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Ten Principles of Economics

Updated on March 26, 2014

Ten Principles of Economics

These are the principles on how the economy works and consists of basic concepts and methods that economists use while doing economics. It offers an overview of what economics is all about and also explains the unifying central idea of the field of economics. Ten principles of economics broadly include first seven micro-economic principles and last three macro-economic principles. Mankiw’s 10 principles of economics are mentioned below:

1. People face trade-offs:
Something must be forgiven so as to attain one thing. Trade-offs between two choices is obvious while making decisions. For example, when a person goes to a theatre to watch movie, he is trading off the money he can use to visit restaurant, buy books, visit museum or, get other required things. At the same time he is also giving up time that he can spend working, playing, skiing, bike riding, studying or, doing some other task.

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2. The cost of something is what you give up to get it:
Decision making encompasses comparison between the costs and alternative course of action as people face trade-offs.

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3. Rational people think at the margin:
Decisions are made on the basis of how much benefit and cost is yielded by a single extra unit. Decisions are made by rational people once marginal exceeds marginal cost. Moreover, best decision can only be made by thinking at the margin. For example, decisions are not made by people whether to work every hour possible or not working at all. Rather the decisions are made between working fifteen hours a day or twenty hours a day. A person decides to work for additional five hours if and only if the benefits are provided by the increase in earnings exceeds the time spend doing nothing.

4. People respond to incentives:
An incentive is commonly some sort of reward or punishment that compels one to act. Change in cost or benefit induces change in behaviour. Incentive is responsible for creating benefits and cost to pursue people to take decision. For example, when the rate of orange rises people swing to other fruits rather than orange as buying orange is quite costly as compared to other fruits. At the same time orange producer will invest more on the production of oranges as there is more benefit

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5. Trade can make everyone better off:
Specialization is created through trade-offs which brings about improvement in variety, quality thereby lowering the cost. Larger diversity of goods and services can be transacted at a lesser cost by trading with others. A particular person or family or society or state or country can never be better off isolating itself from others. For example: if one state of a country is specialized in producing potatoes and other is specialized in rice production, then agricultural production should be prioritized by each state by allocating more resources towards it so as to improve efficiency. Hence, better quality of agricultural products can be achieved at a lower cost.

6. Markets are usually a good way to organize economic activity:
H and firms, in market economy are seemed to be directed by an “invisible hand” which controls the market to run in an efficient manner. Market is the place where transaction of goods and services takes place between consumers and producers at an agreed upon price without any intervention of central planner or the government. For example, the unsuccessful implementation of communism is because of the unwanted consequences of centrally planned economy. Since there are few peoples to carry out decisions in the central economy, the decision regarding the amount of production as well as its cost cannot be made efficiently thereby leading to the misallocation of resources. While in a market economy individual decision makers interact at the market place to bring about anticipated upshot.

7. Government can sometimes improve market outcomes:
Markets, however, being a worthy mode to shape economy, there are certain exceptions for rules and laws. The failure of the market for efficient allocation of the resources brings the need of government who ensures efficiency and brings about equity. Market failure can occur because of externality i.e. impact of single person on welfare of onlooker and market power which is aptitude of an individual person to impact market rates.

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8. A country’s standard of living depends on its ability to produce goods and services:
Living standard is directly proportional to the productivity i.e. the more is the productivity of the country, the more higher will be the living standard of the people. As the growth in the productivity of the country, there is be growth in the average income thereby enhancing the living standard of its citizens.

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9. Prices rise when government prints too much money:
When large quantity of national money is created; the worthiness of money falls on account of which price rises requiring more money to buy goods and services. Inflation occurs when too much money is printed i.e. the worthiness of money decreases. For example, when the government of Zimbabwe printed a lot of money, inflation rate by January end was 231 million per cent. This resulted in gigantic rise of price discouraging consumers to save and also prohibiting growth of economy in the forthcoming days.

10. Society faces a short-run trade-off between inflation and unemployment:
In short-run, reduction of inflation often causes unemployment. In other words, when money supply is increased, the consumption demand for goods and services increases resulting in upsurge of employment opportunities. However, the price goes up and savings is minimal. The trade-off between unemployment and inflation is illustrated by Phillips curve. The trade-off is temporary in nature but still can last for several years. For example, the current supply of huge package of money in the U.S economy will artificially increase employment opportunities but will decrease the worthiness of dollar such that goods and services gets less affordable.

Principle one, two, three and four are relevant to how people make decisions while principle five, six and seven are relevant to how people interact and last three principles i.e. principle eight, nine and ten are relevant to how the economy as a whole works.

N. Gregory Mankiw (2006), Principles of economics, 4th edition.


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