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Detailed summary economics and business book
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Detailed summary of the economics and business book: essential mathematics for economic analysis (4th edition)
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Part I: introduction to economicsChapter 1: the principles and practice of economics
1.1. The scope of economics
Choice – not money – is the unifying feature of all the things that economists study.
An economic agent is an individual or a group that
makes choices.
Scarce resources are things that people want,
where the quantity that people want to exceed the
quantity that is available.
Scarcity is the situation of having unlimited wants in
a world of limited resources.
Economics is the study of how agents choose to
allocate scarce resources and how those choices affect society.
Understanding people’s choices is practically useful for two key reasons:
1. Economic analysis describes what people actually do (positive economics)
2. Economic analysis recommends what people, including society, ought to do
(normative economics).
Positive economics is analysis that generates objective descriptions or predictions,
which can be verified with data.
Normative economics: is analysis that recommends what an individual or society
ought to do.
Microeconomics is the study of how individuals, households, firms, and governments
make choices affect prices, the allocation of resources, and the well-being of other
agents.
Macroeconomics is the study of the economy as a whole. Macroeconomists study
economywide phenomena, like the growth rate of a country’s total economic output, the
inflation rate, or the unemployment rate.
1.2. Three principles of economics
Economists emphasize three key concepts:
1. Optimization means picking the best feasible option, given whatever (limited)
information, knowledge, experience, and training the economic agent has.
Economists believe that economic agents try to optimize but sometimes make
mistakes. Economists believe that people’s goal of optimization – picking the best
feasible option – explains most choices that people make, including minor
decisions. People often make mistakes, but they try to do as well as they can,
given the limited information, knowledge, experience, and training that they
have.
2. Equilibrium is the special situation in which everyone is simultaneously
optimizing, so nobody would benefit personally by changing his or her own
behavior, given the choices of others. Equilibrium is a situation in which everyone
is simultaneously optimizing.
3. Empiricism is analysis that uses data – evidence-based analysis. Economists use
data to develop theories, to test theories, to evaluate the success of different
government policies, and to determine what is causing things to happen in the
world.
People make choices that are motivated by calculations of benefits and costs.
Economics and Business summary 1
,1.3. The first principle of economics: optimization
In the cases where agents make mistakes, normative economic analysis can help them
realize their mistakes and make better choices in the future.
Any decision can depend only on the information available at the time of the choice.
Optimalization means that you weigh the information that you have, not that you
perfectly foresee the future. When someone chooses the best feasible option given the
information that is available, economists say that the decision maker is being rational or
equivalently, that he or she is exhibiting rationality. Evaluating the rationality of a
decision means examining the quality of your initial decision, not the outcome.
All optimization problems involve trade-offs. An economic agent faces a trade-off when
the agent needs to give up one thing to get something else. A budget constraint shows
the bundles of goods or services that a consumer can choose given her limited budget.
Budget constraints are useful economic tools, because they quantify trade-offs. When
economists talk about the choices that people make, the economist always takes into
account the budget constraint. It’s important to identify the feasible options and the
trade-offs – the budget constraint gives us that information.
Evaluating trade-offs can be difficult, because so many options are under consideration.
Economists tend to focus on the best alternative activity, called opportunity cost.
Opportunity cost is the best alternative use of a resource. Economists often try to put
a monetary value on opportunity cost.
Let’s use opportunity cost to solve an optimization problem. Specifically, we want to
compare a set of feasible alternatives and pick the best one, called the cost-benefit
analysis. Cost-benefit analysis is a calculation that identifies the best alternative, by
summing benefits and subtracting costs, with both benefits and costs denominated in a
common unit of measurement, like dollars. Cost-benefit analysis is used to identify the
alternative that has the greatest net benefit, that is the sum of the benefits of choosing
an alternative minus the sum of the costs of choosing that alternative.
1.4. The second principle of economics: equilibrium
Equilibrium is the special situation in which everyone is optimizing, so nobody would
benefit personally by changing his or her own behavior. In equilibrium, all economic
agents are making their best feasible choices, taking into account of all the information
they have, including their beliefs about the behavior of others. In equilibrium, nobody
perceives that they will benefit from changing their own behavior.
1.5. The third principle of economics: empiricism
Economists use data to determine whether our theories about human behavior – like
optimization and equilibrium – match up with actual human behavior. Economists are
also interested in understanding what is causing things to happen in the world. But there
are some cases when cause and effect are hard to untangle.
1.6. Is economics good for you?
Learning to make good choices is the biggest benefit you’ll realize from learning
economics.
Most decisions are guided by the logic of costs and benefits. Accordingly, you can use
positive economic analysis to predict other people’s behavior. Economics illuminates and
clarifies all human behavior.
Economics and Business summary 2
,Chapter 1 summary
• Economics is the study of how agents choose to allocate scarce resources and
how those choices affect society. Economics can be divided into two kinds of
analysis: positive economic analysis (what people actually do) and normative
economic analysis (what people ought to do). There are two key topics in
economics: microeconomics (individual decisions and individual markets) and
macroeconomics (the total economy).
• Economics is based on three key principles: optimization, equilibrium, and
empiricism.
• Choosing the best feasible option, given the available information, is called
optimization. To optimize, an economic agent needs to consider many issues,
including trade-offs, budget constraints, opportunity costs, and cost-benefit
analysis.
• Equilibrium is a situation in which nobody would benefit personally by changing
his or her own behavior, given the choices of others.
• Economists test their ideas with data. We call such evidence-based analysis
empirical analysis or empiricism. Economists use data to determine whether our
theories about human behavior – like optimization and equilibrium – match actual
human behavior. Economists also use data to determine what is causing things to
happen in the world.
Economics and Business summary 3
, Chapter 2: economic methods and economic questions
2.1. The scientific method
Empiricism – using data to analyze the world – is at the heart of all scientific analysis.
The scientific method is the name for the ongoing process that economists, other
social scientists, and natural scientists use to:
• Develop modes of the world
• Evaluate those models by testing them with data
Testing models with data enables economists to separate the good models – those that
make predictions that are mostly consistent with the data – from the bad models. When
a model is overwhelmingly inconsistent with the data, economists try to fix the model or
replace it altogether. However, economists do expect to identify models that are useful
in understanding the world.
A model is a simplified description of reality. Sometimes economists will refer to a
model as a theory. These terms are usually used interchangeably. Because models are
simplified, they are not perfect replicas of reality.
Scientific models are used to make predictions that can be checked with empirical
evidence.
Scientists – and commuters – use the model that is best suited to analyzing the problem
at hand. Even if a model/map is based on assumptions that are known to be false, the
model may still help us to make good predictions and good plans for the future. It is
more important for a model to be simple and useful than it is for the model to be
precisely accurate.
Empirical evidence consists of facts that are obtained through observation and
measurement. Empirical evidence is also called data.
Hypotheses are predictions (typically generated by a model) that can be tested with
data. Whenever such hypotheses are contradicted by the available data, economists
return to the drawing board and try to come up with a better model that yields new
hypotheses.
A simple model is a good starting point for our discussion. It illustrates two important
properties of all models.
- First, economists know that a model is only an approximation and accordingly
understand that the model is not exactly correct. The model’s predicted
relationship between education and wages is a simplification that overlooks lots of
special considerations.
- Second, a model makes predictions that can be tested with data – in this case,
data on people’s education and earnings. We are now ready to use some data to
actually evaluate the predictions of the returns-to-education model.
The mean (or average) is the sum of alle the different values divided by the number of
values.
The median value is calculated by ordering the numbers from least to greatest and then
finding the value half-way through the list.
2.2. Causation and correlation
Causation occurs when one thing directly affects another.
A variable is a changing factor or characteristic. Scientists say that causation occurs
when one variable causes another variable to change.
Think of causation as the path from cause to effect.
Economics and Business summary 4
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