February 21, 2022

Principles of Economics 8th Edition by Gregory Mankiw

10 Principles of Economics

How People Make Decisions

  1. People Face Trade-offs
  2. The Cost of Something Is What You Give Up to Get It
  3. Rational People Think at the Margin
  4. People Respond to Incentives

How People Interact

  1. Trade Can Make Everyone Better Off
  2. Markets Are Usually a Good Way to Organize Economic Activity
  3. Governments Can Sometimes Improve Market Outcomes

How the Economy As a Whole Works

  1. A Country’s Standard of Living Depends on Its Ability to Produce Goods and Services
  2. Prices Rise When the Government Prints Too Much Money
  3. Society Faces a Short-Run Trade-off between Inflation and Unemployment

Business Cycle

The irregular and largely unpredictable fluctuations in economic activity, as measured by the production of goods and services or the number of people employed.

The Production Possibilities Frontier

The production possibilities frontier shows the combinations of output—in this case, cars and computers—that the economy can possibly produce. The economy can produce any combination on or inside the frontier. Points outside the frontier are not feasible given the economy’s resources. The slope of the production possibilities frontier measures the opportunity cost of a car in terms of computers. This opportunity cost varies, depending on how much of the two goods the economy is producing.” Points on (rather than inside) the production possibilities frontier represent efficient levels of production. The production possibilities frontier simplifies a complex economy to highlight some basic but powerful ideas: scarcity, efficiency, trade-offs, opportunity cost, and economic growth.

Circular Flow Diagram

This diagram is a schematic representation of the organization of the economy. Decisions are made by households and firms. Households and firms interact in the markets for goods and services (where households are buyers and firms are sellers) and in the markets for the factors of production (where firms are buyers and households are sellers). The outer set of arrows shows the flow of dollars, and the inner set of arrows shows the corresponding flow of inputs and outputs.


In any market, buyers look at the price when determining how much to demand, and sellers look at the price when deciding how much to supply. As a result of the decisions that buyers and sellers make, market prices reflect both the value of a good to society and the cost to society of making the good. Smith’s great insight was that prices adjust to guide these individual buyers and sellers to reach outcomes that, in many cases, maximize the well-being of society as a whole.


Macroeconomics is the study of economy-wide phenomena, including inflation, unemployment, and economic growth


Microeconomics is the study of how households and firms make decisions and how they interact in markets

Market Economies Need Institutions to Achieve a More Equal Distribution of Economic Wellbeing

A market economy rewards people according to their ability to produce things that other people are willing to pay for. The world’s best basketball player earns more than the world’s best chess player simply because people are willing to pay more to watch basketball than chess. The invisible hand does not ensure that everyone has sufficient food, decent clothing, and adequate health-care. In practice, many public policies, such as the income tax and the welfare system, aim to achieve a more equal distribution of economic well-being.

Market Economies Need Institutions to Correct Market Failures

In the presence of externalities or market power, well-designed public policy can enhance economic efficiency

Market Economies Need Institutions to Enforce the Rules

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. Most important, market economies need institutions to enforce property rights so individuals can own and control scarce resources. A farmer won’t grow food if she expects her crop to be stolen; a restaurant won’t serve meals unless it is assured that customers will pay before they leave; and a film company won’t produce movies if too many potential customers avoid paying by making illegal copies. We all rely on government-provided police and courts to enforce our rights over the things we produce—and the invisible hand counts on our ability to enforce those rights

Different Fields Have Different Tools Available When It Comes to Testing Hypotheses

Physicists studying gravity can drop many objects in their laboratories to generate data to test their theories. By contrast, economists studying inflation are not allowed to manipulate a nation’s monetary policy simply to generate useful data. Economists, like astronomers and evolutionary biologists, usually have to make do with whatever data the world happens to give them.

Seat Belts Result in More Accidents

In 1975 a study by Sam Peltzman showed that these laws give rise to fewer deaths per accident but also to more accidents. He concluded that the net result is little change in the number of driver deaths and an increase in the number of pedestrian deaths.

When a person wears a seat belt, the probability of surviving an auto accident rises. When deciding how safely to drive, rational people compare, perhaps unconsciously, the marginal benefit from safer driving to the marginal cost. As a result, they drive more slowly and carefully when the benefit of increased safety is high. For example, when road conditions are icy, people drive more attentively and at lower speeds than they do when road conditions are clear. Seat belts make accidents less costly because they reduce the likelihood of injury or death. In other words, seat belts reduce the benefits of slow and careful driving. People respond to seat belts as they would to an improvement in road conditions—by driving faster and less carefully.