To understand all the insights of economics, for example, to find the answer to inquiries like what economics is all about, what central idea economics has, and so on, we need to understand the ten principles of economics analyzed by Prof. N. Gregory Mankiw.

People face trade-offs

In economics nothing is free. It means, that if one has to get a particular thing he likes, he has to give up another thing that he likes. Making decisions thus requires trading off one goal against another. Decision-making is the heart of economics and it decides for the well-being of the society and nation. While making different decisions from the individual, societal, regional, national, and international levels, needs a trade-off. Consider a parent deciding how to spend their family income. They can buy food, clothing, or a family vacation or they can save some of the family income for the future of the children’s college education. When they choose to spend extra income on one of these goods, they have that much less amount to spend on some other goods.

In ancient times, when people started to gather into the group and then formed their societies, they faced different kinds of trade-offs. The more a society spends on its defense to protect its shores from foreign aggressors, the less it can spend on consumer goods to raise the standard of living. This classical trade-off has converted into a modern trade-off in-between the choice of a clean environment and a high level of production. Reducing pollution requires a higher cost, lower profit, lower wage, high price, or a combination of these and a good. So healthy, the cleaned environment always comes at the cost of reduced income, profit, and satisfaction of the firm’s owners, workers, and consumers.

In modern times, the states may have to face another trade-off which is between efficiency and equity. Efficiency states the possible maximum from the scarce resources and equity states uniformity in the distribution among the members of the society. So when the government formulates policies to maintain social equity it always comes at the cost of reducing efficiency. When the government redistributes income from the rich to the poor, it reduces the reward for working hard and resulting in a reduction in output. Understanding these trade-offs makes life easier and we can make good decisions when we understand the opposites are available. Economics shows or acknowledges trade-offs.

The cost of something is what you scarify to get it

As people face trade-offs so they have to make a comparison between the cost and benefits of alternative courses of action. When one spends a year listening to lectures, reading textbooks, and writing papers, he cannot spend the time working at a job. Here earning money from a job is given up for enlarging intellectual ability. In economics, the cost of the sacrificed alternative to get the best one is called opportunity cost and plays an important role in making decisions. As the subject matter of economics, we should decide with the least opportunity cost.

Rational people think at the margin

One of the basic assumptions followed by economists in the economic analysis is the rationality of the people. Economists assume that individuals or consumers are rational and their rationality guides them to react systematically and purposefully to maximize the benefits from available opportunities.

This issue is concerned with the decisions of producers as well as individuals, for example, the decision of the firm to a higher certain number of workers or units of output to be manufactured and what goods and services are to buy to achieve their optimization goals. Here the principle is explaining that rational people can get maximum satisfaction or rational producer can get maximum profit with the help of marginal analysis. All the rational stakeholders make a decision only in the case where the marginal benefit of the decision or action exceeds the marginal cost. This tendency can be observed when people want to pay more for diamonds than water and when sometimes airlines are willing to sell the ticket below average cost.

People respond to incentives

The incentive is the thing that induces a person to react. People are rational; they make a comparison between marginal values so they always respond to incentives. In economics, incentives play a crucial role as it studies the economic behavior of human beings living in societies. Economists can analyze the behavior of participants in the economy with the help of incentives.

For example, when the price of apple increases, people decide to eat fewer apples. But apple sellers may decide to employ more workforce and produce more apples. Here rise in price provides an incentive to both the participants of the market economy. The incentive for buyers is to consume less and for sellers to produce more. There is a greater role of incentive in public policymaking also. When economists or think tanks do not succeed to judge how their policies influence incentives, they often create redundant or unwanted consequences.

Policymakers have to consider direct as well as indirect effects that work through incentives. For example, the seat belt law. Making the law that orders all drivers to wear a seat belt while driving has a direct effect on the increase in the possibility of surviving an auto accident. But it may alter the behavior of drivers in terms of speed and care of vehicles which the driver is operating as the incentive of safety policy. It may reduce the number of accidents but it could increase the number of pedestrian death. Similarly, if there is a very high tax on petroleum products by the government, the people may switch to electric cars.

Trade can make everyone better off

People, societies, and nations interact with each other in different forms. While interacting with each other, economic interactions are the subject matter of economics. Trade is the main economic activity through which people interact with each other.

In trade and commerce, there is neither gainer nor looser.  It means the trade between the two countries or two individuals can make each country and every individual better off.

Trade partners are simply looking like competitors but they always contribute in the sense of growing expansion and specialization at the individual, national, and international levels. Let’s take an example given by prof. Mankiw

If an individual belonging to a family seeks a job then he or she has to compete with other individuals belonging to other families who are also searching for a job. 

The families in society are also in competition in different activities at different undertakings. For example, they may struggle or compete at the time shopping. Each family wants to get the best one at the possible lowest prices. Thus each family in the economy competes between them in different economic activities.

On the other side, a family making it isolated from other families cannot better off as s single-family alone cannot able to produce or manage all the things (food, clothes, grain, and so on) that it needs.

It clearly shows that a family gains much from its ability to trade with others than what it would achieve if it would have produced and grown all the needed itself. 

With trade from one to another, individuals can purchase greater varieties of goods and services at competitive prices. Countries and families thus can get benefit from the skill and ability to trade with others. Trade provides nations to concentrate on what they do best and have a greater variety of goods and services.

Markets are usually a good means to systematize economic activity

There are large numbers of buyers as well as sellers in the market. If such a market is free then these large numbers of buyers and sellers are interested primarily in their interest. They are always guided by their interest. Though they make their decisions based on their self-interest, the market economy provides a framework that ensures the continuous functioning of their self-interest and organizational economic activities to promote overall economic well-being.

The notion of a central planning economy is that only the government could organize economic activity in a way that promotes economic well-being for the country as a whole. The number of countries that once followed a centrally planned economic system has vacant the system and are now following market economies. Decisions of the central planning authority are replaced in the market economy through the open and self-guided interaction of millions of firms and households.

Firms are free to make decisions on whom to hire and what is to be produced. Households decide which firms they have to choose or join in their best interest and what are kinds of stuff to purchase from the free market. These firms and households act together in the open market and prices and self-interest direct their actions. Adam Smith’s notion of an invisible hand and desirable market outcome is the breakthrough of the market economy.

Governments can sometimes improve market outcomes

One can say that if the invisible hand of the market is so great, why do we need government, so one purpose of studying economics is to show and analyze the accurate responsibility and applicability or scope of public policy or policies of the authorities.

One reason we need government is that the invisible hand can work its magic only if the government enforces the rules and maintains the institutions that are key to a market economy. Market economies most importantly need institutions to enforce property rights so individuals can own and control scarce resources.

So the market economy needs proper government intervention to promote economic efficiency, and equity, and to avoid market failure. Economists define the term market failure as a situation in which the market fails to produce an efficient allocation of resources. It may be due to market power and externality and to control them well designed governmental policies are required.

A country’s standard of living is based on its capacity to produce goods and services

The standard of living in any particular country is not the same as it is in another country. There are huge differences in the living standards of people from one country to another. It is due to the productive capacity and productivity of the country.

If the worker in any nation or area is able to produce a larger volume of production at a particular point in time or period then the majority of the people’s living standards will be expected to upgrade. In nations where the productivity of the labor force is low and inefficient then the majority of people will suffer from shortages and other types of macroeconomic problems. The expansion rate of the country’s productivity also affects the growth rate of its average income.

The relationship between productivity and living standards also has deep implications for policy. When thinking about how any policy will affect living standards, the key question must be how it will affect the ability to produce goods and services.

To boost living standards, policymakers need to make policies to increase productivity.

Prices rise when the government supplies excess money

A continuous and substantive rise in the price level of all goods and services is called inflation. 

Let’s take an example of the 1920s. In Germany a daily newspaper cost 0.30 marks in January 1921 and almost within two years in November 1922, the cost of the same newspaper was 70,000,000 marks. 

This episode is one of history’s most tremendous examples of inflation, an increase in the overall level of prices in the economy. (Mankiw, 2012)

When a government prints large quantities of the currency, the value of the money falls. In the 1920s there was hyperinflation due to the increase in money supply by triple quantity every month. The economic history of the United States also points to a similar end. The high inflation of the 1970s was also an outcome of the excess money supply. Recent evidence also shows low inflation as a result of a slow money supply. So based on the economic history of the world, it is concluded that all cases of large inflation were the outcome of the growth of the quantity of money supply in the economy.

Societies face a short-run trade-off between inflation and unemployment

Economists believe and illustrate the effects of economic injections in the short-run period. It means growing the quantity of money in the financial system stimulates the overall level of expenditure and thus the aggregate demand.

Higher demand over time leads to an increase in price and at the same time higher prices in the market encourage business firms to offer more employment opportunities. With higher employment, there is a higher production of goods and services in the market. More employment reduces unemployment and ultimately this all leads to the trade-off between a rise in price (inflation) and unemployment.

The British economist A.W Philips studies the relationship between unemployment and the rate of change in money wages in the U.K over the period 1862-1857.

Conclusion

Economics is the study of how people, societies, and nations make economic decisions, how they interact with each other, and how the collective system i.e., the economy as a whole works. People live in society and to fulfill their unlimited wants, they perform several activities. In such a course of action there emerge different relationship between them and all the monetary and economic relation between human beings has created the subject matter of economics.

The above ten principles of economics try to justify that as social science, economics deals with choice problems in the face of scarcity. Whether the economy is developed or developing, strong or weak, an economy is the collective form of the people dealing with one another to fulfill their unlimited demands. So, Prof. Mankiw has explained the economic behavior of the individuals who make up the economy, the way by which they take their economic decisions, the way of their interact, and finally how the economy as a whole work in a way to help the optimization goals of its participants through his ten principles of economics.

Reference

Mankiw, N.G. (2012), Principles of Microeconomics, New Delhi: Cengage Learning India Pvt Ltd