Ten Principles of Economics


Brief Introduction
Welcome to Sarah, Lauren, and Clair's online textbook!:) In this chapter you'll learn the basic principles of Economics.

Key Terms
-scarcity: limited resources in a society
-economics: the study of how the society allocates and manages its scare resources
-efficiency: society getting the maximum benefits from its limited resources
-equity: society distributing the limited resources fairly among its members
-opportunity cost: whatever you must give up to obtain another
-rational people: people who do the best they can do out of the given opportunities to achieve their goals
-marginal changes: an incremental changes to an already existing plan of action
-incentive: a motivator or something that causes a person to act
-market economy: an economy that allocates resources through the decentralized decisions of many firms and households as they interact in markets for goods and services
-property rights: an individual's ability to exercise control over scare resources that one owns
-market failure: market left on its own fails to allocate resources efficiently
-externality: impact of a person's action on the well being of society and the bystander
-market power: the ability of a single economic actor to have a substantial influence on market prices
-productivity: a ratio to measure how well an organization (or individual, industry, country) converts input resources (labor, materials, machines etc.) into goods and services.
A sustained rise in most prices in the economy.
-business cycle:
the fluctuation of economic activity in long terms.

There are 10 principles of economics you should learn before we get in depth with microeconomics. We'll explore these 10 principles throughout the rest of the chapter.


1) Principle 1: People Face Trade-Offs

There’s no “free lunch”. To get one thing, you have to give up something else.
Always relate back to the [Scarcity of Resources]

Examples: 1. Students’ studying time vs. leisure time
2. Studying time between two subjects
3. Households deciding where and how to spend family income.

Society in general is faced with trade-offs (Production Possibilities Frontier)
• “Guns and butter” trade-off
• Promotion of Services vs. Industry
• Growth vs. environmental protection
• Production Efficiency vs. equity (welfare benefits)

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

The true cost of a good or service is the cost of another good or service you give up (best alternative).
Cost of College:
-cost of tuition and books
-value of wages lost (given up to attend college)
Not included in the opportunity cost of attending college are various living expenses one would have had anyway whether he/she attends college or not.

3) Principle 3: Rational People Think at the Margin

It is changes made “on the margin” (that is, small changes) that are relevant in economic analysis and decision-making.
- airlines deciding to price stand-by tickets
- off-peak pricing
incremental vs. average pricing

4) Principle 4: People Respond to Incentives

People respond to incentives (monetary and non-monetary).

5) Principle 5: Trade Can Make Everyone Better Off

No man is an island.
Specialization and exchange increases production and welfare
Adam Smith and David Ricardo: Comparative Cost Advantage

6) Principle 6: Markets Are Usually a Good Way to Organize Economic Activity

Communism vs. Capitalism
Central Planning concept has failed because it leads to mis-allocation of resources, corruption, inefficiencies,... etc

Adam Smith’s “Invisible Hand”: the Price System

How does the complex market system not fall apart?
1. Profits: Motivate economic activity
2. Price System: Directs and facilitates the market’s efficient functioning
3. Competition: Regulates the market players to stay within “the rules of the game”

7) Principle 7: Governments Can Sometimes Improve Market Outcomes

Too much government interference in the market is neither good (efficient), nor desirable.
Some intervention is a necessary evil and sometimes promotes social good.

The acceptable functions of government are:
• To provide for the legal system
• To promote efficiency and regulate competition
• To promote equity (equitable income distribution)
• To provide for public goods
• To facilitate and promote economic growth and development
Correct for externalities (market failures) – pollution and environmental protection regulate monopolies and protect consumers

8) Principle 8: A Country's Standard of Living Depends on Its Ability to Produce Goods and Services

Differences in income levels are very wide around the world. Why?
• Availability of resources
• Productivity of these resources
• Level of technological know-how and usage
Productivity: the amount of goods and services produced per time period by each worker

9)Principle 9: Price Rises When the Government Prints Too Much Money

Nobel prize winner in Economics Milton Friedman said: “Inflation is always and everywhere a monetary phenomenon.”
Prices rise when Demand exceeds Supply.
Too much money chasing too few goods

In Germany in January 1921 a newspaper cost 0.30 Deutschmarks. In November 1922 (20 months later) it cost 70 million marks!!
Hyperinflation: Runaway inflation caused by the printing of money.

10) Principle 10: Society Faces a Short-Run Trade-off between Inflation and Unemployment

In the 1950s and 60s, the above-observed relationship was used in making policy decisions:
Policies to reduce inflation (higher taxes, less government projects, fewer loans, higher interest
rates etc) led to increased unemployment, or policies to reduce unemployment (expansionary
fiscal and monetary policies) led to increased economic activity but also to higher inflation.

In the long-run, there’s no evidence of inflation-unemployment trade-off.

The “stagflation” of the 1970s (co-existence of high inflation and high unemployment)
brought to an end the belief that the Phillips curve was a “theory”.


1. Economics is the study of:
-the choices we must make among alternatives because of scarcity.

2. Which of the following are NOT scarce?
a. time for leisure activities
b. computers
c. compact discs
d. the air we breathe
correct: d

3. The expression "There's no such thing as a free lunch" means:
-the use of resources to meet one need means that those resources can no longer be used to meet another need.


-economics is about the allocation of scarce resources.
-individuals faces trade-offs.
-The meaning of opportunity cost.
-Use marginal reasoning when making decisions.
-Incentives affect people’s behavior
-Trade among people or nations can be good for everyone.
-Markets are a good, but not perfect, way to allocate resources.


Mankiw, Gregory N. Principles of Microeconomics. 4th ed. Print.