution from a factory can
impose costs on nearby residents, while a vaccination
program can produce benefits for the entire community
PRINCIPLE 7:
Key Concepts
• Market power refers to the
ability of a firm or a group of
firms to influence the price or
quantity of goods or services in a
market.
• Market power arises when a firm
has the ability to influence
market prices and output by
manipulating the supply or
demand for its products.
PRINCIPLE 8: A COUNTRY’S STANDARD
OF LIVING DEPENDS ON ITS ABILITY
TO PRODUCE GOODS AND SERVICES
PRINCIPLE 8: Key
Concepts
• Productivity refers to the amount of
output that is produced per unit of
input, such as labor, capital, or time.
• It is a key driver of economic growth
and is often used as a measure of the
efficiency of an economy or a firm.
PRINCIPLE 9: PRICES RISE WHEN THE GOVERNMENT PRINTS TOO MUCH
MONEY
PRINCIPLE 9:
Key Concepts
• Inflation
• It refers to a sustained increase in the
general level of prices of goods and
services in an economy over time.
• In other words, inflation means that
the purchasing power of money
decreases over time.
• It is typically measured using an
inflation rate, which is the percentage
increase in the price level from one
period to another.
PRINCIPLE 10:
SOCIETY FACES A
SHORT-RUN TRADE-
OFF BETWEEN
INFLATION AND
UNEMPLOYMENT
PRINCIPLE 10: Key Concepts
• Philips Curve
• a graphical representation of the inverse
relationship between unemployment and
inflation.
• It shows that as unemployment falls,
inflation tends to rise, and vice versa.
• When the unemployment rate is low,
employers may need to offer higher wages
to attract workers, which can lead to higher
production costs and higher prices for
goods and services.
• Conversely, when the unemployment rate is
high, employers may be able to keep wages
low, which can help to keep production
costs and prices down.
The economic model of supply and demand
10 Commandments for non-economists
1. Economics is a collection of models with no 6. When an economist uses the term “economic
predetermined conclusions; reject any welfare,” ask what he/she means by it.
arguments otherwise.
2. Do not criticize an economist’s model 7. Beware that an economist may speak
because of its assumptions; ask how the differently in public than in the seminar room.
results would change if certain problematic
assumptions were more realistic. 8. Economists don’t (all) worship markets, but
3. Analysis requires simplicity; beware of they know better how they work than you do.
incoherence that passes itself off as 9. If you think all economists think alike, attend
complexity.
one of their seminars.
4. Do not let math scare you; economists use
math not because they are smart, but 10. If you think economists are especially rude
because they are not smart enough. to non-economists, attend one of their
5. When an economist makes a seminars.
recommendation, ask what makes him/her
sure the underlying model applies to the case
at hand.
