Key Concepts in Economics: From Principles to Market Dynamics
Positive and Normative Economics
Positive Economics
Deals with describing, explaining, or predicting economic phenomena. It is objective and fact-based, where statements can be tested and validated.
Normative Economics
Concerns what ought to be in the economy. It is subjective and value-based, often involving policy prescriptions and opinions.
Definition of Economics
Paul Samuelson
Defined economics as the study of how societies use scarce resources to produce valuable commodities and distribute them among different people.
Adam Smith
Viewed economics as a science of wealth which studies the nature and causes of the wealth of nations.
Problems of Economic Organization: Three Questions
- What to produce?
- How to produce?
- For whom to produce?
Models of Economic Organization
Market Economy
Economic decisions are made by individuals or the open market.
Command Economy
Economic decisions are made by a central authority.
Mixed Economy
Combines elements of both market and command economies.
Factors of Production
Resources used to produce goods and services. Generally classified into four categories:
- Land
- Labor
- Capital
- Entrepreneurship
Production Possibility Frontier (PPF)
A curve depicting all maximum output possibilities for two goods, given a set of inputs consisting of resources and other factors.
Market Theory (Adam Smith)
Adam Smith introduced the concept of the ‘invisible hand,’ asserting that an individual’s pursuit of economic self-interest contributes to the overall good of society, guided by the natural dynamics of supply and demand.
Globalization and Organization of the Market: Three Questions
- How does globalization affect market efficiency?
- How does it influence the distribution of wealth?
- How does it impact economic policies and institutions?
Market Failures
Definition
Situations where the market fails to allocate resources efficiently.
Solutions
Government intervention, regulation, or policies to correct the market’s inefficiency.
Externalities and Public Goods
Externalities
Costs or benefits of economic transactions not included in prices. Can be negative (pollution) or positive (education).
Public Goods
Goods that are non-excludable and non-rivalrous in consumption (e.g., national defense, public parks).
Absolute and Comparative Advantage
Absolute Advantage
The ability of an individual or group to carry out a particular economic activity more efficiently than another activity.
Comparative Advantage
The ability to produce a good at a lower opportunity cost than another producer.
Demand Curve
Characteristics
Downward sloping, showing the inverse relationship between price and quantity demanded.
Factors Behind
Income, tastes and preferences, prices of related goods, expectations, number of buyers.
Supply Curve
Characteristics
Upward sloping, showing direct relationship between price and quantity supplied.
Factors Behind
Production technology, costs of resources, prices of other commodities, expectations, number of sellers.
Movement of Curves
Changes in Prices and Quantities
When demand increases, the demand curve shifts rightward, and vice versa. When supply increases, the supply curve shifts rightward, and vice versa.
Market Surplus and Market Shortage
Market Surplus
Occurs when the quantity supplied is greater than the quantity demanded at a given price.
Market Shortage
Occurs when the quantity demanded is greater than the quantity supplied at a given price.
Price Floor and Price Ceiling
Price Floor
A minimum legal price set above the equilibrium price to prevent the price from falling below a certain level.
Price Ceiling
A maximum legal price set below the equilibrium price to prevent the price from rising above a certain level.