Modern Principles:
Microeconomics
Tyler Cowen
and Alex Tabarrok
Chapter 1
The Big Ideas
Copyright © 2010 Worth Publishers • Modern Principles: Microeconomics • Cowen/Tabarrok
Big Ideas in Economics
• The Big Ideas:
1. Incentives matter
2. Good institutions align self-interest with
the social interest
3. Trade-offs are everywhere
4. Thinking on the margin
5. Tampering with the laws of supply and
demand has consequences
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Big Ideas in Economics
• The Big Ideas:
6. The importance of wealth and economic
growth
7. Institutions matter
8. Economic booms and busts cannot be
avoided but can be moderated
9. Prices rise when the government prints
too much money
10.Central banking is a hard job
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Big Idea One: Incentives Matter
1. Incentives Matter
 Incentives are rewards and penalties
that motivate behavior.
 Economists believe that people respond
to incentives in predictable ways.
 Self-interest is an extremely important
incentive in economics.
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Big Idea Two: Good Institutions Align Self-Interest with the
Social Interest
2. Good institutions align self-interest with
the social interest
 Under the right conditions, markets align selfinterest with the social interest.
 When markets work well, individuals acting in
their own self-interest produce outcomes
promoting the social interest.
 Markets do not always align self-interest with
the social interest creating an opportunity for
government to improve the situation by
changing incentives.
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Big Idea Three: Trade-offs Are Everywhere
3. Trade-offs are everywhere
 All economic activity involves choices of
conflicting objectives.
 The Opportunity Cost of a choice is the value
of the opportunities lost.
• Economists use opportunity costs to
measure the extent of the trade-offs involved
in economic activity.
 Recognizing trade-offs is the first step in
making wise decisions.
 It is also important to note that people respond
to changes in opportunity costs.
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Big Idea Four: Thinking on the Margin
4. Thinking on the margin
 Economic activity rarely involves all-ornothing choices.
 Trade-offs typically involve decisions
about a little bit more or a little bit less.
 Thinking on the margin is essential to
properly analyze how people evaluate
the trade-offs they face.
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Big Idea Five: Tampering with the Laws of Supply and
Demand Has Consequences
5. Tampering with the laws of supply
and demand has consequences
 The model of supply and demand is one
of the most important tools in economics
and determines the price of goods and
services.
 Interference by government decree in the
mechanisms of this model rarely works.
 Such controls on price tend to make
matters worse by interfering with
incentives.
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Big Idea Six: The Importance of Wealth and Economic Growth
6. The importance of wealth and
economic growth
 Wealth brings higher standards of living.
 Understanding economic growth (how
economies increase wealth) is one of the
most important tasks of economics.
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Big Idea Seven: Institutions Matter
7. Institutions matter
 Why are some countries rich and others
poor?
• Incentives to save and invest in physical
capital, human capital, innovation, and
efficient organizations determine the wealth
of nations.
 Strong institutions that support these
incentives foster economic growth.
• Such institutions include property rights,
political stability, honest government, a
dependable legal system, and competitive
and open markets.
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Big Idea Eight: Economic Booms and Busts Cannot Be
Avoided but Can Be Moderated
8. Economic booms and busts cannot be
avoided but can be moderated
 Economies do not grow at a constant pace but
rather experience ups and downs, booms and
bust.
 These booms and busts are typically normal
responses to changing economic conditions.
 Monetary and fiscal policy are tools used to
smooth out the fluctuations of a normal
economy.
 Understanding the promise and the limits of
these tools is an important aspect of
economics.
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Big Idea Nine: Prices Rise When the Government Prints Too
Much Money
9. Prices rise when the government
prints too much money
 Monetary policy can be used to mitigate
economic fluctuations, but it can create
unwanted side effects.
 Inflation is an increase in the general
level of prices.
• Inflation comes about when there is a
sustained increase in the supply of money.
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Big Idea Ten: Central Banking Is a Hard Job
10.Central banking is a hard job
 In most nations a central bank sets monetary
policy to ease fluctuations in the economy.
 The difficulty with this approach is that there is
a lag (often many months) between a policy
decision and its effect on the economy.
 Economic conditions can change in the
meantime however, so the central bank is
essentially shooting at a moving target.
 The problem is that too much or too little
money in the economy will influence its general
level of prices.
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The Biggest Idea of All: Economics Is Fun
• Of course, the biggest idea of all is
that economics is fun!
 Economics teaches how to make the world a
better place.
 It is about the difference between wealth and
poverty, work and unemployment, happiness
and squalor.
 Economics increases an understanding of the
distant past, present events, and future
possibilities.
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