Ch. 1 The Big Ideas Original

Economics

is the study of how individuals and societies allocate scarce resources to satisfy their needs and wants. (study of human action)

Incentives

Rewards and penalties that motivate someone’s behavior

Adam Smith

is known as the father of modern economics, advocating for free markets and the idea of the 'invisible hand' guiding economic activity. He emphasized the importance of self-interest in promoting economic prosperity.

Self-interest

is the motivation of individuals to pursue their own personal gain, which can lead to beneficial outcomes for society as a whole.

Self-interest aligns

With the broader public interest, there are good outcomes. When they don’t, there can be bad and sometimes cruel and inhumane outcomes.

Captains' payment system

Incentive structure improving prisoner treatment.

Good market conditions

Alignment of individual self-interest with the social interest

Benevolence and incentives

Kindness influenced by personal motivations.

Invisible hand

A metaphor introduced by Adam Smith where individual self-interest leads to positive economic outcomes for society as a whole.

Market incentives being too strong

can lead to negative externalities, where personal gains result in societal harm.

Market incentives being too weak

can result in inefficiencies and missed opportunities for economic growth.

When a markets self-interest DON’T line up with social interest

Government can improve it with taxes, subsidies, or other regulations

Vioxx controversy

Public outrage over drug withdrawal for safety.

drug lag

the delay in the availability of new drugs to patients due to lengthy approval processes.

drug loss

Failure to develop safe drugs due to testing delays.

Scarcity

Not enough resources to satisfy everyone’s wants

Great economic problem

the challenge of allocating limited resources to meet unlimited wants and needs.

Opportunity costs

the benefits forgone when choosing one option over another. The value of possibilities lost when you make a choice

1st important reason for opportunity costs

If you don’t understand the opportunities you are losing when you make a choice, you won’t recognize the real trade-offs that you face. Recognizing trade-offs is first major step in making wise decisions

2nd important reason for opportunity costs

Most of the time, people often respond to opportunity costs, even when money costs have not changed.

Trade-offs

the alternatives that must be given up when making a decision.

Marginal Benefits

Additional benefits from consuming or producing more.

Marginal costs

Extra costs incurred from producing or consuming more.

Thinking on the margin

making choices by thinking in terms of marginal benefits and marginal costs, the benefits and costs of a little bit more (or a little bit less).

Marginal revenue

Additional income gained from selling one more unit of a good or service.

Marginal tax rates

the tax rate on an additional dollar of income

Marginal revolution

A significant shift in economic thinking during the late 19th century that focused on the importance of marginal utility in determining value and consumer choice.

Specialization

The process of focusing on a specific task or production process to increase efficiency and output.

Division of knowledge

The concept that different individuals or groups specialize in specific areas of expertise, leading to increased efficiency and productivity in the economy. The sum total of knowledge and productivity increases

Economies of scale

the reduction in costs created when goods are mass-produced.

Theory of comparative advantage

The economic theory that explains how countries or individuals can gain from trade by specializing in the production of goods for which they have a lower opportunity cost, thus benefiting from exchanging those goods.

Higher opportunity costs

refers to the cost of forgoing the next best alternative when making a decision, often leading to less efficient resource allocation.

Lower opportunity costs

refers to the cost of forgoing alternatives that are less valuable, allowing for more efficient resource allocation and specialization in production.

More wealth can result in

give the ability to pay for the prevention of the disease, most things are easier to come by that people care about (flush toilets, antibiotics, higher education, the ability to choose the career we want, fun vacations, and, of course, a greater ability to protect our families against catastrophes.)

Wealthier countries lead to

Richer and more fulfilled and even happier lives

Countries with higher GDP

Happier and more satisfied lives

Wealth

the abundance of valuable resources or material possessions, which can enhance quality of life and access to opportunities.

Physical capital

refers to tangible assets such as machinery, buildings, and tools that are used in the production of goods and services, contributing to economic productivity.

Human capital

the skills, knowledge, and experience possessed by individuals that contribute to economic productivity and personal development.

Technological knowledge

the understanding and expertise related to the use of technology and its applications in producing goods and services. Help produce things in a relatively efficient manner

Powerful institutions for supporting good incentives

Property rights, political stability, honest government, a dependable legal system, competitive and open markets.

Institutions

rules and structures that govern economic and social interactions, facilitating cooperation and reducing uncertainty.

Physical and human capital are organized

The latest technological knowledge because of incentives

Entrepreneurs, investors, and savers need incentives

save and invest in physical capital, human capital, innovation, and efficient organization

GDP

Gross Domestic Product; economic output measurement.

No economy

Grows at a constant pace; economics advances and receded; rises and falls; booms and busts

In a recession

wages fall and many people can be left with miserable unemployment; cannot avoid recessions

Booms

periods of rapid economic growth, often leading to increased production, investment, and consumer spending.

Busts

periods of economic decline following booms, characterized by decreased production, investment, and rising unemployment.

Booms and bust are

a normal part of the economy

Most economists believe today that the Great Depression could have been avoided because

The tools of the government, including monetary & fiscal policy, were not understood well, such as monetary and fiscal policy

Monetary policy

a set of tools used by a nation's central bank to control the overall money supply and promote economic growth

Fiscal policy

refers to the use of government spending and tax policies to influence economic conditions

Today, monetary and fiscal policy are better used and understood

When used properly, they can reduce swings of unemployment and GDP. Unemployment insurance can also reduce some of the horrid that comes with a recession

Monetary and fiscal policy were once thought to be

they could end recessions. When the policies are used poorly, monetary and fiscal policy can make recessions worse

federal reserve

the central banking system of the United States, which conducts monetary policy and regulates banks.

Inflation

increase in the general or average level of prices

Inflation makes people and prices

feel poorer and rise extremely and makes it harder for people to figure out what the real value of goods, services, and investments are

Inflation is caused by

a sustained increase in the supply of money

When people have more money

they tend to spend more, leading to increased demand for goods and services.

With people having more money and without an increase in the supply of goods

prices must rise

The federal reserve power can be good

for controlling inflation and stabilizing the economy.

The federal reserve power can be bad

Federal Reserve encourages too much growth in the supply of money. Inflation and a disruption in the economy is a result

GDP swings

can indicate economic fluctuations, reflecting periods of expansion and contraction in economic activity.

Price stability

Maintaining stable prices over time.

There is a lag with the federal reserve bank

Often lasts many months between the Fed making a decision and the effects of the decision on the economy are known. In the meantime, economic conditions can change.

Too much money =

inflation in the economy

Not enough money in the economy =

Leads to a recession or slowing of economic growth

Most economist believe the Fed is

Good than bad. However, to better understand the Fed, one needs to think of it as a highly fallible institution (making mistakes or being wrong) that faces a difficult job