Economic Principles: 10 Basics To Know

Economic principles are the simple concepts which describe how the economy runs (or fails). Understanding these basic economic principles can help everyone make better financial, business, or consumer decisions.

Whether you’re curious about the economy, marketing, government, or personal budgeting, these principles will explain how our everyday choices are part of a larger economic system.

The 10 Basic Economic Principles You Need to Know

Below are the 10 basic principles of economy as outlined by Gregory Mankiw in his book Principles of Economics.

1. People face trade-offs

The principle of trade-offs is quite simple. It states that every time a person acquires something, it is at the cost of something else. A common phrase which is used to describe this concept is, “there’s no such thing as a free lunch.”

2. The cost of something is what you give up to get it

Recognizing the principle of trade-offs allows people to weigh cost opportunities. Cost opportunities require weighing the benefits and costs of a decision.

For example, weighing the decision to go to college is not just about the cost of tuition, but also the time spent in class and commuting which cannot be used for making money at work.

3. Rational people think at the margin

In business, one assumes that consumers are rational. Rational decisions assure that consumers will try to choose a product or service which gives them the best price, opportunity cost, and benefit.

4. People respond to incentives

Because consumers use rational means to make decisions. Companies often need to supply reasons and incentives for consumers to choose their product or service over others. This is done by spelling out what the benefits include so that consumers have enough information to make a decision. The principle of incentives is a familiar approach in most marketing strategies.

5. Trade can make everyone better off

Trade is a mutually beneficial process. Ideally, a trade between two parties is a gain for both sides. In other words, economic trade, whether between individuals, companies and individuals, or even between countries, is not a competition where one side wins and the other loses, but rather, a win-win scenario.

6. Markets are usually a good way to organize economic activity

A market economy has been shown to be very effective compared to centrally planned economies. Centrally planned economies, otherwise known as command economies, are economic systems run by government or authority decisions. A market economy, on the other hand, functions through the decisions of consumers, businesses, and firms.

7. Governments can sometimes improve market outcomes

With this said, governments can be effective in helping during times of market failure. Market failure is a situation in which the market fails to allocate resources properly.

Examples of market failures are situations in which bystanders are harmed by the market (i.e. pollution) or in which there are monopolies affecting equal distribution. Different countries and governments have different policies when it comes to government involvement in the market economy.

8. A country’s standard of living depends on its ability to produce goods and services

There is a connection between a country’s standard of living and productivity. The higher the quantity of goods which a country produces indicates a higher standard of living. The way that a country can improve standards of living is by encouraging higher levels of productivity through education, tools, and access to opportunities.

9. Prices rise when the government prints too much money

This principle is pretty simple: The more money a country prints, the less value the money has. This means that an increase in printing leads to an inflation in prices.

10. Society faces a short-run tradeoff between inflation and unemployment

The short-run effect of printing more money can lead to higher rates of employment along with the higher prices. Some economists believe that this short-run effect is still worth the cost of inflation and eventually evens out over time, while other economists are not sure whether the relationship between employment and prices exist.

Conclusion

Economic principles are the complex ways in which the economy runs (or fails). These 10 economic principles by Gregory Mankiw demonstrate that our everyday decisions as businesses and consumers make a big difference in the economy.

Hopefully, these basic economic principles can help anyone in society make better, more informed choices about finances, business, and consumerism.