Incentives, Trade-offs and Opportunity Cost

• Incentives are rewards and penalties that motivate behavior in predictable ways.
• Good institutions align self-interest with social interests, promoting social well-being when markets function properly.
• Governments can use taxes, subsidies, and regulations to correct markets when they don't work well.
• Choices involve trade-offs, necessitating a balance between competing benefits and costs.
• Drug testing illustrates trade-offs, wherein increased testing may reduce side effects but can also cause delays in drug approval (drug lag) or prevent the development of safe drugs altogether (drug loss).
• Opportunity cost represents the value of the next best alternative foregone when a choice is made.
• Decisions are made by evaluating the incremental benefits and costs of doing a little more or a little less of something.
• Trade enhances well-being by enabling specialization, increasing production, and exploiting economies of scale.
• Wealth and economic growth are important because they foster improved living standards.
• Institutions influence saving and investment decisions related to physical and human capital, innovation, and efficient organization.
• Property rights, political stability, honest government, a dependable legal system, and competitive markets promote economic growth.
• Booms and busts are normal occurrences in economies responding to changing conditions, but government fiscal and monetary policies can moderate these cycles.
• Misapplied fiscal and monetary policies can amplify economic volatility.
• Inflation is caused by an increase in the supply of money without a corresponding increase in goods, leading to a rise in prices.
• Inflation can erode wealth and disrupt the economy by distorting the perceived value of goods, services, and investments.
• Central banks face the difficult task of managing the money supply to avoid recessions and control inflation.
• Central banking policies have lags and therefore require careful oversight and planning.

Trade

• Trade benefits individuals when preferences differ, allowing for the exchange of goods based on varying valuations.
• Trade increases productivity through specialization, dividing knowledge across individuals and sectors.
• Comparative advantage contributes to heightened productivity via trade.
• Trade creates value by moving goods from those who value them less to those who value them more, thereby optimizing resource allocation.
• Specialization can lead to a greater division of knowledge.
• Increases in world trade provides opportunities to increase the division of knowledge.
• Comparative advantage arises when a country can produce goods at a lower opportunity cost compared to others.
• Factors of production include land, labor, capital, and entrepreneurship.

Supply, Demand, and Equilibrium

• Supply, demand, and equilibrium are the most important tools in economics.
• Changes in supply and demand correlate with booms and busts.
• A demand curve illustrates the quantity demanded at different prices, showing a downward slope.
• Consumer preferences and substitution possibilities influence their choices regarding goods.
• Quantity demanded refers to the amount buyers are willing and able to purchase at a specific price.
• The law of demand states that consumers will demand a lower quantity of a good at a higher price.
• As prices fall, consumers find more uses for goods.
• Diminishing marginal utility means that consumers prioritize satisfying their most urgent needs first.
• Consumer surplus measures the gain from exchange, calculated as the difference between the maximum price a consumer is willing to pay and the market price.
• An increase in demand shifts the demand curve to the right, indicating a greater willingness to buy at each price.
• A decrease in demand shifts the demand curve to the left, indicating a reduced willingness to buy at each price.

Factors That Shift Demand

• Income: Higher incomes typically increase demand for normal goods but decrease demand for inferior goods.
• Population: Population growth generally increases demand, while shifts in subpopulations affect demand for specific goods.
• Price of substitutes: A decrease in the price of a substitute reduces demand for the original good.
• Price of complements: Lower prices for complements increase demand for the related good.
• Expectations: Anticipated reductions in future supply can increase current demand.
• Tastes: Changes in tastes, influenced by trends, advertising, and fashion, can shift demand.

Supply Curve

• A supply curve illustrates the quantity supplied at different prices.
• Quantity supplied refers to the amount sellers are willing and able to sell at a particular price.
• Producer surplus measures the gain from exchange for producers, calculated as the difference between the market price and the minimum price at which they are willing to sell.
• An increase in supply shifts the supply curve to the right, reflecting producers' willingness to sell more at each price.
• A decrease in supply shifts the supply curve to the left, reflecting producers' reduced willingness to sell at each price.

Factors That Shift Supply

• Technological innovations and changes in input prices: Improvements in technology or reduced input costs increase supply.
• Taxes and subsidies: Taxes on output decrease supply, while subsidies increase it.
• Expectations: Suppliers expecting future price increases may reduce current supply.
• Entry or exit of procedures: The entry of new procedures increases supply, shifting the curve down and right.
• Changes in opportunity costs: Increasing opportunity costs shift the supply curve up and to the left.

Market Equilibrium

• Equilibrium price and quantity are stable in a free market.
• Shortages in a competitive market lead to price increases.
• A free market maximizes gains from trade, ensuring goods are bought by those with the highest willingness to pay and sold by those with the lowest costs.