Chapter 1: ten principles of economics
The 10 principles of economics: pages 1 to 8 of the book
Economics is the study of how societies manage their scarce and limited resources (land, oil,
physical and human capital) to fulfill their unlimited needs
Microeconomies is the individual behavior of consumers and producers. How consumers and
firms make their decisions. The impact of government on choices.
Principles about how people make decisions:
1. People face trade-offs (to get one thing, we give up another)
2. The cost of something is what you give up to get it (must compare the costs and
benefits of each action to make trade-offs)
A good decision: value of choice > opportunity cost: benefit given up by the chosen
alternative. 5 steps:
How is opportunity of cost determined? What choice was made? Cost of the choice?
alternative choices? best alternative? value of the best alternative? Opportunity
cost.
3. Rational people think at the margin (look at the marginal cost)
We always assume that consumers and producers behave in rational way:
Consumers will always maximize their utility and producers their profits.
This rational behavior will lead to best possible market outcome (efficiency)
Rationality has boundaries.
Rational decision: marginal benefit > marginal cost
Don’t look at average cost but rather marginal cost. If marginal benefit or revenue is
> marginal cost good decision. Compare with earnings
4. People respond to incentives (by comparing costs and benefits, behavior may change
when costs and/or benefits change) outcome may not be expected at all!
Principles about how people interact with each other:
5. Trade can make everyone better off (Trade allows each person to specialize in the
activities he/she does best)
6. Markets are usually a good way to organize economic activity (invisible hand by
Adam Smith) If household and firms do what it is best for themselves, they will often
end up doing what is best for the society. Maximizing efficiency.
7. Governments can sometimes improve economic outcomes:
Two important reasons for the government to interfere with the economy:
The promotion of efficiency: Market fail to allocate resources efficiently by
externality and by market power or monopoly
The promotion of equity: The invisible hand is less able to ensure a fair distribution.
(Income taxes)
Opportunity cost: the loss of other alternatives when one alternative is chosen.
The opportunity cost in making the best choice increases as the revenues of the second best
choice option increase (opportunity cost = cost of chosen option + forgone value of the best
alternative option)
Chapter 2: thinking like an economist
Positive statements describe the world as it is (economists are more of scientists), it
can be tested with data but normative statements (worth more, should…) are about
how the world should be (economists are more of policy advisors), cannot be tested
with data
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, An economist thinks of terms of alternatives, evaluates the cost of individual and social
choices, and examines and understands how certain events and issues are related.
Rational economic agents choose options for which the revenues exceed the opportunity
cost.
Chapter 3: the market forces of supply and demand
Supply and demand are forces that make market economies work, they determine the
quantity and the price of each good.
Market: group of buyers and sellers of a particular good or service. It can be highly organized
or less organized. (Ice cream market)
Types of markets:
Competitive market: many buyers and many sellers so no impact on the market
price, because other sells are offering almost identical product (Milk market)
Noncompetitive market: may affect market price. (Mobile phone providers in
Belgium are big enough to affect market price)
Perfectly competitive markets: identical goods offered + Buyers or sellers are so
numerous that no single buyer or seller can influence the market price: “Price
Takers” (Salt market)
Classification of markets depending on degree of competition: Perfectly competitive
→monopolistically competitive (slightly different product) →oligopolistic (few sellers: phone
providers) → monopolistic (only 1 seller).
In all types of markets, buyers determine the demand and sellers determine supply
Demand:
Demand reflects a decision about which needs/wishes to satisfy between people’s unlimited
wishes/needs for goods and services.
Individual demand is the amount of good that you are willing to buy in a period. (Amount of
ice cream this month) It can be affected by price factor* or non-price factors**.
Factors affecting it: a) price of good*, b) income**, c) price of related goods**, d) tastes**, e)
expectations** and f) advertising**.
a) Law of demand: Other things being equal, the quantity demanded of a good, falls
when the price of the good rises.
b) If the demand for a good, increases when income increases, the good is called a
normal good. If the demand for a good, decreases when income increases, the good
is called an inferior good.
c) Related goods can be substitutes (two goods for which an increase in the price for
one good leads to an increase in the demand for the other good) (ex: pizza and
pasta) or complements (two goods for which an increase in the price for one good
leads to a decrease in the demand for the other good) (ex: pizza and beer)
d) If you like pizza you buy more but for economists this has no interest, but they
examine what happens when taste change. (Vegans)
e) If you expect pizza to be cheaper next week you won’t buy pizza at today’s price.
Market demand is the amount of good that all buyers are willing to buy in a period. The sum
of all individual demands by adding horizontally the individuals demands curves. Factors
affecting it: all factor that affect individual demand and the number of buyers.
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