Ten Principles of Macroeconomics - Chapter 1 (Mankiw)

Principle 1: People Face Trade-Offs

• Scarcity and economics

  • Resources are scarce: the limited nature of society’s resources.
  • Society has limited resources and, therefore, cannot produce all the goods and services people want.
  • Economics is the study of how society manages its scarce resources.

• Economists examine what affects decisions and the economy

  • How people decide how much they work, what they buy, how much they save, how they invest their savings.
  • How firms decide how much to produce and how many workers to hire.
  • Forces and trends that affect the overall economy: growth in average income, unemployment, the rate at which prices are rising.

• Principle 1: People face trade-offs

  • To get one thing you want, you usually must give up another thing you want. Making decisions involves trading off one goal for another.
  • Examples:
  • Going to a party the night before an exam → less time for studying.
  • More money to buy stuff vs less time for leisure.
  • Working longer hours → less time for leisure.
  • Protecting the environment → resources could be used to produce consumer goods.

• EXAMPLE 1A: Society faces trade-offs

  • Spending more on the military (guns) to protect from foreign aggressors → less can be spent on consumer goods (butter).
  • Pollution regulations: cleaner environment and improved health → costs to firms’ owners, workers, and customers.

• EXAMPLE 1B: Trade-offs, efficiency, equality

  • Efficiency: society gets the maximum benefits from scarce resources.
  • Equality: economic prosperity distributed uniformly among society’s members.
  • Trade-off: to achieve greater equality, redistribute income from wealthy to poor, but this reduces incentive to work and produce, shrinking the size of the economic “pie.”

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

  • Making decisions: compare costs with benefits of alternative decisions; include opportunity costs.
  • Opportunity cost: whatever must be given up to obtain it.

• EXAMPLE 2: Opportunity cost

  • What is the opportunity cost of going to college for a year?
  • Tuition, books, and fees.
  • NOT: room and board.
  • PLUS foregone earnings.
  • What is the opportunity cost of going to the movies?
  • The price of the movie ticket.
  • PLUS the value of the time you spend in the theater.

• Principle 3: Rational People Think at the Margin

  • Rational people: systematically and purposefully do the best they can to achieve their goals, given the available opportunities.
  • Decisions are made by evaluating costs and benefits of marginal changes.
  • Marginal changes: small incremental adjustments to a plan of action.
  • Marginal benefit vs. marginal cost.

• Active Learning 1: Thinking at the margin

  • A. Manager at the local Save-a-lot considering hiring one more cashier that would increase sales revenues by $400 per week. The new cashier would earn $300 per week. Should you hire? Why?
  • B. You pay $8/month for access to Disney Plus, regardless of how many movies or TV shows you watch in a month. Should you watch one more movie (or episode)? Why?

• Active Learning 1: Answers, A

  • A. Marginal benefit of hiring one more cashier = $400 per week.
  • Marginal cost of hiring one more cashier = $300 per week.
  • Decision: Because the marginal benefit exceeds the marginal cost, the manager should hire the additional cashier.

• Active Learning 1: Answers, B

  • B. Marginal benefit of watching one more movie = the enjoyment you get from watching the movie.
  • Marginal cost = monetary cost = $0; plus the opportunity cost of time.
  • Decision: If the marginal benefit exceeds the marginal cost, watch the movie.

• Principle 4: People Respond to Incentives

  • Incentive: something that induces a person to act; can have unintended consequences.
  • People respond to incentives because rational people compare costs and benefits.
  • Example: An increase in the price of doughnuts leads to:
  • Consumers buy fewer doughnuts.
  • Sellers produce more doughnuts.

• EXAMPLE 3: Incentives

  • The government increases the gasoline tax by $1 per gallon.
  • How do consumers respond?
    • Drive more fuel-efficient cars, shift to electric cars, carpool, ride bikes, use public transportation, move closer to work.
  • How do businesses respond? (Not fully detailed in the transcript, but consider changes in supply decisions and pricing.)

• Active Learning 2: Applying the principles

  • You are selling your black 1967 Chevy Impala. You have already spent $2,000 on repairs. At the last minute, the transmission dies. You can pay $1,400 to have it repaired or sell the car “as is.” In each scenario, should you have the transmission repaired?
  • A. Blue book value (with transmission working) = $14,500; without = $11,200.
  • B. Blue book value (with transmission working) = $12,300; without = $11,000.

• Active Learning 2: Answers

  • Cost of fixing the transmission = $1,400.
  • A. Benefit of fixing transmission = $14,500 − $11,200 = $3,300. Therefore, fix.
  • B. Benefit of fixing transmission = $12,300 − $11,000 = $1,300. Therefore, do not pay $1,400 to fix.

• Principle 5: Trade Can Make Everyone Better Off

  • People benefit from trade: can buy a greater variety of goods and services at lower cost.
  • Countries benefit from trade: allows countries to specialize in what they do best and enjoy a greater variety of goods and services.
  • Example line: “For $5 a week you can watch baseball without being nagged to cut the grass!”

• 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).
  • Markets organize economic activity: what goods and services to produce, how to produce them, and how to allocate them to final users.
  • Market economy: allocates resources through the decentralized decisions of many firms and households as they interact in markets for goods and services.
  • Prices:
  • Determined by the interaction of buyers and sellers.
  • Reflect the good’s value to buyers.
  • Reflect the cost of producing the good.
  • Adam Smith’s “invisible hand”: prices adjust to guide market participants to reach outcomes that often maximize the well-being of society as a whole.

• Principle 7: Governments Can Sometimes Improve Market Outcomes

  • Government: enforce property rights—police and courts to enforce rules and maintain institutions key to a market economy.
  • People are less inclined to work, produce, invest, or purchase if there is a large risk of their property being stolen.
  • Government can promote efficiency by avoiding market failures:
  • Externality: effects on bystanders (e.g., pollution).
  • Market power: single buyer or seller with substantial influence on market price (e.g., monopoly).
  • Government can promote equality: use tax or welfare policies to change how the economic “pie” is divided.
  • Important caveat: to say government can improve market outcomes does not mean it always will.

• Active Learning 3: The government

  • In each of the following situations, what is the government’s role? 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.

• Principle 8: A country’s standard of living depends on its ability to produce goods and services

  • Huge variation in living standards across countries and over time:
  • 2019 average income: $65,000 in the U.S.; $5,000 in Nigeria.
  • Growth rate: about 2% per year, doubles every 35 years.
  • The U.S. standard of living today is eight times greater than 100 years ago.
  • Productivity is the most important determinant of living standards:
  • Defined as the quantity of goods and services produced from each unit of labor input.
  • Depends on equipment, skills, and technology available to workers.
  • Other factors (e.g., labor unions, competition from abroad) have far less impact on living standards.

• Principle 9: Prices rise when the government prints too much money

  • Inflation: an increase in the overall level of prices in the economy.
  • High inflation imposes various costs on society.
  • Policymakers’ goal: keep inflation at a reasonable rate.
  • 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 government creates money, the greater the inflation rate.

• Principle 10: Society faces a short-run trade-off between inflation and unemployment

  • Short-run trade-off: in the short run, many economic policies push inflation and unemployment in opposite directions.
  • Other factors can make this trade-off more or less favorable, but the trade-off is always present.

• THINK-PAIR-SHARE

  • Your university decides to reduce the price of a parking permit on campus from $250 per semester to $10 per semester.
  • A. The number of students desiring to park their cars on campus will .
  • B. The amount of time it would take to find a parking place will __.
  • C. Will the lower price of a parking permit necessarily lower the true cost of parking? (Hint: opportunity cost)
  • D. Would the opportunity cost of parking be the same for students with no outside employment and students with jobs earning $15 per hour?

• Individual decision making (CHAPTER IN A NUTSHELL)

  • People face trade-offs among alternative goals.
  • The cost of any action is measured in terms of forgone opportunities.
  • Rational people make decisions by comparing marginal costs and marginal benefits.
  • People change their behavior in response to the incentives they face.

• Economic interactions among people (CHAPTER IN A NUTSHELL)

  • Trade and interdependence can be mutually beneficial.
  • Markets are usually a good way of coordinating economic activity.
  • Governments can potentially improve market outcomes by remedying a market failure or by promoting greater economic equality.

• The economy as a whole (CHAPTER IN A NUTSHELL)

  • Productivity is the ultimate source of living standards.
  • Growth in the quantity of money is the ultimate source of inflation.
  • Society faces a short-run trade-off between inflation and unemployment.

• Key formulas and numerical references from the chapter

  • Productivity definition: \text{Productivity} = \frac{\text{Output}}{\text{Labor input}}.
  • Doubling time with a growth rate g: (1+g)^T = 2 \quad\Rightarrow\quad T = \frac{\ln 2}{\ln(1+g)}. For example, with a growth rate of 2% per year, Doubling time ≈ 35 years.
  • Living standards example: 2019 average income in the U.S. ≈ $65{,}000; Nigeria ≈ $5{,}000.
  • Productivity and living standards: productivity growth at ~2% per year leads to substantial long-run increases in living standards (e.g., doubling roughly every 35 years).
  • Real-world contrasts: the U.S. standard of living today is eight times greater than 100 years ago.
  • Example of opportunity costs (narrative): college costs include tuition, books, fees plus foregone earnings; movie-going costs include ticket price plus value of time.
  • Marginal analysis examples: A) MB = $400, MC = $300 per week for a new cashier; B) MB = enjoyment (non-monetary) vs MC = $0 monetary + opportunity cost of time.
  • Government policy response to incentives examples: gasoline tax responses include more fuel-efficient driving; pollution abatement and efficiency gains.
  • Externalities and market power examples: pollution externalities; monopolies as market power.
  • Think about different government roles: public goods (schools, highways), regulation (safety), property rights, patents, and welfare policies.