Principles of Economics summary
Table of Contents
Chapter 1 ‘Ten Principles of Economics’ ............................................................................. 1
Chapter 2 ‘Thinking Like an Economist’ ............................................................................. 4
Chapter 12 ‘Information and Behavioural Economics’ ....................................................... 6
Chapter 3 ‘The market forces of supply and demand’. ....................................................... 6
Chapter 6 ‘Background to supply firms in competitive markets’....................................... 12
Chapter 14 ‘Market structure I: monopoly’...................................................................... 18
Chapter 15 ‘Market Structure II: Monopolistic competition’ ............................................ 23
Chapter 11 ‘Market failure and Externalities’ .................................................................. 28
Chapter 1 ‘Ten Principles of Economics’
The amount of interaction between households and firms – the amount of buying and
selling which takes place – represents the level of economic activity. The more buying and
selling there are the higher the level of economic activity. Households and firms in a
particular geographic region are together referred to as the economy.
The management of society’s resources is important because resources are scarce. Scarcity
means that society has limited resources and therefore cannot produce all the goods and
services people wish to have. Economics is the study of how society manages its scarce
resources.
1.1 How People Make Decisions; Four principles about individual decision making;
1. People Face trade-offs
Making decisions requires trading off one goal against another. When people are
grouped into societies, they face different kinds of trade-offs.
One classic trade-off is between “guns and butter”. The more a society spends on
national defense (guns), the less it can spend on consumers good (butter).
Another trade-off is between a clean environment and a high level of income. Cost of
producing goods and services increases due a more sustainable machine, the profit
will decrease and as a result lower wage.
Another trade-off society face is between efficiency and equality. Efficiency means
that society is getting the maximum benefits from its scare resources. Equality
means that those benefits are distributed uniformly among society’s members.
2. The Cost of Something Is What You Give Up to Get It
Because people face trade-offs, making decision requires comparing the costs and
benefits of alternative courses of action. The opportunity cost of an item is what you
give up getting that item.
, For example, a college athlete who can earn millions if they drop out of school and
play professional sports are well aware that their opportunity cost of attending
college is very high.
3. Rational People Think at the Margin
Rational people systematically and purposefully do the best they can to achieve
their objectives, given the available opportunities. Economists use the term marginal
change to describe a small incremental adjustment to an existing plan of action.
Marginal analysis is based around an assumption that economic agents (an
individual, firm or organization that has an impact in some way on an economy) are
seeking to maximize or minimize outcomes when making decisions.
4. People Respond to Incentives
An incentive is something (such as the prospect of a punishment or reward) that
induces a person to act. Because rational people make decisions by comparing costs
and benefits, they respond to incentives. When analyzing any policy, we must
consider not only the direct effects but also the less obvious indirect effects that
work through incentives. If the policy changes incentives, it will cause people to alter
their behaviour.
1.2 How People Interact; Three principles of the concern how people interact with one
another.
1. Trade Can Make Everyone Better Off
Trade between two countries can make each country better off. Trade allows
countries to specialize in what they do best and to enjoy a greater variety of goods
and services.
2. Markets Are Usually a Good Way to Organize Economic Activity
An economic system is the way in which resources are organized and allocated to
pro-vide for the needs of an economy’s citizens. In many countries of the world, a
capitalist economic system, based on markets, is the primary way in which the three
questions are addressed. A capitalist economic system incorporates the principles of
the private ownership of factors of production to produce goods and services which
are exchanged through a price mechanism and where production is operated
primarily for profit. In an market economy, the decisions of a central planner are
replaced by the decision of millions of firms and households. This is an economy that
allocates resources through the decentralized decisions of many firms and
households as they interact in markets for goods and services. Planned economic
systems is an activity economic organized by central planners who decided on the
answers to the fundamental economic questions.
The three fundamental economic questions:
- What will be produced?
- How will it be produced?
- For whom will it be produced?
3. Goverments Can Sometimes Improve Market Outcomes
One reason we need governments is that the invisible hand can work its magic only
if the government enforces the rules and maintains the institutions that are key to a
market economy. Market economies need institutions to enforce property right, this
is the ability of an individual to own and exercise control over scarce resources.
Another reason we need government is that it is not omnipotent.
, Economists use the term market failure to refer to a situation in which the market
on its own fails to produce and efficient allocation of resources. One possible cause
of market failure is an externality, which is the impact of one person’s actions on the
well-being of a bystander. Another cause of market failure is market power, which
refers to the ability of a single person or firm to unduly influence market prices.
1.3 How the Economy as a Whole Works; The working of the economy as a whole
The field of economics is traditionally divided into two broad subfields. Microeconomics is
the study of how households and firms make decisions and how they interact in specific
markets. Macroeconomics is the study of economy-wide phenomena. Microeconomics and
macroeconomics are closely intertwined. Because changes in the overall economy arise
from the decisions of millions of individuals, it is impossible to understand macroeconomic
developments without considering the associated microeconomic decisions. Despite the
inherent link between microeconomics and macroeconomics, the two fields are distinct.
Because they address different questions, each field has its own set of models, which are
often taught in separate courses.
1. A Economy’s Standard of Living Depends on Its Ability to Produce Goods and Services
A key concept in macroeconomics is economic growth – the percentage increase in
the number of goods and services produced in an economy over a period of time,
usually expressed over a quarter and annually. One measure of the economic well-
being of a nation is given by gross domestic product (GDP) per capita (per head) of
the population which can be seen as being the average income per head of the
population. CALCULATION: Market value market value of all goods and services
produced within a country in a given period of time divided by the population of a
country to give a per capita figure.
Standard of living refers to the amount of goods and services that can be purchased
by the population of a country. Usually measured by the inflation-adjusted (real)
income per head of the population.
Almost all variation in living standards is attributable to differences in countries’
productivity, this is the amount of goods and services produced by each unit of labor
input.
The growth rate of a nation’s productivity determines the growth rate of its average
income. The relationship between productivity and living standers also has profound
implications for public policy. It is generally accepted that there is a relationship
between the growth in the quantity of money and the rate of growth of prices.
2. Prices Rise When the Government Prints Too Much Money
Inflation is an increase in the overall level of prices in the economy. High inflation
imposes various costs on society, keeping inflation at a low level is a goal of
economic policymakers around the world. The cause of inflation is the growth in the
quantity of money.
3. Society Faces a Short-Run Trade-off between Inflation and Unemployment
When the government increases the amount of money in the economy, one result is
inflation. Another result, at least in the short run, is a lower level of unemployment.
The curve that illustrates this short-run trade-off between inflation and
unemployment is called the Phillips curve.
Table of Contents
Chapter 1 ‘Ten Principles of Economics’ ............................................................................. 1
Chapter 2 ‘Thinking Like an Economist’ ............................................................................. 4
Chapter 12 ‘Information and Behavioural Economics’ ....................................................... 6
Chapter 3 ‘The market forces of supply and demand’. ....................................................... 6
Chapter 6 ‘Background to supply firms in competitive markets’....................................... 12
Chapter 14 ‘Market structure I: monopoly’...................................................................... 18
Chapter 15 ‘Market Structure II: Monopolistic competition’ ............................................ 23
Chapter 11 ‘Market failure and Externalities’ .................................................................. 28
Chapter 1 ‘Ten Principles of Economics’
The amount of interaction between households and firms – the amount of buying and
selling which takes place – represents the level of economic activity. The more buying and
selling there are the higher the level of economic activity. Households and firms in a
particular geographic region are together referred to as the economy.
The management of society’s resources is important because resources are scarce. Scarcity
means that society has limited resources and therefore cannot produce all the goods and
services people wish to have. Economics is the study of how society manages its scarce
resources.
1.1 How People Make Decisions; Four principles about individual decision making;
1. People Face trade-offs
Making decisions requires trading off one goal against another. When people are
grouped into societies, they face different kinds of trade-offs.
One classic trade-off is between “guns and butter”. The more a society spends on
national defense (guns), the less it can spend on consumers good (butter).
Another trade-off is between a clean environment and a high level of income. Cost of
producing goods and services increases due a more sustainable machine, the profit
will decrease and as a result lower wage.
Another trade-off society face is between efficiency and equality. Efficiency means
that society is getting the maximum benefits from its scare resources. Equality
means that those benefits are distributed uniformly among society’s members.
2. The Cost of Something Is What You Give Up to Get It
Because people face trade-offs, making decision requires comparing the costs and
benefits of alternative courses of action. The opportunity cost of an item is what you
give up getting that item.
, For example, a college athlete who can earn millions if they drop out of school and
play professional sports are well aware that their opportunity cost of attending
college is very high.
3. Rational People Think at the Margin
Rational people systematically and purposefully do the best they can to achieve
their objectives, given the available opportunities. Economists use the term marginal
change to describe a small incremental adjustment to an existing plan of action.
Marginal analysis is based around an assumption that economic agents (an
individual, firm or organization that has an impact in some way on an economy) are
seeking to maximize or minimize outcomes when making decisions.
4. People Respond to Incentives
An incentive is something (such as the prospect of a punishment or reward) that
induces a person to act. Because rational people make decisions by comparing costs
and benefits, they respond to incentives. When analyzing any policy, we must
consider not only the direct effects but also the less obvious indirect effects that
work through incentives. If the policy changes incentives, it will cause people to alter
their behaviour.
1.2 How People Interact; Three principles of the concern how people interact with one
another.
1. Trade Can Make Everyone Better Off
Trade between two countries can make each country better off. Trade allows
countries to specialize in what they do best and to enjoy a greater variety of goods
and services.
2. Markets Are Usually a Good Way to Organize Economic Activity
An economic system is the way in which resources are organized and allocated to
pro-vide for the needs of an economy’s citizens. In many countries of the world, a
capitalist economic system, based on markets, is the primary way in which the three
questions are addressed. A capitalist economic system incorporates the principles of
the private ownership of factors of production to produce goods and services which
are exchanged through a price mechanism and where production is operated
primarily for profit. In an market economy, the decisions of a central planner are
replaced by the decision of millions of firms and households. This is an economy that
allocates resources through the decentralized decisions of many firms and
households as they interact in markets for goods and services. Planned economic
systems is an activity economic organized by central planners who decided on the
answers to the fundamental economic questions.
The three fundamental economic questions:
- What will be produced?
- How will it be produced?
- For whom will it be produced?
3. Goverments Can Sometimes Improve Market Outcomes
One reason we need governments is that the invisible hand can work its magic only
if the government enforces the rules and maintains the institutions that are key to a
market economy. Market economies need institutions to enforce property right, this
is the ability of an individual to own and exercise control over scarce resources.
Another reason we need government is that it is not omnipotent.
, Economists use the term market failure to refer to a situation in which the market
on its own fails to produce and efficient allocation of resources. One possible cause
of market failure is an externality, which is the impact of one person’s actions on the
well-being of a bystander. Another cause of market failure is market power, which
refers to the ability of a single person or firm to unduly influence market prices.
1.3 How the Economy as a Whole Works; The working of the economy as a whole
The field of economics is traditionally divided into two broad subfields. Microeconomics is
the study of how households and firms make decisions and how they interact in specific
markets. Macroeconomics is the study of economy-wide phenomena. Microeconomics and
macroeconomics are closely intertwined. Because changes in the overall economy arise
from the decisions of millions of individuals, it is impossible to understand macroeconomic
developments without considering the associated microeconomic decisions. Despite the
inherent link between microeconomics and macroeconomics, the two fields are distinct.
Because they address different questions, each field has its own set of models, which are
often taught in separate courses.
1. A Economy’s Standard of Living Depends on Its Ability to Produce Goods and Services
A key concept in macroeconomics is economic growth – the percentage increase in
the number of goods and services produced in an economy over a period of time,
usually expressed over a quarter and annually. One measure of the economic well-
being of a nation is given by gross domestic product (GDP) per capita (per head) of
the population which can be seen as being the average income per head of the
population. CALCULATION: Market value market value of all goods and services
produced within a country in a given period of time divided by the population of a
country to give a per capita figure.
Standard of living refers to the amount of goods and services that can be purchased
by the population of a country. Usually measured by the inflation-adjusted (real)
income per head of the population.
Almost all variation in living standards is attributable to differences in countries’
productivity, this is the amount of goods and services produced by each unit of labor
input.
The growth rate of a nation’s productivity determines the growth rate of its average
income. The relationship between productivity and living standers also has profound
implications for public policy. It is generally accepted that there is a relationship
between the growth in the quantity of money and the rate of growth of prices.
2. Prices Rise When the Government Prints Too Much Money
Inflation is an increase in the overall level of prices in the economy. High inflation
imposes various costs on society, keeping inflation at a low level is a goal of
economic policymakers around the world. The cause of inflation is the growth in the
quantity of money.
3. Society Faces a Short-Run Trade-off between Inflation and Unemployment
When the government increases the amount of money in the economy, one result is
inflation. Another result, at least in the short run, is a lower level of unemployment.
The curve that illustrates this short-run trade-off between inflation and
unemployment is called the Phillips curve.
