ECON: Some Principles of Economics

Hello, readers!

Well, firstly, sorry for not posting here for a long time. Secondly, I would like to interrupt our Economics course to discuss some intriguing topics.

During this week, I was studying the “Principles of Economics” book from the economist Nicholas Gregory Mankiw, and I found a brilliant introductory passage about some Economics foundations. Thus, in this article, I would like to introduce and explore deeper these ten fundamental laws:

1. Individuals deal with trade-offs

You may be questioning what is trade-offs? Trade-offs are circumstances in which there are conflicting choices. Hence, people regularly require to make tough decisions both in their daily routine and in more complex situations; for instance, imagine that you are in a restaurant, and you need to choose what do you want to drink, some people remain in doubt between orange juice and soft drink, others may be in dilemma between grape juice and sparkling water. Therefore, even this seems to be a trivial and obvious situation, economists need to consider that choices have trade-offs, otherwise, they can obtain erroneous outcomes.

2. The price of a choice is what you have to give up to get it

This Principle is related to trade-offs too because when individuals make decisions, they necessarily consider the costs and benefits of doing this particular action as detrimental to others. Thus, economists consider this concept as opportunity cost that is the cost of a decision in terms of the opportunities given up in order for the action to be effective, whereas every application of scarce resources can have an alternative allocation.

3. Individuals tend to think at the edge

When humans need to make decisions, they usually reflect on the margin of the benefit-cost; in other words, as rational people, we are inclined to consider how much we can benefit from little increments when we make choices. This reasoning affects the companies too; for example, firms always face the dilemma of hiring one more person that can lead to an increase in production, but also rise significantly the payroll. In this context, economists need to consider the marginal cost and benefit.

4. Individuals react to incentives

Incentives are vital in the economic analysis because they can influence us to behave in a certain manner. This concept can be illustrated in the Law of Demand (that we discuss in the previous article) as when prices increases, people are less willing to obtain certain good and vice-versa. Moreover, how people answer stimulus is an important detail to judge in the design and implementation of a public policy.

5. Trade can benefit everyone

In accordance with Adam Smith (that we discuss a bit about him in the post entitled What is Economics?), commercial exchanges can benefit both sides because it provokes the specialization of regions and countries in certain goods that has better cost-benefit, leading to more efficient production. Furthermore, recent economic papers have been supporting this thesis of the advantages of free trade since fewer imports will decrease the number of exports.

6. Markets are usually a proper mechanism

In fact, the market is an extremely beneficial tool to allocate resources as the market economy follows the law of demand and supply. Also, the price is an excellent messenger of the economy because it combines the willingness of the consumers and the capacity of the firms. Therefore, the market economy can normally bring a harmonic and collaborative economic, social, political, and cultural environment for everyone.

7. Government can perform necessary roles

Although the market is extremely powerful, it has some specific flaws that can be alleviated through controlled government action. Conforming several economists, there are three markets failures: monopolies (situation of imperfect competition that a limited number of companies controlled the market of a specific good), externalities (outcomes for others that are not considered in either the decision process or the pricing system), and information asymmetry (condition in which some side has more accurate information than the other). Thus, it is essential a government role in these particular situations, which can provoke severe consequences, in order to enhance the welfare of everyone.

8. Implications of productivity on quality of life

Current pandemics evidenced the huge social, economic and geographic disparity. While high-income countries could lead this crisis with relative easiness due to more consolidated industries sectors, low-income nations suffered from the health and economic crisis. This inequality of income can be explained by productivity: more productivity implies a better allocation of resources and better quality of life. Hence, public policies need to consider to enhance the productivity of the economy through investment in education, reduction of excessive bureaucracy, development of structural reforms, and other solutions.

9. Inflation is correlated with how much money the government prints

Money has three main functions: medium of exchange, store of value, and unit of account. When one of these roles becomes unstable, inflation may arise. What is inflation? It is the continuous and overall increase of prices in an economy and can be manifested by a decrease in the demand from consumers or in the supply from companies and by an excessive increase in the quantity of money. Moreover, the supply and demand “problem” can be self-regulated by the market. However, when the government prints too much money, the value of the currency drops, and consequently, the price rises. For example, according to the study entitled “The Monetary Dynamics of Hyperinflation” by Philip Cagan, after the Second World War, the Hungary government increased the average money rate by more than 12,000%, which was followed by an increase of the prices by 20,000% per month.

10. Trade-off between inflation and unemployment

Even though the prices can rise significantly in the log-term due to excessive money printing, there is a choice between inflation and unemployment in the short-term. Conforming to economists, the increase in the money supply will expand the demand for goods; moreover, the businesses will raise the prices of their goods, and hire more workers. Therefore, the employment rate will likely increase in the short-term as stated in the economic model named the “Philips curve”.

Therefore, these were the 10 Principles of Economics, and I hope that you understood and enjoyed them!

Thank you for reading this article so far! Feel free to contact me either in the section 'Contact us' or on Instagram if you have any doubts. Do not forget to subscribe to our blog and to our YouTube Channel, in which we are going to post many nice videos. Also, follow us on Instagram (@meep.blog). “See you” next week!

Luigi

Article based on the book “Principles of Economics”, 7th edition, from N. Gregory Mankiw