Basic Economics Notes PDF

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This is the chapter outline for this secondary textbook required for macroeconomics with professor Santamaria. Read this and there is no need to purchase the textbook. ...

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Chapter 1: What is Economics? Economics: The study of the use of scarce resources which have alternative uses Scarcity means that what everybody wants add up to more than there is – There has never been enough to satisfy everyone completely. Productivity: producing output from scarce resources – turning inputs into output -Economics studies the consequences of decisions that are made about the use of land, labor, capital, and other resources that go into producing the volume of output which determines a country’s standard of living. Each material has more than 1 use  How much of each resource should be allocated to each of its many use efficiently The Role of Economics: Economics is a systematic study of cause and effect, showing what happens when you do specific things in specific ways. Understanding the consequences of economic decisions is to look at the goals they pursue. This means that consequences matter more than intentions.

Part 1: Prices and Markets

I) Chapter 2: The Role of Prices A) How does an economy allocate scarce resources which have alternative uses? 1. Feudal: The lord of the manor told the people under him what to do and where he wanted resources put 2. Communist: Government issues orders 3. Market Economy: coordinated by prices, there is no one at the top to issue orders to control or coordinate activities throughout the economy B) Economic Decision-Making 1. Each consumer, producer, retailer, landlord, or worker makes individual transactions with other individuals on whatever terms (conveyed by prices) they can mutually agree a. If someone else somewhere else has a better product or a lower price for the same product or service, that fact gets conveyed and acted upon through prices, without any elected official or planning commission having to issue orders to consumers or producers- indeed faster than any planners could assemble the information on which to base their orders 2. Where prices coordinate economic activities automatically, that lack of knowledge of economics does not matter nearly as much as in countries where political leaders try to

direct and coordinate economic activities 3. Free market (aka Profit and Loss system): a. Losses force producers to stop producing what consumers don’t want b. Produce what consumers want and stop production of what they don’t want 4. Price-coordinated markets enable people to signal to other people how much they want and how much they are willing to offer for it, while other people signal what they are willing to supply in exchange for what compensation a. Results in natural resources to move from places where they are abundant to places where they are almost nonexistent 4. When more of some item is supplied than demanded, competition among sellers trying to get rid of the excess will force the price down, discouraging future production, with the resources used for that item being set free for use in producing something else that is in greater demand. C) Prices and Costs 1. While sellers can put whatever price they wish on the goods or services they provide, those prices will become economic realities only if others are willing to pay them – how much the consumers want what the seller offers and what prices are other producers charging for the same good/ service. 2. Price change indicates change in circumstances that changes the seller’s ability to charge the same price as before D) Resource Allocation by Prices 1. Since each item has more than 1 use, the use of the ingredient will be allocated to making the item with higher demand a. Resources tend to flow to their most valued uses 2. The price which one producer is willing to pay for any given ingredient becomes the price that other producers are forced to pay for that same ingredient 3. Domino Effect: Demand for cheese increase  Suppliers demand more milk Milk price increases less cows slaughtered  etc …. E) Incremental Substitution 1. After consuming a certain amount, people will no longer want to consume more of it 2. Price coordinate the use of resources, so that only that amount is used for one thing which is equal in value to what it is worth to others in other uses a. From the standpoint of society as a whole, the cost of anything is the value that it has

in alternative uses Ex: The real cost of building a bridge is whatever else could have been built with that same labor and material F) Economic Systems 1. With someone at the top controlling prices etc people try to ask for as much they can get (more than they need) Ex: workers saying they need more time they actually do 2. Incentive to correct mistake: Ex: If a producer uses ingredients which are more valuable elsewhere in the economy is likely to discover that the cost of those ingredients cannot be repaid from what consumers are willing to pay for the product a. For those producers who are too blind or too stubborn to change, continuing losses will force their business into bankruptcy b. In feudal or socialist economy, leaders can continue to make the same mistake indefinitely and the consequences are paid by others in form of a lower standard of living 3. Engels: price fluctuations have forcibly brought home to the individual commodity producers what things and what quantity of them society requires or does not require. II) Chapter 2: Supply and Demand A) Demand versus “Need” (for items and labor) 1. There is no fixed quantity of “need” or demand and likewise, there is no fixed supply 2. The quantity supplied varies directly with the price, just as the quantity demanded varies inversely with the price 3. Although there is a finite amount of each resource but, even when the amount may be enough to last for centuries or millennia, at any given time the amount that is economically feasible to extract and process varies directly with the price for which it can be sold. a. False predictions that we were “running out” of natural resources means it is not economically available at current supply at current prices. B) Real Value 1. The fact that prices fluctuate over time, and occasionally have a sharp rise or a steep drop, misleads some people into concluding that prices are deviating from their real value. 2. The most fundamental reason why there is no such thing as an objective or real value is that there would be no rational basis for economic transactions if there were

a. Ex: The only reason why people are willing to pay a dollar for the newspaper is that the newspaper is more valuable to them than the dollar is. At the same time, the only reason people are willing to sell the newspaper is that the dollar is more valuable to them than the newspaper is. b. If there were anything such as a real value then neither the buyer nor the seller would benefit from making a transaction at the price equal to the value of the object, since what would be acquired would be of no greater value that what is given up C) Competition 1. Competition is the key to the operation of a price-coordinated economy. It forces prices to equality + causes capital, labor, and other resources to flow toward where their rate of return is highest 2. The fact that prices and rates of return on investments tend to equalize means only that their fluctuations, relative to one another, are what move resources from one place where their earnings are lower to where their earnings are higher- that is from where the quantity supplied is greatest, relative to the quantity demanded, to where there is the most unsatisfied demand a. It does not mean that the prices remain the same over time or that some ideal pattern of allocation of resources remains the same indefinitely D) Prices and Supplies 1. Prices not only ration existing supplies, they also act as powerful incentives to cause supplies to rise or fall in response to changing demand Ex: Crop failure in one area causes increase in demand for imports of food, food suppliers elsewhere rush to be the first to get there in order to capitalize on the high prices that will prevail until more supplies arrive and drive food prices back down through competition 2. People tend to do more for their own benefit than for the benefit of others. Freely fluctuating prices can make that turn out to be beneficial to others. 3. The gains and losses are not isolated or independent events. The crucial role of prices is in tying together a vast network of economic activities among people too widely scattered to all know each other E) Unmet Needs 1. Economics being the studying of the use of scarce resources which have alternative uses, then there will always be unmet needs

a. Something will always be given up to meet the need of another thing therefore there will always be unmet needs 2. There are no solutions, there are only trade-offs 3. As long as we respond gullibly to political rhetoric about unmet needs, we will arbitrarily choose to shift resources to whatever the featured unmet need of the day happens to be and away from other things Ex: When the politician discovers that robbing Peter to pay Paul has left Peter worse off, and now wants to help Peter meet his unmet needs, we will start shifting resources in another direction 4. No matter how important the supply is, beyond a certain point, more of that supply is counterproductive or even dangerous Ex: Food is important but too much food= obesity in America III) Chapter 3: Price Controls: Price Ceilings A) Introduction 1. Prices rise because the amount demanded exceed the amount supplied at existing prices (shortage) 2. Prices fall because the amount supplied exceeds the amount demanded at existing prices (surplus) B) Price “Ceilings” and Shortages 1. Price ceilings causes shortages: Ex: As rent controls were passed during WW2, there were a shortage of houses even though the ratio of the population and housing remained the same a. At these artificially low prices, more people had a demand for more housing space than before rent control laws were enacted. b. People use the price controlled goods or services more generously than usual because of the artificially lower price resulting in less than usual remaining available for others C) Demand under Rent Control 1. These artificially low prices created by rent control causes people to seek larger apartments than they ordinarily would have or to live alone when they would otherwise have to share an apartment with a roommate in order to be able to afford rent 2. More tenants seeking both more apartments and larger apartments create a shortage, even when there is not any greater physical scarcity of housing relative to the total

population 3. Just as price fluctuations allocate scare resources which have alternative uses, price controls which limit those fluctuations reduce the incentives for individuals to limit their own use of scare resources desired by others. D) Supply under Rent Control 1. Under rent controls for apartment buildings, developers are less likely to build new buildings because the rent controls make the business unprofitable. 2. Not only is the supply of new apartment construction less, even the supply of existing houses tend to decline. Landlord provides less maintenance and repair since the housing shortage makes it unnecessary for them to maintain the appearance of their premise in order to attract tenants 3. Housing shortage is first only a short term issue because more people want more housing at the artificially low price. Later there may be a real increase in scarcity as well as rental units deteriorate more rapidly with reduced maintenance, while not enough new units are being built to replace them as they wear out. E) The Politics of Rent Control 1. Rent controls seem politically appealing because there are more people who do not understand economics than those that do. 2. The kind of housing likely to be rented by the poor often has owners who are by no means rich 3. Department of Homeless Services was spending over $3,000 a month for each threadbare room without a bathroom or kitchen in a single room occupancy hotel with half the money going to the landlord for rent and the other half for security and social services for homeless tenants 4. The people who actually benefit from rent control can be any income level and so can those who lose out. It depends on who happens to be on the inside looking out, and who happens to be on the outside looking in, when such laws are passed F) Scarcity versus Shortage 1. Scarcity: fewer goods available relative to the population Shortage: price phenomenon a. There can be a growing shortage without an increased scarcity, so there can be a growing scarcity without a shortage: Ex: Earthquake 2. Rising prices not only allocate existing housing, they provide incentives for rebuilding

and for renters to use less space, as well as incentives for people with space in their homes to take in roomers G) Hoarding 1. In addition to shortages and quality deterioration under price controls, there is often hoarding: individuals keeping a larger inventory of price-controlled goods than they would ordinarily under free market conditions because of the uncertainty of being able to find it in the future  less for others that actually need it now 2. Some things even if under price control cannot be hoarded such as strawberries because they are too perishable and services like haircuts H) Black Markets 1. Price control almost invariably produce black markets where prices are not only higher than the legally permitted prices, but also higher than they would be in a free market since legal risk must also be compensated. 2. While small scale black markets may function in secrecy, large scale black markets require bribes to officials to look the other way. 3. Statistics on black market activity are by nature elusive since no one wants to let the whole world know that they are violating the law. a. However there are indirect indications because as price control vanishes, supplies on market increases since less are being allocated to black markets I) Quality Deterioration 1. Medical Example: At artificially low prices, more people go to the doctor for minor issues which increases the number of patience and reduces the amount of time doctors spend on each patient. a. Waitlist also becomes a problem since more people are on the waitlist for surgery IV) Chapter 3: Price Controls: Price Floors and Surpluses A) Price set above the free market level tends to cause more to be supplied than demanded, creating a surplus 1.Farm ex: Great Depression the farmers could not make enough money from the sale of their crops to pay their bills. Farm income fell from $6 bill in 1929 to $2 bill in 1932. a. Government limited the production of food to keep prices high (some still today) b. Government willing to buy up surpluses of food &destroyed them while ppl starved 2. Surplus is a price phenomenon. There was not too much food relative to the population. The people during the Great Depression simply did not have enough money to buy

everything that was produced at the artificially high prices a. A surplus of food in India, where malnutrition is a serious problem. The Indian government was spending more on storage of its surplus produced than on rural development, irrigation, and flood control combined. This is misallocation of scare resources especially in a poor country 3. In mid 1980, price of sugar in world market was 4 cents a pound but in US it was 20 cents a pound. Government was subsidizing the production of something that American could have gotten cheaper by not producing it at all. 4. Scare resources such as land, labor, fertilizer, and machinery are needlessly used to produce more food than the consumers are willing to consume at artificially high prices. Poor people spend an especially high percentage of their income on food are forced to pay more for the amount they received, leaving them with less money for other things 5. Government is wasting money keeping prices high then giving food stamps. But politically, it allows them to win votes from the poor and from farmers B) The Politics of Price Controls 1. Spanish blockade and price ceilings starved Span’s rebellious subjects into surrendering to the Spaniards a. They had to snuggle food but suppliers want to produce less cuz of low price and risk 2. In the 18th Century India famine  Gov imposed price controls on price  shortage  deaths from starvation England experience famine  free markets  people knew where to purchase cheap food V) Chapter 23: International Disparities in Wealth A) There has always been disparities amongst nations and people find it troubling especially when contemplating the fate of people born in such dire poverty that their chances of fulfilling life seem very remote. 1. Fundamental Question: Was there ever any realistic chance that the nations of the world would have had similar prospects of economic development? 2. Innumerable factors go into economic development that causes differences: B) Geographic Factors 1. None of the geographic factors that promote economic prosperity and human development is equally available in all parts of the world. a. Land is not equally fertile everywhere. The unusually fertile soils (Mollisols) are

distributed around the world in a very uneven pattern. b. American upper Midwest & plain states, parts of Canda, Eurasian landmass (southern part of eastern Europe to northeastern China) China has very different varieties of social predominantly rich, black in northeast and less fertile red soil in southeast. c. Little of these soil can be found in South America, Southern Argentina, Southern Brazil and Uruguay. d. Soils of sub Saharan Africa have multiple and severe deficiencies. Topsoil is shallow, allowing little space for roots of plants to go down and collect nutrients and water. 2. Heavy soils in part of Europe became fertile after ways of harnessing horses and oxen to pull the flow were developed 3. Rain that falls on the land is not equal in amount or reliability in different regions of the world, nor does all land absorb and hold rain water equally. a. Loess soil in China can absorb and hold much more of the rain that falls than can limestone soil in parts of the Balkans, leaving less moisture behind to help crops grow. Deserts of the world get little rainfall in the first place. In sub-saharan Africa, long dry spells followed by downpours wash away topsoil 4. During the many centuries when agriculture was the most important economic activity in countries around the world, there was no way that this crucial activity could produce similar economic results everywhere- whether in terms of a general standard of living or in terms of an ability to develop and sustain major urban communities dependent on local agriculture for their food 5. Sunshine and rain vary greatly from one place to another. Average annual hours of sunshine in Athens double that in London. In Spain the annual rainfall ranges from 300mm to just over 1,500mm a. In some areas abundant summer sunshine evaporates more water than falls as the meager summer rain in that region. The season it rains is also important to which kinds of crops can be grown successfully in particular places 6. Isolation: interactions are crucial – waterways. Land transport cost far more than water transport. Given the cast amounts of things that have to be constantly transported into cities and huge volumes of exports, many cities are located on navigable waterways a. Rivers in Sub-Saharan African usually navigable for boats of only limited sizes for only limited times of the year, given the more sporadic rainfall patterns. b. Within Europe, the rivers and harbors of Western Europe are more often flowing into the

open seas and harbors in Eastern Europe froze more often c. In addition to trade, waterways can also supply the drinking water necessary to sustain both human and animal life, as well as water to irrigate crops d. Mountains: Mountain communities tend to be especially isolated. Likewise technological, economic, and other developments reach the mountains long after they had spread across the world 7. Natural Resources in the land is spread unevenly over the planet. a. There have been large petroleum deposits in Middle East for thousands of years 8. Animals: The whole economic wa...