Summary of the material for the final exam (2021) for Economics for Political Scientists.
INCLUDES notes from (Total: 105 pages):
● CORE’s textbook “Economy, Society, and Public Policy (ESPP)”, chapters 1, 2, 3 (sections
3.4-3.6) and 4-12.
● CORE’s textbook “The Economy”, chapters 18 and 20.
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Economics for Political Scientists Notes on Readings
Table of Contents
“Economy, Society, and Public Policy (ESPP)” 2
1. Capitalism and Democracy 2
2. Social Interactions and Economic Outcomes 8
3. Public Policy for Fairness and Efficiency 14
4. Work, Wellbeing, and Scarcity 15
5. Institutions, Power, and Inequality 23
6. The Firm 31
7. Firms and Markets for Goods and Services 41
8. The Labour Market and the Product Market 49
9. The Credit Market 61
10. Banks, Money, Housing, and Financial Assets 68
11. Market Successes and Failures 76
12. Governments and Markets in a Democratic Society 81
“The Economy” 88
18. The Nation and the World Economy 88
20. Economics of the Environment 95
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“Economy, Society, and Public Policy (ESPP)”
1. Capitalism and Democracy
Introduction
The capitalist revolution made the escape from poverty possible.
➔ A minority of countries have achieved affluence.
➔ A significant majority of the world’s population has at least escaped from grinding poverty.
➔ Capitalism has:
◆ Brought advances in technology.
◆ Increased specialisation.
◆ Increased capital.
➔ HOWEVER, the capitalist revolution has also brought unprecedented global economic
inequalities, and growing threats to our natural environment.
Economic Inequality: Differences among members of a society in some economic attribute such as
wealth, income, or wages.
Democracy
Demands for a new political system in democracy; brought greater political equality and had some
mitigating effect on economic inequality.
Affluence and Income Inequality
Measuring Inequality
Statistics are used to make comparisons of incomes within and between countries and at different
periods.
➔ ‘Skyscraper’ Figure: A 3D visualisation of global inequality, where countries in the world are
lined up from poorest (left) to richest (right). For each country, the average income of the
poorest 10% is the lowest bar in the front. The average income of the richest 10% is the
highest bar for that country at the back. The width of the bar corresponds to the size of the
population.
➔ Rich/Poor Ratio: The ratio between the heights of the front and back bars as one measure of
inequality in a country. Trends:
◆ Differences between the rich and poor are huge within each country.
◆ Huge difference in income between countries.
➔ 90/10 Ratio: An alternative ratio between the income of the two individuals at the 90th and
10th percentiles.
Real GDP per capita
Gross Domestic Product (GDP) per capita: The most common income measure, measuring the total
value of all the goods and services produced in a country in a given period (e.g. a year). Economists
can use historical records to apply the same rules and estimate GDP per capita over periods that go
back centuries. To make meaningful comparisons between countries, adjustments need to be made:
1. Divide a country’s total GDP by its population, to derive GDP per capita: a measure of
average annual income.
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2. Correct for changes in spending power within the country (i.e., if GDP per capita rises, but
inflation also rises then the actual spending power of incomes has not risen; no real change in
incomes). It needs to be corrected for inflation to calculate real GDP.
➔ Inflation: An increase in the general price level in the economy.
➔ Real GDP: An inflation-adjusted measure of the market value of the output of the
economy in a given period.
3. To compare GDP per capita between countries, it needs to be measured in the same units
(e.g., the US dollar is a commonly-used unit).
4. Adjust GDP to reflect the purchasing power parity (PPP).
➔ PPP: A statistical correction allowing comparisons of the number of goods people can
buy in different countries that have different currencies.
Line Graph: A chart that shows the behaviour of a particular variable or variables over time. It uses a
‘linear’ scale; each ‘unit’ on the vertical axis represents the same amount. HOWEVER, this scale
does not represent the experience of real people well.
➔ History’s Hockey Stick: A line graph of the real GDP per capita in five countries (Britain,
Japan, Italy, China and India) between 1000–2016.
Economic Growth
The (real) GDP Growth Rate: Used to calculate the annual growth rate of real GDP in a year.
Percentage changes allow us to compare the real GDP growth of a country in different years.
➔ E.g., if real GDP in Country A grew by 1% compared to 2% in Country B, we can say that
Country B’s economy grew faster than Country A’s.
Real GDP Growth Rate:
● 𝑡: The year.
● 𝐺𝐷𝑃𝑡: Real GDP in year 𝑡.
𝐺𝐷𝑃𝑡−𝐺𝐷𝑃𝑡−1
𝑔𝑡(%) = 𝐺𝐷𝑃𝑡−1
∗ 100%
Compound Annual Growth Rate (CAGR): The comparison of the annual growth rate with the average
annual growth rate. Here the principle of compounding is used. This rate is used to calculate
compound annual growth rates over long periods, such as decades.
CAGR:
● 𝐺𝐷𝑃𝑡1: GDP of the most recent year for comparison (e.g., 2011).
● 𝐺𝐷𝑃𝑡2: GDP of the earliest year for comparison (e.g., 1950).
● 𝑛: The difference in years between the two chosen dates (e.g. 61 years).
1
⎡ ⎤
( )
𝐺𝐷𝑃𝑡1 𝑛
𝑔𝑡(%) = ⎢ − 1⎥ ∗ 100%
⎢ 𝐺𝐷𝑃𝑡2 ⎥
⎣ ⎦
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‘Rule of 70’: Look at growth rates over long periods, in which case the number in the denominator is
the compound annual growth rate. If the economy is growing at a constant rate, the number of years it
will take for real GDP per capita to double is approximately 70 divided by the annual growth rate.
‘Rule of 70’:
70
𝑟𝑒𝑎𝑙 𝐺𝐷𝑃 𝑝𝑒𝑟 𝑐𝑎𝑝𝑖𝑡𝑎 𝑡𝑜 𝑑𝑜𝑢𝑏𝑙𝑒 = 𝑎𝑛𝑛𝑢𝑎𝑙 𝑔𝑟𝑜𝑤𝑡ℎ 𝑟𝑎𝑡𝑒 (%)
Ratio Scale: A scale that uses distances on a graph to represent ratios. Using this scale:
● A straight line means a constant growth rate.
● A steeper line means a faster growth rate.
Growth and Inequality
Three lessons learned about growth and inequality:
1. For a very long time, living standards did not grow in any sustained way, anywhere.
2. In some countries (e.g. China and India) per-capita income fell over long periods.
3. When sustained growth occurred, it began at different times in different countries.
➔ In some economies, substantial improvements in people’s living standards did not
occur until they gained independence from colonial rule or interference by European
nations.
➔ Capitalism encouraged a ‘permanent technological revolution’.
Adam Smith (1723-1790): The founder of modern economics. In his book, An Inquiry into the Nature
and Causes of the Wealth of Nations (1776) gave insights on the ‘invisible hand’, the division of
labour (specialisation), monopolies and the government’s role in a market system.
The Technological Revolution
Technology: A process taking a set of materials and other inputs, including the work of people and
capital goods (such as machines), to produce an output.
➔ The Industrial Revolution: A wave of technological advances and organisational changes
starting in Britain in the 18th century, which transformed an agrarian and craft-based
economy into a commercial and industrial economy.
➔ Technological Progress: A change in technology that reduces the number of resources (labour,
machines, land, energy, time) required to produce a given amount of output. This can
significantly increase living standards.
This revolution could only be implemented by a large increase in the number of capital goods in the
economy.
➔ Capital Goods: The durable and costly non-labour inputs used in production (machinery,
buildings), not including essential inputs.
The Capitalist Revolution
Capitalism: An economic system where the main form of economic organisation is the firm, in which
the private owners of capital goods hire labour to produce goods and services for sale on markets with
the intent of making a profit. NO economic system in the world is ‘purely’ capitalist.
