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Economics: An Overview

Basics

Definition of Economics
The study of the economy
The social science concerned with the factors that determine the production, distribution, and
consumption of goods and services.
A broad term referring to the scientific study of human action, particularly as it relates to human
choice, the utilization of scarce resources, and the reaction to incentives
The study of the choices that individuals, businesses, and governments make as they cope with
scarcity
Describes relationship between supply and demand, price and quantity

“The” Economy - Definition


“An” economy is an area of production and consumption by different agents in a given space.
The root of the word “economy” is Greek – “he who manages the house”
When people talk about “the” economy, they could be referring to the local, regional, national, or
global economy.
Usually people are referring to whichever economy has the most impact on their day-to-day lives
(local and perhaps regional).
The global economy is the entire system of production and consumption.
A market is a medium that allows buyers and sellers of specific goods and services to interact in
order to facilitate an exchange.
An economy is a collection of markets.
Markets and economies do not necessarily have to have a physical presence.

Big Economic Questions


What should be produced?
How should it be produced?
Who gets what share?
Self interest vs. social interest

Principles of Economics
1. People face trade-offs.
2. The cost of something is what you give up to get it.
3. Rational people think at the margin.
4. People respond to incentives.
5. Trade can make everyone better off.
6. Markets are usually a good way to organize economic activity.
7. Governments can sometimes improve market outcomes.
8. A country’s standard of living depends on its ability to produce goods and services.
9. Prices rise when the government prints too much money.
10. Society faces a short-run trade-off between inflation and unemployment.

Layperson’s explanation
Some people make things, other people buy those things, sometimes too much is made,
sometimes not enough, and other times more or the less the right amount.
Economics looks at this interaction.

Scarcity
Refers to the tension between our limited resources and unlimited needs and wants
For an individual, resources include time, money, and skill.
Even very wealthy people deal with the problem of scarcity because their time is limited.
For a country, limited resources include natural resources, capital, its labour force, and its level
of technology.
While it is true that some particular wants and needs can be singled out and met 100%, this
means other desires will become even more unfulfilled.
If scarcity didn’t exist, economics wouldn’t matter since everybody would be able to provision
all of their needs and wants at all times, and for free.

Microeconomics
Branch of economics concerned with behaviour on a small scale, ex. an individual concerned
about the price of groceries

Macroeconomics
Branch of economics concerned with large-scale issues, ex. why are some countries rich

Supply and Demand


One of the most fundamental concepts of economics and the backbone of a market economy

Law of demand
All other factors remaining equal, the higher the price of a good, the less quantity demanded
People will naturally avoid buying a product that will force them to forgo the consumption of
something else they value more.
Downward slope

Law of supply
All other factors remaining equal, the higher the price, the greater the quantity supplied
Producers supply more at a higher price because selling a higher quantity at a higher price
increases revenue.
Upward slope
Typically the independent variable is on the x-axis (horizontal) and the dependent variable is on
the y-axis (vertical).
Price and quantity axes can be interchanged depending on the model.
Both are the result of the interaction of the supply and demand curves.
Market structure plays a role in determining which variable has more influence, ex. whether a
monopoly exists (price-takers vs price-setters).
Small, isolated markets may have quantity as the dependent variable.
Larger, established, entwined markets would have price as the dependent variable.

Equilibrium or market-clearing price


A point in a model where price paid and quantity demanded are equal or balanced
None of the agents have an incentive to change
No leftover supply or demand

Excess supply (disequilibrium)


Supply is greater than demand, prices fall

Excess demand (disequilibrium)


Demand is greater than supply, prices rise

Movements along the curves


A movement refers to a change along a curve.
On the demand curve, a movement denotes a change in both price and quantity demanded from
one point to another on the curve.
A movement occurs when a change in the quantity demanded is caused only by a change in
price, and vice versa.
Shifts along the curves
A shift in a demand or supply curve occurs when a good's quantity demanded or supplied
changes even though price remains the same.
For instance, if the price for a bottle of beer was $2 and the quantity of beer demanded increased
from Q1 to Q2, then there would be a shift in the demand for beer.
A shift in the demand relationship would occur if, for instance, beer suddenly became the only
type of alcohol available for consumption.
Utility
The advantage, pleasure, or fulfillment a consumer gets from a good or service.
The viewpoint that people maximize utility, known as utilitarianism, has been taken up by the
field of economics, but also criticized by some who claim that pleasure and freedom from pain
are not the only goals that matter in life.
Utility is an abstract theoretical concept rather than a concrete, observable quantity.

Diminishing returns
A point at which the level of benefits gained is less than the amount of money or energy
invested.
If one factor is increased (ex. number of workers), output will eventually decrease (workers
waiting around or getting in each other’s way).

Marginal analysis
Looking at the effects of one additional unit

Marginal benefit
The additional utility an individual receives from consuming an additional unit of a good

Marginal cost
The cost of a producing an additional unit of a good

Propensity to consume
Increase in income leads to increase in consumption.

Diminishing marginal utility


The law of diminishing marginal utility is a law of economics stating that as a person increases
consumption of a product while keeping consumption of other products constant, there is a
decline in the marginal utility that person derives from consuming each additional unit of that
product.

Opportunity cost
The value of the choice of the next best alternative while making a decision
The cost of choosing one alternative over another and missing the benefit offered by the forgone
opportunity or what you gave up
Trade-offs are expressed in terms of the opportunity costs

Trade-off
A sacrifice that must be made to obtain a certain product, service, or experience, rather than
others that could be made or obtained using the same required resources
Guns vs butter is the classic example of trade-offs
It demonstrates the relationship between a nation's investment in defence and civilian goods.
In this example, a nation has to choose between two options when spending its finite resources.
It may buy either guns (invest in defence/military) or butter (invest in production of goods), or a
combination of both.
No free lunch
Expresses the idea that you cannot get something for nothing
Even if something seems free, there is always a cost, no matter how indirect or hidden.
The origin of the phrase goes back to the 19th century practice in American bars of offering a
“free lunch” to entice drinking customers.
Many foods on offer were high in salt, so those who ate them ended up buying a lot of beer.
Alternatively, a bar offering a free lunch may charge more for beer.
If one individual or group gets something at no cost, somebody else ends up paying for it.
If there appears to be no direct cost to any single individual, there is a social cost.

Models and assumptions


Economists simplify the real-world by using models
A model is effective if it has sufficient predictive power

Positive vs. Normative Economics


Positive – Objective statements – “If your goal is x, you should do y.”
Normative - Subjective, value-based statements – “Your goal should be x, so you should do y.”

Post Hoc Fallacy


The error of reasoning that a first event causes a second event because the first occurred before
the second
For example, people shopping in early December does not cause the holiday season, even though
it precedes the holiday season.
It is in fact the holiday season that causes the shopping.
A later event causes an earlier event.

Fallacy of Composition
The error of reasoning that what is true of the parts is true for the whole or that what is true of the
whole is true of the parts.
For example, standing at a ball game to get a better view works for one person but not for all
Or a firm cuts staff to reduce costs and improve its profits – if all firms did this then income falls
and so does spending.

Prices, Income, and Choice

Price
The quantity of payment or compensation given by one party to another in return for one unit of
goods or services.

Price level
The average of prices across the entire spectrum of goods and services produced in an economy
Cost of living
The amount of money needed to sustain a certain level of living, including basic expenses such
as housing, food, taxes, and healthcare.

Consumer Price Index


A measure used to track inflation in an economy.
Calculated by taking price changes for each item in the predetermined basket or bundle of goods
and averaging them

Purchasing Power
The number of goods or services that can be purchased with a unit of currency

Price controls
Price controls are government-mandated legal minimum or maximum prices set for specified
goods, usually implemented as a means of direct economic intervention to manage the
affordability of certain goods.
Governments most commonly implement price controls on staples, essential items such as food
or energy products.
Price controls that set maximum prices are price ceilings, while price controls that set minimum
prices are price floors.
Price controls – to judge by the long history of governments making use of such measures – has
shown that, at best, they are only effective measures on an extremely short-term basis.

Over the long term, price controls inevitably lead to problems such as shortages, rationing,
deterioration of product quality, and black markets that arise to supply the price-controlled goods
through unofficial channels.

One example in the United States is the price controls set on gasoline established during the
Nixon administration, which eventually led to major shortages in supply and long, slow lines at
gas pumps.

Rent control
A type of price control that limits the amount of money a landlord can charge to rent out
housing.
The amount of rent permitted may vary across jurisdictions and property types, but is generally
set at a level considered affordable to renters and fair to property owners.
Some economists consider rent controls, like other price ceilings, to be market distortions that
discourage the construction of more homes by limiting the profits owners can earn from them.
By discouraging the construction of new housing stock, regulators may create the same housing
shortage they sought to prevent by enacting the legislation in the first place.
Others believe rent control is a viable method of ensuring affordable housing for renters that
prevents landlords from capriciously raising prices.
Paradox of value or Diamond-water paradox
The apparent contradiction that, although water is on the whole more useful, in terms of survival,
than diamonds, diamonds command a higher price in the market

Inflation
A sustained increase in the general price level in an economy over a period of time
Purchasing power is reduced unless wages increase to keep up.

Causes of inflation:
(1) Increase in the movement of the money supply (amount of money in an economy; coins, bill,
and deposits) or Demand-Pull Inflation

Money supply injections to the economy can include, for example, increases in loan amounts
which increases money held by consumers thereby increasing demand.
Firms cannot keep up production/supply in the short-run, demand exceeds supply, prices rise.
Too much money spent chasing too few goods

Velocity of Money
The rate at which money is exchanged
Key input in measuring inflation
Number of transactions roughly equals output.
GDP = Money supply x Velocity of Money

(2) Decreases in aggregate supply (output/production) or Cost-Push Inflation

Price of inputs/raw materials may increase or a natural disaster may strike. This reduces supply
and prices increase.

Hyperinflation
Very high and accelerating rates of inflation
Caused by governments who print money to finance debt
Often seen in times of war or revolution

Deflation
Negative rates of inflation, price level decreases

Stagflation
High rates of inflation, but relatively steady, high prices mean less production and less
employment

Inflation and employment


With higher employment, more people have money, demand increases, prices rise

Negative effects of inflation


Increase in opportunity cost of holding money/cash
Uncertainty over future investment

Positive effects of inflation


Debtors effectively pay back less, creditors lose

Historical trends
Both Canada and the US have seen increased money supply and inflation over the past 50+ years

How do central banks inject money into the economy?


(1) By modifying reserve requirements.
A reserve requirement is a central bank regulation that sets the minimum fraction of customer
deposits that must be held by a commercial bank (rather than lent out).

(2) By lowering interest rates.


This makes it cheaper to borrow money.

(3) Open-market operations


One option is to buy and sell government bonds on the open market.
Buying them injects liquidity into the economy.
Or more commonly, a central bank loans money to commercial banks in exchange for collateral.
There is more demand for the money and interest rates rise.

Exchange rate
The rate at which one currency will be exchanged for another

Factors influencing exchange rates


Differentials in inflation. As a general rule, a country with a consistently lower inflation rate
exhibits a rising currency value, as its purchasing power increases relative to other currencies.
Differentials in interest rates. Higher interest rates give investors more return on their money and
can attract foreign capital.
Public debt. Countries with higher debt are less attractive to foreign investors.
Political stability. Stable countries have higher exchange rates.
Current account. If a country exports more than it imports, there is high demand for its good and
therefore its currency.

Interest rate
The amount charged, expressed as a percentage of principal, by a lender to a borrower for the use
of assets or money.
The Bank of Canada (Canada’s central bank) sets interest rates.
Target is 1 to 3%.
Low interest rates stimulate investment and retain purchasing power but reduce the incentive to
save.
The conventional wisdom is that raising interest rates usually cools the economy to rein in
inflation; lowering interest rates usually accelerates the economy, thereby boosting inflation.
Real vs Nominal
Real value takes inflation into account, nominal does not.
Real interest rate = nominal - inflation

Liquidity
The degree to which something can be quickly bought/sold without significantly reducing the
price
A healthy number of buyers and sellers are willing and ready.
Cash is the most liquid asset.
Consumer electronics would be liquid too as one can sell them at a pawn shop and get cash the
same day.
Real estate and fine art are relatively illiquid.

Market liquidity
A market’s ability (for example, a stock market or real estate market) to facilitate the sale or
purchase of an asset at a fair price
Liquidity is about how big the trade-off is between the speed of the sale and the price it can be
sold for. In a liquid market, the trade-off is mild: selling quickly will not reduce the price much.
In a relatively illiquid market, selling it quickly will require cutting its price by some amount.

Substitute goods
Goods a consumer perceives as comparable; as price of x rises, demand for y rises

Complementary goods
Goods usually consumed together; as price of x rises, demand for y falls

Income effect – as an individual’s income rises, their demand for goods also rises
Normal good – consumer demands more of as income rises
Inferior good – consumer demands less as income rises (ex. low quality goods)

Substitution effect – as prices rise, consumers will replace costly goods with less expensive
alternatives
Ordinary good – as price rises, a consumer demands less
Giffen good – as price rises, a consumer demands more (ex. high-end items, status items)

Elasticity
Measurement of how responsive or sensitive one variable is to a change in another
The degree to which demand or supply reacts to a change in price

Elastic variable
Demand changes drastically when its price changes (ex. luxuries)

Inelastic variable
Demand changes very little when its price changes (ex. necessities)

Factors affecting elasticity


Availability of substitutes
Necessity
Time

Money

Definition
Any item or verifiable record that is generally accepted as payment for goods and services and
repayment of debts in a particular country or socio-economic context
Technically speaking, money is simply a mathematical expression – one of x is worth something
of y – so it can be argued the concept of money is probably as old as human thought

Functions
Medium of exchange – used in trade to avoid credit systems or barter
Unit of account – places value on goods and services
Store of value

Before money
It’s often assumed societies would engage in barter amongst each other
Reality is that barter was used mainly with outsiders
Internally, gift and informal credit systems were used

Commodity money
Money whose value comes from the material it is made from
Ex. gold, silver, shells, cigarettes

Gold standard
Circulation of gold coins and bars instead of fiat money or circulation of currency that is easily
convertible into gold

Advantages of gold standard


Long-term price stability – difficult for governments to increase money supply and thus inflation
Provides fixed exchange rates – reduces uncertainty in international trade

Disadvantages of gold standard


Unequal distribution of gold deposits makes the gold standard more advantageous for countries
that produce more
Acts as a limit to economic growth - the scarcity of the metal constrains the ability of the
economy to produce more capital and grow

Mercantilism
An economic theory and practice in 15th to 18th century Western Europe.
Goal was to enrich and empower nations by acquiring and retaining as much economic activity
within their borders.
Hoarding of precious metals was a key element.

Fiat money
Has no actual value - derives its value from government declaration
Most contemporary systems are based on this type of money

Money or Credit Multiplier


The expansion of an economy’s money supply that results from banks being able to lend
The size of the multiplier effect depends on the percentage of deposits that banks are required to
hold as reserves (the reserve ratio).
This means banks can lend out more “money” than there is physical currency.

Central Bank
A central bank, reserve bank, or monetary authority is an institution that manages a state's
currency, money supply, and interest rates.
In Canada it’s the Bank of Canada
In the US it’s the Federal Reserve

Production and Supply

Profit
A financial gain; revenue less expenses

Profit maximization
The process by which a firm determines the price and output level that returns the greatest profit.
It is assumed all firms are profit-maximizers

When MR > MC, greater quantity should be produced.


When MC > MR, lesser quantity should be produced
When MR = MC, profit is maximized
Factors of production
Inputs in the production system
Land – earns rent
Labor – earns wages
Capital – earns interest
Entrepreneurship – earns profit

Short run – all or some variables are fixed


Long-run – nothing is fixed

Fixed costs (overhead) – business expenses not dependent on the level of goods produced (ex.
salaries and rent)
Variable costs – dependent on output (ex. raw materials and hourly employees)

Production function
Relationship between physical output of a production process to physical inputs.
Specifies maximum output obtainable from a given set of inputs.
Typically involves capital and labour.

Marginal product
Change in output resulting from an increase in one unit for a particular input

Returns to scale
Constant - output increases by that same proportional change as all inputs change
Increasing - output increases by more than that proportional change in inputs
Decreasing - output increases by less than that proportional change in inputs

Perfect competition - no individual firm has sufficient market power to exert any influence on
the price output is sold at – firms are price takers

Monopoly – one seller, many buyers; the firm is a price-setter


Monopolistic competition – many sellers supplying differentiated products; monopolistic
because firms set their own prices

Oligopoly – small number of sellers

Monopsony – many sellers, one buyer (ex. buyer is government)

Economies of scale – cost advantages firms obtain as size increases; the greater the quantity of a
good produced, the lower the per-unit fixed cost because these costs are spread out over a larger
number of goods

Market efficiency – achieved when it is impossible to reallocate goods to make everyone better
off

Market failure
Occurs when a market fails to efficiently allocate resources, such as a monopoly

Consumer surplus - monetary gain obtained by consumers because they are able to purchase a
product for a price that is less than the highest price that they would be willing to pay

Producer surplus or profit - the amount that producers benefit by selling at a market price that
is higher than the least that they would be willing to sell for

Externality – a consequence of an economic activity experienced by unrelated third-parties,


either positive (new bus terminal helps local businesses) or negative (pollution)

Deadweight Loss - a cost to society created by market inefficiency; often characterized by


reduced consumption, ex. rise in tax or monopoly

Private cost – a firm’s cost of producing a good

Social optimum – the level of output where all parties are satisfied

Solutions and approaches to externalities


Taxing negative activities
Subsidizing positive activities
Internalize the externality – force the producer to take the affected party’s views into account
Recognize a missing market exists and create it

Pivotal agent – an individual or business whose action(s) lead to influential change

Emissions trading or cap and trade


Government-mandated, market-based approach to controlling pollution by providing economic
incentives for achieving reductions in pollution; central authority sells permits, firms are required
to hold permits equal to the amount they pollute, firms are allowed to buy and sell permits from
other firms.

As firms trade permits, a market price for them emerges. Firms will have an incentive to sell
permits whenever the money they raise from the sale is higher than the cost of not being allowed
to pollute.

Public good – a good that individuals cannot be effectively excluded from use and where use by
one individual does not reduce availability to others, that is, it is non-excludable and non-rival
(ex. street lighting, national defence)

Public sector – the part of the economy concerned with providing government services; military,
police, infrastructure, education, health care; these are seen as essential services or social
obligations

Private sector – the part of the economy consisting of firms operating for profit

Privatization
The process of transferring ownership from the public sector to the private sector
Privatizing public goods can raise prices and reduce service quality.
Opponents claim government is always less efficient than the private sector.

Monopoly
Definition
A monopoly exists when an individual or business is the only supplier in a given community.
Monopolies are characterized by lack of competition, higher prices, and reduced quality.
Monopolies are price-setters; competitive firms are price-takers.

Price discrimination
A pricing strategy where identical or largely similar goods or services are transacted at different
prices by the same provider in different markets
Monopolies can increase profits by using this tactic.

First-degree discrimination
Selling to each customer at a different price – one-to-one marketing

Second-degree discrimination
Creating slightly different products – versioning

Third-degree discrimination
Dividing the market into groups and charging each group the same price – group pricing (ex.
students and seniors)

Natural monopoly
Sometimes a monopoly is the only option.
Water or electricity companies have steep upfront costs in constructing a distribution network.
If every residence and business were served by multiple water mains or power lines,
infrastructure would have to be inefficiently duplicated.

Solutions to natural monopolies


Nationalization – government takes ownership and is able to fire/hire management
Price regulation – government sets price caps

Competition or anti-trust law


Laws that maintain a healthy competitive environment by regulating uncompetitive practices.
Policy options can and will stop monopolies from arising in the first place
Regulators can block mergers and acquisitions if they believe the new firm will exert too much
market power.

Other anti-competitive practices


Collusion (ex price fixing)
Predatory pricing or undercutting (setting very low prices to drive out competitors)
Product bundling/tying (consumer has less choice)
Refusal to deal (simply not engaging in business to exert market power)
Exclusive dealing (establishing contracts that force businesses to sell exclusively though one or
more outlets)
Division of territories (companies agreeing to stay out of each other’s way, consumers then have
less choice)

Barriers to entry
Costs or that must be incurred by a new entrant that incumbents do not have or have not had to
incur.
They can cause or aid companies in achieving greater market power.

Examples of barriers to entry


Advertizing (larger firms being able to afford more)
Capital
Customer loyalty/Network effect
Economies of scale
Exclusive distributor agreements
Intellectual property (ex. patents)
Occupational licensing (limiting the number of professionals who can enter an industry)
Research and development (some products require steep upfront costs)
Taxes, tariffs, import duties, etc.
Zoning
Barriers to exit
Obstacles that prevent a company from exiting a market

Examples of barriers to exit


Having highly specialized equipment that is difficult to sell

Information and Contracting


Contract
Spells out the terms and conditions of a transaction
Contract enforcement is a key feature of a political and economic climate attractive to investors

Asymmetric information
One party has more or better information than the other.
This creates an imbalance of power in transactions, which can sometimes cause the transactions
to go awry.

Adverse selection
A type of information asymmetry surrounding something that happened before the contracting

Moral hazard
Information asymmetry surrounding something that happened after the contracting
The risk that a party to a transaction has not entered into the contract in good faith, has provided
misleading information about its assets, liabilities or credit capacity, or has an incentive to take
unusual risks in a desperate attempt to earn a profit before the contract settles.

National Income Accounting


Stock
A measure of how much of something exists at a specific point in time
Ex. bank account balance at a particular date and time

Flow
A measure over an interval of time
Ex. annual income

Gross Domestic Product (GDP)


A measure of the market value of all final goods and services produced in a country in a given
year.
Intermediate goods are not counted as that would lead to double counting.
Real vs Nominal GDP
Real GDP is adjusted for inflation
As a result, nominal GDP is often higher than real GDP
Real GDP tells us our economic situation as if prices hadn’t gone up

Net Domestic Product


GDP minus depreciation of a country’s capital goods

Gross National Product


GDP plus income received from overseas investment by residents minus income earned within
the domestic economy by foreign residents.

GDP per capita


GDP divided by the population
This takes into account the number of people that income must be shared amongst
A more useful measure than raw GDP
Large countries may have a larger total GDP simply due to a larger population

GDP per worker


Takes into account sociological differences in terms of how many people are actually working to
produce this GDP

Problems with GDP


Does not take population into account (see GDP per capita or GDP per worker)
Does not take purchasing power/cost of living into account (can be adjusted though)
Also does not include natural resources, the underground economy, the second-hand market,
public debt, political climate, leisure time, domestic or voluntary work, counts bads (ex. undoing
damage from crime and other social problems), difficult to measure value of government projects
(ex. a bridge)

Debt-to-GDP ratio
A ratio of a country’s government debt to its GDP
Typically expressed as a percentage
Many developed Western countries, including Canada, US, Western Europe, and Japan, have
very high ratios

Measuring output (GDP)


Two methods are commonly used:

Expenditure method – measuring how much is spent – Consumption + Investment + Government


Spending + Exports – Imports
Y = C + I + G + (X – M)

Income method – measuring how much is earned

Business or Economic Cycle


The downward and upward movement of GDP around its long-term growth trend
These fluctuations in economic activity do not exhibit uniform or predictable periodicity
They include expansion, crisis, recession, recovery
These cycles are driven by how much consumers and businesses spend, which in turn depends a
lot on their view of the future
Eventually, expectations get ahead of fundamentals, creating imbalances and total supply
exceeds total demand.
Recessions create pent-up demand. Lower interest rates release that demand, bringing the
recession to a close

Recession
Generally identified by a fall in GDP growth in two successive quarters

Paradox of Thrift
Individuals try to save more during an economic recession, which essentially leads to a fall in
aggregate demand and hence in economic growth.

Depression
Sustained long-term economic downturn that is more severe than a recession

Structural unemployment
Changes occur in market economies such that demand increases for some jobs skills while other
job skills become outmoded and are no longer in demand. For example, the invention of the
automobile increased demand for automobile mechanics and decreased demand for farriers
(people who shoe horses).

Frictional Unemployment
This type of unemployment occurs because of workers who are voluntarily between jobs.
This is a desirable type of unemployment.

Cyclical Unemployment
This occurs due to downturns in overall business activity.

Seasonal unemployment
Occurs in industries that thrive during a particular season(s)

Full employment
No cyclical unemployment, only seasonal and frictional unemployment

Economic indicators
Statistics about economic activity that allows for analysis and predictions, such as relating to the
business cycle

Leading indicators
Indicators that usually, but not always, change before the economy as a whole changes
Examples:
(1) Stock market returns
(2) Interest rates, mortgage rates
(3) Foreign exchange rate
(4) Unemployment claims
(5) Consumer confidence
(6) Average weekly employee hours (manufacturing)
(7) Manufacturers’ new orders
(9) Building permits

Lagging Indicators
(1) GDP Changes
(2) Income/wages
(3) Unemployment rate
(4) Interest rates

Commodity
Basic goods typically used as inputs to produce other goods.
They generally have little product differentiation.
Demand for certain commodities is generally the same.
Some traditional examples of commodities include grains, gold, beef, oil and natural gas.
"From the taste of wheat, it is not possible to tell who produced it, a Russian serf, a French
peasant or an English capitalist."
A stereo system, for example, is not a commodity, as there are many aspects of product
differentiation. Demand for various stereo systems will differ.

Commoditization
Occurs as goods or services lose product differentiation, often by diffusion of capital necessary
for efficient production.

Economic sectors
Primary sector: retrieval of raw, natural resources
Secondary sector: transformation of raw materials into goods
Tertiary sector: sales and services to consumers and businesses

Definition of capital
Goods used in the production of other goods or services.
Capital is more durable and used to generate wealth through investment.
Any produced thing that can enhance a person's power to perform economically useful work—a
stone or an arrow is capital for a caveman who can use it as a hunting instrument, and roads are
capital for inhabitants of a city.
1. Wealth in the form of money or assets, taken as a sign of the financial strength of an
individual, organization, or nation, and assumed to be available for development or investment.
2. Accounting: Money invested in a business to generate income.
There is also a concept of human capital.

Economic system
A system of production, resource allocation, and distribution of goods and services within a
society or a given geographic area
It includes the combination of the various institutions, agencies, entities, decision-making
processes, and patterns of consumption that comprise the economic structure of a given
community.
Economic systems dictate who or what sets prices.
A market economy may or may not be free (could be free or mixed).
There may be overlap between systems.

Traditional economy
Ruled by a feudal lord, little freedom of choice, barter main form of trade

Command Economy or Planned Economy or State Economy


State decides all economic activity, no freedom of choice, government sets prices

Free-market economy
Little or no government role, consumers and producers have freedom of choice, interplay of
supply-demand sets prices

Mixed-economy
Government regulates business activity, limited choice given government controls
Contemporary Western democracies fall into this category

Other systems of resource allocation


Contest – This allocates resources to a winner or group of winners. Contracts are often given out
this way.
First-come, First-served – Works best when a scarce resource can serve just one user at a time in
sequence, for example casual restaurants, highway space, etc.
Lottery – Works best when there is no effective way to distinguish among potential users of a
scarce resource, like landing slots to airline at some airports or allocating the electromagnetic
spectrum used by cell phones.
Personal Characteristics – Selecting a marriage partner based on personal characteristics is
acceptable but allocating jobs to members of a certain race is not.
Force – Military action, war, and theft can be used to take things from others but force also
provides the state with an effective method of enforcing contracts and upholding the rule of law.
Example: An earthquake has broken the pipes that deliver drinking water to a city. Bottled water
is available but there is no tap water. What is the fair way to allocate the bottled water?

Market Price: A price is set, those who can pay are not denied, but those who cannot pay are left
thirsty.
Command system: Someone decides who is the most deserving and needy. Perhaps everyone is
given an equal share. Or perhaps government officials and their families end up with the most
water.
Contest: Bottles of water are prizes that go to those who are best at a particular contest.
First-come, First-served: Water goes to the first off the mark or to those who place the lowest
value on their time and can afford to wait in line.
Lottery: Water goes to those in luck.
Personal Characteristics: Water goes to those with the “right” characteristics. Perhaps the old,
the young, or pregnant mothers get the water.

Except by chance, none of these methods delivers an allocation of water that is either fair or
efficient

Monetary policy
Involves the interest rate and the money supply

Fiscal policy
Involves tax rates and government spending

Debt
Running tally

Deficit
Calculated over a particular period

Capitalism

Capitalism is an economic system based on private ownership of the means of production and
their operation for profit.
Also known as a market economy

Capital accumulation: Production for profit and accumulation as the implicit purpose of all or
most of production, constriction or elimination of production formerly carried out on a common
social or private household basis.
Commodity production: Production for exchange on a market; to maximise exchange-value
instead of use-value.
Competitive markets
Private ownership of the means of production
The investment of money to make a profit
The use of the price mechanism to allocate resources between competing uses

Profit motive
Ensures efficient use of capital
Allows innovation and leads to competition
Unchecked profit, greed, and seeking short-term gains can be disastrous; businesses may
sacrifice worker safety, environment laws, and other ethical behaviour
Captured by the metaphor of the invisible hand coined by Adam Smith, where individual
actions supposedly lead to unintended social benefits

Economic Growth
Definition
An increase in the production capacity of an economy

How to increase growth


Increase capital
Increase size and/or quality of labour pool
Invest in technological progress, research and development
Make it easier for businesses to operate (Ease of Business Index)
Increase trade (an absolute advantage exists when one country requires fewer inputs to produce a
good; a comparative advantage is one where one country can produce a good at a lower
opportunity cost)
Improve legal and political institutions to boost investor confidence - key areas are contract
enforcement and property rights
Some researchers argue democracies are more receptive to technological change and therefore
growth

Trickle-down economics
An economic theory that advocates reducing taxes on businesses and the wealthy in society as a
means to stimulate business investment in the short term and benefit society at large in the long
term
It is a form of laissez-faire capitalism (free from government intervention) in general and more
specifically supply-side economics.
Multiple studies have found a correlation between trickle-down economics and reduced growth.

Stock Market or Stock Exchange


A physical or virtual space where brokers and traders buy and sell stocks, bonds, and other
securities
Businesses can raise capital by listing themselves on the exchange and offering stock.
Investors buy stock, the company uses the funds to further production, investors get a return
Major stock exchanges include the New York Stock Exchange, NASDAQ (also in New York),
and the Toronto Stock Exchange
Stock Market Index
A measurement of the value of a section of the stock market
Computed from the prices of selected stocks
An index can be narrow or broad, regional, national, or international
Well-known indices include the Dow Jones Industrial Average (30 US companies), S&P 500
(500 NYSE or NASDAQ companies)
The Wilshire 5000 includes all stocks traded in the US

Barometer of the Economy


Share prices tend to rise or remain stable when companies and the economy in general show
signs of stability and growth.
An economic recession, depression, or financial crisis could eventually lead to a stock market
crash.
Therefore, the movement of share prices and in general of the stock indices can be an indicator
of the general trend in the economy.

Financial Crisis of 2008-9


Sub-prime mortgage rates were introduced to help low and middle income Americans own
homes.
Mortgage lenders adopted loose underwriting criteria and aggressive and predatory lending.
The housing bubble burst and the high default rate led to the financial crisis.
Regulatory failures were blamed

Economic bubble
Definition
Trade in an asset at a price or price range that strongly exceeds the asset's intrinsic value.
It could also be described as a situation in which asset prices appear to be based on implausible
or inconsistent views about the future.
Asset bubbles date back as far as the 1600s and are now widely regarded as a recurrent feature of
modern economic history.
Historically, the Dutch Golden Age's Tulipmania (in the mid-1630s) is often considered the first
recorded economic bubble.
Because it is often difficult to observe intrinsic values in real-life markets, bubbles are often
conclusively identified only in retrospect, once a sudden drop in prices has occurred.
There are no clear causes of bubbles but they may form during periods of innovation, easy credit,
or loose regulations.

Great Depression
Severe worldwide depression in the 1930s
Characterized by stock market crash and high unemployment
1973 Oil Crisis
The 1973 oil crisis began in October 1973 when the members of the Organization of Arab
Petroleum Exporting Countries proclaimed an oil embargo.
The embargo was targeted at nations perceived as supporting Israel during the Yom Kippur War.
The initial nations targeted were Canada, Japan, the Netherlands, the United Kingdom and the
United States with the embargo also later extended to Portugal, Rhodesia and South Africa.
By the end of the embargo in March 1974, the price of oil had risen from US$3 per barrel to
nearly $12 globally; US prices were significantly higher.
The embargo caused an oil crisis, or "shock", with many short- and long-term effects on global
politics and the global economy.

Business Basics
Assets and Liabilities
An asset is something a company owns that can provide future economic benefit.
A liability is an obligation, for example money that must be paid.

Four types of accounting statements


1. Balance sheet – includes assets, liabilities, and shareholder equity
2. Income statement – Revenue less expenses
3. Statement of Cash Flow – shows sources of cash
4. Statement of Owner’s Equity

Profit
Revenue minus expenses

Profit Margin
Profit/Revenue
Expressed as a percentage – the larger the better

Limited Liability Company (LLC)


A person's financial liability is limited to a fixed sum, most commonly the value of a person's
investment in a company or partnership

Corporation
To incorporate means to create a separate legal entity
Owners are protected from personal liability
Differs from a LLC in how it is taxed

Principal-agent problem
One person or entity is able to make decisions on another person’s or entity’s behalf.
The problem arises in circumstances where agents are motivated to act in their own best interests
that go against the interests of their principal.
Examples include management and shareholders, politicians and voters.

Canadian Economy
Top 20 in the world by GDP (over $1 trillion)
Dominated by service industry (employs about 75% of workforce and accounts for 70% of GDP)
Service sector breakdown in order by productivity – real estate/rental/leasing (12% of GDP),
finance and insurance, health care and social assistance, public admin
Goods sector breakdown in order by productivity – mining and oil/gas (8% of GDP),
manufacturing, construction
GDP = Household consumption (60%) + Government consumption (20%) + Investment (20%) +
Exports (30%) – Imports (>30%)
Imports are slightly higher than exports leaving Canada with a trade deficit
Significant primary sector (mining, oil/gas, forestry, fishing, agriculture)
Significant manufacturing sector (automotive, aerospace)
Exports in order of dollar value – Cars and parts [18% of exports], Consumer goods (main one is
food) [14% of exports], Energy products (main one is oil) [14% of exports], Metals [11% of
exports], Forestry and packaging products [8% of exports], Chemical/plastic/rubber products
[6% of exports]
Imports in order of dollar value – Consumer goods [22% of imports], Cars and parts [19% of
imports], Electronics and electrical parts [12% of imports], Industrial machinery [10% of
imports], Metals [8% of imports], Chemical/plastic/rubber parts [8% of imports]
Largest companies include banks, energy firms, and food retailers
Largest source of electricity in Canada is hydroelectric – nuclear in Ontario
Largest trading partner is the US
Unemployment rate of about 7%, provincial rates vary from 5% to 13%
Highest household debt among G7 nations – both mortgage and consumer debt

Canada’s economic issues


High household debt
Unaffordable housing
Poor competitiveness on a global scale (issues cited include lack of skilled workers, high taxes,
bureaucracy)

US Economy
Top in the world by GDP ($18 trillion)

G20
International forum for governments of 20 major economies promoting high-level policy issues
related to global financial stability.

 Argentina
 Australia
 Brazil
 Canada
 China
 European Union
 France
 Germany
 India
 Indonesia
 Italy
 Japan
 South Korea
 Mexico
 Russia
 Saudi Arabia
 South Africa
 Turkey
 United Kingdom
 United States

If nations are ranked by GDP per capita, most G20 members fall out of the top 20.
Luxembourg, Switzerland, Qatar are the most prosperous countries by GDP/capita.
These countries have smaller populations.

Odds and ends


Why do professional athletes get paid so much while professions like teaching get paid
relatively little?

It essentially comes down to high demand and low supply.


There are very few people who can excel at professional sports while there are many more
people who can be teachers.
Sporting events are popular and bring in a lot of money.
This supports athletes’ high salaries.
Teaching in schools does not bring in any revenue so teachers’ salaries are relatively lower.
It is important to note that there are many athletes who only make a modest living and there are
superstar teachers and professors who get paid a lot more.

Humor
An economist is someone who states the obvious in terms of the incomprehensible.
Alfred Knopf

If all economists were laid end to end, they would still not reach a conclusion.
G.B. Shaw

Everything reminds Milton Friedman of the money supply. Everything reminds me of sex, but I
try to keep it out of my papers.
Robert Solow

Under capitalism, man exploits man. Under communism, it's just the opposite.
John Kenneth Galbraith

What’s the capital of Greece?


About $5

Economics is the painful exaggeration of the obvious.

Talk is cheap. Supply exceeds demand.

In the long run, we are all dead.

The main difference between micro-economists and macro-economists is that micro-economists


are wrong about specific things, while macro-economists are wrong about things in general.

Economists are pessimists: they've predicted 8 of the last 3 depressions.

A study of economics usually reveals that the best time to buy anything was last year.

Girls who say, “Lots of guys are after me,” should never forget that low prices attract the most
customers.

The first lesson of economics is scarcity. There is never enough of anything to satisfy everyone.
The first lesson of politics is to disregard the first lesson of economics.

A consultant is someone who takes the watch off your wrist and tells you the time.

I've put something aside for a rainy day – an umbrella.

Bobby Hill: In America, you put “In God We Trust,” on your money. In Russia, we have no
money.
CIRCULATION OF CASH ANECDOTE

It’s a cold day in the small Saskatchewan town of Pumphandle and streets are deserted.
Times are tough, everybody is in debt, and everybody is living on credit.

A traveler comes to town and lays a $100 bill on the hotel desk saying he wants to inspect the
rooms upstairs to pick one for the night.

As soon as he walks upstairs, the hotel owner grabs the bill and runs next door to pay his debt to
the butcher.

The butcher takes the $100 and runs down the street to retire his debt to the pig farmer.

The pig farmer takes the $100 and heads off to pay his bill to his supplier, the Co-op.

The guy at the Co-op takes the $100 and runs to pay his debt to the local prostitute, who has also
been facing hard times and has had to offer her “services” on credit.

The hooker rushes to the hotel and pays off her room bill with the hotel owner.

The hotel proprietor then places the $100 back on the counter so the traveler will not suspect
anything.

At that moment the traveler comes down the stairs, states that the rooms are not satisfactory,
picks up the $100 bill and leaves.

No one produced anything. No one earned anything….

However, the whole town is now out of debt and now looks to the future with a lot more
optimism.

TOP REASONS TO STUDY ECONOMICS


Economists are armed and dangerous: “Watch out for our invisible hands.”
You can talk about money without ever having to make any.
When you are in the unemployment line, at least you will know why you are there.
When you get drunk, you can tell everyone that you are just researching the law of diminishing
marginal utility.

ECONOMICS AND TWO COWS

Feudalism
You have two cows.
Your lord takes some of the milk.
Traditional capitalism
You have two cows.
You sell one and buy a bull.
Your herd multiplies, and the economy grows.
You sell them and retire on the income.

Pure Communism
You have two cows.
Your neighbors help you take care of them, and you all share the milk.

Applied Communism
You have two cows.
You have to take care of them, but the government takes all the milk.

Fascism
You have two cows.
The government takes both, hires you to take care of them, and sells you the milk.

Dictatorship
You have two cows.
The government takes both and shoots you.

Pure Democracy
You have two cows.
Your neighbors decide who gets the milk.

Representative Democracy
You have two cows.
Your neighbors pick someone to tell you who gets the milk.

American Democracy
The government promises to give you two cows if you vote for it. After the election, the
president is impeached for speculating in cow futures. The press dubs the affair "Cowgate".

Socialism
You have 2 cows.
The State takes one and gives it to your neighbour who doesn’t have a field to put it in.

Nazism
You have 2 cows.
The State takes both and shoots you. Then the cows are killed in the war.

Surrealism
You have two giraffes.
The government requires you to take harmonica lessons.
Bureaucracy
You have two cows. At first the government regulates what you can feed them and when you can
milk them. Then it pays you not to milk them. After that it takes both, shoots one, milks the other
and pours the milk down the drain. Then it requires you to fill out forms accounting for the
missing cows.

European Union Bureaucracy


You have 2 cows.
The EU takes both, shoots one, milks the other, and then throws the milk away because the quota
has been exceeded.

An American Corporation
You have two cows.
You sell one, and force the other to produce the milk of four cows. Later, you hire a consultant to
analyse why the cow has dropped dead.

Enron Venture Capitalism


You have two cows.
You sell three of them to your publicly listed company, using letters of credit opened by your
brother-in-law at the bank, then execute debt/equity swap with an associated general offer so that
you get all four cows back, with a tax exemption for five cows.
The milk rights of the six cows are transferred via an intermediary to a Cayman Island Company
secretly owned by the majority shareholder who sells the rights to all seven cows back to your
listed company.
The annual report says the company owns eight cows, with an option on one more.
You sell one cow to buy a new president of the United States, leaving you with nine cows.
No balance sheet provided with the release.
The public then buys your bull.

A French Corporation
You have two cows.
You go on strike, organise a riot, and block the roads, because you want three cows.

A Japanese Corporation
You have two cows. You redesign them so they are one-tenth the size of an ordinary cow and
produce twenty times the milk. You then create a clever cow cartoon image called ‘Cowkimon’
and market it worldwide.

A German Corporation
You have two cows. You re-engineer them so they live for 100 years, eat once a month, and milk
themselves.

An Italian Corporation
You have two cows, but you don’t know where they are. You decide to have lunch.

A Russian Corporation
You have two cows.
You count them and learn you have five cows.
You count them again and learn you have 42 cows.
You count them again and learn you have 2 cows.
You stop counting cows and open another bottle of vodka.

A Swiss Corporation
You have 5000 cows. None of them belong to you. You charge the owners for storing them.

A Chinese Corporation
You have two cows.
You have 300 people milking them. You claim that you have full employment, and high bovine
productivity. You arrest the newsman who reported the real situation.

An Indian Corporation
You have two cows.
You worship them.

A British Corporation
You have two cows. Both are mad.

An Iraqi Corporation
Everyone thinks you have lots of cows. You tell them that you have none. No-one believes you,
so they bomb the hell out of you and invade your country. You still have no cows, but at least
now you are part of a Democracy.

An Australian Corporation
You have two cows. Business seems pretty good.
You close the office and go for a few beers to celebrate.

Sources
The Rough Guide to Economics by Andrew Mell and Oliver Walker
The Little Book of Economics by Greg Ip
Economics: Canada in the Global Environment textbook by Michael Parkin and Robin Bade
Wikipedia and Investopedia articles

Further reading
Freakonomics by Steven Levitt
Basic Economics by Thomas Sowell
23 Things They Don’t Tell You about Capitalism by Ha-Joon Chang
Business Studies for Dummies
Behavioural Economics for Dummies