Principles of Economics

Clarification and Proposal
In the beginning there is Econ 101 that introduces students to the "Principles of Economics". Many introductory textbooks use this term in their title (see eg. the widely used books by Gregory Mankiw and by Frank & Bernake). There appear to exist several dozens of books with this title.
Not surprisingly, the meaning of the term "Principles of Economics" varies. There are two main concepts of "Principles":
  • Economic Principles*, referring to the idea of "principles of economic life". Mankiw's list of 10 principles (below) is a good example of this notion. These are principles of how the economy works (or should work), hence, they refer to the economy or economic actors. They are thought to parallel the principles or laws in natural science.
  • Principles of Economics, referring to the basic methods and concepts economists use when doing economics, hence to economic analysis. In this view the term "economics" refers to the discipline, not to the economy. This type of principles is often interwoven with the first type in the textbooks. Lists of principles of doing economics are harder to find. I propose such a list below in order to clarify the basic concepts that make up and shape the analysis and the thinking of economists.
*) Taken literally, the principles are not thought to be "economic" themselves --- though, of course, the employment of "economic principles" can often be economical.
Mankiw's "Ten Principles of Economics"
How People Make Decisions
  • People Face Tradeoffs. To get one thing, you have to give up something else. Making decisions requires trading off one goal against another. 
  • The Cost of Something is What You Give Up to Get It. Decision-makers have to consider both the obvious and implicit costs of their actions. 
  • Rational People Think at the Margin. A rational decision-maker takes action if and only if the marginal benefit of the action exceeds the marginal cost. 
  • People Respond to Incentives. Behavior changes when costs or benefits change. 
How the Economy Works as A Whole
  • Trade Can Make Everyone Better Off. Trade allows each person to specialize in the activities he or she does best. By trading with others, people can buy a greater variety of goods or services. 
  • Markets Are Usually a Good Way to Organize Economic Activity. Households and firms that interact in market economies act as if they are guided by an "invisible hand" that leads the market to allocate resources efficiently. The opposite of this is economic activity that is organized by a central planner within the government. 
  • Governments Can Sometimes Improve Market Outcomes. When a market fails to allocate resources efficiently, the government can change the outcome through public policy. Examples are regulations against monopolies and pollution. 
How People Interact
  • A Country's Standard of Living Depends on Its Ability to Produce Goods and Services. Countries whose workers produce a large quantity of goods and services per unit of time enjoy a high standard of living. Similarly, as a nation's productivity grows, so does its average income.
  • Prices Rise When the Government Prints Too Much Money. When a government creates large quantities of the nation's money, the value of the money falls. As a result, prices increase, requiring more of the same money to buy goods and services. 
  • Society Faces a Short-Run Tradeoff Between Inflation and Unemployment. Reducing inflation often causes a temporary rise in unemployment. This tradeoff is crucial for understanding the short-run effects of changes in taxes, government spending and monetary policy.  
Slembeck's "Ten Principles of Economics (as a Discipline)"
  • Scarcity: Economists study situations where needs or wants exceed means. Therefore, people have to make choices.
  • Rationality is assumed to guide people's choices or decisions. They systematically gauge all pros (benefit or "utility") and cons ("cost") of all alternatives or options they are facing when deciding. 
  • Preferences: People are equipped with fixed and given preferences that allow them to assign utilities to all options, and to choose the option that maximizes (net) utility.
  • Restrictions: People face constrains that they cannot change themselves, and thus have to take as given (such as budgets, input cost etc.). Maximization is always constriaint by restrictions.
Combining the first four points makes up for the "rational choice approach" of Neoclassical economics.
  • Opportunity Cost is induced by scarcity, and by the need to make choices. All choices always involve opportunity cost because deciding in favor of one option always means deciding against some other option(s). There are two main aspects of opportunity cost: 1) Utility maximizing choices induce opportunity cost to be minimal (static aspect). 2) Choices may be revised when opportunity cost rises (dynamic aspect).
  • The Economic Principle is the application of rationality to situations of scarcity: Minimize cost with regard to a given goal (e.g., level of utility) OR maximize utility for a given level of cost or input. Hence the "economic principle" frames situations as a minimizing or a maximizing problem, and allows to assess efficiency. Do not mix the two formulations! Applying the principle avoids wasting valuable resources.
  • Efficiency of activities, rules, transactions or distributions is a basic theme in economic analysis. Efficiency is most often assessed either in terms of the economic principle (minimize cost or maximize utility) or the Pareto criterion (with regard to transactions and distributions).
  • Marginal Analysis is a typical way for economists to look at problems. They analyze decisions in terms of marginal benefits and marginal costs. Marginal thinking is rather uncommon among non-economists, however.
  • Equilibrium is a fundamental notion in economic analysis. Basic economic models deal with the comparison of two (or possibly more) equilibria (comparative statics). Economist think in terms of equilibria, which are situations where no one has an incentive to change his or her behavior. The Nash equilibrium is the most fundamental formulation of the concept of equilibrium as used in economics.
  • Game Theory is an approach to study situations of interdependence where people have incentives to think and behave strategically.
Download Slembeck's 10 Principles (in PDF)

Comment (to follow).................

Page by Tilman Slembeck, 6 October 2001, last modified 1 Oct. 2006
What do you think about my list? - Comments are very welcome! ->