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Economics
The study of how human beings coordinate their wants and desires, given the decision-making mechanisms, social customs, and political realities of the society.
3 central problems of economics:
What, and how much, to produce.
How to produce it.
For whom to produce it.
Coercion
Limiting people’s wants and increasing the amount of work individuals are willing to do to fulfill those wants.
Opportunity Cost
The benefit that you might have gained from choosing the next-best alternative. (Must give up something else).
Marginal cost
The additional cost to you over and above the costs you have already incurred.
Sunk costs
Costs that have already been incurred and cannot be recovered.
Marginal costs
The additional benefit above what you’ve already derived.
The economic decision rule:
If the marginal benefits of doing something exceed the marginal costs, do it.
If the marginal costs of doing something exceed the marginal benefits, don’t do it.
Economic forces
The necessary reactions to scarcity (rationing mechanisms).
Market force
An economic force that is given relatively free rein by society to work through the market.
Invisible hand
The price mechanism, the rise and fall of prices that guides our actions in a market
2 elements of scarcity
Our wants
Our means of fulfilling those wants
Economic reality is controlled by 3 forces:
Economic forces (the invisible hand)
Social and cultural forces
Political and legal forces.
Abduction
Method of analysis that uses a combination of inductive and deductive methods.
Economic model
A framework that places the generalized insights of the theory in a more specific contextual setting.
Economic principle
A commonly held economic insight stated as a law or general assumption.-ex: when you learned to add you didn’t memorize 147+138 (you learned a principle of addition).
Experimental economics
A branch of economics that studies the economy through controlled laboratory experiments.
Natural experiments
Naturally occurring events that approximate a controlled experiment where something has changed in one place but has not changed somewhere else.
Theorems
Propositions that are logically true based on the assumptions in a model.
Precepts
Policy rules that conclude that a particular course of action is preferable.
The Invisible Hand Theorem
A market economy, through the price mechanism, will tend to allocate resources efficiently.
When the quantity supplied is greater than the quantity demanded, price has a tendency to fall.
When the quantity demanded is greater than the quantity supplied, price has a tendency to rise.
Efficiency
Achieving a goal as efficiently as possible.
Microeconomics
The study of individual choice, and how that choice is influenced by economic forces.
study things like pricing policies of firms, household decisions on what to buy etc
Macroeconomics
The study of the economy as a whole.
study inflation, unemployment, business cycles, growth
Economic policies
Actions taken by government to influence economic actions.
to carry out economic policy effectively, one must understand how institutions might change as a result of the economic policy
Positive economics
The study of what is, and how the economy works.
explores the pure theory of economics (lots of assumptions)
Normative economics
The study of what the goals of the economy should be.
What should distribution of income be?
What should tax policy be designed to achieve?
Art of economics (political economy)
The application of knowledge learned in positive economics to the achievement of the goals one has determined in normative economics.
To achieve the goals that society wants, how would you go about it, given the way the economy works?
art of economics is about policy; designed to arrive at precepts (guides for policy)
Production possibility table
A table that lists a choice’s opportunity costs by summarizing what alternative outputs you can achieve with your inputs.
Output
A result of an activity.
Input
What you put into a production process to achieve an output.
Production possibility curve (PPC)
A curve measuring the maximum combination of outputs that can be obtained from a given number of inputs.
What does PPC demonstrate:
There is a limit to what you can achieve, given the existing institutions, resources, and technology.
Every choice you make has an opportunity cost. You can get more of something only by giving up something else.
Slope of PPC
Production Possibility Curves are downward sloping. Most are outward bowed because of increasing marginal opportunity cost; if opportunity cost doesn’t change, the PPC is a straight line.
The principle of increasing marginal opportunity cost
In order to get more of something, one must give up ever-increasing quantities of something else.
Comparative advantage
The ability to be better suited to the production of one good than to the production of another good.
Productive efficiency
Achieving as much output as possible from a given amount of inputs or resources.
Inefficiency
Getting less output from inputs that, if devoted to some other activity, would produce more output. (Inside the PPC so this is bad)
Efficiency
Achieving a goal using as few inputs as possible. (On the PPC)
Outside PPC…
Unattainable, given our resources and technology.
Trade and Comparative Advantage (Adam Smith)
Adam Smith argued that it is humankind’s proclivity to trade that leads to individuals using their comparative advantage.
Benefits of trade
Both parties benefit from a trade, otherwise why would they be doing it?
Laissez-faire
An economic policy of leaving coordination of individuals’ actions to the market.
Laissez-faire is not a theorem; it is a precept
Outsourcing
The relocation of production once done in the U.S. to foreign countries.
Insourcing
The relocation of production done abroad to the U.S.
Comparative advantage (countries)
If one country has a comparative advantage in producing one set of goods, the other country has to have a comparative advantage in the other set of goods.
Globalization
The increasing integration of economies, cultures, and institutions across the world.
In a globalized world economies of the world are highly integrated.
Affects of globalization on firms:
Positive: because the world economy is so much larger than the domestic economy, the rewards for winning globally are much larger than domestically.
Negative: it is much harder to win, or stay in business competing in a global market.
Exchange rate
The value of a currency relative to the value of foreign currencies.
The Law of One Price
The wages of workers in one country will not differ significantly from the wages of (equal) workers in another institutionally similar country.
Law of demand
Quantity demanded rises as price falls, other things constant
or Quantity demanded falls as price rises, other things constant
ex of “other things constant” = income, taste
Demand curve
The graphic representation of the relationship between price and quantity demanded.
Slopes downward
Demand
A schedule of quantities of a good that will be bought per unit of time at various prices, other things constant.
Quantity demanded
A specific amount that will be demanded per unit of time at a specific price, other things constant.
demand refers to entire demand curve
quantity demanded refers to a point on a demand curve
Movement along a demand curve
The graphical representation of the effect of a change in price on the quantity demanded.
Shift in demand
The graphical representation of the effect of anything other than price on demand.
Shift factors of demand
Society’s income
The price of other goods
Tastes
Expectations
Taxes and subsidies to consumers
Types of goods
Normal goods – rise in income = rise in demand (steak)
Inferior goods – rise in income = decrease in demand (spam)
Substitutes vs Complements
Substitutes – when price of substitute rises, demand for original good rises (ex. Jeans and khakis, when price of jeans rises and price of khakis stays the same, demand for khakis rises)
Complements – when price of good goes down, the demand for the good’s complement goes up (ex. Movie tickets and popcorn)
Market demand curve
The horizontal sum of all individual demand curves.
Law of supply
Quantity supplied rises as price rises, other things constant
or Quantity supplied falls as price falls, other things constant
law of supply is based on substitution and the expectation of profit
Supply curve
The graphical representation of the relationship between price and quantity supplied.
Slopes upward (quantity supplied varies directly with the price)
Supply
A schedule of quantities a seller is willing to sell per unit of time at various prices, other things constant. (refers to whole supply curve)
Quantity supplied
A specific amount that will be supplied at a specific price. (refers to point on supply curve)
Movement along a supply curve
The graphical representation of the effect of a change in price on the quantity supplied.
ex. change in quantity supplied that occurs because of a higher price
Shift in supply
The graphical representation of the effect of a change in a factor other than price on supply.
ex. change in supply that occurs because of one of the shift factors
Shift factors of supply
Price of inputs
Technology
Expectations
Taxes & Subsidies
Supply shift - Price of inputs
If costs rise, profits decline and supply falls.
Supply shift - Technology
Reduction in cost of production increases profits, leading to increase in supply.
Supply shift - Expectations
ex: if a supplier expects the price of his good to rise in the future, he may store some of today’s output in order to sell it later and make money (decrease supply now & increase it later)
Supply shift - Taxes & subsides
Taxes increase cost of production, profit declines, suppliers reduce supply
Subsidies to suppliers are payments by the gov to produce goods-
they reduce cost of production
From a supply table to a supply curve
Supply curve represents the set of minimum prices an individual seller will accept for various quantities of a good.
Individual and market supply curves
Market supply curve is derived from individual supply curves (just like market demand curve).
Market supply curve
The horizontal sum of all individual supply curves.
Slopes upward (rise in price leads to existing suppliers supplying more, and new suppliers entering the market).
Equilibrium
A concept in which opposing dynamic forces cancel each other out.
upward pressure on price is exactly offset by downward pressure on price
Equilibrium quantity
The amount bought and sold at the equilibrium price.
Equilibrium price
The price toward which the invisible hand drives the market.
quantity demanded = quantity supplied
Excess supply
Surplus, quantity supplied is greater than quantity demanded.
Excess demand
shortage, quantity demanded is greater than quantity supplied
Price adjusts
Quantity demanded greater than quantity supplied = prices rise
Quantity demanded less than quantity supplied = prices fall
Political and social forces on equilibrium
Equilibrium is not good or bad (simply state in which dynamic pressures offset each other)
In real world, political and social forces push supply/demand equilibrium away.
Fallacy of composition
The false assumption that what is true for a part will also be true for the whole.
ex. a lone supplier lowers price of his good, so people substitute that good for other goods and quantity demanded increases
but what if all suppliers lower prices?
Demand is elastic if…
Quantity demanded changes significantly as the result of the price change.
Demand is inelastic if…
Quantity demanded changes a small amount as the result of the price change.