Summary Principles of economics

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ISBN-10 0077132734 ISBN-13 9780077132736
292 Flashcards & Notes
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This is the summary of the book "Principles of economics". The author(s) of the book is/are Moore McDowell. The ISBN of the book is 9780077132736 or 0077132734. This summary is written by students who study efficient with the Study Tool of Study Smart With Chris.

Summary - Principles of economics

  • 2.1 Exchange and opportunity cost

  • The scarcity principle tells us that:
    The opportunity cost of spending more time on any one activity is having less time available to spend on others.
  • 2.1.1 The principle of comparative advantage

  • One person has an absolute advantage over another if:
    An hour spent in performing a task earns more than the other person can earn in an hour at the task.
  • One person has an comparative advantage over another in a task if:
    His or her opportunity cost of performing a task is lower han the other person's opportunity cost.
  • The principle of comparative advantage states:
    Everyone does best when each person (or each country) concentrates on the activities for which his or her opportunity cost is lowest.
    -> the gains made possible from specialization based on comparative advantage constitute the rationale for market exchange.
  • 2.2 Comparative advantage and production possibilities

  • The production possibilities curve is:
    A graph that describes the maximum amount of one good that can be produced for every level of production of the other good.
    Because the PPC marks the boundary between what an economy can produce from its own resources and levels of production that are beyond its capability, it is frequently referred to as the 'production possibility frontier' or PPF.
  • On the PPC, an attainable point is:
    Any combination of goods that can be produced using currently available resources.
  • Outside the PPC, an unattainable point is:
    Any combination of goods that cannot be produced using currently available resources.
  • Inefficient points are:
    Any combination of goods for which currently available resources enable an increase in the production of one good without a reduction in the production of the other.
  • Efficient points are:
    Any combination of goods for which currently available resources do not allow an increase in the production of one good without a reduction in the production of the other.
  • The Principle of Increasing Opportunity Cost (also called 'The Low-Hanging-Fruit Principle') states:
    In expanding the production of any good, first employ those resources with the lowest opportunity cost, and only afterwards turn to the resources with higher opportunity costs.
  • 2.3 Factors that shift the economy's PPF

  • The three main factors that drive economic growth (and therefore shift the economy's PPF) are:
    • Increases in productive resources: capital equipment (investment in new factories and equipment)
    • Increases in productive resources: labour (population growth)
    • Improvements in knowledge and technology
  • 2.3.1 Why have some countries been slow to specialize?

  • Three important factors that influence the degree of specialization in an economy are:
    • Population density to avoid too small and fragmented markets.
    • Laws and customs that limit people's freedom to transact freely with one another.
    • The size of the market: it is worth doing only if a significant quantity of output is to be produced.
  • 2.4 Comparative advantage and the gains from international trade

  • The slope of the PPF tells us:
    The costs of one product/activity in terms of the other product/activity. This is the rate at which the economy can exchange the products/activities from its own resources at that specific point at the PPF.
  • When the prices at which a country can trade are different from the opportunity cost of the two goods (the slope of the PPF) the country can increase its total consumption by changing what is produces and exchanging goods at trade prices.
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Different costs of economic growth are:
  • The costs of creating new capital. High rates of investment in new capital require people to consume less and save more.
  • Costs of research and development (R&D) -> scarcity principle 
Rather than thinking of A as a measure of technical progress only, we can think of it as the contribution to the growth in total output made by factors other that the inputs capital and labour. When viewed in this way, A is often referred to as:
Total factor productivity (TFP), because it is the amount by which output would increase even if the quantities of capital and labour are constant.
Significant differences in human capital can also explain differences in productivity and living standards, this is:
The accumulation of skills, experience and knowledge by the workforce.
y = Af(k, h)
Average labour productivity can increase even if the capital-labour ratio is constant because of technical progress, this is:
An improvement in knowledge that enables a higher output to be produced from existing resources.
we can write the production function as: y = Af(k) where A denotes technology.
The assumption of constant returns to scale means:
If the labour and capital inputs are both increased by equal proportions then total output increases by the same proportion.
We write the production function as: zY = F(zK, zN)
The assumption of diminishing marginal product means:
If the amount of labour and other inputs employed is held constant, then the greater the amount of capital already in use, the less an additional unit of capital adds to production.
Two assumptions about the production function are:
  • Production is subject to diminishing marginal product 
  • Constant returns to scale to individual inputs.
We assume that there are only two inputs, physical capital (K) and labour (N). The relationship between Y, K, and N is known as:
The production function, written as: Y = F(K,N)
We express real GDP as the product of two terms:
Average labour productivity and the share of the population that is working. Real GDP per person can grow only to the extent that there is growth in worker productivity and/or the fraction of the population that is employed. Increases in output per person primarily arise from increases in average labour productivity.
The power of compound interest is that:
Even at relatively low rates of interest, a small sum, compounded over a long enough period, can greatly increase in value. Economic growth rates are similar to compound interest rates. Over the long run, the rate of economic growth is an extremely important variable. Hence, government policy and other factors that affect the long-term growth rate even by a small amount will have a major economic impact.