Economics: An Introduction to Economic Principles and Concepts
Unit 1 – Introduction to Economics
Economics: a practical science dealing with the production, distribution, and use of goods, services, resources, and wealth. It is ”the science of scarcity and choice.”
Fallacy: a hypothesis that has been proven false but is still accepted by many people because it appears, at first glance, to make sense. The Fallacy of Composition: A mistaken belief that what is good for an individual is automatically good for everyone, or what is good for everyone is good for the individual. The Post Hoc Fallacy(also known as the “cause-and-effect” fallacy): A mistaken belief that what occurs before some event is logically the cause of it. The Fallacy of Single Causation: A mistaken belief, based on oversimplification, that a particular event has one cause rather than several.
Opportunity Cost: The value or benefit that must be given up to achieve something else. For example, by choosing to produce item A, a business
gives up the benefit that it could have gained from producing item B using the same resources.
Relative Cost: The cost of producing one item, A, expressed in terms of the numbers of another item, B, which must be given up to produce A(that is, A’s opportunity cost). Law of Increasing Relative Cost: The increase in the relative cost of producing more of item A, measured by the numbers of another item, B, that could be produced with the same resources.
Frontier: The curve on a production possibilities graph representing the maximum numbers of two items that can be produced with a given amount of resources.
Law of Diminishing Returns: The eventual decline in the rate of extra outputs produced that occurs when one input used in production of the output is held constant and the others are increased.
Law of Increasing Returns to Scale: The increase in the rate of extra outputs produced when all inputs used in production are increased and no inputs are held constant.
Productive Resources(or Factors of Production): Resources (such as land, labor, and capital) that are used to produce goods and services. Land: A factor of production that includes all natural resources used to produce goods. Labour: A factor of production comprising the physical and mental effort contributed by people to producing goods and services. Capital: A factor of production that refers to the machinery, factories, warehouses,
and equipment used to produce goods and services. Real Capital: A more precise term than capital for the machinery, factories, warehouses, and equipment used to produce goods and services. It is distinct from money capital-Money Capital: The funds used to acquire real capital. Productivity: A firm’s ability to maximize output from the resources available, usually measured as the firm’s output per worker. Entrepreneurship: The contribution made by an owner, manager, or innovator who organizes land, labor, and capital to produce goods and services.
Tangible Resources: Physical resources (such as land and labor) that are necessary for production and are visible.
Intangible Resources: Resources that are necessary for production, such as entrepreneurship, knowledge, and an environment for enterprise. Intangibles are not as visible as tangible resources, but they are no less important.
Economic System: The laws, institutions, and common practices that help a country determine how to use its resources to satisfy as many of its people’s needs and wants as possible. Traditional Economy: An economic system in which production decisions are determined by the practices of the past. Command Economy: An economic system in which production decisions are made by government-appointed central planners. Market Economy: An economic system in which production decisions are made by the actions of buyers and sellers in the marketplace. Mixed Economy: An economic system, such as Canada’s, that contains elements of market, command, and traditional systems. Mixed Market Economy: An economic system predominantly featuring characteristics of a free market system but also incorporating some qualities of command economies, such as government-owned enterprise.
Capitalism: An economy characterized by private ownership of business and industry, the profit motive, and free markets. Communism: A political system on the extreme left, founded on the theory of Karl Marx, that calls for government or community ownership of the means of production. Socialism: A political system of the moderate left that calls for public ownership of the principal means of production, to be achieved in a democratic and peaceful manner. Fascism: A political system on the extreme right, combining a free-market economy with a non-democratic form of government.
Political Stability: A stable government can help long-term planning and investment to flourish. Consistency in policy-making promotes both investor and consumer confidence and provides a climate conducive to economic growth. Reduced Public Debt: With very few exceptions, government spending in Canada has increased faster than the revenues being collected through taxes, and as a result, Canada’s public debt has grown larger year after year. Concerned Canadians have begun to demand more balanced budgets from their elected government. Economic Growth: Defined as an increase in the economy’s total production of goods and services. Economic growth can result from the discovery of new natural resources, an increase in the skilled labor force, technological innovations, and more efficient production processes. Increased Productivity and Efficiency: Maximizing productivity means that scarce productive resources are put to efficient use to get as much as possible out of them. Economic efficiency is often the result of healthy competition. Equitable Distribution of Income: The equitable, or fair, distribution of income may be the most value-laden of all economic goals; it is certainly the most controversial. When it comes to dividing up total national output, there can be as many interpretations of what makes for a fair division of wealth as there are stakeholders. Price Stability: Stable prices generally indicate that an economy is healthy. Fluctuating prices complicate planning and discourage investment. Both inflation, a general rise in prices, and deflation, a general fall in prices, are symptoms of an unhealthy economy. Full Employment: In an attempt to reach their optimal production targets, governments try to promote the full employment of the labor force. “Full employment” is usually defined as between 6 and 7 percent of the labor force being out of work. Viable Balance of Payments and Stable Currency: The balance of payments accounts summarize all currency transactions between Canada and foreign economies. If Canadians import significantly more than we export, there will be a negative effect on employment rates in Canada as well as the foreign exchange value of the Canadian dollar. Economic Freedom: Economic freedom refers to the freedom of choice available to workers, consumers, and investors in the economy. Canadian public policy generally promotes economic freedom. Environmental Stewardship: Economic activity must be carried out
without significantly harming the natural environment. Even if this means higher prices for consumers and lower profits for producers, it is important to find ways to reduce the negative effects we are having on the natural environment.
Unit 2 – Demand and Supply
Demand: The quantity of a good or service that buyers will purchase at various prices during a given period of time. Law of Demand: The quantity demanded of a good or service varies inversely with price, as long as other things do not change. This inverse relationship between price and quantity demanded holds for the majority of goods we buy.
Supply: the quantities that sellers will offer for sale at various prices during a given period of time. Law of Supply: The quantity supplied of a good or service will increase if the price increases, and it will fall if the price falls, as long as other things do not change.
Equilibrium price: A price set by the interaction of demand and supply in which the absence of surpluses or shortages in the market means there is no tendency for the price to change.
A price above the equilibrium price will result in a surplus of goods, a price below the equilibrium price will result in a shortage of goods.
Non-price factors: On the demand side: income, population, tastes and preferences, expectations, and prices of substitute and complementary goods; and on the supply side: costs, number of sellers, technology, nature and the environment, and prices of related goods.
Perfect (or pure) Competition: A rare market structure characterized by many sellers (selling exactly the same product) and many buyers, no barriers to entry into the market for new firms, and perfect knowledge of prices (so there are no price differences and no individual can influence them). Characteristics of a perfectly competitive market: It has many producers or sellers, with no single seller large enough to dominate the market. It has many consumers, with no single consumer large enough to dictate price to sellers. Each seller’s product is exactly the same as that of the others so that no seller can increase price based on having a higher-quality product than another seller. All sellers and consumers know what the prices and conditions are throughout the entire market, thereby eliminating the possibility of any price differences.
Price Elasticity of Demand (PED): An expression of how much more or less consumers will buy of a product if its price changes. Price inelastic: If the quantity of a good or service bought does not change much when price rises or falls, it is said to be price inelastic. Price elastic: If the quantity of a good or service bought changes a lot when price rises or falls, it is said to be price elastic. If the PED coefficient is greater than 1.0, then the product is classified as
price elasticity. If the PED coefficient is less than 1.0, then the product is classified as price inelastic.
PED = % change in quantity demanded divided by % change in price (same rules apply for PES) (for PED use minus signs) (for PES use no minuses)
Consumer Surplus: The difference between what consumers are willing to pay for an item and what they actually pay.
If the government believes that people are paying too high a price for a product, it will introduce a ceiling price as a solution. If the government believes that sellers are receiving too low a price for a product, it will introduce a floor price as a solution. If the government believes that it must intervene in a market for social or environmental reasons, it will introduce a subsidy or a quota as a solution.
Ceiling Price: A restriction imposed by a government to prevent the price of a product from rising above a certain level.
Black Market: Shortages can result in black markets: the illegal exchange of goods in short supply.
Floor Price: A restriction imposed by a government to prevent the price of a product from rising below a certain level.
Subsidy: A grant of money from a government to a producer to achieve some desired outcome, such as the installation of pollution-control equipment.
Quota: A restriction placed on the amount of product that domestic producers are allowed to produce; also, a limit on the total quantity of goods imported into a country.
Unit 3 – Business and Labor
Marginal Revenue Product of Labour (MRPL): The amount of additional, or marginal, revenue that is generated for a firm as a result of adding one more worker to the production process. Marginal Product: The change in output that occurs from adding an additional unit of input.
Human Capital: The knowledge, skills, and talents possessed by workers.
Labour Union: A workers’ organization that negotiates with employers and promotes the interests of its members.
Total Profit = Total Revenue – Total Costs
Efficiency: A firm’s ability to produce at the lowest possible cost, measured by either its cost per unit or its unit labor cost.
Total Revenue = (Price x Quantity Sold) – Total Costs Total Profit = (Price x Quantity Sold) – (Fixed Costs + Variable Costs)
Profits maximization when Marginal revenue is ≥ or = Marginal cost and when MRPL > or = MCL VC = TC – FC TP2 – TP1 = MP MR x MP = MRPL
Monopolistic competition: A market structure in which many small to medium-sized firms sell a differentiated product, each having some control over price.
Oligopoly: A market structure characterized by a few large firms, selling an identical or differentiated product, each with some substantial control over price.
Monopoly: A market structure in which one firm has complete control over supply, allowing it to set a profit-maximizing price.
Sole Proprietorship: a business owned and operated by a single person.
Partnership: a firm owned by two or more people and bound by the terms of a legal document known as a partnership agreement.
Corporation: a business firm recognized legally as a separate entity in its own right. Corporations can be either public or private.
Co-Operative: a business owned equally by its various members. Members of a particular co-operative must have a common relationship, goal, or economic purpose. In any co-operative enterprise, for the purposes of collective decision making, each member (regardless of the amount invested) is entitled to a single vote, and a majority vote is required to carry any decision.
Government Enterprise: A business that provides services owned by the federal, provincial, or municipal government. Governments generally provide services that the private sector won’t offer because the profits generated are low relative to the amount of capital invested.
Unit 4 – Intro to Macroeconomics
Macroeconomics: The study of the economy as a whole.
Gross Domestic Product (GDP): The total market value of all final goods and services produced by an economy in a given year.
GDP = C + G + I + (X – M) C = Consumption G = Government Spending I = Investment X = Exports M = Imports
Unemployment rate: The percentage of the labor force that is not working at any given time; the total number of unemployed people divided by the total labour force. Full Employment: The lowest possible rate of unemployment, seasonally adjusted, after allowing for frictional and structural unemployment.
Aggregate demand (AD) is the total demand for all goods and services in an economy. Aggregate supply (AS) is the total supply of all goods and services produced in an economy. Recessionary Gap: The gap between aggregate demand and full-employment equilibrium, characterized by high unemployment, low inflation, and low GDP growth. Inflationary Gap: The gap between aggregate demand and full employment equilibrium; characterized by high inflation, low unemployment, and high GDP growth. An Increase in Aggregate Demand(left): Increase in consumption, decrease in taxes, decrease in savings, decrease in import spending, increase in investment, increase in government spending, increase in exports. A decrease in aggregate demand(right): decrease in consumption, increase in taxes, increase in savings, increase in import spending, decrease in investment, decrease in government spending, decrease in exports.
Recession: A contraction of the economy in which real GDP declines for a minimum of two consecutive business quarters (six months).
Depression: A prolonged recession characterized by falling GDP, very high unemployment, and price deflation. Fiscal policy is the use by a government of its powers of expenditure, taxation, and borrowing to stabilize the economy. The government could increase aggregate demand by using an expansionary fiscal policy. This type of fiscal policy involves decreasing taxes, increasing government spending, or both to stimulate economic growth and lower unemployment rates.
When the economy is suffering from inflation, aggregate demand is too high. Employment is high, and there is high output growth. In this context, the government may wish to decrease aggregate demand by using a contractionary fiscal policy. Tight money policy : a monetary policy of high interest rate, more difficult availability of credit, and a decrease in the money supply. (contractionary policy solves inflationary FE > UE) Easy money policy : A monetary policy of low interest rates, easy availability of credit, and growth of the money supply. (expansionary policy solves recessionary UE>FE)
Employment/Unemployment Rate = (Number of employed divided by the labor force) x 100
GDP Gap = Real GDP x ((unemployment% – full employment%) x 2.5) potential output = real GDP +/- GDP Gap SM = 1/MPW 1 = MPC + MPW
Climate Change and Externalities: Greenhouse gasses (GHGs): Gasses such as carbon dioxide, methane, and nitrous oxide released by the burning of fossil fuels that are contributing to global warming and climate change. The varied consequences of global warming, including excessive rainfall and drought, and other extreme weather events, linked to the release of greenhouse gasses. The effects of climate change are a perfect example of externalities in economics. The emission of GHGs in electricity production, manufacturing, and transportation are not included as “costs of production”; therefore, the third parties that bear the costs of these emissions are subject to the external costs. The Coase theorem states that private transactions can be efficient, accounting for externalities through bargaining and negotiation, under the following conditions: The property rights are clearly defined. The number of firms, people, or parties involved is limited to a few. The level of cost is low and easily negotiable. The issue is simple and clearly understood. Private negotiations are more efficient than government intervention in dealing with negative externalities such as pollution. Subsidy: A grant of money from a government to a producer to achieve some desired outcome, such as the installation of pollution- control equipment. The federal and provincial governments may use direct regulations to limit externalities. Regulation is usually necessary when the production of a good or service results in a highly toxic or dangerous by-product. The government might also use regulations to protect renewable resources such as fish and lumber. Quotas such as restrictions on the amount of fish that can be caught within territorial waters are designed to help manage public resources that would otherwise be overused. Previous environmental crises such as acid rain and depletion of the ozone layer have largely been mitigated through international cooperation. United Nations Framework Convention on Climate Change (UNFCCC): An international agreement negotiated in 1992 that establishes how future treaties called “protocols” or “agreements” are to be negotiated to address the issue of climate change.
Kyoto Protocol: Set targets and standards to generate mandatory greenhouse gas emission reductions in 41 industrialized countries and the European Union.
Tight money policy : a monetary policy of high interest rate, more difficult availability of credit, and a decrease in the money supply. (contractionary policy solves inflationary FE > UE) Easy money policy : A monetary policy of low interest rates, easy availability of credit, and growth of the money supply. (expansionary
policy solves recessionary UE>FE)