Mankiw, N.G.

- Principles of economics
Resources are SCARCE.

The 10 Principles of Economics:

How People make decisions:
1. People face tradeoffs (ex. Efficiency vs. Equity).
2. The cost of something is what you give up to get it = opportunity cost.
3. Rational people think at the margin (marginal changes, marginal costs,
marginal benefits).
4. Peoples respond to incentives.
How People interact:
5. Trade can make everyone better off.
6. Markets are usually a good way to
organize economic activity.
7. Governments can sometimes improve
market outcomes. (market failure - the
market left on its own fails to allocate
resources
efficiently,
externality,
market power).

It is not from the benevolence of the butcher, the

brewer, or the baker that we expect our dinner,
but from their regard to their own interest. . . .
Every individual . . .neither intends to promote
the public interest, nor knows how much he is
promoting it. . . .
Adam Smith An Inquiry into the Nature and
Causes of the Wealth of Nations (1776)

How the economy as a whole works:

8. A countrys standard of living depends on its ability to produce goods and
services (productivity, budget deficits depress growth in living standards).
9. Prices rise when the government prints too much money.
10.Society faces a short-run tradeoff between inflation and unemployment
(because because prices are sticky in the short-run).
Circular-flow diagram two
types
of
decisionmakers

households and firms.

Firms
produce
goods
and
services using inputs, such as
labor, capital and land factors
of production.
Households consume goods and
services and own the factors of
production.
Ex 2 production possibilities
frontier

Interdependence and gains from trade

Absolute advantage comparison among producers according to productivity;
Comparative advantage comparison among producers according to their
opportunity cost.

Market Forces of supply and demand

Competitive markets markets in which there are many buyers and many
sellers so that each has a negligible impact on the market price (they are price
takers).
Perfect competition oligopoly monopolistically competitive (software industry)
monopoly.
Quantity demanded goods that buyers are willing and able to purchase
Price Law of demand price rises then demand falls;
Income (normal (if income falls demand falls) inferior goods)
Price of related goods (substitutes (if related goods prices falls it
reduces demand for another good) complements)
Tastes
Expectations
Quantity supplied goods that sellers are willing and able to sell

Price Law of supply supply rises when price rises;

Input prices
Technology
Expectations

Equilibrium a situation when supply and demand have been brought into
balance (quantity, price) market clearing price
Shortage quantity demanded is greater than quantity supplied;
Surplus quantity supplied is greater than quantity demanded.
Law of supply and demand the price adjusts to bring supply and demand into
equilibrium.
Elasticity a measure of the responsiveness of quantity demanded or quantity
supplied to one of its determinants

% change in quantity demanded

% change in price

Price elasticity of demand

Determinants of the price of elasticity in demand:
Necessities versus luxuries
Availability of close substitutes
Definition of the market

Q2 Q1
Q2 Q1
2

P2 P1
P2 P1
2

Time horizon

% change in quantity demanded

% change in income

Price elasticity of demand

Income elasticity of demand

% change in quantity demanded of good 1

% change in price of good 2
Cross price elasticity of demand

% change in quantity suPPlied

% change in price

Price elasticity of demand

Supply,demand and government forces

Price ceilings create shortages.
Price floors create surpluses.
Tax incidence the study of who bears the burden of taxation
Taxes on buyers and taxes on sellers are equivalent.
FICA- Federal Insurance Contribution Act Social Security and Medicare.
Payroll tax a tax on the wages a firm pays its workers.
A tax burden falls more heavily on the side that is less elastic.

Consumers, producers and the efficiency of markets

Consumer surplus represents the amount a consumer is willing to pay minus the
amount he actually pays. Consumer surplus measures the benefit that buyers
receive from a good as the buyers themselves perceive it.
Producer surplus is the amount a seller is paid minus the cost of production.
Total surplus= Value to buyers Cost to sellers.

1. Free markets allocate the supply of goods to the buyers that value them
most highly, as measured by their willingness to pay.
2. Free markets allocate the demand for goods to the sellers that can produce
them at least cost.
3. Free markets produce the quantity of goods that maximizes the sum of
consumer and producer surplus.
Deadweight loss is a fall in total surplus that
results from a market distorsion, such as a
tax. The greater the elasticities of supply
and demand the greater the deadweight
loss of a tax.

International Trade
Benefits: increased variety of goods, lower
costs through economies of scale,
increased competition, enhanced flow of
ideas.
Negative externalities in production or
consumption lead markets to produce a larger quantity than is socially desirable.
Positive externalities in production or consumption lead markets to produce a
smaller quantity than is socially desirable. The government can internalize the
externality by taxing goods that have negative externalities and subsidizing
goods that have positive externalities.
Command and control policies regulation market based policies pigovian
taxes.

Public goods and common resources

Excludable, rival private goods are both excludable and rival, public goods are
neither, common resources are rival but not excludable, natural monopolies are
excludable but not rival.

The tax system

Naitonal government: income tax, corporate tax, social insurance taxes, excise
taxes; local government sales and property taxes, fares fees and tolls.
Average tax rate / marginal tax rate
Vertical / horizontal equity

The costs of production

Profit=Total revenue total costs
Production function the relationship between the quantity of inputs used to
produce a good and the quantity of output of that good.

Fixed / variable costs.

At the profit maximizing level of output, marginal revenue and marginal cost are
the same.

In competitive markets price equals marginal cost. In monopolized markets, price

exceeds marginal cost.

Nash equilibrium a situation in which economic actors interacting with one

another each choose their best strategy given the strategies that all the other
actors have chosen.
The output effect because price is above marginal cost, selling 1 more gallon of
water at the going price will raise profit.
The price effect raising production will increase the total amount sold which will
lower the price of water and lower the profit on all the other gallons sold.

The markets for the factors of production

Derived demand
A competitive profit maximizing firm hires workers up to the point where the
value of the marginal product of labor equals the wage. The value of marginal
product curve is the labor demand curve for a competitive profit maximizing firm.
When a competitive firm hires labor up to the point ar which the value of the
marginal product equals the wage, it also produces up to the point at which the
price equals the marginal cost.
Determinants of the labor demand curve:
1. The output price
2. Technological change
3. The supply of other factors
Determinants of the labor supply curve:
1. Changes in taste
2. Change in Alternative opportunities
3. Immigration
The wage adjusts to balance supply and demand of labor; the wage equals the
value of the marginal product of labor.

Determinants of productivity:
1. Physical capital;
2. Human capital;
3. Technological knowledge.
Land labor and capital each earn the value of their marginal contibution to the
production process.