Summary of the book 'Modern Principles of Economics'. Cowen, T., and Tabarrok, A. (2018). Modern Principles of Economics. 4th edition. Includes all necessary chapters for the endterm. First year of the Bsc Business Administration at the University of Amsterdam.
Modern Principles of Economics, Cowen - Solutions, summaries, and outlines. 2022 updated
Principles of Economics and Business 2 (POEB2) - Moral Limits of Markets: Book Summary & Lecture Notes - GRADE 8,0
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Hoofdstuk 1
Incentives=rewards and penalties that motivate behavior.
Big ideas:
- incentives matter -> self-interest.
- good institutions align self-interest with the social interest. Invisible hand=when markets work well,
those who pursue their own interest end up promoting the social interest (sometimes greed is good).
- trade-offs are everywhere: drug lag=die because drug has not yet been approved, drug loss=safe
drug is never developed because longer testing costs more money.
- opportunity cost=value of the opportunities lost.
- thinking on the margin: making choices by thinking in terms of marginal benefits and costs, a little
bit more or less?
- the power of trade: trade makes everyone better off, power to increase production through
specialization, sum total of knowledge increases, economies of scale (reduction in costs).
Comparative advantage=specialize in lowest opportunity cost, trade to mutual advantage -> you can
benefit from hiring someone to do something that you can do better yourself if your opportunity cost
is too high. The more productive you are, the higher your demand for trade.
- the importance of wealth and economic growth -> lead to happier lives.
- institutions matter: NK & ZK, lack of incentives -> lack of new ideas and innovation. Ideas aren’t
used up when they have been used.
- economic booms and busts cannot be avoided but can be moderated, through monetary and fiscal
policy, can also make things worse.
- prices rise when the government prints too much money. Inflation=an increase in the general level
of prices, harder to figure out real values of goods & services. When people have more money, they
spend it, if supply cannot increase prices will.
- central banking is a hard job: lag between decision and effects, economic conditions change. Too
much money -> inflation, too little money -> cut wages, recession.
Hoofdstuk 2
Benefits of trade:
- Trade makes people better off when preferences differ: create value by moving goods from people
who value them less to people who value them more.
- Trade increases productivity through specialization and the division of knowledge.
- Trade increases productivity through comparative advantage. Absolute advantage=country can
produce the same good using fewer inputs than another country, not necessary to benefit from
trade.
Production possibilities frontier (PPF)=line that shows all the combinations of goods that a country
can produce given its productivity and supply of inputs (trade-offs). Opportunity costs: making 1
computer costs 6 shirts etc, country has comparative advantage in producing goods for which it has
the lowest opportunity cost. Can only consume outside PPF through trade. Everyone will always be a
low-cost seller of some good: the greater the advantage of producing A, the greater the cost of
producing B. (Not everyone has an absolute advantage).
In a free market, all workers of the same type will earn the same wage, so the wages in different
countries are the same. Wage=value of total consumption/number of workers. However, lower
productivity means lower wages. Trade increases wages in both countries. Low wages vs. high
productivity.
Not everyone always benefits from trade: workers cannot easily switch jobs for higher wages, the
wages in the decreased demand will fall. Trade does always increase total wealth.
, Hoofdstuk 3
Demand curve=a function that shows the quantity demanded at different prices/the maximum
willingness to pay for any quantity.
Demand curve is negatively sloped because oil is not equally valuable in all of its uses: more valuable
for producing gasoline than rubber duckies. Depends on substitutes.
Consumer surplus=the consumer’s gain from exchange or the difference between the maximum
price a consumer is wiling to pay and the market price.
Total consumer surplus=the area beneath the demand curve and above the price. BxH/2.
Increase in demand shifts demand curve outward, up and to the right. Decrease in demand shifts
demand curve inward, down and to the left. Important demand shifters:
- Income. Normal good=increase in income increases demand. Inferior good=increase in income
decreases demand.
- Population: more people, more demand. Aging -> different demands.
- Price of substitutes.
- Price of complements. Complements=things that go well together.
- Expectations: reduction in future supply increases the demand today/price increases.
- Tastes, changed by fashion and advertising etc.
Supply curve=a function that shows the quantity that suppliers would be willing and able to sell at
different prices. Low price, only countries where the costs of producing the good are low will supply,
won’t be profitable in countries with higher costs.
Producer surplus=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.
Total producer surplus=the area above the supply curve and below the price.
Total gains from trade/measure of welfare: consumer surplus + producer surplus.
Decrease in costs increases supply: curve shifts down and to the right. Higher costs mean that the
supply curve shifts up and to the left. Important supply shifters:
- Technological innovations (reduce costs) and changes in the price of inputs.
- Taxes and subsidies. Curve shifts up/down with same number as the tax/subsidies, but the price
does not necessarily change with the same amount! (new equilibrium)
- Expectations: increasing price, sell less, shift to the left. Speculation=the attempt to profit from
future price changes.
- Entry or exit of producers: entry increases supply, curve shifts to the right.
- Changes in opportunity costs: if the price of product A increases, the opportunity costs of product B
increases, curve shifts up and to the left.
Hoofdstuk 4
Equilibrium: meeting point supply and demand curves, stable, no incentives to change prices.
Surplus=the quantity supplied is greater than the quantity demanded. Competition will push prices
down. It costs sellers more to produce a good than it is worth to buyers, resources are wasted.
Shortage=the quantity demanded is greater than the quantity supplied. Competition (between
buyers) will push prices up. Unsatisfied wants, limited goods used for highest-valued wants. There
are unexploited gains from trade at any quantity less than the equilibrium quantity.
A free market maximizes the gains from trade when:
- The supply of goods is bought by buyers with the highest willingness to pay,
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