ECN104 Chapter notes
Chapter 1 – Ten Principles of Economics
Scarcity - The limited nature of society’s resources.
Economics - The study of how society manages its scarce resources, e.g.
- how people decide what to buy,
- how much to work, save, and spend
- how firms decide how much to produce,
- how many workers to hire
- how society decides how to divide its resources between national
defence, consumer goods, protecting the environment, and other
Principle #1: People Face Trade-offs.
- All decisions involve giving up one thing for another.
- Society faces an important trade-off: Efficiency vs. Equality. To achieve greater equality, redistribution
of income from wealthy to poor is required through the progressive tax system, food stamps and
unemployment insurance. However this reduces incentive to work and produce, and as a result shrinks
the economic “pie”.
Efficiency - When society gets the most from its scarce resources.
Equality - When prosperity is distributed uniformly among citizens.
Principle #2: The Cost of Something Is What You Give Up to Get It.
- Making decisions requires comparing the costs and benefits of
Opportunity Cost - What is given up to obtain something else. (Time, Money, Items, Etc..)
- The relevant cost for decision making.
Principle #3: Rational People “Think at the Margin.”
- Rational people systematically and purposefully do the best they can to
achieve their objectives by evaluating cost and benefits of marginal changes.
Marginal Changes - Incremental adjustments to an existing plan.
Principle #4: People Respond to Incentives.
Incentive - Something that induces a person to act. (Prospect of reward or punishment)
Principle #5: Trade Can Make Everyone Better Off
- Rather than being self-sufficient, people can specialize in producing one good
or service and exchange it for other goods. - Countries also benefit from Trade & Specialization because they can get better
prices abroad for their good produced, and purchase goods cheaper abroad
than it would cost to produce them at home.
Principle #6: Markets are Usually a Good Way to Organize an Economic Activity
- “Organize economic activity” means determining…
- what goods to produce
- how to produce them
- how much of each to produce
- who gets them
Market - A group of buyers and sellers (not necessarily in a single location.)
Market Economy - Allocation of resources through the decentralized decisions of many
households and firms as they interact in markets.
- A market economy is “decentralized,” meaning that there is no government
committee that makes the decisions about what goods to produce and so forth.
Instead, many households and firms make their own decisions.
“Invisible Hand” - A general motion of households and firms acting to promote general economic
- Works through the price system as the buyers and sellers determine prices of
goods and services. Each price reflects the good’s value to the buyer and the
cost of producing/providing the good/service.
- Price guide self-interested households and firms to make decisions that in
many cases maximize society’s economic well-being.
Principle #7: Governments Can Sometimes Improve Market Outcomes.
- Government enforces property rights for example, and as a result people are
more inclined to work/produce/invest without the risk of property being stolen.
Market Failure - When the market fails to allocate society’s resources efficiently, caused by
externalities and market power.
Externalities - When the production or consumption of a good affect bystanders
Market Power - When a single buy or seller has substantial influence on price (monopoly).
Principle #8: A country’s standard of living depends on its ability to produce goods &
- Huge variation in living standards exist across countries and over time.
Productivity - The amount of goods and services produced in each hour of a worker’s time.
- Depends on the equipment, skills, and technology available to workers.
- Other factors (e.g., labour unions, competition from abroad) have far less
impact on living standards. Principle #9: Prices rise when the government prints too much money.
Inflation - Increases in the general level of prices.
- almost always caused by excessive growth in the quantity of money, which
causes the value of money to fall.
Principle #10: Society faces a short-run tradeoff between inflation and unemployment.
- In the short-run (1 – 2 years), many economic policies push inflation and
unemployment in opposite directions.
- An increase in the quantity of money causes spending to rise, which causes
prices to rise, which induces firms to produce more goods and services, which
requires that they hire more workers.
Chapter 2 – Thinking Like an Economist
- Economists play two roles: 1. Scientists: Try to explain the world.
2. Policy advisors: Try to improve it.
- Economists use Assumptions and Models to make complex ideas easier to understand and predict.
Circular-Flow Diagram - A visual model of the economy showing how money flows through the
markets of households and firms.
Factors of Production - Resources the economy uses to produce goods and services.
• Land •Labour •Capital
Red Arrows = Flow of Goods & Services
Green Arrows = Flow of Money Production Possibilities- A graph that shows the combinations of two goods the economy can produce
Frontier (PPF) given the available resources and technology.
Points on the PPF
efficient: all resources are fully utilized
Points under the PPF
not efficient: some resources underutilized
(e.g., workers unemployed, factories idle)
Points above the PPF
- To calculate the opportunity cost of an item, you can use the slope of the PPF.
Rise/Run = Y axis/X axis = Cost of X is Change in Y
- Economic Growth and the PPF: With additional resources or an improvement in technology,
the economy can produce more computers, more wheat, or any combination in between. PPF could be
a straight line, or bow-shaped…
Depends on what happens to opportunity cost as economy shifts resources from one
industry to the other.
If opp. cost remains constant, PPF is a straight line.
If opp. cost of a good rises as the economy produces more of the good, PPF is bow-
PPF is bow-shaped when different workers have different skills, different opportunity
costs of producing one good in terms of the other, shows increasing opportunity cost.
The PPF would also be bow-shaped when there is some other resource, or mix of
resources with varying opportunity cost. (E.g., different types of land suited for
Positive Statements - Attempt to describe the world as it is.
- Can be confirmed or refuted.
Normative Statements - Attempt to prescribe how the world should be.
- Cannot be confirmed or refuted.
Chapter 3 – Interdependence and the Gains from Trade
Interdependence - Reliance on each other for the good and services you enjoy.
Exports - Good produced domestically and sold abroad.
Imports - Good produced abroad and sold domestically.
Absolute Advantage - The ability to produce a good using fewer inputs than another producer. Comparative - The ability to produce a good at a lower opportunity cost than another
- Two countries can gain from trade when each specializes in the good it produces at lowest opportunity
Chapter 4 – The Market Forces of Supply and Demand
Competitive market - A market with many buyers and sellers, each has a negligible effect on price.
Perfectly Competitive - All goods exactly the same, Buyers & sellers so numerous that no one can
Market affect market price – each is a “price taker”.
Law of Demand - The claim that the quantity demanded of a good falls when the price of the
good rises, other things equal.
Quantity Demanded - The amount of the good that buyers are willing and able to purchase.
Demand Schedule - A table that shows the relationship between the price of a good and the
Market Demand - The quantity demanded in the market is the sum of the quantities demanded
by all buyers at each price. Demand Curve Shifters - Increase in number of buyers
- Increases quantity demanded at each price,
shifts demand curve to the right.
- Normal goods: Increase in income causes increase in quantity
demanded at each price, shifts demand curve to the right.
- Inferior goods: Increase in income causes increase in quantity
demanded at each price, shifts demand curve to the left.
- Prices of Related Goods
- Two goods are substitutes if an increase in the price of one causes an
increase in demand for the other.
- Two goods are complements if an increase in the price of one causes a
fall in demand for the other.
- Anything that causes a shift in tastes toward a good will increase
demand for that good and shift its demand curve to the right.
- If people expect their incomes to rise, their demand for meals at
expensive restaurants may increase now.
Quantity Supplied - The amount that sellers are willing and able to sell.
Supply Schedule - A table that shows the relationship between the price of a good and the
Market Supply - The quantity supplied in the market is the sum of the quantities supplied
by all sellers at each price. Supply Curve Shifters - Input Prices
- A fall in input prices makes production more profitable at each output
price, so firms supply a larger quantity at each price, and the supply
curve shifts to the right.
- A cost-saving technological improvement has the same effect as a fall
in input prices, shifts supply curve to the right.
- Number of Sellers
- An increase in the number of sellers increases the quantity supplied at
each price, shifts supply curve to the right.
- In general, sellers may adjust supply when their expectations of future
Equilibrium Price - The price that equates quantity supplied with quant