Summary Introduction to Economics - Parkin: Economics - Readings for Week 1
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Introduction to Economics
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Rijksuniversiteit Groningen (RuG)
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Economics
This document contains a comprehensive summary of all readings for Week 1 - so, for both lecture 1 and 2 - of the first-year IRIO course Introduction to Economics at the RUG.
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Summary Economics, ISBN: 9781292147826 International Macroeconomics For Business
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Rijksuniversiteit Groningen (RuG)
International Relations and International Organization
Introduction to Economics
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Voorbeeld van de inhoud
Introduction to Economics International Relations and international Organization
Week 1: Lecture 1 - Consumer behaviour
What is economics? (p. 1-10)
Economics is the social science that studies the choices that individuals, businesses, governments,
and entire societies make as they cope with scarcity and incentives that influence and reconcile
those choices. The subject divides into two main parts:
- Microeconomics is the study of the choices that individuals and businesses make, the way
these choices interact in markets and the influence of governments.
- Macroeconomics is the study of the performance of the national economy and the global
economy.
Two big questions summarise the scope of economics:
1. How do choices end up determining what, how and for whom goods and services are produced?
- Goods and services are the objects that people value and produce to satisfy wants.
- Economics provides answers to all the questions below:
What? What we produce changes over time. Every year, new technologies allow us to
produce better and/or new goods and services.
How? Goods and services get produced by using productive resources that economists call
factors of production: land (‘gifts of nature’), labour (time and effort put in to produce goods
and services; quality of labour depends on human capital), capital (things used to produce
goods and services; not financial, but physical capital), entrepreneurship (human resource
that organises the other factors of production).
For whom? Who gets the goods and services that are produced depends on the incomes that
people earn. Incomes are earned by selling the services of the factors of production they
own: land earns rent; labour earns wages; capital earns interest; entrepreneurship earns
profit. The factor of production of labour earns the most income.
2. Do choices made in the pursuit of self-interest also promote the social interest?
- Self-interest: a choice is in your self-interest if you think that choice is the best one available for
you. Most of the choices made are in self-interest.
- Social interest: An outcome is in the social interest if it leads to an outcome that is the best for
society as a whole. If a decision makes everyone involved better off, it is in the social interest.
- Efficiency and the social interest: Economists use the everyday word ‘efficient’ to describe a
situation that can’t be improved upon. Resource use is efficient if it is not possible to make someone
better off without making someone else worse off.
- Fair shares and the social interest: The idea that social interest requires fair shares is a deeply held
one. For economists, however, that does not have to be the case. But what is fair? There is no neat
definition of fairness, but almost everyone agrees that too much inequality is unfair.
The protest against market capitalism
- Market capitalism is an economic system in which individuals own land and capital are free to buy
and sell land, capital and goods and services in markets.
- Centrally planned socialism is an economic system in which the government owns all the land and
capital, directs workers to jobs and decides what, how and for whom to produce.
-> our economy today is a mixed economy: market capitalism combined with government regulation
- The protesters against market capitalism takes many forms: historically, Karl Marx and other
communist and socialist thinkers wanted to replace it. The Occupy Wall Street movement is a visible
example of today’s protest against the power of big corporations and large incomes of the top 1%
- Smith gave the first systematic account of how capitalism works: self-interest of corporations is
maximum profit; invisible hand leads decision on the market; market transaction is a ‘win-win’ event
The economic way of thinking
There are six key ideas that define the economic way of thinking:
- A choice is a trade-off: giving up one thing to get something else
,Introduction to Economics International Relations and international Organization
- People make rational choices by comparing benefits and costs
-> benefit is what you gain from something (benefits are determined by preferences); cost is what
you must give up to get something (opportunity cost is the highest valued alternative that must be
given up to get it).
- Most choices are ‘how-much’ choices made at the margin
-> marginal benefit is the benefit that arises from an increase in an activity (only the increase is
considered, not the result already achieved)
-> marginal cost is the opportunity cost of an increase in an activity, e.g. marginal cost of studying
one more night is the cost of not spending that night on your favourite leisure activity
- Choices respond to incentives: the central idea of economics is that we can predict the self-
interested choices that people make by looking at the incentives they face. People undertake those
activities for which marginal benefit exceeds marginal cost and reject those for which marginal cost
exceeds marginal benefit
Economic coordination (p. 44-45)
For the world’s population to specialise and produce all sorts of goods, individual choices must
somehow be coordinated. Central economic planning works and worked badly because the planners
do not know people’s production possibilities and preferences. Decentralised coordination works
best, but needs four complementary social institutions:
- Firms: economic unit that employs factors of production and organises them to produce and sell
goods and services. Firms coordinate a huge amount of economic activity
- Markets: any arrangement that enables buyers & sellers to get information and to do business with
each other, e.g. the world oil market, which is not a place, but a network of producers, users etc.
- Property rights: social arrangements that govern the ownership, use and disposal of anything that
people value are called property rights
-> real property includes land, buildings and durable goods; financial property includes shares, bonds
and money in the bank; intellectual property is the intangible product of creative effort
- Money: any commodity or token that is generally acceptable as a means of payment
Trading in markets for goods and services and factors of production creates a circular flow of
expenditure. Markets coordinate all these decisions through price adjustments
Demand (p. 53-59)
Markets and prices
A market has two sides: buyers and sellers. There are many types of markets: for goods, services,
resources, inputs, money and financial securities. Some markets are physical places, but most
markets are unorganised collections of buyers and sellers. A competitive market is a market that has
many buyers and many sellers, so no single buyer or seller can influence the price.
The relationship between a price and an opportunity cost is important to examine price responses:
the price of a good or service is called the money price, while opportunity cost is the highest-valued
alternative forgone, which is often measured in the quantity of the product or service that is forgone.
The ratio of one price to another is called a relative price and a relative price is an opportunity cost.
To calculate this relative price, we divide the money price by the money price of a ‘basket’ of all
goods (a price index). The resulting relative price tells us the opportunity cost of the goods in terms
of how much of the basket we must give up to buy it. When we predict that a price will fall, we do
not mean its money price (although it might), but its price relative to other goods and services.
Demand
The quantity demanded of a good or service is the amount that consumers plan to buy during a
given time period at a particular price, which is not necessarily the same as the quantity actually
bought: sometimes demand exceeds the amount of goods available. Many factors influence buying
, Introduction to Economics International Relations and international Organization
plans and one of them is price. While looking at the relationship between quality demanded and
price, we make a ceteris paribus assumption: that all other factors remain the same.
The law of demand: Other things remaining the same, the higher the price of a good, the smaller is
the quantity demanded; and the lower the price of a good, the greater is the quantity demanded.
Two reasons:
1. Substitution effect: As the opportunity cost of a good rises, people buy less of that good and more
of its substitutes.
2. Income effect: Faced with a higher price and unchanged income, people cannot afford to buy all
the things they previously bought and must, therefore, decrease quantities demanded of at least
some goods.
In working with a demand curve and schedule, the distinction between demand and quantity
demanded is crucial. The term demand refers to the entire relationship between the price of the
good and the quantity demanded of the good, while the latter is a point on a demand curve. A
demand curve shows the relationship between the quantity demanded of a good (x-axis) and its
price (y-axis) ceteris paribus. A demand schedule does the same, but data are visualized in a table.
We can also view a demand curve as a willingness-and-ability-to-pay curve: willingness and ability to
pay is a measure of marginal benefit. If a small quantity is available, the highest price that someone is
willing and able to pay for one more is high. As the quantity available increases, the marginal benefit
falls and the highest price that someone is willing and able to pay falls along the demand curve.
When any factor that influences buying plans other than the price of the good changes, there is a
change in demand. Six main factors bring changes in demand:
- Prices of related goods: The quantity of a good that consumers plan to buy depends in part of the
prices of its substitutes and complements. A substitute is a good that can be used in place of another
good, while a complement is a good that is used in conjunction with another good.
- Expected future prices: If the expected future price of a good rises and if the good can be stored,
the opportunity cost of obtaining the good for future use is lower today than it will be when the price
has increased. Therefore, people retime their purchases: they substitute over time.
- Income: Consumers’ income influences demand. A normal good is one for which demand increases
as income increases. An inferior good is one for which demand decreases as income increases.
- Expected future income or credit: When expected future income increases or credit becomes
easier to get, demand might increase now (resulting in debt, which will be compensated later on).
- Population: Demand also depends on the size and the age structure of the population
- Preferences: Demand depends on preferences. Preferences are an individual’s attitude towards
goods and services
Changes in the factors that influence buyers’ plans cause either change in the quantity demanded or
a change in demand:
1. A movement along the demand curve shows a change in the quantity demanded and is caused
by a change in price
2. A movement of the demand curve shows a change in demand and is not caused by a change in
price but simply a change in demand (as a consequence of one of the six factors explained above)
- When demand increases, the demand curve shifts rightward
- When demand decreases, the demand curve shifts leftward
Households’ choices (p. 173-181; 183-185)
Consumption possibilities
Consumption choices are limited by income and by the prices of goods and services. A household’s
budget line describes the limits to its consumption choices.
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