The Basic Principals of Economics


Everything is scarce. Everything has an opportunity cost.
Capital is anything used in the production of goods.
CPI (consumer price index) is used to measure inflation, based on price of about 200
commonly sold goods.
Unemployment is all people age 16+ looking for work. 3 kinds are frictional (people
willingly changing jobs), structural (people are not trained in the jobs that need to be
filled, seasonal labor) and cyclical (economy is in a down cycle, layoffs are caused)
people not looking for work are not unemployed
Nominal is in that years dollars (actual #), real is in a constant dollar (for comparison) .
Three economic capacities: consumer (seeks personal satisfaction)
producer (uses capital to produce goods)
citizens (social goods and services)
There is an inferred direct relationship between supply and demand, assuming you have
perfect information. Some goods like gas and medicine are not in this relationship.
People will pay any price for them, and will not buy more than they need.
Taxes: proportional (same rate for everyone), progressive (rich pay higher percentage of
total income), regressive (poor pay higher percentage of total income)
production possibility curve: compares the ability of a group to produce amounts of
various goods.
Adam Smith- The Wealth of Nations-Laisez Fairez- the invisible hand of self interest will
drive the market, no need for government or mercantilist intervention. Everything works
out because people are greedy. Capitalism. Traditional economy
planned economy- Marxism- communism- government owns the capital- no entrepreneur
government should spend money only in bad times-opposite of lassez fairez- John
Maynerd Keynes- General theories about employment interest and money - believes
economy is an escalator, needs to be jump started.
Basis of trade is that one person is better off and no one is any worst off. This is called
allocative efficiency- parcto efficiency
two types of goods, public and private. Used for society or for yourself.
Opportunity cost if the value of the next best alternative
4 factors in production: land, labor, capital, and entrepreneurship. Marxism believes
human resources are the productive physical and mental resources of the people
entrepreneur does not need to be present for production.
The margin is the amount of material that you put into each possibility. Finite amount
inferior goods are goods of lower quality and price.
5 goals of a market economy: economic freedom, private property, economic incentive,
competitive market, government that is not enveloped
fiscal policy is the government contribution to the gross national product.
Employment is subject to reasonable measurement
real capital is aids to production
to improve future production possibilities, capital goods must be improved
a mixed economy combined traditional and planned economies
freedom of enterprise is the right to decide what to produce and sell
a curve shift to the right is an increase in demand or supply, left is a decrease
equilibrium is were supply and demand meet
third party factors are externalizes
interest is a payment to the capital as a factor of production
inflation is a sustained increase in the level of prices.
Monetary policy is under the control of the federal reserve banking system
the stock market is ownership, not investment.
A decline in government spending not offset by a tax break will reduce employment but
not affect the price level
currency is pegged, bought or sold by a nation to maintain its value
a floating rate is not pegged, it is determined by the supply and demand for that nations
The foreign exchange rate compares one currency to another
less developed countries try to acquire technology advances
absolute advantage is when one nation produces goods at a lower cost. Comparative
advantage is when the cost of production is similar in two nations
a change only happens in a PP curve if there is an improvement in capital of technology
to maintain high profit, a company must erect barriers to prevent new companies from
entering the market.
if economic growth occurs, capital must increase faster than consumer goods
a circular flow model is used to show the organization of the production and consumption
of goods and services in an economic system.
Complementary goods are goods that require each other to be fully used.
70% of national income is spent on wages
collusion, trust, cartels, and monopolies fix prices
the misery index is total unemployment and total consumer debt.
Stagflation is neither inflation nor deflation
the equation of exchange is MV=PQ
a newly industrialized country is a developing country that has advanced technology
hyper inflation is to much money chasing to few goods
Since wages tend to not be flexible downwards, unemployment is the general case

robots can build a machine, but they will never buy one

government controls the economy by influencing the overall level of consumer
expeditures, investment expenditures, and government expenditures.

Investment behavior depends on interest rates. In fact, almost everything depends on
interest rates. High interest rates disscourage investment, low rates encourage

The federal reserve bank can influence investment spending by changing the interest rates.

To increase the level of economic activity, the goverments can increase government
expenditures or lower taxes. To lower the level of activity, it can lower government
expenditures or raise taxes.

Once the economy is at full employment, we must keep savings and taxes equal to
government expenditures and investment. Any variation will cause inflation or

The economy is controled by the federal governments fiscal policy (expendityures and
taxes) and the feds monetary poilicy (interest and money supply). These are the keynsian
tools that are used to adjust economic activity. The use of these tools depends on the
goals of the administration in power.

Macroeconomics explains the trade off between inflation and unemployment.

Profit is total revenues minus total cost.

If cost don’t cange as output changes, to maximize profit maximize revenues.

Price elastic demand: % change in demand is greater than % change in price. If it is a
large part of the budget or has lots of substitutes it is price elastic. Lower price to
maximize profit.

Price inelastic demand: % change in demand is less than % change in price. If it dosen’t
cost much or has few substitutes, it is probly price inelastic. Raise price to maximize

When cost vary with output, maximizing profit means finding the level at wich the
difference between total cost and total revenue is greatest.

Variable cost are the cost to consider in making a decision about at what level to produce.

Average cost is total cost divided by total output.

Marginal cost is the change in total cost due to a change in output.

To maximize profits, produce at the level where maginal revenues equal marginal costs.

It makes economic sense to persue any activity up to the point where marginal cost equals
marginal benifit.

Implicit or opportunity cost are the cost of the next best foregone alternative.

In a perfectly competative market: large number of independent buyers and sellers,
products are identical and there are no barrieres to entry.

In a monopolistic market: a single seller selling a single product with no close substitutes
and entry into the bussiness is barred.

In a monopolistic competition: large number of firms selling partially differentiated
products with no barrier to entry. Two unique features are advertising and other forms of
non price competition, and excess capacity (producing at less than optimal capacity).

In an oligopoly: a small number of large firms producing partially differentialed products
with barriers to entry. They are inter dependent, attempt to avoid price warfare, and
have price leadership pricing.

The theory of comparative advantage states that everyone gains when coutries produce
what they can most efficiently and trade these products for products they cannot trade

The bretton woods agreement made the us dollar the international currency. Almost all
international transactions were and still are denominated in us dollars.

The ottowa agreement was an economic union between grat britan and her dominions
creating lower taxes and tarrifs between these members of the british commonwealth.

In august 1971 the US removed itself from the gold standard, demotetizing gold. Gold
became a commodity traded according to supply and demand. The money became fiat
money, without the backing of gold.

High interest rates discourage domestic investment and cause the value of the dollar to
rise. This increases imports and decreases exports, costing us jobs. All of this allows us
to run a balance of payments deficts, wich are financed by investments from abroad.