Going back to our awesome Prof. N. Gregory Mankiw, we can start by learning about the 10 most fundamental principles of Economics like he’s mentioned in his book.
Ummm okay but what do I do with these principles?
Well, for starters, you can look around and try to see if theses principles fit in or if they’re outdated or if we’re bluffing.
Principle 1: People face trade-offs
So how many times have we been in a situation that to get something we’d have to give upon another? We are faced with Alternate Choices.
Consider how right now rather than reading my blog, you could just be there watching The Sherlock Series. So how is any of this Economics?
A classic Trade-off is having to choose between “Guns and Butter”. So if you were governing a country and let’s say you had a 1000 bucks, how much of it would you spend on securing your country, strengthening border forces and make sure the soldiers are fed enough and on the other hand spend on ensuring your citizens have enough to satisfy their needs? Its a toughie, I know.
So here we also get to learn the term Consumer Goods which mean,’ Goods bought and used by consumers, rather than by manufacturers for producing other goods, also called final goods’. In the above example, guns refer to Defense expenditure and butter refers to consumer goods.
Principle 2: The cost of something is what you give up to get it
You know when you go to the mall and pick up fancy sunglasses and pay how much is written on the tag, that’s not the cost I’m talking about.
Think of it this way. You own 20 books and here’s what you can do with it:
- Either rent them out to your friends and make some money
- Or read them all, acquire knowledge and maintain the books in your personal library.
Both of them have their own merits and demerits. So that’s where we learn Opportunity Cost : The loss of other alternatives when one alternative is chosen. So now that I’m talking about cost, there’s gotto be a math to arrive at it. Watch this Video to learn the math.
Principle 3: Rational people think at the margin
Now, of course we’ve heard of the usage of ‘Rational Human Behavior’ in my previous post. So you will notice that most people and firms and Governments make rational decisions. So what do I mean by thinking at the margin? Well the decisions you take often are not between two extremes but a decision of whether or not to something a little more or a little less. Like an extra hour of watching series or complete a chapter of the novel in the same allotted time. Like how during exams you would either want to use your time revising or use the time relaxing. So what you do is compare the benefits and cost of this margin. So here we arrive at Marginal Cost and Marginal Benefit.
Marginal Cost: The cost added by producing one additional unit of a product or service. Or in your case, the cost of watching an extra hour of series if that’s what you choose.
Marginal Benefit: The additional benefit arising from a unit increase in a particular activity. So, the benefit you got by spending that extra money on something.
So let me give you a classic example that my professors gave me that their professors gave them and even theirs :
Why is water so cheap while diamonds so expensive?
Because how much a person is willing to pay is based on how much satisfaction one derives by that extra unit of good.
So, how much satisfaction I’d derive by an additional unit of water is way less than an
additional unit of diamond. I mean, come on, another diamond ring? I’m on cloud 9
already! So feel free to gift me one !
So what’s my point?
You and I and all of these rational people only take action if the marginal benefit over-
weighs the marginal cost.
Principle 4: People respond to incentives
It’s an incentive if it’s inducing you to act. Simplest example, you’re still looking out for
that flash sale on Amazon or wanting to watch a movie on a weekday so that you get
tickets at lower price. Also when you notice that the fuel prices are going up, you try to
cut down on your travel ( or at least that’s how you’re supposed to think) .
Incentives are extremely important for policy makers. That’s how they determine taxes
and subsidies so that they can have some sort of control over what the masses of people
are going to demand and buy.
If you’re really curious to read more on this and specifically a case study that will help
Principle 5: Trade can make everyone better off
You remember the times when in India a page on the internet would take minutes to load and you’d just sit there waiting forever? But now it’s there before you even completely type in your search.!? It’s not just advancement of technology that’s lead to this but also a lot of growing companies in the market who provide these services. So one company is competing with the other to acquire you as their customer and also that’d mean they’d have to be the best to get your attention and sell to you.
So all this rivalry and competition isn’t that bad after all huh. Didn’t you study more when you thought someone would and could score more than you? Didn’t you feel good when you got that top for 600 while she got it for 800?
It’s all the same logic.
Principle 6: Markets are mostly a good way to organize economic activities
Okay hold on, Markets , economic activities, give us a little background, right? Okay… Is it the same market as where I buy my stuff? NO.
Here the economists refer to Market Economy which is an economic system in which production and prices are determined by unrestricted competition between privately owned businesses.
So now you already know there’s a lot of competition out there and that’s between business owners and manufacturers which puts in a system as to know how much to produce and how much to sell them for. Let’s look at this in a very simpler way.
So you have this pen you bought for 200 bucks and you wanna sell it off at 220. Imagine all these scenarios and think on what’d be the outcome for it
- You are lucky! you got a buyer and is okay paying you 220.
Done deal right?
- You got so lucky that now two of your buddies want it
Now that obviously you can’t break the pen into two and give it to them, you’re gonna have to increase the price so much that only one of them can and is willing to pay. Thereby you also learnt that 2 people are demanding for your pen.
3. Your buddy does wanna buy it but thinks 220 is too much and it doesn’t look like anyone else in interested
You might want to reduce the price so that he does buy or wait until someone pops up in your life willing to pay 220 bucks. Also, it gave you the vibes that selling a pen isn’t that great after all.
This is also how the market functions, based on demand and supply and their differences lead to change in prices and production. We can talk in detail a little later.
It’s finally time to meet the big guy, Father of Economics, Prof. Adam Smith who was one of the early thinkers of this subject. In his book An inquiry into the nature and causes of the Wealth of Nations, he presents this concept in a different way. He talks about something called Invisible Hand. So this is simple; when you’re out watching a movie you don’t say, “Lemme do this guy a favor and buy pop corns from him”. You’d rather wanna buy it cause it serves your need and you see him selling and grab yours. In the same way, if everyone satisfy their needs, it will be a mechanism that will make sure the economy runs and it’s more like a natural course.
Principle 7: Governments can sometimes improve market outcomes:
Without much drag, lemme tell you what it is. The way our big fella said that everything will be taken care of, on its own, was proved wrong after The Great American Depression in 1930s and they realized the importance of Governments interfering in economic activities. So the governments show interest through their policies and laws and keep an eye on things. Oh yeah, it’s got eyes on you too!
Say there’s a situation where the market fails to function the way it’s supposed to, which we call Market Failure, you’d notice the government taking rectification actions.
Let’s now widen to the whole economy
Principle 8: A country’s standard of living depends on its ability to produce goods and services
May be you can survive in Mumbai with 20,000 INR a month but do you think that’d be enough in New York or Chicago or Switzerland? Your common sense just said NO. That’s because we have the basic understanding that goods and services, although similar or same, cost different in different parts of the world and how much you’ll be paid for the same job is also different in different parts of the world. So this is what I mean by, Standard of Living.
Economists have established that there’s a relationship between a country’s productivity and standard of living. Productivity is the quantity of goods and services produced from each unit of labor input. So basically, higher your and my ability to produce goods and services, better standard of living we enjoy. So buckle up you all.
Principal 9: Prices rise when government prints too much money
When I was little I always wondered why you couldn’t print like 1000 notes for everyone and end poverty. If only it were that simple. (When I was really very little)
So this is simple to understand, higher the money in the economy, more prices you’ll have to pay. This brings us to the most commonly heard term Inflation which means an increase in the overall level of prices in the economy. No rocket science, that’s all it means. So you pay 10 bucks for chocolate today and buy the same chocolate for 12.50 after 6 months, it’s inflation in play. And of course no one likes to pay more.
This is because the value of money decreases due to addition of quantity of money. So when would you value your Ipad more? When you have 1 of it or 5 of it on your table?
Principal 10: Society faces a short-run trade off between inflation and unemployment
Okay how does this stuff work now?
More money in the economy – people are gonna spend more on goods and services – firms would wanna produce more thereby employ more people – Tada, reduced unemployment.
So you could say that its more like policy tool where the government decides what is required at the moment and acts upon it.
So that’s about the Ten Principles Of Economics and come back tomorrow while we’re gonna Think like an economist.
Source: Our awesome Prof. N Gregory Mankiw