1. Basic Principles of Economics
Chapter 1
Basic Principles of Economics

2. What is Economics? Scarcity … our wants exceed our resources Decisions
Consumers
Business
Governments

3. “Micro”
Microeconomics relates to specific individuals, companies, industries and markets
e.g. the price of milk or dvds

4. “Macro” Macroeconomics relates to the whole economy
e.g. Gov’t decides to raise interest rates to lower inflation

5. More Macro…

6. Terms Ceteris Peribus Opportunity Cost Production Possibilities
Supply and Demand
Price
Elasticity
Economic Profit
Profit Maximum Rule
Costs (marginal, average, minimum, etc.)
Monopoly, Oligopoly, Perfect Competition, etc.
Labour
Globalization

7. Economists David Ricardo Adam Smith Karl Marx John Maynard Keynes
Frederick Von Hayek
John Kenneth Galbraith

8. Theories Law of Diminishing Returns
Law of Increasing Opportunity Costs
Profit Maximization Rule
Quantity Theory of Money
Labour Theory of Value
Okun’s Law

9. Formulas Total Revenue = Price x Quantity
Total Costs = Fixed Costs + Variable Costs
Average Cost = Total Cost / Quantity
Average Variable Cost = Variable Cost / Quantity
Marginal Revenue = rTotal Revenue / rTotal Quantity
Marginal Cost = rTotal Cost / rTotal Quantity
Profit Max. Point where Marginal Revenue = Marginal Cost
Profit in $ = Total Revenue – Total Costs

10. Graphs

11. And more graphs Quantity Revenue MC AC D=AR=MR P Profit AVC Cost
Revenue Rectangle

12. People

13. Expectations of Teacher
Excellent knowledge and delivery of content
Provide multiple opportunities to earn marks in each category
Create inviting atmosphere of shared experience

14. Expectations of Student
Come to class
Come to class on time (1:30pm)
Leave class when it ends (2:45pm)
Do your homework
Participate
Listen
Allow others to learn
Actively review
Come for extra help

15. Things NOT to do: Part time student status Hand in assignments late
Miss tests
Say “I wasn’t here”
Say “My partner isn’t here”
Waste work periods
Plagiarize or copy
Wine about marks

16. What is Economics?
the study of how we make decisions about the use of scarce resources
a social science because it’s a study of people making decisions
a self-sustaining system in which independent transactions create distinct flows of money

17. About Economics
difficult to predict individual human behaviour it is often possible to predict group behaviour
Economic decisions should be effective (achieve goal) and efficient (use least amount of resources)

18. Opportunity Cost
the sum of all that is lost from taking one course of action over another
eg. Study or work the night before a big test … opportunity cost is what you give up by taking one course of action

19. Production Possibilities Model
a visual model showing the choices faced by people in a simple economy
Assumptions:
- only two products can be produced … leading to a trade-off
- fixed resources and technology
- full-employment

20. Production Possibilities Model
The economy can produce good A or good B (in this case food or clothing)

21. Production Possibilities Model
If the economy chooses to produce more of one good over another it can but must shift resources
resources do not shift easily and it costs progressively more of one good to produce more of the other … this is called the law of increasing relative cost

22. More “Laws”
The Law of Diminishing Returns states outputs increase with a particular input but only to a point
The Law of Increasing Returns to Scale states output can increase if all productive resources are increased at the same time and in the same quantity

23. Productive Resources Tangible: Land (raw materials) Labour
Capital – real: goods used to produce other goods
Capital – money: funds used
Intangible:
Knowledge
Entrepreneurship
Environment for enterprise

24. Three Fundamental Questions
What to Produce
For Whom to Produce
How to Produce

25. Types of Economy Traditional: Focus on family needs
Methods handed down
Use most, trade surplus

26. Types of Economy Command:
Central authority decides what, for whom and how to produce

27. Types of Economy Market: sell popular goods at best price
keep costs low and be efficient
consumers are those that can afford the product

28. Types of Economy Mixed:
markets and governments interact as producers and consumers
taxes create the desire to cheat, e.g. Hidden Economy

29. Political Economies
Democracy means political system involves freely elected government and allows differing political views
Dictatorship involves a single person or party having authority over a nation

30. Political Economies Communism: the “left”
government owns control of all means of productions
no private property rights
can use violence to retain power
Marx and Engells

31. Political Economies Socialism: left centre
government control of means of production
democracy favoured
free enterprise is inefficient and wasteful

32. Political Economies Capitalism: moving to the right
freely elected gov’t
private property encouraged
free market for consumers and producers
Adam Smith stressed the “invisible hand”

33. Political Economies Facism: extreme right free market economy
non-democratic/authoritarian gov’t
private property ownership encouraged if gov’t dictates followed

34. Adam Smith (1723 –1790 The Wealth of Nations)
laissez-faire term meaning leaves things alone
individual self-interest and wealth creation good for all individuals
“invisible hand” is the market competition and will serve the common good
division of labour

35. Adam Smith
division of labour (specialization of workers) led to increased production, increased profits for investors, more consumer goods for workers and greater economic efficiency for society
law of accumulation meant profits would be reinvested and create more prosperity for investors and workers

36. Adam Smith
law of population implies increased capital requires more workers, leading to higher wages, improved living conditions, reduced mortality, increase in population and labour force … keeping wages low

37. Thomas Robert Malthus (1766-1834 Population)
predicted inevitable poverty and famine for the masses
Industrial Revolution meant farm to urban change
Population doubles every 25 years if unchecked, geometric progression
but food can only grow in an arithmetic progression, Positive checks include war, famine, disease, epidemics and reduce pop. Growth rate
preventative checks include late marriage, sexual abstinence (and now birth control)
tech. breakthroughs in food production were not imagined

38. Thomas Robert Malthus
Positive checks include war, famine, disease, epidemics and reduce pop. Growth rate
preventative checks include late marriage, sexual abstinence (and now birth control)
tech. breakthroughs in food production were not imagined

39. David Ricardo ( Rent)
three groups: working class, industrialist class, landlords
one group could only prosper at the expense of others
Iron Law of Wages implied higher reproduction kept wages low
Trade – absolute advantage meant a nation could produce a product more efficiently than another nation
but Trade could still exist if each nation produced the product it had a comparative advantage in and traded the surplus

40. David Ricardo
Trade – absolute advantage meant a nation could produce a product more efficiently than another nation
but Trade could still exist if each nation produced the product it had a comparative advantage in and traded the surplus

41. Karl Marx (1818-1883 Communist Manifesto)
believed workers – the proletariat – would always be exploited by the ruling class
workers in urban areas endured no labour laws and children were abused
believed all workers would eventually unite to overthrow the ruling class
Labour Theory of Value – means labour receives only a portion of its worth; the rest being surplus value
e.g. cost of sweater is $10 in materials, $40 in labour and sold for $80 … surplus value is $30

42. Karl Marx
Labour Theory of Value – means labour receives only a portion of its worth; the rest being surplus value
e.g. cost of sweater is $10 in materials, $40 in labour and sold for $80 … surplus value is $30

43. John Maynard Keynes (1883-1946 Gov’t intervention)
gov’t could and should intervene in economy to smooth the effects of business cycles methods
include control of interest rates and gov’t spending
critics suggest his policies lead to high inflation rates and massive public debts

44. John Kenneth Galbraith
(1908 Social Balance)
in good times consumer goods such as tv’s and cars produced in abundance but public goods such as hospitals and parks not a priority
believed corporate managers held real decision-making power (not shareholders or consumers)
argued for more gov’t involvement and regulation

45. Milton Friedman (1912 Monetarism)
argued gov’t involvement worsened economy
also it put individuals more dependent on gov’t
pro-laissez-faire, self-sufficiency and work ethic
replace gov’t welfare programs with a guaranteed income (negative income tax)
advocated voucher system for schools
Monetarist School of Thought – gov’t should only manage the economy by guaranteeing a constant money supply and yearly increase (3-5%)

46. The Market
can be a location, network of buyers and sellers for a product, demand for a product or a price-determination process
the interaction of buyers and sellers determines what the price will be for a good or service

47. Demand
the quantity of a good or service buyers will purchase at various prices during a given period of time
the law of demand states the quantity demanded varies inversely with price (Ceteris Paribus – all other things remain the same)

48. Demand Reasons supporting the law of demand:
Substitution Effect – we buy different goods when prices rise or fall
Income Effect – we can more if price falls or less if it rises

49. Demand
the demand schedule is the entire relationship between each price and quantity demanded
the demand is downward-sloping

50. Demand
the sum of all individual consumer demand curves for a good is the market demand curve
“demand” is the entire set of price and quantity relationships while “quantity demanded” is the amount demanded at one price

51. Supply
the quantities sellers will offer for sale at various prices during a given period of time
law of supply states the quantity supplied will increase if price increases and fall if price falls
“supply” is the entire set of price and quantity relationships while “quantity supplied” is the amount offered at one price

52. Supply
Supply curve is upward sloping to the right

53. Market Equilibrium
the interaction of buyers and sellers, of demand and supply
equilibrium price is the result of supply and demand forces
a price above the equilibrium leads to a surplus which can only be cleared by a drop in price
a price below equilibrium leads to a shortage and can only be cleared with a price increase

54. Market Equilibrium
The intersection of demand and supply

55. Demand Determinants (changes in Demand)
Non-price factors shifting the entire curve (at every price)
Income – more leads to increased demand
Population – more leads to increased demand
Tastes/Preferences – various reasons, reports, advertising
Expectations – of a future event may lead to more or less demand now
Price of Substitute Goods – if a compliment, demand shifts in the same direction; if substitute the opposite direction; eg. bread price increase, demand for butter decreases (compliment); e.g. steak price increases, hamburger demand increases

56. Supply Determinants (changes in Supply)
Costs – increase/decrease in production costs decrease or increase supply
Number of Sellers – new producers increase market supply
Technology – usually decreases costs and increases supply
Nature – weather or disaster can affect supply
Prices of related outputs – if another good has higher price, producers may shift production

57. Movement along Demand curve
Can only be caused by change in price

58. Movement along Supply Curve
Can only be caused by price change

59. Shortage decrease in price, away from equilibrium
Excess will be cleared with an increase in price and shrinking quantity demanded

60. Surplus Increase in price, causing excess quantity supplied
Cleared by lowering prices and reducing quantity demanded

61. Change in Demand
Can only be caused by a demand determinant (no price change)
The whole demand curve shifts

62. Change in Supply
Caused by change in supply determinant (no price change)

63. Profit & the Firm The “Bottom Line” Incentive and reward for risks
Leads to better decision making and greater productivity
Accounting profit = revenue – costs
Revenue = price x quantity
Costs = Fixed Costs + Variable Costs
Short Run – at least one resource can’t be changed
Long Run – all costs , including buildings, can be variable

64. Production
Marginal Revenue is the additional revenue earned producing one more unit of output
Marginal Cost is the additional cost of that unit
Profit maximized where MR = MC
Productivity – maximize output from resources used
Efficiency – producing at lowest cost

65. Productivity factors Skills, education, experience of workforce
Quantity and quality of resources
State-of-the-art machinery
Aim to lower cost per unit
Capital-intensive (using machines) vs. Labour-intensive
Economies of scale relates to the efficient use of machinery
Producing more output lowers the cost per unit

66. Useful Formulas Total Revenue = Price x Quantity
Total Costs = Fixed Costs + Variable Costs
Average Cost = Total Cost / Quantity
Average Variable Cost = Variable Cost / Quantity
Marginal Revenue = rTotal Revenue / rTotal Quantity
Marginal Cost = rTotal Cost / rTotal Quantity
Profit Max. Point where Marginal Revenue = Marginal Cost
Profit in $ = Total Revenue – Total Costs

67. Perfect Competition Many buyers and sellers identical product
price taker … no control over price
no barriers to entry
little non-price competition
may not actually exist

68. Perfect Competition Profit Maximization
Quantity
Revenue MC
Profit Max AC
D=AR=MR P
Profit
AVC
Cost
Revenue Rectangle
Profit Max Quantity

69. Monopolistic Competition
Many firms
Similar product
Some influence over supply and price
Easy entry
Non-price competition high

70. Monopolistic Competition Profit Maximization
Quantity
Revenue
D=AR MC MR P AC
Profit
Cost Q

71. Oligopoly Few firms dominate Products may be similar or different
Influence over price varies
Barriers to entry high
Non-price competition high

72. Oligopoly Profit Maximization
Quantity
Revenue
“Kink”
D=AR MR MC P
Profit AC
Cost Q

73. Monopoly One firm dominates Unique product
Price maker and control over supply
Barriers to entry very high
No need for non-price competition

74. Monopoly Profit Maximization
Quantity
Revenue
D=AR MR MC P AC
Profit
Profit max
Cost Q
Note: Similar to Mono. Comp. but more inelastic demand curve

75. Issues
Natural Monopoly – where high fixed costs make one firm the choice (e.g. utilities, public transit)
Deregulation – allow competition
Privatization – sell public assets to private interests
Fewer bigger firms may mean collusion
Third-party costs – social costs such as pollution are borne by others
Public-Private Balance – gov’t as a provider of goods and services (health, education, etc.) increased in last 40 years as deficits soared
Regulation – firms may prefer less but gov’t must balance with needs of individuals