1

INTRODUCTION

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Ten principles of
Economics
Chapter 1
In this chapter,
look for the answers to these questions:

• What is economics?
• 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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1.Economics and Scarcity

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 1.1. What is
Economics?

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 Economy. . .

. . . The word economy comes from a Greek

word oikonomos for “one who manages a
household.”

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What is economics?

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 What is economics?
how to make
money in how to
own and
stocks, bonds
operate a
or real estate? business

how to develop a
new tax law or
new budget to
reform the welfare
system

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 What is economics?
• Economics is the study of choice under
conditions of scarcity
• Scarcity: . . . means that society has limited
resources and therefore cannot produce all
the goods and services people wish to have.
• Wants: human has unlimited wants. They
always wants more and more.
• → Households and society have to make
CHOICE under scarcity

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 1.2. Scarcity

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Why do we need to earn money?

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 Needs
People have to satisfy their needs & wants

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Maslow’s hierarchy of needs

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 Consumption
To satisfy needs, people need to consume goods
and services

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 Production
In order to have goods and services for consumption, there
must be production activities.

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 Is production….unlimited?
Needs/Wants Consumption Production

Unlimited…. Unlimited….? Unlimited….?

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 Resources
These are the factors that are used to produce the
goods and services

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Scarcity Resource

All factors are

LIMITED
supply

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1.Are resources limited or
unlimited?

2.Are wants limited or

unlimited?

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 Scarcity?
Scarcity: . . . means that society has limited resources and
therefore cannot produce all the goods and services people
wish to have.
UNLIMITED
WANTS LIMITED
(cars, RESOURCES
house,…) (time,
money,….)

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Does a person face scarcity?

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Solution to
scarcity?

Choice
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What is economics?

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 1.3.
Economic
actors

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 Economic actors

1. Household

– They buy goods and service – They supply resources (labour,

produce by firms (e.g. food, land, capital) to firms
clothes)

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 Economics actors

2. Firms

– They buy factors of productions – They produce and supply

from household (labour, land, goods and services
capital)

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 Economics actors
3. Government

– Supply public good – Redistribute income in the

economy

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 Who do not face scarcity?

1. Household face scarcity of

time, money, health…
2. Firms face scarcity of
capital, labours…
3. Government face scarcity
of resource, budget…

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Three economic questions– Household

1. 2. 3.
How much to Consume
What goods
consume the good to
to consume?
them? whom?

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Three economics questions– Firms and Government

1. 2. 3.
How to Produce to
What good
produce whom?
to produce?
them?

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2. Ten
principles
of
Economics
 TEN PRINCIPLES OF ECONOMICS
• How people make decisions.
– People face tradeoffs.
– The cost of something is what you give up to get
it.
– Rational people think at the margin.
– People respond to incentives.

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 TEN PRINCIPLES OF ECONOMICS
• How people interact
– Trade can make everyone better off.
– Markets are usually a good way to organize
economic activity.
– Governments can sometimes improve market
outcomes.

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 TEN PRINCIPLES OF ECONOMICS
• How the economy as a whole works
– A country’s standard of living depends on its
ability to produce goods & services.
– Prices rise when the government prints too much
money.
– Society faces a short-run tradeoff between
inflation and unemployment.

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The principles of
HOW PEOPLE
MAKE DECISIONS

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 Principle #1: People Face Tradeoffs.

“There is no such thing as a free lunch!”

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World of trade-off

To get one thing, we usually have to give up

another thing.
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 Example of trade off
Person:
• Buy clothes or food?
• Leisure time vs. work?
Firm:
• Labour vs. Machine?
Society:
• Education vs. Army?
• Efficiency vs. Equality?
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 Principle #1: People Face Tradeoffs.

• Society faces an important tradeoff:

efficiency vs. equality
• Efficiency: means society gets the most from its scarce
resources
• Equality: means the benefits of those resources are
distributed fairly among the members of society
• Tradeoff: To achieve greater equality,
could redistribute income from wealthy to poor.
But this reduces incentive to work and produce, shrinks
the size of the economic “pie.”

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 Principle #1: People Face Tradeoffs.

Efficiency vs. Equality

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Understand life’s trade-offs is important
because people are likely to make good
decisions only if they understand the
options that they have available

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

• Decisions require comparing costs and benefits

of alternatives.
– Whether to go to college or to work?
– Whether to study or go out on a date?
– Whether to go to class or sleep in?

• The opportunity cost of an item is the second –

best thing what you give up to obtain that
item.

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Chi phí cơ hội Example
(Opportunity – Đức: has 50000 VND
cost) – What can he buy with 50000đ?
– Milk tea, movie ticket, comic book, notebook…
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Chi phí cơ hội
(Opportunity cost)

– Two best options: Comic book and

milk tea
– Final decision: Milk tea
– The opportunity cost of the milk tea is
the comic book that he didn’t buy

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 Opportunity Cost

Discussion
You receive a free ticket to see
the music concert tonight?
You do not face the
opportunity costs???
 Remind: Opportunity Cost

Definition – the cost expressed in terms of the next

best alternative sacrificed

• In Economics, costs are

always understood as
opportunity cost
• Every economic selection
always include opportunity
costs
ACTIVE LEARNING 1:
Calculate opportunity cost
Based on, the following data, what is the
opportunity cost of attending university?
Average Cost of a 4-year University

Tuition and fees $20,082

Books and supplies $870

Rooms or apartment $6,617

Transportation $1,031

Other costs $1,524

Total costs $30,124

Expected income for 1 year $20,000

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

LA Laker basketball star

Kobe Bryant chose to
skip college and go
straight from high
school to the pros
where he has earned
millions of dollars.

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

• Bill Gates and Mark Zuckerberg may have

attended Harvard, but they never graduated.

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

So, 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

• Water is a human need to survive

• Diamonds are unnecessary to survive
Why is water so cheap but diamonds are so
expensive?
→Answer: People think at the margin

Diamond is not essential,

Water is essential but is plenty, marginal cost for but it is rare, marginal
cost for an extra
an extra cup of water is small
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diamond is large
Principle #3: Rational People Think at the Margin

Rational people
– systematically and purposefully do the best they
can to achieve their objectives.
– make decisions by comparing marginal costs and
marginal benefits (marginal changes)
– marginal changes – incremental adjustments to an
existing plan.

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 HOW
Principle #3: PEOPLE
Rational MAKE
People DECISIONS
Think at the Margin

Examples:
• Cell phone users with unlimited minutes (the
minutes are free at the margin)
- Are often tend to making long calls
- Marginal benefit of the call > 0
- Marginal cost of an extra minute = 0
• 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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A C T I V E L E A R N I N G 2:
Applying the principles
You are selling your 1996 Toyota. You have already
spent $1000 on repairs.
At the last minute, the transmission dies. You have
2 choices: you can pay $600 to have it repaired
before selling or sell the car “as is.”
In each of the following scenarios, should you
repair the transmission? Explain.
A. Selling value is $6500 if transmission works,
$5700 if it doesn’t
B. Selling value is $6000 if transmission works,
$5500 if it doesn’t
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ACTIVE LEARNING 1
Answers
Cost of fixing transmission = $600
A. Selling book value is $6500 if transmission works,
$5700 if it doesn’t
Benefit of fixing the transmission = $800
($6500 – 5700) > Cost =$600
It’s worthwhile to have the transmission fixed.
B. Selling value is $6000 if transmission works,
$5500 if it doesn’t
Benefit of fixing the transmission is only $500.
Paying $600 to fix transmission is not worthwhile.
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A C T I V E L E A R N I N G 2:
Answers
Observations:
• 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.
• $1000 is sunk cost

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 Principle #4: People Respond to Incentives.

• Incentive: something that induces a person to

act, i.e. the prospect of a reward or punishment.
• Marginal changes in costs or benefits motivate
people to respond.
• The decision to choose one alternative over
another occurs when that alternative’s marginal
benefits exceed its marginal costs!
• Examples:
– When gas prices rise, consumers buy more hybrid cars
and fewer gas guzzling SUVs.
– When cigarette taxes increase, teen smoking falls.
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The principles of
HOW PEOPLE
INTERACT

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Principle #5: Trade Can Make Everyone Better Off.

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 Principle #5: Trade Can Make Everyone Better Off.

• People gain from their ability to trade with one

another.
• Trade allows people & country to specialize in what
they do best.
– 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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Principle #6: Markets Are Usually A Good Way to
Organize Economic Activity
• Market
– A group of buyers and sellers of a particular good or
service (need not be in a single location)
– Buyers
• Determine the demand for the product
– Sellers
• Determine the supply of the product

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 Principle #6: Markets Are Usually A Good Way to
Organize Economic Activity
• “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 #6: Markets Are Usually A Good Way to
Organize Economic Activity
• A market economy allocates resources through
the decentralized decisions of many households
and firms as they interact in markets.
• Centralized vs. Decentralized system
• 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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 Principle #7: Governments Can Sometimes Improve
Market Outcomes
1. Government - enforce property rights
(with police, courts)
• People are less inclined to work, produce, invest,
or purchase if large risk of their property being
stolen.

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Principle #7: Governments Can Sometimes Improve
Market Outcomes
2. Government - promote efficiency
• 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)

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Principle #7: Governments Can Sometimes Improve
Market Outcomes
3. Government - promote equality
– Avoid disparities in economic wellbeing
– Use tax or welfare policies to change how the
economic “pie” is divided

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The
principles of
HOW THE
ECONOMY
AS A WHOLE
WORKS

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 Principle #8: A country’s standard of living depends
on its ability to produce goods & services.

• 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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Table 1: The Variety of Growth Experiences

7 times

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Table 1: The Variety of Growth Experiences

25 times

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Table 1: The Variety of Growth Experiences

3 times same

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 Principle #8: A country’s standard of living depends
on its ability to produce goods & 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.
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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.

• The Phillips Curve illustrates the tradeoff

between inflation and unemployment:
Inflation  Unemployment
It’s a short-run tradeoff!

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CHAPTER SUMMARY

The principles of decision making are:

• 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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 reading
C H A P T E R 1 - M A N K I W, N . G ( 2 0 1 8 )
P R I N C I P L E S O F E C O N O M I C S , 8 TH E D I T I O N