Harvard economist Gregory Mankiw, a former White House economic adviser and the author of a textbook that is used in many college courses on basic economics, identified three types of principles. These relate to how individuals make decisions, how people interact and how economies work.
Economists constantly remind us that there is no such thing as a free lunch; in other words, getting what you want means giving up something else, a trade-off. Spending money for a vacation, for example, may mean less money for savings or home improvements. Societies face a trade-off between a cleaner environment and a higher cost of living because of taxes and higher prices because of the costs associated with environmental regulations.
Another principle related to individual decisions is that people respond to incentives. Higher gasoline prices may lead people to drive less or demand more fuel-efficient vehicles. Lower taxes may provide an incentive to work more and earn more money.
Economists assume that people are rational decision-makers who rank their preferences and pursue those that will provide the highest level of satisfaction, or utility. This principle is especially associated with economists of the Neoclassical tradition, the dominant school of thought in mainstream economics.
In addition, individual decisions involve what Mankiw calls thinking at the margin. This means people weigh the costs of a decision against the additional benefit. For example, a person may weigh the costs of an additional year of school against the added income resulting from the additional education.
Economies involve interactions among individuals and firms. People buy goods and services, and sell their labor to get the money to afford those purchases. Firms sell goods and buy labor and other goods needed for production. Economists consider markets, in which individuals and firms are free to interact with each other, as the best mechanism for organizing economic activity. Through markets, forces of supply and demand can help determine the prices of labor (wages) and of all goods and services, ranging from a gallon of gasoline to a state-of-the-art computer.
Economists also believe that trade, whether among families or entire nations, can benefit everyone by allowing individuals, firms and nations to specialize in particular activities, while acquiring the rest through trade.
Most economists believe that markets, rather than government authorities, are the best way to organize economic activity. But economists also recognize that governments have an important role to play. A legal system protects property rights and enforces contracts. In addition, governments can improve economic outcomes through policies that are designed to promote efficiency and equity.
Mankiw outlines three key principles on how the economy as a whole works. One is that a country's ability to produce goods and services will determine its standard of living. The more productive a nation, the higher the living standard its people enjoy.
Another principle is that prices rise when the government allows too much money to circulate. This overall price increase is known as inflation. With an abundant supply of money, there is higher demand for a limited supply of goods. When demand for goods exceeds the supply, inflation is the result.
Finally, economists recognize that there is a short-term trade-off between inflation and joblessness. Higher inflation may lead to lower unemployment in the short term, under what economists call the Phillips Curve.