All Principles of Economics Chapter PDF

Preview

Summary

EXCELLENT INFORMATION !...

Description

Principles of Economics Chapter 1 Thinking Like an Economist Introduction Thinking like an economist teaches you to think about problems and solutions to problems in a way that others find challenging. The economist approach is, first, based on confronting a hypothesis with evidence before conditionally accepting it. Economist argues that people tend to behave in a self-interested fashion and will talk about marginal, or incremental costs, and marginal or incremental benefits.

Economics: studying choice in a world of scarcity (Mangel) Scarcity is a fundamental fact of life. There is never enough time, money or energy to do everything we want to do or have everything we would like to have. Economics is the study of how people make choices under conditions of scarcity and of the results of those choices for society. Scarcity Principle (also called the No-Free-Lunch Principle) although we have boundless needs and wants, the resources available to us are limited, so having more of one good thing usually means having less of another; hence the cliché, (‘there are not no such thing as a free lunch’ acronym: TANSTAAFL) Cost-Benefits Principle an individual (or a firm, or a society) should take an action if, and only if, the extra benefits from taking that action at least as great as the extra costs. Economist take costs and benefits into account and psychologist ignores costs and looks only at the optimal possible solution/outcome.

Applying the Cost-Benefit Principle Rational person someone with well-defined goals, who tries to fulfil those goals as best she can. Often the only real difficulty in applying the cost benefit rule is to come up with reasonable measures of the relevant benefits and costs. The benefit of taking any action is the money of everything you gain by taking it. Example 1.1: Should you walk to the center of town to save 10 Euro on a 25 Euro computer game? à If the costs of walking to town is greater than 10 Euro than you should walk.

Economic surplus (Überschuss) Economic surplus the economic surplus form taking any action is the benefit of taking that action minus its cost. As economist you should always choose the action which brings the largest economic surplus.

Opportunity cost Opportunity cost the opportunity cost of an activity is the value of the next best alternative that must be forgone (verzichten/aufgeben) in order to undertake the activity.

The role of economic models

The Cost-Benefits Principle is an abstract model of how an idealized rational individual would choose among competing alternatives. All the Cost-Benefit Principle really says is that a rational decisions is one that is explicitly or implicitly based on a weighting of costs and benefits. ‘Abstract model’ a simplified description that captures the essential elements of a situation and allows us to analyze them in a logical way.

Four important decision pitfalls Pitfall 1: measuring costs and benefits as proportions rather than absolute money amounts. Example 1.2: Should you walk 3 km to save 10 Euro on 1000 Euro laptop? à From an economist point of view, you should walk into town, because the parameters are the same as before in the example with the computer game. The only thing that changes it the proportion of money that you safe on the original price. The absolute money amount you safe stays the same. The pitfall of measuring costs or benefits proportionally. Pitfall 2: Ignoring opportunity costs. Many of us tend to overlook the implicit value of activities that fail to happen. As discussed earlier, however intelligent decisions require taking the value of forgotten opportunities properly into account. The opportunity cost of an activity is the value of the next best alternative that must be forgone in order to engage in that activity. Example 1.3: How should you use your father’s frequent flyer points? à Expected to make 600 € in the US after all costs. Total round trip costs 800 €. Father pays flight back with frequent flyer points. Sister marries in Nairobi. Attendance is non-negotiable. Cost-Benefits Principles tells us that you should go to New York if the benefits of the trip exceed its costs. Without the frequent flyer points, you would not go because the costs exceed the benefits. If you use the frequent flyer program to go to NY, then your opportunity costs using them really are 700 €. If you use the points to go to NY, the trip still ends up being a loser, because the cost, 700€ exceeds the benefit (600) by 100€. The pitfall of ignoring opportunity costs.

Pitfall 3: failure to ignore sunk cost: Sunk cost a cost that is beyond recovery at the moment a decision must be made. Example 1.4: How much should you eat at an all you can eat restaurant? à all-you-can-eat buffet for 15€ at the door. 20 Randomly selected customers are getting told that their lunch is on the house (at paying at the door). Should you now eat more or less? No way to recover it if you have paid at the door. Since their respective costs and benefits of an additional helping are the same, the two groups should eat the same number of helpings, (Portionen) on average. Studies show that people try to get their money worth when they have paid and often regret it that they have gone back for their last helpings. If you are letting sunk costs influence your decisions, you can do better by changing your behavior. The pitfall of not ignoring sunk costs. Pitfall 4: failure to understand the average-marginal distinction Marginal cost the increase in total cost that results from carrying out one additional unit of an activity Marginal benefit the increase in total benefit that results from carrying out one additional unit of an activity

Average cost the total cost of undertaking n units divided by n Average benefits the total benefit of undertaking n units of an activity divided by n Example 1.5 Should the European Space Agency expand the Ariane program from four to five launches a year? à Estimated average gains per launch are 3 billion Euro (12 billion Euro per year). Costs are 2.5 billion per launch (10 billion Euro per year). Should the ESA add another launch if the benefits for an extra launch are 3 billion Euro? Not if the costs of adding another launch would be more than the 3 billion Euro. The real costs of launching 5 times a year is 15 billion Euro. So the average costs are actually increasing from 2.5 billion Euro to 3 billion Euro from 4 to 5 launches. This does not make any economic sense! The pitfall of using average instead of marginal costs and benefits.

The Not-All-Costs-and-Benefits-Matter-Equally Principle is that some costs and benefits (for example, opportunity costs and marginal costs and benefits) matter in making decisions, whereas others (for example, sunk costs and average costs and benefits) do not.

Economics: micro and macro Microeconomics the study of individual choice under scarcity and its implications for the behavior of prices and quantities in individual markets. Macroeconomics the study of the performance of national economies and the policies that governments use to try to improve that performance. Clear thinking about economic problems must therefore always take into account the idea of trade offs- the idea that having more of one good think usually means having less of another.

The approach of this text does not seem to add any new knowledge and only states how the book works.

Economic naturalism 1.1 The benefit of owning and using any given software program increases with the number of other people who use that same product. 1.2 At some point it actually became cheaper to put heaters in all cars, rather than bear the administrative expense of making some cars with heaters and others without. Catering for customers which still wanted a car without heater, was just not longer worth it anymore. 1.3 The cost of producing buttons with Braille dots is no higher than the cost of producing smooth buttons. That is why drive in ATM’s have Braille dots.

A cautionary note: economists and economics We have to distinguish between economics statements and propositions that are ‘value-free’ and those that are based on a value system. The former constitute ‘positive’ economics and can be accepted or rejected wihout reference to the value system of the speaker or the listener. The latter constitute ‘normative’ economics. The tricks is to distinguish between them.

Principles of Economics Chapter 2 Markets, Specialization and Economic Efficiency

Introduction One aspect of the differences in economic life between developed and undeveloped countries is the high degree of specialization by firms and households in developed countries compared with that in undeveloped countries. Organization for Economic Cooperation and Development (OECD) In advanced economies products which are consumed are mainly produced outside of the household. In poorer economies we see more often products consumed which are produced in the same household. Vertical disintegration of production a procedure of which many levels in the production and/or, administering a product or service starting with the raw materials, are controlled by one business, company or institution, so the said entity can gain strength in the marketplace. People in poorer countries do not provide their own services because they are poor; rather, they are poor largely because they provide their own services. Economic system based on specialization and the exchange of goods and services are generally far more productive than those with less specialization. The reason that specialization is so productive is the existence of what economists call comparative advantage. The production possibilities curve (PPC), which is a graphical method of describing the combinations of goods and service that an economy can produce will be introduced.

Exchange and opportunity cost Absolute advantage one person has an absolute advantage over another if an hour spen performing a task earns more than the other person can earn in an hour at the desk. Comparative advantage one person has a comparative advantage over another in a task if his or her opportunity cost of performing a task is lower than the other person’s opportunity cost. Example 2.1 Should a doctor prescribe for himself/herself? à For example, if a family member has a headache and you are a doctor. As a doctor you can treat a family member, then you are loosing this hour payment. This cost is higher than the treatment of a general practitioner, where you could send the family member. The opportunity cost of an hour of you as a doctor’s time exceeds the fee charged by the general practitioner. The point is not that people should never perform their own services. If that were the case most DIY stores have many fewer customers. The point is that where time and resources are scarce it is economically efficient to specialize along lines dictated by comparative advantages.

The principle of Comparative Advantage When two people (or nations) have different opportunity costs of performing various tasks they can always increase the total value of available goods and services by trading with one another. The principle of Comparative Advantage everyone does best when each person (or each country) concentrates on the activities for which his or her opportunity cost is lowest.

Example 2.2 Should Paula update her own web page? à Paula Beth

Time to update a web page (minutes) 20 30

Time to complete a bicycle repair (minutes) 10 30

Since Beth takes 30 minutes to update each a page - the same amount of time she takes to fix a bicycle – her opportunity cost of updating a web page in one bicycle repair. Paula in contrast can complete two bicycle repairs in the time she takes to update a single web page. For her, the opportunity cost of updating a web page is two bicycle repairs. Paula’s opportunity cost of programming, measured in terms of bicycle repairs forgone, is twice as Beth’s. Beth has a comparative advantage at programming. If each of them works half day on web pages and half day on bicycles they accomplish 16 web page updates and 36 bicycle repairs together. When Paula specializes on bike repairs and Beth on web pages they will update 16 web pages and 48 bike repairs.

Sources of comparative advantage At the individual level, comparative advantage often appears to be the result of inborn talent. At the national level, comparative advantage may derive from differences in natural resources or from differences in society or culture. Seemingly non-economic factors can also give rise to comparative advantage. For instance, the emergence of English as the de facto world language gives English speaking countries a comparative advantage over non-English speaking nations in the productions of books, movies and popular music.

Comparative advantage and production possibilities Comparative advantage and specialization allow an economy to produce more than if each person tries to produce a little of everything.

The production possibilities curve Production possibilities curve (PPC) a graph that describes the maximum amount of one good that can be produced for every possible level of production of the other good.

Example 2.3 What is the PPC for and economy in which Susan is the only worker? à Population only Susan. Allocates production time between coffee and nuts. She is short and has nimble fingers à better at picking coffee. She can pick either 2kg nuts or 4kg of coffee an hour.

The absolute value of the slope of Susan’s PPC is the ratio of its vertical intercept to its horizontal intercept: (24kg of coffee/day)/(12kg of nuts/day) = (2kg of coffee)/(1kg of nuts). This ratio means that Susan’s opportunity cost of an additional kilogram of nuts is 2kg of coffee. Opportunity Costs of nuts can also be expressed as:

𝑂𝐶#$%& =

()&&*+#*,)--.. /0+#*+#*#$%&

12

= 31 = 2𝑘𝑔

Loss in coffee = the amount of coffee given up Gain in nuts = the corresponding increase in nuts Opportunity costs of coffee can be expressed as:

𝑂𝐶,)--.. =

()&&*+#*#$%&* /0+#*+#*,)--..

=

31 12

= 0,5𝑘𝑔

Susan’s opportunity cost of a kilogram of coffee is 0.5 kg of nuts.

Attainable point any combination of goods that be produced using currently available resources. Unattainable point any combination of goods that cannot be produced using currently available resources. Inefficient point any combination of goods for which currently available resources enable an increase in the production of one good without a reduction in the production of the other. Efficient point any combination of goods for which currently available resources do not allow an increase in the production of one good without a reduction in the production of other.

How individual productivity affects the slope and position of the PPC

Example 2.4 How do changes in productivity affect the opportunity cost of nuts?

àPopulation Tom and Susan. Tom allocates production time between coffee and nuts as well. He is tall and an agile climber. He can pick 4 kg of nuts or 2 kg of coffee per hour.

How does Tom’s PPC compare with Susan’s?

Note that, because Tom is absolutely less productive than Susan at picking coffee, the vertical intercept of his PPC lies closer to the origin than Susan’s. In this example, Tom has an absolute advantage and a comparative advantage over Susan in picking nuts. Susan for her part has an absolute advantage and a comparative advantage over Tom in picking coffee.

The gains from specialization Example 2.5 How costly is failure to specialize?

à Assume Tom and Susan again. If they both harvest as many nuts and as coffee for themselves. Tom spends 2 hours picking nuts and 4 hours collecting coffee. Susan spends 4 hours picking nuts and 2 hours collecting coffee. In total they will produce 16kg of nuts and coffee.

If they had specialized in their respective activities if comparative advantage, they would have produce in total 24kg of each good. Only trough exchange they both can consume an amount of nuts and coffee that would have not been possible without exchange. When they specialize according to comparative advantage the combination of coffee and nuts they can produce is given by the solid line production ‘frontier’. This lies outside the alternative ‘frontier’, implying that specializing according to comparative advantage makes possible higher level of output of both good and higher incomes for the two producers. The PPC marks the boundary between what an economy can produce from its own resources and levels of production that are beyond its capability, it is frequently to as the production possibility frontier (PPF).

A PPF for a many-person economy The PPF for the multi-person economy is bow shaped. Some resources (workers as Susan or Tom) are relatively well suited to picking nuts while others are relatively well suited to picking coffee. The principle is the same in any large multi-person economy, except that the range of opportunity cost difference across workers is even greater than in Example 2.5.

When resources have different opportunity costs, we should always exploit the resource with the lowest opportunity cost first ß Low-Hanging-Fruit-Principle The Principle of Increasing Opportunity Cost (Low-Hanging-Fruit-Principle): in expanding the production of any goods, first employ those resources with the lowest opportunity cost, and only afterwards turn to resources with higher opportunity costs.

Note one the logic of the fruit picker’s rule A fruit picker should pick the low hanging fruit first because it is easier to pick, even if they plan on picking all fruit, they will enjoy the revenue of the fruit sooner if they start with the low fruits. Take advantage of your most favorable opportunities first.

Factors that shift the economy’s PPF It is often possible to increase production of all goods. This is what people refer to as economic growth. Can happen trough an increase in the amount of productive resources available or from improvements in knowledge or technology that render (ausführen/leisten/machen) existing resources more productive. Investment can grow the quantity of productive resources à new factories and equipment. Differences in investment are often self-reinforcing: not only do higher rates of saving and investment cause incomes to grow, but the resulting higher income levels also make it easier to devote additional resources to savings and investment. Population growth causes an economy’s PPF to shift outwards, but it also generates more mouth to feed, which also can lead to decline in standard of living if existing population has already but pressure on available land, water and other scarce resources. Improvement in know-how and technology is probably the most important source of economic growth. This leads to higher output through increase specialization. Occur spontaneously. Results of direct or indirect increase in education. Breaking a task down into simple steps, each of which can be performed by a different machine, greatly multiplies the productivity of individual workers.

Why have some countries been slow to specialize? Population density is an important precondition for specialization. Extreme isolation (Nepal for example) through natural barriers are blockades as well. Laws and customs (Zölle) that limit people’s freedom to transact freely with one another, can stand in people’s way to improve in certain areas. Division of labor is only worth if a significant quantity of output is to produced.

Can we have to much specialization Specialization entails (schließt ein) costs. Karl Marx’s central themes was that the fragmentation of workplace tasks often exacts a heavy psychological toll (Gebühr/Tribut) on workers: All means for the development of production… mutilate the laborer into a fragment of a man, degra...