Chapter 1: The Big Ideas
1. Idea one: Incentives matter
Incentives: are rewards and penalties that motivate behaviour
(things that make people tick)
People respond in predictable ways to incentives
(important incentives are fame, power, reputation, sex, and love)
2. Idea two: Good institutions align self-interest with the social interest
an organization founded for a religious, educational, professional, or
social purpose.
Most of the time results in bad outcomes
The government can sometimes improve the situation by changing
incentives with taxes, subsidies, or other regulations.
Drug lag: lives are being lost because safe drugs that are still in the testing stage have not
yet been approved.
Drug loss: because of the higher the cost of testing a drug, fewer drugs are made, and more
lives are lost.
3. Idea three: Trade-offs are everywhere
We face trade-offs because we do not have enough resources for the wants of our society
scarcity.
The great economic problem: how to arrange our scare resources to satisfy as many of our
want as possible.
Opportunity cost of a choice is the (highest) value of the opportunities lost
Important for two reasons:
Trade-offs are faced
People respond to changes in opportunity costs (apart from price)
Differences in opportunity costs create mutually beneficial trading opportunities
4. Idea four: Thinking on the Margin
Making choices by thinking in terms of marginal benefits and marginal costs, the benefits,
and costs of a bit more or a bit less.
Marginal tax rates: the tax rate on an additional dollar of income
5. Idea five: The Power of Trade
The real power of trade is the power to increase production through specialization
The theory of comparative advantage:
when people or nations specialize in good in which they have a low opportunity cost, they
can trade in mutual advantage.
6. Idea six: The Importance of Wealth and Economic Growth
Wealthier economies lead to richer and more fulfilled, even happier lives.
Wealth matters, and understanding economic growth is one of the most important tasks of
economics.
7. Idea seven: Institutions Matter
,The entrepreneurs, investors and savers get incentives which lead to:
Wealthy countries have lots of physical and human capital per worker and they produce
things in a relatively efficient manner, using the latest technological knowledge.
8. Idea eight: economic booms and bust cannot be avoided, but can be moderated
There are busts and booms that are considered normal, like a depression. With tools you can
reduce the swings in unemployment and GDP. However, those tools cannot end recessions.
When you use them in the wrong way, they can even make a recession worse.
9. Idea nine: inflation is caused by increases in the supply of money
Inflation is the rise of the general level of prices. Inflation makes it hard to figure out the real
value of goods, services, and investments.
central bank increases supply of money -> consumption increases -> supply of goods stays
the same -> inflation
10. Idea ten: central banking is a hard job
The central bank must make a lot of decisions and that takes time. Sometimes when the
decision is finally made, the economy has significantly changed and the action does not
match the state of the economy. Therefore, there will be too much or too little supply of
money which will lead to inflation or deflation.
Chapter 2: The Power of Trade and Comparative Advantage
Three benefits of trade:
1. Trade makes people better off when preferences differ.
Trade creates value by moving goods from people who value them less to people
who value them more.
2. Trade increases productivity through division of labour and specialization.
3. Trade increases total production through comparative advantage.
PFF (production possibilities frontier) this graph shows all the combinations of goods
that a country can produce given its productivity and supply of inputs.
As a trade develops, so does specialization, and specialization turns out to vastly increase
productivity.
Comparative advantage: a country in producing goods had the lowest opportunity cost.
Trade does not increase productivity directly, only when trade leads to specialization. Trade
means that workers in both countries can raise their wages to the highest level.
Absolute advantage is the ability to produce the same good using fewer inputs than another
producer. This is necessary to benefit from a trade. (US had absolute advantage)
Specialization and trade raise wages in both countries that are party to the trade.
Mexico 12 units to make one computer and
2 units to make one shirt
US 1 unit to make one computer or one shirt
, Chapter 3: Supply and Demand
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 Law of Demand:
Demand curve is typically negatively sloped.
Demand summarizes how consumers choose to use a good, given their preferences
and the possibilities of substitution.
Consumer surplus: the consumer’s gain from exchange, or difference between the
maximum price a consumer is willing to pay for a certain quantity at the market price.
What Shifts the Demand Curve?
Taste: what the consumers like, caused by fads, fashions, and advertising.
Income: when people get richer, they buy more stuff.
Normal good: increase in income -> increases the demand for a good.
Inferior good: increase in income -> decreases the demand for a good.
Population: an increase of population increases demand for a good, curve to the right.
Price of substitutes: decrease price of a substitute -> increase demand for the
substitute -> decrease demand for the other good. Demand curve to the left.
Price of complements: goods that go well together (sugar and tea)
Drop in the price of good A leads to an increase in demand for good B.
Expectations: the expectation of a reduction in supply in the future, meaning a rise in
price increases the demand today.
Supply curve: a function that shows the quantity supplied at different prices
Quantity supplied: the quantity that sellers are willing and able to sell at a particular price.
Produce more, more expensive to produce suppliers ask for higher price
The Law of Supply:
A supply curve is positively
The higher the price the greater the quantity supplied.
Producer surplus: this is 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 a particular
quantity.
What Shifts the Supply Curve?
Technological innovations and changes in the price of inputs: Costs will decrease, curve
will move to the right.
Taxes and subsidies: Taxes will leas to an increase in costs for producers, curve to the
left. Subsidies shift the supply curve to the right.
Expectations: suppliers who expect that prices will increase in the future have an
incentive to sell less today, so that they can store goods for future sale.
Entry or exits of producers: Reducing barriers will lead to new producers to the market
the curve shifts to the right. Applying barriers will lead to less producers and less supply,
the curve shifts to the left.
Changes in opportunity costs: when the opportunity cost increase the supply, curve
shifts up to the left, suppliers will get more value from trading with another product. A
decrease in opportunity costs shift the supply curve to the right.
