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Summary Principles of Economics and Business 1 (6011P0200Y)
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Principles of Economics & Business 1Notes book
Chapters: 1, 2, 3, 4, 11, 14, 7, 12, 27, 29, 19, 32, 37.
Chapter 1: The Big ideas
Incentives are rewards and penalties that motivate behaviour (prisoner transport to AUS)
Big idea one: Incentives matter:
When the captains were paid for every prisoner that they took on board, they had little
incentive to treat the prisoners well. These incentives changed when the captains were paid
for prisoners who survived the journey.
Big idea two: Good institutions align self-interest with social interest:
In the process of getting food into the supermarket, the people accountable for that all acted
in their own interest, but by doing that, they also acted in your interest.
Adam Smith “when markets work well, those who pursue their own interest end up
promoting the social interest, as if led to do so by an invisible hand.”
The idea that the pursuit of self-interest can be in the social interest was one of the most
surprising discoveries of economic science.
But sometimes the invisible hand is absent markets do not always align self-interest with
social interest. In some markets, the incentives can be too strong
The government can sometimes improve the situation by changing incentives with taxes,
subsidies, or other regulations.
Big idea three: Trade-offs are everywhere:
With drug testing trade off: drug lag or drug loss (testing too long).
On average, new drugs work better than old drugs. So, the longer it takes to bring new drugs
to the market, the more people are harmed who could have benefited if the new drugs had
been approved earlier. You can die because an unsafe drug is approved, you can also die
because a safe drug has not yet been approved (Drug lag)
A resource is scarce when there isn’t enough to satisfy all our wants.
We face trade-offs because we don’t have enough resources to satisfy all of our wants (more
of this means less of that)
The great economic problem is how to arrange our scarce resources to satisfy as many of
our wants as possible
The opportunity cost of a choice is the value of the opportunities lost.
, Big idea four: Thinking on the margin:
Weighing benefits and costs and making a decision based on that.
Thinking on the margin is just making choices by thinking in terms of marginal benefits and
marginal costs.
Big idea five: The power of trade:
The real power of trade is the power to increase production through specialization.
We survive and prosper only because specialization increases productivity.
Trade also allows us to take advantage of economies of scale if a farmer can produce
wheat in very large quantity, he can reduce the cost of bread for all. When he would
produce it on a smaller scale, bread would be more expensive.
Big idea six: The importance of wealth and economic growth:
Big idea seven: Institutions matter:
Big idea eight: Economic booms and busts cannot be avoided but can be moderated:
Booms and busts are part of the normal response of an economy to changing economic
conditions. A significant task of macroeconomic theory is to understand both the promise
and the limits of monetary and fiscal policy on smoothing out the normal booms and busts
of the macroeconomy.
Big idea nine: Inflation is caused by increases in the supply of money:
Inflation is an increase in the general level of prices.
When people have more money, they spend it, and without an increase in the supply of
goods, prices must rise.
Big idea ten: Central banking is a hard job:
Typically, there is a lag (often of many months) between when the Fed makes a decision and
when the effects of that decision on the economy are known.
Not enough money in the economy is bad as well and can lead to a recession or a slowing of
economic growth.
Chapter 2: The power of trade and comparative advantage
Trade creates value by moving goods from people who value them less to people who value
them more. Trade ensures that people with different preferences are better off.
Specialization greatly increases productivity.
The human brain is limited and there is much to know. Thus, it makes sense to divide
knowledge across many brains and trade. Knowledge increases productivity so specialization
increases total output. All this knowledge is possible, however, only because each person
can specialize in the production of one good and then trade for all other desired goods.
Without trade, specialization is impossible.
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