Economics Notes PDF

The Economic Perspective 1.​ Scarcity and Choice: Resources are scarce, so choices must be made about how to use them. 2.​ Opportunity cost refers to what you give up when making a choice. 3.​ Purposeful Behavior: Individuals and firms act in rational self-interest to maximize their...

The Economic Perspective 1.​ Scarcity and Choice: Resources are scarce, so choices must be made about how to use them. 2.​ Opportunity cost refers to what you give up when making a choice. 3.​ Purposeful Behavior: Individuals and firms act in rational self-interest to maximize their utility (satisfaction) and profit. 4.​ Marginal Analysis: Decision-making involves comparing marginal benefits and marginal costs—the extra benefits and costs of one more unit of something. Opportunity Cost - Whatever you give up to do something. Scarcity - The tension between infinite wants and limited resources. Incentives - A set of external motivators that explain people’s choices. MarcoEconomics- The study of production, employment, prices, and policies on a national scale. They predict the direction of the whole economy. EX: of Macro - Will unemployment rise if there is an increase in taxes? MicroEconomics- The study of how consumers, workers, and firms interact to generate outcomes in specific markets. EX: Micro: How many workers should we hire to maximize profit? Economics- A social science concerned with making optimal choices under conditions of scarcity. If the Ceiling is higher than the equilibrium, nothing happens. Usually a ceiling price prevents u Reaching equilibrium. Price Floor - Prices are set above the correct market price. Positive vs. Normative Economics: ​ Positive economics- is based on factual statements about the economy.  ​ Normative economics- involves value judgments about economic policies or outcomes. International Trade: ​ Specialization increases production possibilities by allowing countries to focus on producing goods they can make efficiently and trade for goods they can't produce as efficiently. Pitfalls to Sound Economic Reasoning: ​ Biases: Be cautious of emotional or subjective views that distort economic analysis. ​ Loaded terminology: Words that manipulate or skew opinions (e.g., “welfare queen”). ​ Fallacies: Errors in logic, such as post hoc fallacy (assuming causality from correlation) or the fallacy of composition (assuming what’s true for one part is true for the whole). The Economizing Problem: ​ Limited income vs. unlimited wants leads to the budget line and trade-offs. ​ The budget line shows attainable and unattainable combinations of goods you can purchase given your income. Consumer’s Budget Line: ​ Given an income (e.g., $120), if you can buy either DVDs ($20 each) or books ($10 each), the budget line shows combinations of these items that are affordable. Society’s Economizing Problem: ​ Economic resources: Land, Labor, Capital, and Entrepreneurial ability. ​ Entrepreneurs make decisions, innovate, and take risks in organizing production. Production Possibilities Model: ​ A model showing different combinations of two goods (e.g., pizza and robots) that an economy can produce with its resources. ​ Assumptions: Full employment, fixed resources, and fixed technology. Increasing Opportunity Costs: ​ The law of increasing opportunity costs suggests that as more of one good is produced, the opportunity cost of producing additional units increases. This is reflected in a concave production possibilities curve. Optimal Output: ​ The point where marginal benefit (MB) equals marginal cost (MC) represents the optimal output. Economic Growth: ​ Economic growth expands an economy’s production possibilities, allowing it to produce more goods, like pizza or robots, in the future. Theories, Principles, and Models: ​ The scientific method in economics involves observation, forming hypotheses, testing, and revising hypotheses as necessary. ​ Economic principles generalize behaviors in economies using assumptions like ceteris paribus (everything else being equal) and are often represented graphically. ### **Economic Systems:** Economic systems are ways that societies organize and coordinate their economic activities. Different systems vary in how much **government control** and **market freedom** they allow. - **Economic systems**: Set of arrangements and mechanisms to solve the **economizing problem** (scarcity). - **Difference in systems**: The **degree of decentralized decision-making** (market-based systems) vs. **centralized control** (government-run systems). ### **Types of Economic Systems:** 1. **Laissez-Faire Capitalism**: - **Ideal economy**: Limited government involvement. - Government's role is only to **protect private property**, **enforce contracts**, and maintain legal order. - Individuals and businesses interact freely in the market. 2. **The Command System (Socialism/Communism)**: - **Government ownership** of resources (land, labor, capital). - A **central planning board** makes all the decisions about what, how, and for whom to produce. - Examples: North Korea, Cuba, Myanmar. 3. **The Market System (Mixed Economy)**: - A **mix of decentralized decision-making** and **government control**. - Private markets and self-interest drive much of the economy, but there is some government regulation (e.g., regulations, taxes). - **Private ownership** resources is fundamental. **Characteristics of the Market System:** 1. **Private Property**: Individuals and businesses own resources. 2. **Freedom of Enterprise**: Entrepreneurs can start and run businesses. 3. **Freedom of Choice**: Consumers and producers make their own choices. 4. **Self-Interest**: People and firms act in their own best interests. 5. **Competition**: Multiple firms compete for customers, which leads to innovation and lower prices. 6. **Market and Prices**: Prices are determined by supply and demand in markets. **Key Elements of the Market System: 1. **Technology and Capital Goods**: - Encourages **advanced technology** and the use of **capital goods**. - **Specialization** and **division of labor** lead to efficiency and increased production. - **Geographic specialization** maximizes the production of goods and services in a location. 2. **Use of Money**: - **Money** facilitates trade, avoiding the need for **barter**. - It acts as a **medium of exchange**, making transactions easier and more efficient. 3. **Active but Limited Government**:  - **Market failures** (like monopolies or externalities) may require government intervention. - Government can also help improve the functioning of the market, but **government failure** can also occur if intervention is inefficient. The Five Fundamental Questions: 1. **What goods and services will be produced?** - Goods that can be produced for a profit. - **Consumer sovereignty** (consumer preferences drive what’s produced) using **dollar votes**. 2. **How will the goods and services be produced?** - **Minimize costs** by using efficient production methods. - Decisions depend on **technology** and **resource prices**. 3. **Who will get the goods and services?** - **Consumers with the ability and willingness to pay** (based on income and wealth). 4. **How will the system accommodate change?** - Adaptations occur due to **consumer preferences**, **technological changes**, and **resource prices**. 5. **How will the system promote progress?** - Through **technological advancement**, **creative destruction** (old products replaced by new ones), and **capital accumulation** (investing in capital for future production). - The **invisible hand**, a term coined by **Adam Smith** in "Wealth of Nations," describes how individual self-interest leads to positive outcomes for society as a whole, such as: - Efficiency (resources are allocated optimally). - Incentives** (profits motivate innovation and hard work). - **Freedom** (individuals and businesses have the freedom to act in their own interests). The Demise of Command Systems: - Coordination problem: Governments in command systems have difficulty determining how much of each good should be produced. - Incentive problem Without profit motives, there’s no incentive for producers to be efficient or responsive to consumer demand. - Example: The Soviet Union, Eastern Europe, and **China The Circular Flow Model: - The circular flow diagram represents the economy’s transactions. - Households** sell resources to **businesses** in the **resource market**. - Businesses** sell goods and services to **households** in the **product market**. - Real flow** (resources and goods) and **money flow** (payments for resources and goods). How the System Deals with Risk: -Business risks Owners and investors take risks related to resource shortages, consumer demand changes, or external events (e.g., natural disasters). - **Business owners** assume personal risk for outcomes. -Employees and suppliers typically don’t share in the risks directly but have job security and are paid regardless of firm performance. Shuffling the Deck (Economic Organization): - The market economy avoids random outcomes and ensures efficient allocation of resources using private property rights and rational decision-making. 1. Construction of a Graph: ​ Graph: A visual representation of the relationship between two variables. ​ Axes: ○​ Horizontal axis: This is the x-axis where the independent variable is plotted. ○​ Vertical axis: This is the y-axis where the dependent variable is plotted. ○​ Independent variable: The variable that is being manipulated (often represented on the x-axis). ○​ Dependent variable: The variable that changes in response to the independent variable (often represented on the y-axis). ○​ Ceteris Paribus: This Latin term means "all else being equal" and is used to isolate the effect of one variable while assuming other factors remain constant. 2. Direct and Inverse Relationships: ​ Direct Relationship: ○​ Both variables move in the same direction. ○​ Example: If income increases, consumption also increases. This can be represented with a positive slope in the graph. ​ Inverse Relationship: ○​ Variables move in opposite directions. ○​ Example: As ticket price increases, attendance decreases. This can be represented with a negative slope in the graph. 3. Graph Construction Example: ​ Example 1: Income and Consumption: ○​ As income (independent variable) increases, consumption (dependent variable) increases. This is a direct relationship. ○​ The graph for this might look like: ​ Income: 100, 200, 300, 400 ​ Consumption: 50, 100, 150, 200 ​ Example 2: Ticket Price and Attendance:  ○​ As ticket price (independent variable) increases, attendance (dependent variable) decreases. This is an inverse relationship. ○​ The graph for this might look like: ​ Ticket Price: 50, 40, 30, 20, 10 ​ Attendance: 0, 4, 8, 12, 16 4. Slope of a Line: ​ Slope: The slope of a line measures how steep it is, i.e., the rate of change between the two variables. ○​ Formula: Slope = (vertical change) / (horizontal change) ○​ Positive slope: If the line rises from left to right, the slope is positive, meaning the dependent variable increases as the independent variable increases. ​ Example: From (0, 50) to (100, 150) gives a slope of (150 - 50) / (100 - 0) = 100 / 100 = 1. ○​ Negative slope: If the line falls from left to right, the slope is negative, meaning the dependent variable decreases as the independent variable increases. ​ Example: From (0, 50) to (100, 30) gives a slope of (30 - 50) / (100 - 0) = -20 / 100 = -0.2. ○​ Zero slope: A horizontal line has a slope of 0, meaning the dependent variable does not change as the independent variable changes. ○​ Infinite slope: A vertical line has an infinite slope, meaning the dependent variable changes drastically for a tiny change in the independent variable. 5. Equation of a Linear Relationship: ​ A linear equation is a mathematical expression for a straight line. The general form is:​ y = a + bx ○​ y: Dependent variable. ○​ a: Vertical intercept (the value of y when x = 0). ○​ b: Slope of the line. ○​ x: Independent variable. ○​ Example: ​ The equation Y = 50 + 0.5C represents a relationship between consumption (C) and income (Y). Here, 50 is the vertical intercept, and 0.5 is the slope. ​ The equation P = 50 - 2.5Q represents the relationship between ticket price (P) and attendance (Q), where 50 is the intercept and -2.5 is the slope. 6. Slope of a Nonlinear Curve: ​ Nonlinear Curve: A curve where the slope changes at different points along the curve. Tangent Line: To find the slope at a particular point on a nonlinear curve, you draw a  tangent line (a straight line that touches the curve at only one point) and calculate the slope of that line. ○​ The slope at any point on a nonlinear curve is not constant, and it varies as you move along the curve. ​ Market: The interaction between buyers and sellers where goods and services are exchanged. ○​ Markets can be local, national, or international. ○​ Price: It's determined through the interactions of buyers and sellers, acting as a signal for how much of a good will be bought or sold. 2. Demand: ​ Demand refers to the quantity of a good that consumers are willing and able to purchase at a specific price, given that all other factors are constant (ceteris paribus). ○​ Demand Schedule: A table showing the relationship between price and quantity demanded. ○​ Demand Curve: A graphical representation of the demand schedule. Law of Demand: ​ Law of Demand: As price falls, quantity demanded rises (and vice versa), assuming all other factors are constant. ○​ Reasons for this: ​ Price acts as an obstacle to buyers. ​ Law of diminishing marginal utility: The more you have of something, the less satisfaction you get from each additional unit, which makes you willing to pay less. ​ Income effect: As price decreases, your income can buy more. ​ Substitution effect: As prices drop, consumers switch from other goods to the cheaper alternative. Shifting the Demand Curve: ​ The demand curve shifts when factors other than price change: ○​ Increase in demand: The curve shifts to the right.  ○​ Decrease in demand: The curve shifts to the left. Determinants of Demand: 1.​ Change in consumer tastes and preferences (e.g., fitness trends increasing demand for athletic gear). 2.​ Change in the number of buyers (e.g., more buyers lead to more demand). 3.​ Change in income: ○​ Normal goods: Demand increases when income increases (e.g., restaurants, cars). ○​ Inferior goods: Demand decreases when income increases (e.g., cheap fast food, generic brands). 4.​ Change in prices of related goods: ○​ Complementary goods: Goods that are often consumed together (e.g., DVD players and DVDs). ○​ Substitute goods: Goods that can replace each other (e.g., tea and coffee). 5.​ Change in consumer expectations (e.g., higher future prices increase demand today). 3. Supply: ​ Supply refers to the quantity of a good that producers are willing and able to sell at a specific price. ○​ Supply Schedule: A table showing the relationship between price and quantity supplied. ○​ Supply Curve: A graphical representation of the supply schedule. Law of Supply: ​ Law of Supply: As price rises, quantity supplied rises, and as price falls, quantity supplied falls. ○​ Producers are motivated by price incentives to increase supply at higher prices, but at some point, rising costs can limit this. Shifting the Supply Curve: ​ The supply curve shifts when factors other than price change: ○​ Increase in supply: The curve shifts to the right. ○​ Decrease in supply: The curve shifts to the left. Determinants of Supply: 1.​ Change in resource prices: Lower costs make it easier to supply goods (e.g., cheaper microchips increase computer supply).  2.​ Change in technology: Better technology increases supply (e.g., improved farming equipment raises crop yield). 3.​ Change in the number of sellers: More sellers increase market supply (e.g., more suppliers of tattoos increases tattoo availability). 4.​ Change in taxes and subsidies: Higher taxes can reduce supply (e.g., increased cigarette taxes reduce cigarette supply). 5.​ Change in the prices of other goods: If the price of one good rises, producers may divert resources from other goods, reducing supply (e.g., if cucumber prices rise, watermelon supply decreases). 6.​ Change in producer expectations: Expecting higher future prices can reduce current supply (e.g., expecting higher future log prices decreases current log supply). 4. Market Equilibrium: ​ Equilibrium occurs when the demand and supply curves intersect. At this point: ○​ Equilibrium price: The price where quantity demanded equals quantity supplied. ○​ Equilibrium quantity: The quantity of goods bought and sold at the equilibrium price. ​ Surplus: When the price is above equilibrium, quantity supplied exceeds quantity demanded, leading to unsold goods. ​ Shortage: When the price is below equilibrium, quantity demanded exceeds quantity supplied, leading to unmet demand. ​ Rationing function of prices: Prices adjust to balance supply and demand, ensuring that goods are allocated efficiently. 5. Efficient Allocation: ​ Productive efficiency: Producing goods at the lowest possible cost (e.g., using the best technology and resources). ​ Allocative efficiency: Producing the combination of goods that society values the most. 6. Changes in Demand and Supply: ​ Increase in Demand: Prices rise and quantities increase. ​ Decrease in Demand: Prices fall and quantities decrease. ​ Increase in Supply: Prices fall and quantities increase. ​ Decrease in Supply: Prices rise and quantities decrease. Complex Cases:  ​ If both supply and demand change: ○​ Increase in supply and decrease in demand: Price falls, quantity change is indeterminate. ○​ Decrease in supply and increase in demand: Price rises, quantity change is indeterminate. ○​ Increase in both supply and demand: Quantity rises, price change is indeterminate. ○​ Decrease in both supply and demand: Quantity falls, price change is indeterminate. 7. Government Set Prices: ​ Price Ceiling: A maximum price set below equilibrium (e.g., rent control). ○​ Results in shortages (more demand than supply) and may lead to black markets. ​ Price Floor: A minimum price set above equilibrium (e.g., minimum wage law). ○​ Results in surpluses (more supply than demand). 8. Legal Market for Human Organs (Hypothetical Example): ​ Positive Effects: Could solve the shortage of organs by incentivizing donations and eliminating black markets. ​ Negative Effects: Could commercialize life-saving goods, exclude the poor, and raise healthcare costs.