CH 1 – The Big Ideas
- Incentives: rewards and penalties that motivate behavior
Big Idea One: Incentives Matter
- For example: when captains were paid for every prisoner on board, they had a little incentive
to treat them well. If the captains were paid for every prisoner that survived on board, their
incentives changed.
Big Idea Two: Good Instructions Align Self-Interest with the Social Interest
- When self-interest aligns with broader public interest, we get good outcomes, but when self-
interest and social interest are at odds, we get bad outcomes (ex. Cruel/inhumane)
Big Idea Three: Trade-offs Are Everywhere
- Drug lag: you can die because and unsafe drug is approved – you can also die because a safe
drug has not yet been approved
- Drug loss: you can die because an unsafe drug is approved – you can also die because a safe
drug is never developed
- Society faces a trade-off: more testing means the drugs that are (eventually) approved will be
safer but it also means more drug lag and drug loss.
- Scarcity: a resource is scarce when there isn’t enough to satisfy all our wants
- The great economic problem: is how to arrange our scarce resources to satisfy as many of our
wants as possible
Opportunity Cost
- Opportunity cost: the opportunity cost of a choice is the value of the opportunities lost
- Example: attending college vs full-time job
- Concept for opportunity cost important for two reasons:
1. if you don’t understand the opportunities that you are losing when you make a choice, you
won’t recognize the real trade-offs that you face
2. most of the time people do respond to changes in opportunity costs – even when money
costs have not changed – so if you want to understand behavior, you need to understand
opportunity cost
Big Idea Four: Thinking on the Margin
- Thinking on the margin is just making choices by thinking in terms of marginal benefits and
marginal costs, the benefits and costs of a little bit more (or a little bit less)
Big Idea Five: The Power of Trade
- The real power of trade is the power to increase production through specialization
- Through division of knowledge, the sum total of knowledge increases and in this way so does
productivity
- Trade also allows us to take advantage of economies of scale (=cost advantages reaped by
companies when production becomes efficient)
Big Idea Six: The Importance of Wealth and Economic Growth
- The lesson is wealth, the ability to pay for the prevention of malaria – ended the disease in the
US, and wealth comes from economic growth
- Wealth matters, and understanding economic growth is one fo the most important tasks of
economics
Big Idea Seven: Institutions Matter
- Entrepreneurs, investorsm and savers need incentives to save and invest in physical capital,
human capital, innovation, and efficient organization. (ex. incentive: property rights, stability,
honest government, open markets etc.)
Big Idea Eight: Economic Booms and Busts Cannot be Avoided but Can Be Moderated
- No economy grows at a constant pace
Big Idea Nine: Inflation is Caused by Increases in the Supply of Money
- Inflation makes people feel poorer, and it makes it harder for people to figure out real values
of goods, services, and investments that’s why they dislike inflation
Big Idea Ten: Central Banking is a Hard Job
, - Too much money in the economy means that inflation will result. Not enough money in the
economy is bad as well and can lead to a recession or a slowing of economic growth
The Biggest Idea of All: Economics if Fun
- Economics teaches us how to make the world a better place. It increases your understanding
of the past, present, and future
CH 2 – The Power of Trade and Comparative Advantage
Trade and Preferences
- Trade makes people with different preferences better off
Specialization, Productivity, and the Division of Knowledge
- Specialization increases productivity
- The division of knowledge increases with specialization and trade
Comparative Advantage
- To take advantage of the differences
- A country has absolute advantage in production if it can produce the same good using fewer
inputs than other country
- To benefit from trade, a country does not need to have absolute advantage
The Production Possibility Frontier
- The production possibility frontier shows all the combinations of computers and shirts that
Mexico can produce given its productivity and supply of inputs
Opportunity Costs and Comparative Advantage
- A country has comparative advantage in producing goods for which it has the lower
opportunity costs
- The theory of comparative advantage says that to increase its wealth, a country should
produce the goods it can make a t low cost and buy the goods that it can make only at high
cost
- When each country produces according to its comparative advantage and then trades, total
production and consumption increase. They gain both
Comparative Advantage and Wages
- Reason for lower wage in Mexico: productivitiy of labor Is lower in Mexico. Productivity
determines the wage rate
Adam smith on Trade
- “if a foreign country can supply us with a commodity cheaper than we ourselves can make it,
better buy it of them with some part of the produce of our own industry employed in a way in
which we have some advantage”
Trade and Globalization
- Greater trade increases total wealth
- “globalization is the advance of human cooperation across national boundaries”
Takeaway
- Simple trade makes people better off when preferences differ, but the true power of trade
occurs when trade leads to specialization (creates increases in productivity). With
specialization and trade, total sum of knowledge used in an economy inreases and far exceeds
that of any one brain
- Everyone has comparative advantage in something
CH 3 – Supply and Demand
The Demand Curve for Oil
- A demand curve is a function that shows the quantity demanded at different prices
- The quantity demanded is the quantity that buyers are willing and able to buy at a particular
price
- Oil is very valuable for transportation because in that use oil has few substitutes
, - Why is a demand curve negatively sloped: a demand curve summarizes how millions of
consuemrs choose to use oil given their preferences and the possibilities for substitution
- Law of demand: the lower the price the greater the quantity demanded
Consumer Surplus
- Consumer surplus is the consumer’s gian from exchange
- Total consumer surplus is the shaded area between the demand curve and above the price
- How to calculate consumer surplus: base x height / 2
What Shifts the Demand Curve?
- An increase in demand shifts the demand curve outward, up and to the right
- A decrease in demand shifts the demand curve inward, down and to the left
Important Demand Shifters
- Income
Normal good
Inferior food
- Population
- Price of subsititutes
- Price of complements
- Expectations
- tastes
The Supply Curve for Oil
- the supply curve for oil is a function showing the quantity of oil that suppliers would be
willing and able to sell at different prices
- the quantity supplied is the amount of a good that sellers are willing and able to sell at a
particular price
- law of supply: the higher the price, the greater the quantity supplied
Producer Surplus
- producer surplus is the producer’s gain from exchange, or the difference between the market
price and the minimum price at which a producer would be willing to sell a particular quantity
- total producer surplus is measured by the are above the supply curve and below the price
- consumer surplus measures the consumer’s benefit from trade, and producer surplus the
producer’s benefit from trade.
What Shifts the Supply Curve?
- A decrease is costs means that the supply curve shifts down and to the right
- Higher costs mean that the supply curve shifts up an to the left
Important Supply Shifters
- Technological innovations and changes in the price of inputs
- Taxes and subsidies
- Expectations
- Entry or exit of producers
- Changes in opportunity costs
CH 4 – Equilibrium (How Supply and Demand Determine Prices)
Equilibrium and the Adjustment Process
- Equilibrium occurs when quantity demanded equals quantity supplied
- A surplus is a situation in which the quantity supplied is greater than the quantity demanded
- Competition will push prices down whenever there is a surplus
- A shortage is a situation in which the quantity demanded is greater than the quantity supplied
- Competition will push prices up whenever there is a shortage
- The equilibrium price is the price at which the quantity demanded is equal to the quantity
supplied
- The equilibrium price is stable because at the equilibrium price the quantity demanded is
exactly equal to the quantity supplied
, Who Competes with Whom?
- Sellers compete with other sellers and buyers compete with other buyers
A Free Market Maximizes Producer Plus Consumer Surplus (the Gains from Trade)
- There are unexploited gains from trade at any quantity less than the equilibrium quantity
- Resources are wastes at quantities greater than the equilibrium quantity
- The equilibrium quantity is the quantity at which the quantity demanded is equal to the
quantity supplied
- A free market maximizes the gains from trade
- Gains from trade = producer and consumer surplus
- Thus, a free market maximizes producer plus consumer surplus
- It requires that goods must be produces at the lowest possible cost and they must be
used to satisfy the highest value demands
- When we say that a free market maximizes the gains from trade we mean:
1. the supply of goods is bought by the buyers with the highest willingness to pay
2.the supply of goods is sold by the sellers with the lowest costs
3. between buyers and sellers, there are no unexploited gains from trade and no wasteful
trades,
Does the Model Work? Evidence from the Laboratory
- Vernon smith, test group of students willingness to pay and to sell
Shifting Demand and Supply Curves
- A decrease in supply will raise the market price and reduce the market quantity, exactly the
opposity effects to an increase in supply
Terminology: Demand Compared with Quantity Demanded and Supply Compared with Quantity
Supplied
- Difference between demand and quantity demanded: an increase in quantity demanded is a
movement along the fixed demand curve. An increase in demand is a shift of the entire
demand curve (up and to the right).
- The increase in supply pushes the price down, thereby causing an increase in the quantity
demanded
- Shifts in supply curve cause movements along the demand curve
Takeaway
- Market competition brings about an equilibrium in which the quantity supplied is equal to the
quantity demanded
- Only one price/quantity combination is a market equilibrium and you should be able to
identify this equilibrium in a diagram
- The sum of consumer and producer surplus (the gains from trade) is maximized at the
equilibrium price and quantity, and no other price/quantity combination maximizes consumer
plus producer surplus
CH 11 – Costs and Profit Maximization under Competition
- Three questions present themselves:
1. what price to set?
2. what quantity to produce?
3. when to enter and exit the industry?
What price to set?
- Under some conditions, firm does not set prices it accepts price that is given by the market
- To maximize profit, you sell at the market prize (you can sell as many as you want)
- Demand curves are more elastic in the longrun
- Incentives: rewards and penalties that motivate behavior
Big Idea One: Incentives Matter
- For example: when captains were paid for every prisoner on board, they had a little incentive
to treat them well. If the captains were paid for every prisoner that survived on board, their
incentives changed.
Big Idea Two: Good Instructions Align Self-Interest with the Social Interest
- When self-interest aligns with broader public interest, we get good outcomes, but when self-
interest and social interest are at odds, we get bad outcomes (ex. Cruel/inhumane)
Big Idea Three: Trade-offs Are Everywhere
- Drug lag: you can die because and unsafe drug is approved – you can also die because a safe
drug has not yet been approved
- Drug loss: you can die because an unsafe drug is approved – you can also die because a safe
drug is never developed
- Society faces a trade-off: more testing means the drugs that are (eventually) approved will be
safer but it also means more drug lag and drug loss.
- Scarcity: a resource is scarce when there isn’t enough to satisfy all our wants
- The great economic problem: is how to arrange our scarce resources to satisfy as many of our
wants as possible
Opportunity Cost
- Opportunity cost: the opportunity cost of a choice is the value of the opportunities lost
- Example: attending college vs full-time job
- Concept for opportunity cost important for two reasons:
1. if you don’t understand the opportunities that you are losing when you make a choice, you
won’t recognize the real trade-offs that you face
2. most of the time people do respond to changes in opportunity costs – even when money
costs have not changed – so if you want to understand behavior, you need to understand
opportunity cost
Big Idea Four: Thinking on the Margin
- Thinking on the margin is just making choices by thinking in terms of marginal benefits and
marginal costs, the benefits and costs of a little bit more (or a little bit less)
Big Idea Five: The Power of Trade
- The real power of trade is the power to increase production through specialization
- Through division of knowledge, the sum total of knowledge increases and in this way so does
productivity
- Trade also allows us to take advantage of economies of scale (=cost advantages reaped by
companies when production becomes efficient)
Big Idea Six: The Importance of Wealth and Economic Growth
- The lesson is wealth, the ability to pay for the prevention of malaria – ended the disease in the
US, and wealth comes from economic growth
- Wealth matters, and understanding economic growth is one fo the most important tasks of
economics
Big Idea Seven: Institutions Matter
- Entrepreneurs, investorsm and savers need incentives to save and invest in physical capital,
human capital, innovation, and efficient organization. (ex. incentive: property rights, stability,
honest government, open markets etc.)
Big Idea Eight: Economic Booms and Busts Cannot be Avoided but Can Be Moderated
- No economy grows at a constant pace
Big Idea Nine: Inflation is Caused by Increases in the Supply of Money
- Inflation makes people feel poorer, and it makes it harder for people to figure out real values
of goods, services, and investments that’s why they dislike inflation
Big Idea Ten: Central Banking is a Hard Job
, - Too much money in the economy means that inflation will result. Not enough money in the
economy is bad as well and can lead to a recession or a slowing of economic growth
The Biggest Idea of All: Economics if Fun
- Economics teaches us how to make the world a better place. It increases your understanding
of the past, present, and future
CH 2 – The Power of Trade and Comparative Advantage
Trade and Preferences
- Trade makes people with different preferences better off
Specialization, Productivity, and the Division of Knowledge
- Specialization increases productivity
- The division of knowledge increases with specialization and trade
Comparative Advantage
- To take advantage of the differences
- A country has absolute advantage in production if it can produce the same good using fewer
inputs than other country
- To benefit from trade, a country does not need to have absolute advantage
The Production Possibility Frontier
- The production possibility frontier shows all the combinations of computers and shirts that
Mexico can produce given its productivity and supply of inputs
Opportunity Costs and Comparative Advantage
- A country has comparative advantage in producing goods for which it has the lower
opportunity costs
- The theory of comparative advantage says that to increase its wealth, a country should
produce the goods it can make a t low cost and buy the goods that it can make only at high
cost
- When each country produces according to its comparative advantage and then trades, total
production and consumption increase. They gain both
Comparative Advantage and Wages
- Reason for lower wage in Mexico: productivitiy of labor Is lower in Mexico. Productivity
determines the wage rate
Adam smith on Trade
- “if a foreign country can supply us with a commodity cheaper than we ourselves can make it,
better buy it of them with some part of the produce of our own industry employed in a way in
which we have some advantage”
Trade and Globalization
- Greater trade increases total wealth
- “globalization is the advance of human cooperation across national boundaries”
Takeaway
- Simple trade makes people better off when preferences differ, but the true power of trade
occurs when trade leads to specialization (creates increases in productivity). With
specialization and trade, total sum of knowledge used in an economy inreases and far exceeds
that of any one brain
- Everyone has comparative advantage in something
CH 3 – Supply and Demand
The Demand Curve for Oil
- A demand curve is a function that shows the quantity demanded at different prices
- The quantity demanded is the quantity that buyers are willing and able to buy at a particular
price
- Oil is very valuable for transportation because in that use oil has few substitutes
, - Why is a demand curve negatively sloped: a demand curve summarizes how millions of
consuemrs choose to use oil given their preferences and the possibilities for substitution
- Law of demand: the lower the price the greater the quantity demanded
Consumer Surplus
- Consumer surplus is the consumer’s gian from exchange
- Total consumer surplus is the shaded area between the demand curve and above the price
- How to calculate consumer surplus: base x height / 2
What Shifts the Demand Curve?
- An increase in demand shifts the demand curve outward, up and to the right
- A decrease in demand shifts the demand curve inward, down and to the left
Important Demand Shifters
- Income
Normal good
Inferior food
- Population
- Price of subsititutes
- Price of complements
- Expectations
- tastes
The Supply Curve for Oil
- the supply curve for oil is a function showing the quantity of oil that suppliers would be
willing and able to sell at different prices
- the quantity supplied is the amount of a good that sellers are willing and able to sell at a
particular price
- law of supply: the higher the price, the greater the quantity supplied
Producer Surplus
- producer surplus is the producer’s gain from exchange, or the difference between the market
price and the minimum price at which a producer would be willing to sell a particular quantity
- total producer surplus is measured by the are above the supply curve and below the price
- consumer surplus measures the consumer’s benefit from trade, and producer surplus the
producer’s benefit from trade.
What Shifts the Supply Curve?
- A decrease is costs means that the supply curve shifts down and to the right
- Higher costs mean that the supply curve shifts up an to the left
Important Supply Shifters
- Technological innovations and changes in the price of inputs
- Taxes and subsidies
- Expectations
- Entry or exit of producers
- Changes in opportunity costs
CH 4 – Equilibrium (How Supply and Demand Determine Prices)
Equilibrium and the Adjustment Process
- Equilibrium occurs when quantity demanded equals quantity supplied
- A surplus is a situation in which the quantity supplied is greater than the quantity demanded
- Competition will push prices down whenever there is a surplus
- A shortage is a situation in which the quantity demanded is greater than the quantity supplied
- Competition will push prices up whenever there is a shortage
- The equilibrium price is the price at which the quantity demanded is equal to the quantity
supplied
- The equilibrium price is stable because at the equilibrium price the quantity demanded is
exactly equal to the quantity supplied
, Who Competes with Whom?
- Sellers compete with other sellers and buyers compete with other buyers
A Free Market Maximizes Producer Plus Consumer Surplus (the Gains from Trade)
- There are unexploited gains from trade at any quantity less than the equilibrium quantity
- Resources are wastes at quantities greater than the equilibrium quantity
- The equilibrium quantity is the quantity at which the quantity demanded is equal to the
quantity supplied
- A free market maximizes the gains from trade
- Gains from trade = producer and consumer surplus
- Thus, a free market maximizes producer plus consumer surplus
- It requires that goods must be produces at the lowest possible cost and they must be
used to satisfy the highest value demands
- When we say that a free market maximizes the gains from trade we mean:
1. the supply of goods is bought by the buyers with the highest willingness to pay
2.the supply of goods is sold by the sellers with the lowest costs
3. between buyers and sellers, there are no unexploited gains from trade and no wasteful
trades,
Does the Model Work? Evidence from the Laboratory
- Vernon smith, test group of students willingness to pay and to sell
Shifting Demand and Supply Curves
- A decrease in supply will raise the market price and reduce the market quantity, exactly the
opposity effects to an increase in supply
Terminology: Demand Compared with Quantity Demanded and Supply Compared with Quantity
Supplied
- Difference between demand and quantity demanded: an increase in quantity demanded is a
movement along the fixed demand curve. An increase in demand is a shift of the entire
demand curve (up and to the right).
- The increase in supply pushes the price down, thereby causing an increase in the quantity
demanded
- Shifts in supply curve cause movements along the demand curve
Takeaway
- Market competition brings about an equilibrium in which the quantity supplied is equal to the
quantity demanded
- Only one price/quantity combination is a market equilibrium and you should be able to
identify this equilibrium in a diagram
- The sum of consumer and producer surplus (the gains from trade) is maximized at the
equilibrium price and quantity, and no other price/quantity combination maximizes consumer
plus producer surplus
CH 11 – Costs and Profit Maximization under Competition
- Three questions present themselves:
1. what price to set?
2. what quantity to produce?
3. when to enter and exit the industry?
What price to set?
- Under some conditions, firm does not set prices it accepts price that is given by the market
- To maximize profit, you sell at the market prize (you can sell as many as you want)
- Demand curves are more elastic in the longrun
