Fundamentals Cheat Sheet
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Capitalism Socialism *Private ownership of mass & production *Public (gov.) ownership of the means & production *Free markets *Central planning Trade Surplus Exports > Imports Five Fundamental Questions: 1) What gets produced? 2) How much? 3) How? 4) Who gets what? 5) How do we cope with the change? Persuasion is at the heart of what constitutes the economy *The more important you are, the bigger your reward *In the free market economy, we rely on people buying and selling products The Wealth of Nations: *Dominant school at the time was mercantilism Beginning of the 16 th century to end of 18 th century *Dominant characteristics: 1) Bullionism (gold or silver) Nations were obsessed with accumulating as much gold and silver as possible (to regulate Trade Surplus’) Imports of gold/silver > exports of gold/silver creates balance Smith’s point is that they got this completely wrong *Smith is a philosopher and a humanist Deeply concerned about the way people live and the way they view each other in relation to each other * When the rate of economic growth exceeds the rate of population, the average income increases More prosperity = higher mortality rates * The sustenance of life is physical as well as spiritual Adam Smith draws a connection between a means to feel compassion in society and the ability to do so POVERTY HEALTH DEATH LIFE Smith argues that gold and silver do not = national wealth * It is the ability to produce the goods and services for a nation’s necessaries and conveniences of life National Wealth: resides in the skill, dexterity, and spirit of industriousness of that nation’s labor What Causes National Wealth? * The measure of labor productivity is the amount of output/time * The single most important cause of National Wealth is improvements in the social division of labor Smith * Limits improvement in division of labor: extent of the market Existence of opportunities for people to exchange in mutually beneficial exchanges * Causes improvement: non-interference * Bissez-faire : Let people trade freely Money is NOT National Wealth * No money barter economy (has never existed in specialized economy) – aka goods exchanged directly for goods * Money as a medium of exchange Reduces transaction costs “It is cheaper to go t hrough the middle-man” Chapter Seven: The “Invisible Hand” of the market * Two prices in connection with goods: 1) Pm = Market price of a good 2) Pn = Natural price of a good A price that is just barely high enough to cover the cost of producing a thing, it can be higher or lower than market price * Productive resources are necessary to produce things But they are scarce – THINGS < WANTS * For everything that gets produced, something does NOT get produced – everything we do entails cost in a world of scarcity * The cost of producing a thing reflects the value of the resources used to produce it in their next best alternative use EX: accounting professors vs. English professors The market places a very low value on intelligence and a very high value on sociability – If Pm > Pn: 1) Provides people with information 2) Provides people with incentives Pm decreases and Pn increases until Pm = Pn Productive resources are relocated toward increased production of the thing Arbitrage: attempting to take advantage of an opportunity to realize greater than “normal” gains, and in doing so, reducing the gains to others engaging in the same action EX: Lines in a checkout grocery store * The only way you can do better than everybody else, is by knowing something they don’t know * The invisible hand of the market process is constantly allocating productive resources away from less valuable uses and towards more valuable uses Market: Some sort of institutional mechanism in which people are buying and selling things in terms of a mutually agreeable trade * Markets allocate productive resources in a way that maximizes individual well-being as the individuals themselves perceive it to best be served Markets work better than any other institutional mechanism that people have devised to answer the 5 basic economic Q’s Do a good job of ensuring human freedom Smiths Distinction Between Productive and Unproductiv e Labor Productive Labor: That part of the labor force that is directly involved in producing the community’s means of subsistence Unproductive Labor: That part of the labor force that is directly involved in producing things other than community’s means of subsistence Smith talks about how this is important for the “Arts of Civilization”: they produce things that are enjoyable to society Not unproductive, just different * The problem is that those who are involved in productive labor must produce more than enough to support themselves in order to sustain unproductive workers Mathus’ Law: Population tends to grow arithmetically : 1, 2, 3, 4, … BUT REALLY Population grows geometrically: 1, 2, 4, 8, … * This is because we have a natural tendency to outdo the rate that nature can produce resources * Therefore, Mathus’ Law is not a law at all * Montaigne’s advice is to be intellectually humble; every age has taken something for granted which is false * Mathus is wrong because he did not foresee human ingenuity and the technological progress Our ability to support an enormous amount of unproductive workers CAPITAL THEORY: very murky concept Three main sources: 1) Labor 2) Land 3) Capital: produced goods that are used to produce other goods for sale * Capital and improvements in the division of labor go hand in hand with this economy * The problem is that it is hard to acquire and accumulate capital – what has to happen?? GDP Two options: 1) consume it 2) save it Capital cannot exist unless SAVING is a prerequisite – saving gives rise to capitalism Appreciation: Capital being used up slowly * The biggest industry that consumes far more than it saves is GOVERNMENT Problem of current consumerist economy Modern Economic Theory: Peter Heyne’s The Economic Way of Thinking (Bias = Libertarian) Authors are spelling out basic principles * Keyne’s wrote that there is some factual content to economics, but that’s not all It is a method rather than a doctrine * The approach to economic involves a particular way of thinking using Methodological Individualism: In trying to understand social economic phenomenon, the individual human person is the ultimate unit of exploration * All social phenomenon result from the calculated choices and actions of individuals (The actions that people take after making calculations based on expected benefits or losses to themselves) * Cannot locate a distinct point of consciousness (mind) in society w/o disregarding the other points (people) that make up the whole thing society cannot want something Property Rights: The rules of the game that govern what you can and cannot do with things and yourself private property rights are generally acknowledged by everybody Biases of Economic Theory: Tends to favor/exclude certain systems (theories) * Estimator is biased if it tends to give rise to systematic error – also applies to hard sciences Pro-Market Bias: In terms of market progress Common Economic Fallacy: 1) Ad Hoc Ergo Prompter Hoc Fallacy 99.8% all heroin addicts drank milk as children – therefore, we should ban milk Correlation is not the same thing as cause 2) Fallacy of Composition Assuming that what’s true for the one is true for the whole 3) Man on the Street Fallacy Unqualified authoritative pronouncements on the economy Fundamental Principles of Economic Theory: * We live in a world of SCARCITY! The condition that makes economics possible Scarcity: The stuff that we use to satisfy is fewer in number than the wants that those goods could be used to satisfy * Scarcity DOES NOT = rarity Scarcity implies a relationship between stuff and wants The Law of Demand: When the cost of any activity increases, people tend to engage in less of the activity. There is a negative relationship between the cost of doing something, and the amount of the thing people will want to do. EX: If everyone were armed, would deaths increase or decrease? More people would use handguns to settle disputes than currently do. Marginalism: Implies that people make calculated choices on the basis of a comparison of the MB’s & MC’s of different courses of action * MB’s are the values we expect to realize or gain as a result of engaging in some yet to be undertaken action * MC’s are the values we expect to give up as a result of engaging in some yet to be undertaken action To claim that costs don’t matter is to claim that there is only one good * People make calculated choices on the basis of a comparison of the MB’s and MC’s of different courses of action * Value the importance we attach to something as a result of our awareness t hat it can be used to satisfy Production Possibilities Frontier: * In order to get to point D, we must consider: 1) An economy’s supply of resources 2) The state of production technology 3) The state of economic organization Chapter 2: The Economic Way of Thinking: We must judge by EFFICIENCY Energy output/ energy input * Positive Statement – What IS * Normative Statement – What OUGHT to be Efficiency: Is a measure of how well things are working to achieve maximum benefits with minimum costs Has to do with subjective value Simply the ratio of MB’s/ MC’s The Relationship btw Exchange and Efficiency: THREE GAINS – 1) + Sum: Gains to Winner > Losses to Loser 2) 0 Sum: Losses to Loser = Gains to Winner 3) - Sum: Losses to Loser > Gains to Winner Pursuit of Comparative Advantage: You can do something at a lower cost than someone else 1) More efficient resource, use and allocation 2) Explains the pattern of the social division of labor EX: Jane is accountant – gets paid $100/hr Would take 10 hrs to paint her house George offers to paint for $10/hr in 30 hrs George has a comparative advantage * Example of Comparative Advantage to International Trade: US has CA in producing wheat, Brazil has CA in producing coffee – Brazil offers 1 ½ C for 1 W In a move from anarchy to free trade, the gains to the winners outweigh the losses to the losers
Transcript of Fundamentals Cheat Sheet
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apitalism Socialism
Private ownership of mass & production
*Public (gov.) ownership of themeans & production
Free markets *Central planning
de Surplus Exports > Imports Fundamental Questions:
What gets produced? 2) How much? 3) How? 4) Who getst? 5) How do we cope with the change?
suasion is at the heart of what constitutes the economye more important you are, the bigger your rewardthe free market economy, we rely on people buying andng productsWealth of Nations:
minant school at the time was mercantilismeginning of the 16th century to end of 18th centuryminant characteristics:ullionism (gold or silver)
Nations were obsessed with accumulating as much gold ander as possible (to regulate Trade Surplus’) orts of gold/silver > exports of gold/silver creates balance
Smith’s point is that they got this completely wrongith is a philosopher and a humanist
Deeply concerned about the way people live and the way theyw each other in relation to each otherhen the rate of economic growth exceeds the rate of ulation, the average income increases
More prosperity = higher mortality ratese sustenance of life is physical as well as spiritual
Adam Smith draws a connection between a means to feelpassion in society and the ability to do so
VERTY HEALTH DEATH LIFE
mith argues that gold and silver do not = national wealths the ability to produce the goods and services for a nation’s
essaries and conveniences of lifeonal Wealth: resides in the skill, dexterity, and spirit of
ustriousness of that nation’s labor at Causes National Wealth?
e measure of labor productivity is the amount of output/timee single most important cause of National Wealth isrovements in the social division of labor
thmits improvement in division of labor: extent of the market xistence of opportunities for people to exchange in mutuallyeficial exchangesuses improvement: non-interferencessez-faire: Let people trade freely
Money is NOT National Wealth
o money barter economy (has never existed in specializednomy) – aka goods exchanged directly for goodsoney as a medium of exchange
Reduces transaction costss cheaper to go t hrough the middle-man” pter Seven: The “Invisible Hand” of the market
wo prices in connection with goods:m = Market price of a goodn = Natural price of a good
A price that is just barely high enough to cover the cost of ducing a thing, it can be higher or lower than market priceoductive resources are necessary to produce thingsut they are scarce – THINGS < WANTSr everything that gets produced, something does NOT get
duced – everything we do entails cost in a world of scarcitye cost of producing a thing reflects the value of the resources
d to produce it in their next best alternative useaccounting professors vs. English professorshe market places a very low value on intelligence and a very
h value on sociability – If Pm > Pn:rovides people with informationrovides people with incentivesm decreases and Pn increases until Pm = Pnroductive resources are relocated toward increased
duction of the thingitrage: attempting to take advantage of an opportunity toize greater than “normal” gains, and in doing so, reducing thes to others engaging in the same actionLines in a checkout grocery storee only way you can do better than everybody else, is bywing something they don’t know e invisible hand of the market process is constantly
cating productive resources away from less valuable uses and
ards more valuable uses
Market: Some sort of institutional mechanism inwhich people are buying and selling things interms of a mutually agreeable trade* Markets allocate productive resources in away that maximizes individual well-being as theindividuals themselves perceive it to best beservedMarkets work better than any otherinstitutional mechanism that people havedevised to answer the 5 basic economic Q’s Do a good job of ensuring human freedomSmiths Distinction Between Productive and
Unproductive Labor
Productive Labor: That part of the labor forcethat is directly involved in producing thecommunity’s means of subsistence
Unproductive Labor: That part of the labor forcethat is directly involved in producing thingsother than community’s means of subsistence Smith talks about how this is important forthe “Arts of Civilization”: they produce things
that are enjoyable to societyNot unproductive, just different * The problem is that those who are involved inproductive labor must produce more thanenough to support themselves in order tosustain unproductive workersMathus’ Law: Population tends to growarithmetically : 1, 2, 3, 4, … BUT REALLYPopulation grows geometrically: 1, 2, 4, 8, … * This is because we have a natural tendency tooutdo the rate that nature can produce
resources* Therefore, Mathus’ Law is not a law at all * Montaigne’s advice is to be intellectuallyhumble; every age has taken something forgranted which is false* Mathus is wrong because he did not foreseehuman ingenuity and the technological progress Our ability to support an enormous amount of unproductive workersCAPITAL THEORY: very murky concept Three main sources:1) Labor 2) Land 3) Capital: produced goodsthat are used to produce other goods for sale* Capital and improvements in the division of labor go hand in hand with this economy* The problem is that it is hard to acquire and
accumulate capital – what has to happen??GDP Two options: 1) consume it 2) save it Capital cannot exist unless SAVING is aprerequisite – saving gives rise to capitalismAppreciation: Capital being used up slowly* The biggest industry that consumes far morethan it saves is GOVERNMENT Problem of current consumerist economyModern Economic Theory: Peter Heyne’s The
Economic Way of Thinking (Bias = Libertarian) Authors are spelling out basic principles* Keyne’s wrote that there is some factualcontent to economics, but that’s not all It is a method rather than a doctrine* The approach to economic involves aparticular way of thinking using MethodologicalIndividualism: In trying to understand socialeconomic phenomenon, the individual humanperson is the ultimate unit of exploration* All social phenomenon result from thecalculated choices and actions of individuals(The actions that people take after makingcalculations based on expected benefits orlosses to themselves)* Cannot locate a distinct point of consciousness(mind) in society w/o disregarding the otherpoints (people) that make up the whole thing society cannot want something
Property Rights: The rules of the game that govern what you can and cannot do with thingsand yourself private property rights aregenerally acknowledged by everybodyBiases of Economic Theory: Tends to
favor/exclude certain systems (theories)
* Estimator is biased if it tends to give rissystematic error – also applies to hard scPro-Market Bias: In terms of market progCommon Economic Fallacy:1) Ad Hoc Ergo Prompter Hoc Fallacy 99.8% all heroin addicts drank milk aschildren – therefore, we should ban milk Correlation is not the same thing as ca2) Fallacy of Composition Assuming that what’s true for the one
for the whole3) Man on the Street Fallacy Unqualified authoritative pronouncemon the economyFundamental Principles of Economic The
* We live in a world of SCARCITY! The condition that makes economics pScarcity: The stuff that we use to satisfy isin number than the wants that those goodcould be used to satisfy* Scarcity DOES NOT = rarity Scarcity ia relationship between stuff and wantsThe Law of Demand: When the cost of anyactivity increases, people tend to engage iof the activity. There is a negative relationbetween the cost of doing something, andamount of the thing people will want to dEX: If everyone were armed, would deathincrease or decrease? More people wouldhandguns to settle disputes than currentlMarginalism: Implies that people make
calculated choices on the basis of a compaof the MB’s & MC’s of different courses of * MB’s are the values we expect to realizegain as a result of engaging in some yet toundertaken action* MC’s are the values we expect to give upresult of engaging in some yet to be undeaction To claim that costs don’t matterclaim that there is only one good* People make calculated choices on the ba comparison of the MB’s and MC’s of diff
courses of action* Value the importance we attach to someas a result of our awareness that it can beto satisfyProduction Possibilities Frontier:
* In order to get to point D, we must cons1) An economy’s supply of resources2) The state of production technology3) The state of economic organizationChapter 2: The Economic Way of ThinkinWe must judge by EFFICIENCY Energy output/ energy input * Positive Statement – What IS* Normative Statement – What OUGHT to Efficiency: Is a measure of how well thingworking to achieve maximum benefits wiminimum costs Has to do with subjective value Simply the ratio of MB’s/ MC’s The Relationship btw Exchange and EfficiTHREE GAINS – 1) + Sum: Gains to Winner > Losses to Lo2) 0 Sum: Losses to Loser = Gains to Winn3) - Sum: Losses to Loser > Gains to WinnPursuit of Comparative Advantage: You csomething at a lower cost than someone e1) More efficient resource, use and alloca2) Explains the pattern of the social divisilaborEX: Jane is accountant – gets paid $100/hWould take 10 hrs to paint her house George offers to paint for $10/hr in 30 George has a comparative advantage* Example of Comparative Advantage toInternational Trade: US has CA in producing wheat, Brazil hin producing coffee – Brazil offers 1 ½ C f In a move from anarchy to free trade, t
gains to the winners outweigh the losses losers
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mand for Donuts:hen price falls from $0.75 to $0.50, the demand foes not nge, but rather the Qd changes A change in the good’s own
e does not change the demand, only the Qd increase in demand means at every price, Qd goes up and at
ry Qd, price goes up Demand curve shifts out decrease in demand means at every price, Qd goes down andvery Qd, price goes down Demand curve shifts in
w of Demand: When a good’s price increases, people will buy
of it and when its price decreases, people will buy more of it ess of it (decrease of quantity demanded)
More of it (increase of quantity demanded)e demand for a good is the specific relationship that exists
r a certain time period between a good’s own price and theount of that good that people are willing and able to buy (Qs)
mand Theory: Has to do with the side of the market that dealsh (Substitutes for nearly everything)ngs Held Constant:opulation
ncomes:Normal goods – When income goes up, demand goes upnferior goods – When income goes up, demand goes downechnologyransactions Costseople’s tastes, preferences, perceptions of a good’s quality xpected Future Prices: Expected future goes up, D: Now goes up: Expected future goes down, D: now goes downhe Price of Other Goodsonsider goods A and B – One of three possible relationships:O RELATIONSHIP b. SUBSTITUTES c. COMPLEMENTS
e Elasticity of Demand:e availability of substitutes: The more substitutes = the moree elastic demand will be (Ed = higher); the fewer substitutese less price elastic demand will be (Ed = lower)onger time period, the higher the price elasticity of demandply: A behavioral relationship between P and Qs over aain time periodhen S goes up, at every P, Qs go up and at every Qs, P goes
wn Supply curve shifts out and downhen S goes down, at every P, Qs go down and at every Qs, Ps up Supply curve shifts up and inply and Demand: How markets determine prices and howes provide people with information and incentives that erally enable efficient coordination of a complex socialsion of laborsons Supply Curves are Upward Sloping:
igher prices attract resources away from alternate resourcesigher prices increase the opportunity costs of not producingthing whose price has risen, therefore, people tend toduce more of the thing
nything that causes production costs to increase at all levels of duction will CAUSE a decrease in supply – Three Causes:n increase in the monetary costs of productive resourcesdecrease in productivityn increase in the opportunity cost of producing something
ministered Prices: Government interferes in price settinglegislated maximum price is called a price ceilinglegislated minimum price is called a price flooregislated maximum price is above market equilibrium price,ill have NO effect e Ceiling: If price is set below market equilibrium price therebe a shortage
arcity entails rationing Rationing entails discrimination
e Floor: Minimum WageAt Pf, Qs > Qd (Pf = minimum price to keep the small guy in)
mpetition involves people striving to fulfill the criteria that ers are causing to ration the scarce goods that they ownket Efficiency:uyers and sellers must be price takers
f one seller than monopoly – Q* will be too low & P* too highm the standpoint of efficiency
erfect Information (transparency of markets)o externalitieshe condition that all wants and values must be solvent Princeton – criteria is not only $ but grades and qualificationsmpetition takes place between sellers; not buyers and sellersmpetition takes place between buyers; not buyers and sellers
ernalities: Spill-over costs and benefits that are taken intoount by neither suppliers nor demanders in market progress
egative Externalities: Spill-over costsositive Externalities: Spill-over benefits
Market Failure: Market fails to provide theefficient outcome* Goods that generate negative externalities* As you pursue an activity, marginal costs (mc)increase and marginal benefits (mb) decreaseEliminating Negative Externalities:* Tax vs. Command-&-Control (four industries) 10k tax revenue distribute as 2.5k tax rebateElastic: Price/Expenditures = oppositedirection; Inelastic: Price/Expenditures – same
Positive ExternalitiesSmb > Pmb at all Q’s Government Intervention1) Subsidize Demand – this persuadespeople to buy more of the thing in question
than they otherwise would => D increase2) Subsidize Supply – this occurs whenpayments are made to producers to offsetproduction costs => S increase (P increase &Q decrease)Free-Rider Problem – a free rider is someonewho thinks they will get a good whether theypay for it or not -> this problem likely to bemost evident in the case of goods that aredifficult to exclude non-payers fromconsumingPrisoner Dilemma Problem – people think they will not get the good, whether they payfor it or not*coercion works by threatening to reduceoptions*persuasion works by offering to increaseoptionsPrinciple-Agent Problem – interests beingserved-principle is those who are being served-agent is those who are doing the servingGovernment Failure – governmentintervention in the market results in lesseffective outcomes than non-intervention*government has power to legally coerceadultsProblem: rent-seeking behavior – seek toget govern’t to impose restrictions so theycan get more benefits than they would getthru the free marketASSUMPTION: govern’t sees public asrationally ignorant, free-riders, and rationally
apathetic2 Cases Requiring Government Intervention1) any business that is too big to fail, must beregulated to prevent its failure2) anytime upside gains are privatized andlosses are socialized, institutions will take onfar more risk than is socially optimalMACROECONOMICSSymbols: GDP = Y UnemploymentRate = M
Price Level = P %changeP =Nominal Interest Rate = i Real Interest Rate= rGDP – all the goods and services that are
produced in a country’s borders in a calendar
year measured at current market prices*Real GDP – found when the GDP deflator
filters out adjustments to price changes-> GDP is best measure of economicperformance but does not include everything
– does include some things that don’t makeus better off (storm cleanup)Rate of Economic Growth = %changeGDPExpansion = %change Y > 0 and eitherincreaseSlowdown = %change Y > 0 and decreasingRecession = %change Y < 0Per Capita GDP = Y/populationUnemployment Rate = MM = labor force – employed / labor force*Full Employment is the desiredunemployment being achieved (varies,currently 4.5% and %.5%)
Frictional Unemployment – people who arechanging jobs
Structural Unemployment – results ftechnological change or change in the Cyclical Unemployment – those wholayed off Inflation => %changeP > 0Deflation => %changeP < 0Interest Rate is the premium one mustthe future to borrowPositive Time Preference = things are valuable in the present than the future people discount futureFunctions of Money1) medium of exchange 2) store of val3) unit of account 4) standard of defepayment
*central bank controls the money supp(Fed)*Msupply increase => when Fed buyssecurities*Msupply decrease => when Fed sellssecuritiesReserve Requirement: Fed controls Mthru forcing banks to maintain a minimreserveMv = velocity of money-how fast $ mthru the economyIncrease Msupply = decrease i = increPbond = increase Dstock = increase PsD(houses) increase => P(houses)Fiscal Policy – refers to the governt’s
spending policiesTrade Deficit = net export < 0
Net Exports = exports-importsENCYCLICALSocialism is based on a lie, and anyeconomic system based on a lie cannoendure*consumerism – an emphasis on “hav
rather than “being” Obligations – obligated to individual (person) and society*negative rights – entail obligations to
do” something *positive rights – entail obligations to
somethingPope says supply and demand take effinto account, but not justice
