Fundamentals of Economics and Microeconomics

Posted on Jan 25, 2025 in Economy

Economy: The economy is the study of how nations use scarce resources to produce valuable commodities and distribute them to different groups.

Microeconomics: A behavioral analysis of specific components, such as industry, business, etc.

Pitfalls in Economic Reasoning

  1. Not Keeping Other Things Constant: The key step to isolating the effect of a variable is to keep the others constant.
  2. The “Post Hoc” Fallacy: The fact that event A is observed before event B does not prove that A caused B.
  3. Fallacy of Composition: The whole is not always the sum of its parts. This fallacy occurs when what is believed to be true for a part is also necessarily true for the whole.
  4. Subjectivity: The result of any analysis depends on the perspective from which it is performed, so the findings must be free of these biases.

Principles of Economics

  1. Economic laws are true only on average and not as exact relations.
  2. The Law of Averages states that the average behavior of groups is much more predictable than the average behavior of each individual.
  3. Efficiency: Production efficiency is where the company cannot increase the production of a good without reducing the production of another. [An efficient economy is on its Production Possibilities Frontier (PPF)]
  4. Opportunity Cost: A decision has opportunity costs because choosing one thing in a world of scarcity means giving up something else.
  5. Law of Diminishing Returns states that when adding successive quantities of a factor and keeping those of others constant, we get an additional amount of product that is increasingly smaller.

The Three Problems of Economics

Every society must decide what goods will be produced, how it will produce them, and for whom they will be produced.

Production Possibilities Frontier

A graph showing the various combinations of products that may be produced by the economy given the factors of production and the existing production technology. The PPF shows a trade-off that society faces. The PPF shows the opportunity cost of a good expressed in terms of the other.

Opportunity Cost

A decision has an opportunity cost because choosing one thing in a world of scarcity means giving up something else. The opportunity cost is the value of a good or service forgone.

The 10 Principles of Microeconomics

How Do Individuals Make Decisions?

  1. Individuals Face Trade-offs: Decision-making is a choice between two objectives. Society also faces a choice between:
    • a) Efficiency: The property whereby society takes advantage of its scarce resources in the best possible way and refers to the size of the economic “cake.”
    • b) Equity: The property under which economic prosperity is fairly distributed among members of society and refers to how the “pie” is divided.
  2. The Cost of Something Is What You Give Up to Get It: People should compare the costs and benefits of various options to make decisions.
  3. Rational People Think at the Margin: “Marginal changes” is a term used by economists to describe the small, additional adjustments to a plan that already existed.
  4. Individuals Respond to Incentives: Individuals make decisions by comparing costs and benefits; their behavior can change when the costs or benefits change. That is, individuals respond to incentives.

How Do Individuals Interact?

  1. Trade Can Improve the Welfare of the World: Through competition, firms benefit. Trade between two countries can improve the welfare of both.
  2. Markets Usually Provide a Good Mechanism to Organize Economic Activity.
  3. The State Can Sometimes Improve Market Outcomes: There are two major reasons the state intervenes in the economy: to promote efficiency and equity.

How Does the Economy as a Whole Work?

  1. The standard of living of a country depends on its ability to produce goods and services.
  2. Prices rise when the government prints too much money.