The Ten Principles of Economics: Part I, Principles 1 - 4

The Ten Principles of Economics: Part I, Principles 1 - 4

As conceived by Dr. Gregory Mankiw

For Jessi and Tim

1. People face tradeoffs

Many of the emergent orders we see in economics arise because people are trying to play this delicate balancing game. People face tradeoffs between work and leisure, saving money and spending it, eating well and living long, reaping reward and minimizing risk. Very few things are free. When people, firms, or policy-makers do things... there is always something given up.

2. Cost is what you give up

Costs are not money. They are lost opportunities. For instance, what is the biggest cost of college? Certainly not dorms or food... you would have had to buy housing and food anyway. The biggest cost of college is almost always the wages you sacrifice by going to school, and not working. Similarly, firms incur costs when they operate, costs that have nothing to do with labor, materials, or overhead. They are opportunity costs, the opportunities sacrificed by the firm when it devotes its resources to plan A and not plan B. In this way, accountants view profit differently than economists do.

3. Think on the margin

Imagine you run a store, but the economy isn't so hot, so people just aren't shopping much anyway. You're losing money. But quite often, it will be rational for you to stay open, despite generating a loss, even before the economy picks back up. This is because there is a difference between the margin and the totality. If you thought about the totality, you would say, "in total, my costs exceed my revenues... I'm losing money... I should leave the market." But the margin is the edge. Marginal means "just one more."

So, you look at the "marginal" profit of staying open just one more day. Sure, you're losing money, but that's because you pay rent, purchase inventory, and pay for insurance. Those costs are the same whether you keep your doors open or not. On the margin, the costs of you keeping the doors open just one more day (some labor hours and the electricity bill) are less than the revenues from staying open that day. In total (for right now) you are losing money. On the margin, you are making money (therefore making the total loss a bit less).

4. People Respond to Incentives

When a behavior is rewarded (becomes less costly or more profitable), it is encouraged. When punished, it is discouraged. The idea is simple, but profound, and we often neglect its implications. When you tax income, you punish labor. When you provide welfare, you encourage not working. When firms receive patents to products they invent, they invent more products. When professors stand to risk losing their jobs for expressing radical ideas, they are discouraged from expressing them. When stand no risk of losing their jobs for being lazy (if they have tenure), they are encouraged to be lazy. When you force people to wear seatbelts, lowering the risk of death in case they are in a wreck, you encourage them to drive less carefully.

Lots of very, very stupid economic policies come from politicians and laymen not thinking very clearly about the rewards and punishments they met out with their policies, and what consequences those will have.
These principles deal with how people think and behave by themselves. The others will deal with phenomena that occur when they interact with one another.