Principles of Economics, (GEO1-2255)
Summary CORE economics
Unit 1 The Capitalist Revolution
GDP (gross domestic product) is the total value of everything produced in a given period such
as a year, also referred to as gross domestic income.
1.1 income inequality
measure of inequality → 90/10 ratio = average income of the richest 10% divided by the
average income of the poorest 10%.
1.2 measuring income and living standards
GDP is not the same as the disposable income of a person = the amount of wages or salaries,
profit, rent, interest and transfer payment from the government or from others received over a
given period such as a year, minus any transfers the individual made to others (including
taxes). Disposable income leaves out:
- quality of social and physical environment
- amount of free time
- goods and services not bought when provided by the government
- goods and services produced within the household, such as meals or childcare
in GDP goods and services provided by the government are included, therefore better measure
of living standards.
where pi is the price of good I & qi is the quantity of good i.
purchasing power parity (PPP) A statistical correction allowing comparisons of the amount
of goods people can buy in different countries that have different currencies.
1.3 History’s hockey stick: growth in income
(times 100 to get %)
For a very long time, living standards did not grow in any sustained way. When sustained
growth occurred, it began at different times in different counties, leading to vast differences in
living standards around the world.
Claims of Adam Smith: coordination among all actors might spontaneously arise, without any
person or institution consciously attempting to create or maintain it. Idea that this could take
place as a result of individuals pursuing their self-interest.
1.4 The permanent technological revolution
In economics, technology is a process that takes a set of materials and other inputs -including
the work of people and machines- and creates an output.
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,Principles of Economics, (GEO1-2255)
1.6 Capitalism defined: private property, markets and firms
Capitalism is an economic system characterized by a particular combination of institutions.
capital goods The equipment, buildings, and other durable inputs used in producing goods
and services, including where applicable any patents or other intellectual property that is used.
Raw materials used in production are referred to as intermediate inputs.
Markets differ from theft, gift or government order in three ways;
1. they are reciprocated
2. they are voluntary
3. in most markets there is competition
a firm is a way of organizing production with the following characteristics:
- one or more individuals own a set of capital goods that are used in production
- they pay wages and salaries to employees
- they direct the employees in the production of goods and services
- the goods and services are the property of the owners
- the owners sell the goods and services on markets with the intention of making a
profit.
Government-owned entities (such as railways and power and water companies) are not
considered firms → either because they do not make a profit or because the owners are not
private individuals who own the assets of the firm and employ others to work here. Labour
market → employers on demand side, employees on the supply side.
Institutions of capitalism = private property, markets and firms.
1.7 Capitalism as an economic system
In a capitalist system, production takes place in firms.
Market and private property are essential parts of how firms
function for two reasons:
- inputs and outputs are private property: buildings,
equipment, patents and other inputs into production
belong to the owners.
- Firms use markets to sell outputs
Private property is an essential condition for the operation of markets: buyers will not want to
pay for goods unless they can have the right to own them. Distinctive hallmark of the
capitalist economic system is the private ownership of capital goods that are organized for
use in firms. It is a system that combines centralization with decentralization.
Two major changes accompanied the emerge of capitalism, both of which enhanced the
productivity of individual workers:
- Technology
Firms competing with each other in markets had strong incentives to adopt and develop new
and more productive technologies.
- Specialization
The growth of firms allowed historically unprecedented specialization in the tasks and
products on which people worked → can raise labour productivity and living standards.
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,Principles of Economics, (GEO1-2255)
1.8 The gains from specialization (called the division of labour)
We become better at producing things when we each focus on a limited range of activities:
- Learning by doing: we acquire skills as we produce things
- Difference in ability
- Economies of scale: producing a large number of units of some good is often more
cost-effective than producing a small number.
However, people will not specialize unless they have a way to acquire the other goods they
need → direct government requisitioning and distribution, gift and voluntary sharing.
Markets accomplish an extraordinary result; unintended cooperation on a global scale. All
producers can benefit by specializing and trading goods, even when this means that one
producer specialized in a good that another could produce at lower cost.
Greta has an absolute advantage in both
crops and Carlos has an absolute
disadvantage.
Greta has a comparative advantage in wheat; Carlos has a comparative advantage in apples.
Greta bought apples from
Carlos even though she could
produce them herself at a
lower cost (in terms of labour
time). Greta had an absolute
advantage in producing both
goods, Carlos had a
comparative advantage in
producing apples.
1.9 Capitalism, causation and history’s hockey stick
Natural experiment = An empirical study exploiting naturally occurring statistical controls
in which researchers do not have the ability to assign participants to treatment and control
groups, as is the case in conventional experiments. Instead, differences in law, policy,
weather, or other events can offer the opportunity to analyse populations as if they had been
part of an experiment. The validity of such studies depends on the premise that the assignment
of subjects to the naturally occurring treatment and control groups can be plausibly argued to
be random.
1.10 Varieties of capitalism: institutions, government, and the economy
South Korea take off: government of SK (along with a few very large corporations) played a
leading role in directing the process of development, explicitly promoting some industries,
requiring firms to complete in foreign markets and also providing high quality education for
its workforce. → developmental state = A government that takes a leading role in promoting
the process of economic development through its public investments, subsidies of particular
industries, education and other public policies.
Dynamic economy: bringing sustained growth in living standards. The existence of capitalist
institutions is not enough to create a dynamic economy. Two sets of conditions contribute to
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, Principles of Economics, (GEO1-2255)
the dynamism of the capitalist economic system: one set is economic; the other is political,
and it concerns the government and the way it functions.
Economic conditions:
Where capitalism is less dynamic, the explanation might be that:
- Private property is not secure: weak enforcement of the rule of law and of contracts
- Markets are not competitive: no carrots and sticks
- Firms are owned and managed by people who survive because of their connections to
government or their privileged birth
It is important to stay ahead of the competition; this means constantly innovating.
Political conditions
Markets, private property and firms are all regulated by laws and policies. By creating or
allowing monopolies, government may take the teeth out of competition. In addition to
supporting the institutions of the capitalist economic system, the government provides
essential goods and services such as physical infrastructure, education and national defence.
Capitalism can be a dynamic economic system when it combines:
- Private incentives for cost-reducing innovation: these are derived from market
competition and secure private property
- Firms led by those with proven ability to produce goods at low cost
- Public policy supporting these conditions: supplies essential goods that would not be
provided by private firms
- A stable society, biophysical environment and resource base
These are the conditions that together make up the capitalist revolution
The differences among democracies are part of the explanation of why the government’s
importance in the capitalist economy differs so much among nations.
1.11 Economics and the economy
Economics is about:
- How we come to acquire the
things that make up our livelihood
- How we interact with each other
- How we interact with our natural
environment
- How each of these changes over
time
1.12 conclusion
Living standards have risen rapidly in some countries since 1700, this upturn coincided with
rapid technological progress, and with the advent of a new economic system, capitalism, in
which private property, markets and firms play a major role. The capitalist economy provided
incentives and opportunities for technological innovation, and gains from specialization.
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