Principles of Economics and Business 1 (6011P0200Y)
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Universiteit Van Amsterdam (UvA)
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Modern Principles of Economics
Summary of the book 'Modern Principles of Economics'. Cowen, T., and Tabarrok, A. (2018). Modern Principles of Economics. 4th edition. Worth Publishers – Macmillan Education, ISBN-13: 978-5, (c. €69,90).
This summary includes the necessary chapters for BSc students 1st year Business Administra...
Summary ALL ARTICLES + CHAPTERS 'Moral Limits of Markets' - ENDTERM UVA EBE/BA (Grade: 9.3)
Summary Economics (Modern Prinicples of Economics)
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Principles of Economics and Business 1 (6011P0200Y)
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Modern Principles of Economics
Chapter 1
Incentives = rewards and penalties that motivate behaviour. Every day we rely on the work
of millions of other people to provide us with food, clothing, and shelter. Economists do
think that people react to incentives in predictable ways. Fame, power, reputation, sex and
love are all important incentives. Economists even think that benevolence responds to
incentives (dus dat kindness gereguleerd kan worden met stimulansen. Bijvoorbeeld dat
goede doelen de namen van hun donors bekend maken, om zo mensen aan te trekken).
When self-interest aligns with the broader public interest, we get good outcomes, but when
self-interest and the social interest are at odds, we get bad outcomes, sometimes even cruel
and inhumane. (de kapiteins op het schip kregen door het gezond afleveren van hun slaven,
niet alleen het rechte eind voor zichzelf maar ook voor de slaven en de overheid). Under the
right conditions markets align self-interest with the social interest. All the workers that bring
the fruit to your supermarket, acted in their own interest and by doing so, also in your
interest. Which is the perfect example of the invisible hand. Markets, however, do not
always align self-interest with the social interest. The invisible hand can be gone then.
Market incentives can be too strong. (A firm that does not pay for the pollution that it emits
into the air has too great an incentive to emit pollution, or the fisherman that catches too
much fish thereby driving the stock of fish into collapse). Market incentives could be too
weak as well.
Trade-offs = a situation in which you balance two opposing situations or qualities, are
everywhere. In the testing of new medicine, there are a lot of trade-offs. The longer it takes
to bring a new drug to the market, the more people are harmed who could have benefitted
if the new drugs had been approved earlier. You can die because of the approval of an
unsafe drug, but you can also die because a safe drug has not yet been approved = drug lag.
The greater the cost of testing, the fewer new drugs will be available. Higher cost means
fewer new drugs and fewer lives saved. You can die because an unsafe drug is approved, you
can also die because this drug is never developed = drug loss. More testing means safer
drugs but also drug lag and loss.
Opportunity cost = the value of the opportunities lost (opofferingskosten). Recognizing
trade-offs is the first step in making wise choices, and most of the time people do respond to
changes in opportunity cost
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 less).
The benefits of trade go beyond those of exchange. The real power of trade is the power to
increase production through specialization. Self-sufficiency is death. Through the division of
knowledge, the sum total of knowledge increases and in this way so does productivity. Trade
allows us to take advantage of the mass production (schaalvoordelen). Everyone can benefit
from trade, especially those who are not productive. If someone’s opportunity cost for an
,activity are very high, e.g. when someone does the ironing but also the running of a
business, those people are more likely to run the business instead of ironing. The theory of
comparative advantage says that when people or nations specialize in goods in which they
have a low opportunity cost, they can trade to mutual advantage
A good economy leads to wealth and as a consequence, better health. It brings luxury and
women’s rights, political liberty. Wealth matters, and understanding economic growth is one
of the most important tasks of economics.
What makes a country rich? Wealthy countries have lots of physical and human capital per
worker and they produce things in a relatively efficient manner. Because of incentives, it is
organized in a better way in some countries. Entrepreneurs, investors and savers need
incentives to save and invest in physical capital, human capital, innovation and efficient
organization. Among the most powerful institutions for supporting good incentives are
political stability, honest government, open markets. (Noord-Korea is arm en Zuid-Korea
relatief rijk. De stimulansen zijn erg verschillend in deze twee landen.) Macroeconomics are
interested in the incentives to produce new ideas. Ideas have peculiar properties, one apple
feeds a person but the one idea can feed the world.
No economy grows at a constant pace. The Great Depression did not have to happen if the
government had acted more quickly and appropriately. Today, the tools of monetary and
fiscal policy are much better understood. Unemployment insurance can reduce some of the
misery that accompanies a recession. The tools of monetary and fiscal policy are not all-
powerful.
Inflation = an increase in the general level of prices. It makes it harder for people to figure
out the real values of goods, services and investments. Inflation comes about when there is
a sustained increase in the supply of money. More money is spent, production stagnates so
prices rise.
There is a lag between a decision of the Fed and the effects, which can be a problem
because the economy changes in the meantime. A low or falling money supply forces people
to cut their prices and wages and this adjustment does not always go smoothly.
Chapter 2
Trade creates value by moving goods from people who value them less to people who value
them more. Trade makes people better off.
In a world without trade, no one can afford to specialize. Specialization increases
productivity. Knowledge increases productivity, so specialization increases total output.
Another reason to trade is the advantage of differences. Education, climate, etc. the world’s
production can be maximized when Brazil produces sugar, China assembles iPads and the US
uses its knowledge. A country has an absolute advantage in production if it can produce the
, same good using fewer inputs. A country does not need an absolute advantage to benefit
from trade.
Production Possibilities Frontier = show all combinations of goods that a country can
produce given its productivity and supply of inputs. A PPF illustrates trade-offs. If the slope
of the PPF is -1, it means that for every unit, it must produce one fewer unit of the other
good. For (e.g.) Mexico, the slope is 1/6th, so in other words, for every additional shirt that
Mexico produces, it must produce 1/6th less of a computer. That also tells the opportunity
cost; 1 computer cost 6 shirts. A country has a comparative advantage in producing goods
for which it has the lowest opportunity cost. After trade, both countries can consume
outside the PPF. When countries produce according to its comparative advantage and then
trades, total production and consumption increase. Both countries gain from the trade even
though the US is more productive in both computers and shirts. A country/person will
always be the low-cost seller of some good. A country will always have some comparative
advantage.
In a free market, all workers of the same type will earn the same wage. We can calculate the
wage in Mexico by summing up the total value of consumption in Mexico and dividing the
number of workers. Wages go up with the help of trade. It is the productivity of labor that
determines the wage rate. Different wages reflect differences in productivity.
Not everyone always benefits from increased trade. Workers in the computer sector in
Mexico and shirt sector in the US will see their wages fall. People will switch to the other
sector until their wages equalize. Greater trade increases total wealth.
Chapter 3
The demand curve for oil
Demand curve = a function that shows the quantity demanded at different prices.
Quantity demanded = the quantity that buyers are willing and able to buy at a particular
price.
The negative slope of the demand curve can be explained through the fact that oil is not
equally valuable in all of its uses. When the price is high, consumers will choose to use oil
only in its most valuable uses (e.g. jet fuel). As the price of oil falls, consumers will choose to
also use oil in its less and less valued uses (rubber duckies). Thus, a demand curve
summarizes how millions of consumers choose to use oil given their preferences and the
possibilities for substitution.
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