Chapter 1
Incentives matter: People behave in a self-interested way and respond to incentives. They will
combine to press for changes that improve their economic welfare. Tell themselves what they seek
for is to everyone else’s advantage. Won’t change things if it reduces their welfare.
Experiments cost money, are the expected benefits worth the money? Social costs of putting money
in healthcare or education > other things can’t be done as a consequence.
>Core principle: Cost-benefit analysis: you should stop reducing class size at a certain point, because
it will not have effect on outcome. Marginal costs should equal marginal benefits. A strife for higher
benefits will cost more.
Economics: study of how people make choices under conditions of scarcity, and of the results of
those choices for society.
>Core principle: Scarcity Principle: forces you to make choices, if you want one thing, you’ll have less
of the other. You are trading off things you can do if you don’t do the other thing. Resources
available are limited. ‘There ain’t no such thing as a free lunch’ > TANSTAAFL, somebody has to pay
for them.
Action should be taken if benefits exceeds costs
Rational person: someone with well-defined goals, who fulfills those goals as best she can. People
think about when benefit is biggest. Depends on the value people give to, for example, time.
People want to create the largest surplus > difference between benefit of making the trip and its
cost.
Opportunity cost: the value of the next best alternative that must be forgone in order to undertake
the activity > safe 10 euro’s by going to the city centre or saving the time of going to the city centre
to study for an exam.
Pitfalls of rational choices: people thing they are behaving rationally, but they are wrong sometimes
1. Measuring costs and benefits as proportions rather than absolute money
When you can buy a 25 euro computer game for 15 in the city centre, but you have to take a
walk of 3 km, so 10 euro’s cheaper. People tend to think, well it’s 40% discount. When you
buy a laptop of 1000 euro’s and it’s 10 euro’s cheaper if you take a walk of 3 km. People
think it’s only 1% cheaper so they don’t go to the centre. It’s both 10 euro’s > faulty
reasoning, it’s absolute money you save and not a proportion.
2. Ignoring opportunity costs
We tend to overlook the implicit value of activities that fail to happen. Take value of forgone
opportunities into account. Value of best alternative that must be forgone in order to engage
in that activity.
3. Failure to ignore sunk costs
Decision should be influenced by costs that we can avoid by not taking the action. But,
mostly decision influenced by sunk costs; costs that are beyond recovery at the moment a
decision is made. Sunk costs must be borne whether or not an action is taken, so irrelevant
to decision of whether to take the action. When a group pays 15 euro’s for all-you-can-eat
lunch and other group can eat for free. Group who paid eat more, because they want to ‘get
their money’s worth’. They want to minimize their average cost per mouthful.
4. Failure to understand the average-marginal distinction
, To what extent should an activity be pursued? Look at marginal costs; the increase in total
cost that results from carrying out one additional unit of an activity. Marginal benefit;
increase in total benefit that results from carrying out one additional unit of an activity.
Pursue an activity as long as marginal benefit exceeds its marginal cost. People look at
average cost and benefit instead of marginal and make a mistake. Average cost goes from 2.5
to 3, but total cost goes from 10 to 15, so marginal cost for extra launch is 5.
Microeconomics: study of individual choices and of group behavior in individual markets.
Macroeconomics: study of the performance of national economies and of the policies that
governments use to try to improve that performance. Understand determinants of such things as the
national unemployment rate, overall price level etc.
Economic naturalism: use insights from economics to help make sense of observations from
everyday life.
Chapter 2
Developed countries have much higher degree of specialization than under-developed countries.
OECD: Organization for Economic Co-operation and Development, ‘club’ of advanced economies.
Parts are made into final goods, by specialization.
Less specialization contains a wider variety of skills > poorer countries. In rich countries people hire
others to do things for them. Why difference? Poor people are poor largely because they provide
their own services. Why don’t they specialize and then be not poor anymore?
- Size of the market determines the limits to the benefits from the specialist division of labor.
People need to specialize at same time, so market is needed for potentially increased supply
of goods and services.
- Specialization may require training or skills that are hard to acquire. May require capital.
It’s a chicken and egg problem: specialization increases the value of goods and services being
produced, but incentive to specialize may depend on the existing size of economy.
Specialization is productive because of The Principle of Comparative Advantage: if a person is
relatively more efficient at producing for instance haircuts than at producing other goods. It enables
us to have more of every good and service if each of us specializes at activities at which we have a
comparative advantage. Opportunity cost of performing a task is lower than the other person’s
opportunity cost.
PPC= Production possibilities curve. Describes combinations of goods and services that an economy
can produce. Shows how specialization enhances productive capacity of even simplest economy.
If two nations have different opportunity costs of performing various tasks, they can increase total
value of available goods and services by trading with one another.
Absolute advantage: one person has an absolute advantage over another if an hour spent in
performing a task earns more than the other person can earn in an hour at the task.
Specialization part of market exchange. Everyone does what he’s best in > produce together vastly
more.
Individual level comparative advantage result of inborn talent.
English is world language and gives English-speaking countries a comparative advantage over non-
English-speaking countries in production of books, movies, popular music.
Production possibility curve: graph that describes the maximum amount of one good that can be
produced for every possible level of production of the other good.
, Production possibility frontier: curve marks boundary between what an economy can produce from
its own resources and levels of production that are beyond its capability
OC nuts = loss in coffee / gain in nuts
OC coffee = loss in nuts / gain in coffee
Attainable points: combination of goods that can be produced using currently available resources.
Point along or within PPC.
Unattainable points: combination of goods that cannot be produced using currently available
resources. Lies outside the curve.
Inefficient points lie inside the curve. Combination of goods for which currently available resources
enable an increase in the production of one good without a reduction in the production of the other.
Efficient points lie along PPC, producing more of one good means producing less of the other.
Opportunity cost can be increased, if the economy produces more nuts. More nuts, higher cost of
producing additional nuts, because coffee is sacrificed. If Tom and Susan both do coffee, but
economy needs someone for nuts, they should choose Tom, because it would only cost half as much
coffee as Susan’s.
The Principle of Increasing Opportunity Cost: When resources have different opportunity costs we
should exploit the resource with the lowest opportunity cost first > low-hanging-fruit Principle
Curve in multi-person economy has shape of a bow. A CEO first focuses on problems that are easiest
to correct and elimination will provide biggest improvements.
PPF confronts society with trade-off: produce more of one is less of the other. In long run increasing
production of all goods > economic growth > improvements in knowledge or technology
Difference poor and rich
Different rates of savings and investments. Self-reinforcing: higher rates of saving and investment
cause incomes to grow, also easier to devote additional resources to savings and investment. Small
advantages can translate into very large income gaps.
>Population growth makes PPF shift outwards.
Limits to specialization
- Adam Smith says population density is precondition for specialization. More specialization in
big cities than in rural areas.
- Laws and customs that limit people’s freedom to transact freely.
- Size of the market. It is worth doing only if a significant quantity of output is to be produced.
Specialization entails costs. More specialization not always better. People want variety in work, but
if specialization is narrower, variety tends to be one of the first casualties.
Failure to specialize entails costs as well > low wages, work long hours.
Comparative advantage between nations
EU and US protect their production by subsidies. They didn’t allow free trade, because they didn’t
want to be losers. Result; everyone lost.
With trade a country can consume a combination of products outside the frontier. > increases
economic welfare.
When trade is possible, trade prices determine its consumption possibilities given its production
potential. Both countries gain from trade, always better to specialize.
Chapter 3
Individuals determine the end result, so that what we wish to buy is available > people sometimes
have a role in the collective effort of taking food to people; truck driver, farmer. Shortage is rare.
Incentives matter: People behave in a self-interested way and respond to incentives. They will
combine to press for changes that improve their economic welfare. Tell themselves what they seek
for is to everyone else’s advantage. Won’t change things if it reduces their welfare.
Experiments cost money, are the expected benefits worth the money? Social costs of putting money
in healthcare or education > other things can’t be done as a consequence.
>Core principle: Cost-benefit analysis: you should stop reducing class size at a certain point, because
it will not have effect on outcome. Marginal costs should equal marginal benefits. A strife for higher
benefits will cost more.
Economics: study of how people make choices under conditions of scarcity, and of the results of
those choices for society.
>Core principle: Scarcity Principle: forces you to make choices, if you want one thing, you’ll have less
of the other. You are trading off things you can do if you don’t do the other thing. Resources
available are limited. ‘There ain’t no such thing as a free lunch’ > TANSTAAFL, somebody has to pay
for them.
Action should be taken if benefits exceeds costs
Rational person: someone with well-defined goals, who fulfills those goals as best she can. People
think about when benefit is biggest. Depends on the value people give to, for example, time.
People want to create the largest surplus > difference between benefit of making the trip and its
cost.
Opportunity cost: the value of the next best alternative that must be forgone in order to undertake
the activity > safe 10 euro’s by going to the city centre or saving the time of going to the city centre
to study for an exam.
Pitfalls of rational choices: people thing they are behaving rationally, but they are wrong sometimes
1. Measuring costs and benefits as proportions rather than absolute money
When you can buy a 25 euro computer game for 15 in the city centre, but you have to take a
walk of 3 km, so 10 euro’s cheaper. People tend to think, well it’s 40% discount. When you
buy a laptop of 1000 euro’s and it’s 10 euro’s cheaper if you take a walk of 3 km. People
think it’s only 1% cheaper so they don’t go to the centre. It’s both 10 euro’s > faulty
reasoning, it’s absolute money you save and not a proportion.
2. Ignoring opportunity costs
We tend to overlook the implicit value of activities that fail to happen. Take value of forgone
opportunities into account. Value of best alternative that must be forgone in order to engage
in that activity.
3. Failure to ignore sunk costs
Decision should be influenced by costs that we can avoid by not taking the action. But,
mostly decision influenced by sunk costs; costs that are beyond recovery at the moment a
decision is made. Sunk costs must be borne whether or not an action is taken, so irrelevant
to decision of whether to take the action. When a group pays 15 euro’s for all-you-can-eat
lunch and other group can eat for free. Group who paid eat more, because they want to ‘get
their money’s worth’. They want to minimize their average cost per mouthful.
4. Failure to understand the average-marginal distinction
, To what extent should an activity be pursued? Look at marginal costs; the increase in total
cost that results from carrying out one additional unit of an activity. Marginal benefit;
increase in total benefit that results from carrying out one additional unit of an activity.
Pursue an activity as long as marginal benefit exceeds its marginal cost. People look at
average cost and benefit instead of marginal and make a mistake. Average cost goes from 2.5
to 3, but total cost goes from 10 to 15, so marginal cost for extra launch is 5.
Microeconomics: study of individual choices and of group behavior in individual markets.
Macroeconomics: study of the performance of national economies and of the policies that
governments use to try to improve that performance. Understand determinants of such things as the
national unemployment rate, overall price level etc.
Economic naturalism: use insights from economics to help make sense of observations from
everyday life.
Chapter 2
Developed countries have much higher degree of specialization than under-developed countries.
OECD: Organization for Economic Co-operation and Development, ‘club’ of advanced economies.
Parts are made into final goods, by specialization.
Less specialization contains a wider variety of skills > poorer countries. In rich countries people hire
others to do things for them. Why difference? Poor people are poor largely because they provide
their own services. Why don’t they specialize and then be not poor anymore?
- Size of the market determines the limits to the benefits from the specialist division of labor.
People need to specialize at same time, so market is needed for potentially increased supply
of goods and services.
- Specialization may require training or skills that are hard to acquire. May require capital.
It’s a chicken and egg problem: specialization increases the value of goods and services being
produced, but incentive to specialize may depend on the existing size of economy.
Specialization is productive because of The Principle of Comparative Advantage: if a person is
relatively more efficient at producing for instance haircuts than at producing other goods. It enables
us to have more of every good and service if each of us specializes at activities at which we have a
comparative advantage. Opportunity cost of performing a task is lower than the other person’s
opportunity cost.
PPC= Production possibilities curve. Describes combinations of goods and services that an economy
can produce. Shows how specialization enhances productive capacity of even simplest economy.
If two nations have different opportunity costs of performing various tasks, they can increase total
value of available goods and services by trading with one another.
Absolute advantage: one person has an absolute advantage over another if an hour spent in
performing a task earns more than the other person can earn in an hour at the task.
Specialization part of market exchange. Everyone does what he’s best in > produce together vastly
more.
Individual level comparative advantage result of inborn talent.
English is world language and gives English-speaking countries a comparative advantage over non-
English-speaking countries in production of books, movies, popular music.
Production possibility curve: graph that describes the maximum amount of one good that can be
produced for every possible level of production of the other good.
, Production possibility frontier: curve marks boundary between what an economy can produce from
its own resources and levels of production that are beyond its capability
OC nuts = loss in coffee / gain in nuts
OC coffee = loss in nuts / gain in coffee
Attainable points: combination of goods that can be produced using currently available resources.
Point along or within PPC.
Unattainable points: combination of goods that cannot be produced using currently available
resources. Lies outside the curve.
Inefficient points lie inside the curve. Combination of goods for which currently available resources
enable an increase in the production of one good without a reduction in the production of the other.
Efficient points lie along PPC, producing more of one good means producing less of the other.
Opportunity cost can be increased, if the economy produces more nuts. More nuts, higher cost of
producing additional nuts, because coffee is sacrificed. If Tom and Susan both do coffee, but
economy needs someone for nuts, they should choose Tom, because it would only cost half as much
coffee as Susan’s.
The Principle of Increasing Opportunity Cost: When resources have different opportunity costs we
should exploit the resource with the lowest opportunity cost first > low-hanging-fruit Principle
Curve in multi-person economy has shape of a bow. A CEO first focuses on problems that are easiest
to correct and elimination will provide biggest improvements.
PPF confronts society with trade-off: produce more of one is less of the other. In long run increasing
production of all goods > economic growth > improvements in knowledge or technology
Difference poor and rich
Different rates of savings and investments. Self-reinforcing: higher rates of saving and investment
cause incomes to grow, also easier to devote additional resources to savings and investment. Small
advantages can translate into very large income gaps.
>Population growth makes PPF shift outwards.
Limits to specialization
- Adam Smith says population density is precondition for specialization. More specialization in
big cities than in rural areas.
- Laws and customs that limit people’s freedom to transact freely.
- Size of the market. It is worth doing only if a significant quantity of output is to be produced.
Specialization entails costs. More specialization not always better. People want variety in work, but
if specialization is narrower, variety tends to be one of the first casualties.
Failure to specialize entails costs as well > low wages, work long hours.
Comparative advantage between nations
EU and US protect their production by subsidies. They didn’t allow free trade, because they didn’t
want to be losers. Result; everyone lost.
With trade a country can consume a combination of products outside the frontier. > increases
economic welfare.
When trade is possible, trade prices determine its consumption possibilities given its production
potential. Both countries gain from trade, always better to specialize.
Chapter 3
Individuals determine the end result, so that what we wish to buy is available > people sometimes
have a role in the collective effort of taking food to people; truck driver, farmer. Shortage is rare.
