Economics -is the social science that analyzes the production, distribution, and consumption of goods -aims to explain

how economies work and how economic agents interact.

and services.

The theory of the Invisible Hand states that if each consumer is allowed to choose freely what to buy and each producer is allowed to choose freely what to sell and how to produce it, the market will settle on a product distribution and prices that are beneficial to all the individual members of a community, and hence to the community as a whole. The reason for this is that self-interest drives actors to beneficial behavior

Division of Labor I put the division of labor first mainly because Adam Smith did, arguing that division of labor is the key cause of improving standards of living. Modern economics doesn't do much with the concept of division of labor, but two closely related concepts are important: Returns to Scale Returns to scale may be increasing, constant or decreasing. It refers to changes in output resulting from a proportional change in all inputs (where all inputs increase by a constant factor). Virtuous Circles in Economic Growth is a complex of events that reinforces itself through a feedback loop. A virtuous circle has favorable results, and a vicious circle has detrimental results. A virtuous circle can transform into a vicious circle if eventual negative feedback is ignored. Opportunity Cost The idea is that anything you must give up in order to carry out a particular decision is a cost of that decision. Explicit costs Explicit costs are opportunity costs that involve direct monetary payment by producers. The opportunity cost of the factors of production not already owned by a producer is the price that the producer has to pay for them. For instance, a firm spends $100 on electrical power consumed, the opportunity cost is $100. The firm has sacrificed $100, which could have been spent on other factors of production. Implicit costs Implicit costs are by contrast, the opportunity costs that involve only factors of production that a producer already owns. They are equivalent to what the factors could earn for the firm in alternative uses, either operated within the firm or rent out to other firms.

Scarcity . Scarcity means not having enough to fill subjective wants. Resources scarcity is defined as there being a difference between the desire and the demand for a good. Production Possibility Frontier The production possibility frontier is the diagrammatic representation of scarcity in production. is a graph that shows the different rates of production of two goods and/or services that an economy can produce efficiently during a specified period of time with a limited quantity of productive resources Comparative Advantage says that two countries. can both gain from trade if, in the absence of trade, they have different relative costs for producing the same goods. Even if one country is more efficient in the production of all goods (absolute advantage), it can still gain by trading with a less-efficient country, as long as they have different relative efficiencies

Discounting of Investment Returns Another application of the opportunity cost principle that is very important in itself, this one tells us how to handle opportunities that come at different times. The Equimarginal Principle This is the diagnostic principle for economic efficiency. It has wide applications in modern economics. Two of the most important are key principles of economics in themselves: The Fundamental Principle of Microeconomics This principle describes the circumstances under which market outcomes are efficient, and The Externality Principle describes some important circumstances in which they are not. Of course, the equimarginal principle is founded on Marginal Analysis Also an important principle in itself and very widely applied in modern economics. There is no major topic in microeconomics (I believe) that does not apply marginal analysis and opportunity cost. The link shown above is the marginal analysis of productivity, but marginal analysis also has applications to cost, revenue, consumers' utility and benefits, and more. Market Equilibrium

occurs where quantity supplied equals quantity demanded, the intersection of the supply and demand curves in the figure above. At a price below equilibrium, there is a shortage of quantity supplied compared to quantity demanded.
Elasticity and Revenue These ideas are a key to understanding how market changes transform society. The Entry Principle This tells us that, when entry into a field of activity is free, profits (beyond opportunity costs) will be eliminated by increasing competition. This has a somewhat different significance depending on whether competition is "perfect" or monopolistic. Cobweb Adjustment This might give the explanations when the market does not move smoothly to equilibrium, but overshoots. Competition vs. Monopoly Why economists tend to think highly of competition, and lowly of monopoly. Diminishing Returns Perhaps the best-known of major economic principles, the Principle of Diminishing Returns is much more reliable in short-run than in long-run applications, so the Long Run/Short Run dichotomy is an important subsidiary principle. Modern economists think of diminishing returns mainly in marginal terms, so marginal analysis and the equimarginal principle are closely associated. Game Equilibria Game theory allows strategy to be part of the story. One result is that we have to allow for several kinds of equilibria. We have

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Noncooperative equilibrium o Prisoners' Dilemma (dominant strategy) equilibria which are o Nash (best response) equilibria, (but not all Nash equilibria are dominant strategy equilibria), and Cooperative equilibria And that's just the beginning. The main applications in this book, and traditionally, are in the study of oligopoly.

Measurement Principles Economics is multidimensional, and that creates some difficulties in measuring things like production, incomes, and price levels. Some of the problems can be solved more or less fully. Value Added and Double Counting One for which we have a pretty complete solution is the problem of double counting: the solution is, use value added. "Real" Values and Index Numbers Since we measure production and related quantities in dollar terms, we have to correct for inflation. Index numbers are a pretty good workable solution, but there are some problems and criticisms. Measurement of Inequality Another issue is that the "average income" may not mean very much, because nobody is average and income is unequally distributed. Even if we cannot correct for that (what would that mean?) we can get a rough measure of the relative inequality and see where it is going. Medium of Exchange Money is whatever is generally acceptable as a medium of exchange. That means a bank, or similar institution, can literally create money, so long as people trust the bank enough to accept its paper as a medium of exchange. We might call this magical fact the Fiduciary Principle. Income-Expenditure Equilibrium Like the market equilibrium principle, but even moreso, this model pulls together a number of subsidiary principles that complement one another and together constitute the "Keynesian" theory of aggregate demand. The implications of this theory are less controversial than the word "Keynesian" is -- controversy has to do more with the details than the applications. Among the subsidiary principles are

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Coordination Failure The income-consumption relationship The Multiplier Unplanned inventory investment Fiscal Policy The Marginal Efficiency of Investment The influence of money on interest Real Money Balances Monetary Policy

The Surprise Principle People respond differently to the same stimuli if the stimuli come as a surprise than they would if the stimuli do not come as a surprise. This new economic principle plays the key role with respect to aggregate supply that "Income-Expenditure Equilibrium" plays with respect to aggregate demand. Rational Expectations

People don't want too many unpleasant surprises. If they use the information available to them efficiently, then they won't be surprised in the same way very often. This can lead to Policy ineffectiveness But it is hard to reconcile this way of thinking with the apparent Permanence of many economic changes, especially those in unemployment. These suggest that the economy has a high degree of Path Dependence, and that would put the independence of aggregate supply into some doubt. . The invisible hand (ceteris paribus- all other things being equal) means that what needs to be produced, with what, how, by whom, gets decided without any central authority planning it. It happens spontaneously from people following their self interest. The great benefits that human beings receive from society, such as morality, language, food, clothing, shelter, transport, communications, entertainment - these happen without the need for anyone to plan them. Each person's self-interest leads him to serve the wants of his fellow man. The interests of all people in society are in harmony while ever they are free to trade peacefully with each other. 2. The division of labour means that different people do different works. Instead of one person making his own food, clothing, shelter, etc. human beings specialise in smaller aspects of production. Why do they do this? Because labour in isolation is not as productive as labour in cooperation. If it was, we would have evolved to be a solitary species, like the snow leopard. By co-operating with each other, there is more for everyone to share, so everyone is better off. The division of labour is *the* social principle. It is the reason why humans form societies. At first, when it was not well understood, only people who were closely related, like families and villages, shared in the division of labour: everyone else they fought with. As people more and more understand the benefits of the division of labour, they extend it more and more. The division of labour is the basis of increasing wealth, as well as the basis of human society. 3. Laissez-faire means that government should leave people alone to follow their own interests. As long as force or fraud are illegal, people's freedom to trade with each other will be good for *all* the people in society. There is no quicker or better or fairer way to make everyone better off. Relations between consenting parties are *not* exploitative, and there is no need for government to step in to try to improve them. Government's attempts to manage the economy are both unfair and counter-productive. They create privileges and social injustice. And they produce results that are worse from the point of view of the people advocating the government intervention in the first place. demand is the relation of the quantity that all buyers would be prepared to purchase at each unit price of the good. Supply is the relation between the price of a good and the quantity available for sale at that price. The Law of Demand The law of demand states that, if all other factors remain equal, the higher the price of a good, the less people will demand that good. In other words, the higher the price, the lower the quantity demanded The Law of Supply

This means that the higher the price, the higher the quantity supplied. Producers supply more at a higher price because selling a higher quantity at a higher price increases revenue. Time and Supply Unlike the demand relationship, however, the supply relationship is a factor of time. Time is important to supply because suppliers must, but cannot always, react quickly to a change in demand or price. So it is important to try and determine whether a price change that is caused by demand will be temporary or permanent. Let's say there's a sudden increase in the demand and price for umbrellas in an unexpected rainy season; suppliers may simply accommodate demand by using their production equipment more intensively. If, however, there is a climate change, and the population will need umbrellas year-round, the change in demand and price will be expected to be long term; suppliers will have to change their equipment and production facilities in order to meet the long-term levels of demand.

C. Supply and Demand Relationship Now that we know the laws of supply and demand, let's turn to an example to show how supply and demand affect price. Imagine that a special edition CD of your favorite band is released for $20. Because the record company's previous analysis showed that consumers will not demand CDs at a price higher than $20, only ten CDs were released because the opportunity cost is too high for suppliers to produce more. If, however, the ten CDs are demanded by 20 people, the price will subsequently rise because, according to the demand relationship, as demand increases, so does the price. Consequently, the rise in price should prompt more CDs to be supplied as the supply relationship shows that the higher the price, the higher the quantity supplied. If, however, there are 30 CDs produced and demand is still at 20, the price will not be pushed up because the supply more than accommodates demand. In fact after the 20 consumers have been satisfied with their CD purchases, the price of the leftover CDs may drop as CD producers attempt to sell the remaining ten CDs. The lower price will then make the CD more available to people who had previously decided that the opportunity cost of buying the CD at $20 was too high. D. Equilibrium When supply and demand are equal (i.e. when the supply function and demand function intersect) the economy is said to be at equilibrium. At this point, the allocation of goods is at its most efficient because the amount of goods being supplied is exactly the same as the amount of goods being demanded. Thus, everyone (individuals, firms, or countries) is satisfied with the current economic condition. At the given price, suppliers are selling all the goods that they have produced and consumers are getting all the goods that they are demanding. E. Disequilibrium Disequilibrium occurs whenever the price or quantity is not equal to P* or Q*. 1. Excess Supply If the price is set too high, excess supply will be created within the economy and there will be allocative inefficiency. At price P1 the quantity of goods that the producers wish to supply is indicated by Q2. At P1, however, the quantity that the consumers want to consume is at Q1, a quantity much less than Q2. Because Q2 is greater than Q1, too much is being produced and too little is being consumed. The suppliers are trying to produce more goods, which they hope to sell to increase profits, but those consuming the goods will find the product less attractive and purchase less because the price is too high. 2. Excess Demand Excess demand is created when price is set below the equilibrium price. Because the price is so low, too many consumers want the good while producers are not making enough of it. In this situation, at price P1, the quantity of goods demanded by consumers at this price is Q2. Conversely, the quantity of goods that producers are willing to produce at this price is Q1. Thus, there are too few goods being produced to satisfy the wants (demand) of the consumers. However, as consumers have to compete with one other to buy the good at this price, the demand will push the price up, making suppliers want to supply more and bringing the price closer to its equilibrium.

F. Shifts vs. Movement For economics, the movements and shifts in relation to the supply and demand curves represent very different market phenomena: 1. Movements 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. The movement implies that the demand relationship remains consistent. Therefore, a movement along the demand curve will occur when the price of the good changes and the quantity demanded changes in accordance to the original demand relationship. In other words, a movement occurs when a change in the quantity demanded is caused only by a change in price, and vice versa. Like a movement along the demand curve, a movement along the supply curve means that the supply relationship remains consistent. Therefore, a movement along the supply curve will occur when the price of the good changes and the quantity supplied changes in accordance to the original supply relationship. In other words, a movement occurs when a change in quantity supplied is caused only by a change in price, and vice versa. 2. Shifts 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. Shifts in the demand curve imply that the original demand relationship has changed, meaning that quantity demand is affected by a factor other than price. A shift in the demand relationship would occur if, for instance, beer suddenly became the only type of alcohol available for consumption.

Conversely, if the price for a bottle of beer was $2 and the quantity supplied decreased from Q1 to Q2, then there would be a shift in the supply of beer. Like a shift in the demand curve, a shift in the supply curve implies that the original supply curve has changed, meaning that the quantity supplied is effected by a factor other than price. A shift in the supply curve would occur if, for instance, a natural disaster caused a mass shortage of hops; beer manufacturers would be forced to supply less beer for the same price.