Modern Principles of Economics

• Incentives Matter
• Good Institutions Align self-intersts with social intersest
• Trade-offs are everywhere
• Marginal Thinking
• Trade makes people better off
• Wealth and Economic Growth are important
• Institutions Matter
• Economic Cycles can be moterated, but not avoided
• Inflation is caused by increased money supply
• Central Banking is Hard

Scarcity is the root cause of trade-offs. How do we allocate scarce resources.

With out trade specilaization is impossible. There are basic things you need to survive. You cant afford the luxury of specilaization unless you are able to trade you niche knowledge/skills for the necessities.

The size of the market matters

A simple rule of thumb which will help everything fall into place is that what changes the equilibrium price and quantity are shifts in demand and supply, and that’s it. So whenever you are asked, “Why did the price rise?” or “Why did the quantity fall?” always start with a shift in demand or supply. Everything else follows.

Who ultimately pays the tax does depend on the relative elasticities of demand and supply.

A price is a signal wrapped up in an incentive. One of the most fundamental insights of economics

Price system like EFT

A price is a signal wrapped up in an incentive because prices signal the value of resources to consumers, suppliers, and entrepreneurs, and they incentivize everyone to take appropriate actions to respond to scarcity and changing circumstances.

When a crisis in the Middle East reduces the supply of oil, the price system rationally responds by reallocating oil from lower-valued uses to the highest-valued uses. Because the price gets bid up

In contrast, when the supply of oil is reduced and there are price ceilings, oil is allocated according to random and often trivial factors. eg: first come first serve

At best, the minimum wage will raise the wages of some teenagers and young workers whose wages would increase anyway as they improve their education and become more skilled. At worst, the minimum wage will raise the price of a hamburger and create unemployment among teenagers, many of whom will simply choose to stay in school longer (not necessarily a bad thing). The minimum wage debate is more about rhetoric than reality.

When externalities are significant, markets work less well and government action can increase social surplus.

The Coase theorem says that if transaction costs are low and property rights are clearly defined, then private bargains will ensure that the market equilibrium is efficient even when there are externalities.

markets alone will not solve all externality problems.

What we have shown is that trading pollution allowances is like a new technology that reduces pollution at lower cost.

The EPA’s system of tradeable allowances is a successful application of the Coase theorem. Recall that the Coase theorem says that markets can internalize externalities when transaction costs are low and property rights are clearly defined.

The marginal cost equals the average cost, when the average cost is at the minimum :

Average Cost (AC) = C / Q d(AC)/dQ = - C / Q² + 1/Q dC/dQ = 0 => C/Q = dC/dQ but, Marginal cost (MC) = dC/dQ so AC = MC at the minumum

Another way to think about this… The average is falling when the marginal cost is below the average cost. Likewise, the average is growing when the marginal cost is above the average.

When we say that a firm is earning zero profits, we mean that the price of output is just enough to pay labor and capital their ordinary opportunity costs.

The first 1st invisible hand property tells us that in a competitive industry, the total industry costs of production are minimized. The second invisible hand property ensures the total value of all production is maximized.

The elasticity of demand determines the size of the monopoly markup

The problem with monopoly is the deadweight loss it causes, similar to prisoners dillemma payouts. They can keep get more by reducing the overall surplus.

modern theories of economic growth emphasize that monopoly—when it increases innovation—may increase economic growth.

A cartel is a group of suppliers who try to act as if they were a monopolist.

The prisoner’s dilemma is the negative counterpart to the invisible hand. In one case, the persuit of self interest leads to the optimal outcome in the other self interest leads to an outcome that no one wants.

Since it’s more valuable to keep a productive workplace clean than to keep a less productive workplace clean, the wages of U.S. janitors are higher than those in India.

The second reason that janitors in the United States have a higher marginal product than janitors in India is that the supply of janitors is lower in the United States than in India.

Markets tend to underprovide public goods. No one has yet discovered a workable process that, as if guided by an “invisible hand,” produces optimal amounts of public goods.

Many of the world’s problems arise when property rights to goods are either not possible, not protected, or not easily implemented.

We learn from our “capital only” model that the economy will move toward a steady state in which there is no capital accumulation. Thus, long-run economic growth cannot be due to capital accumulation. The logic of diminishing returns means that eventually capital and output will cease growing.

The logic of diminishing returns applies to human capital just as much as to physical capital and neither can drive long-run economic growth.

the money necessary to cover the government’s budget deficit comes from a combination of reduced consumption and reduced private investment and other private borrowing.

interest rates and bond prices move in opposite directions. The inverse relationship between bond prices and interest rates tells us that in addition to default risk, people who buy bonds also face interest rate risk. In other words, bond buyers are making bets that interest rates will fall (bond prices will rise), or at least they are hoping that interest rates will fall.

The important lesson, however, is that slogans like “make corporations pay their fair share!” don’t make sense. We can call it a “corporate tax” but that doesn’t mean that corporations or even capitalists end up paying the final bill.

The great debate over fiscal policy is about the balance of two opposing forces: crowding out versus the multiplier effect.