Applied Economics
Lecture 1
Chapter 1-2-3
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Course Materials
MAIN TEXTBOOK
§ “Business Economics”
by N. Mankiw, M. Taylor and A. Ashwin
§ “Core Economics”
• Free access once you register on their site
§ The course web page in QMPlus contains lecture notes for
each lecture and class exercises
• Study the material and prepare ahead of the classes
ASSESSMENT
§ Midterm Test: 40%
§ Exam in January: 60% 3 of 38
Module description
§ Focus on businesses & households decision-making
• Every single day, every time you make a decision, you
behave like an economist!
§ Course covers both micro and macro-economics
• Micro: focus on how households/firms makes decisions
• Macro: focus on the environment in which firms have to
operate
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Syllabus
1. Introduction / Economic principles
2. Supply and demand
3. Elasticities
4. Firm behaviour
5. Production, pricing and market structures (I)
6. Production, pricing and market structures (II)
7. … Reading Week…
8. Consumer Theory
9. Behavioural Economics & Policy
10.Macro Aggregates - Aggregate demand & supply
11.Unemployment & Inflation
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12.Fiscal, monetary and supply-side policies
Economics is:
Making decisions + Scarcity
§ A CEO faces many decisions (i.e. how many people to
employ, wages...)
• And has to allocate scarce resources among competing uses
§ A society/country faces many decisions as well (i.e. what
job will be done and who will do those)
• Also with scarce resources
§ Scarcity = limited nature of society’s resources
§ Economics is the study of how society manages its scarce
resources => that is how the society (Firms+ households)
makes decisions 6 of 38
Economics is:
Making decisions + Scarcity
§ The management of the scarce resources is down to
individuals and/or group decisions
§ People want to get the most from scarce resources
whether they are buyers, producers or sellers
§ Economics has many facets BUT there are key
principles about:
(i) how people and business make decisions (principles 1-4)
(ii) how people and businesses interact (principles 5-7)
(iii) how economy work (principles 8-10)
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Let’s review these in turn
How do people and business
make decisions?
Principles 1-4
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Principle 1
Decision making involves trade-offs
§ Different types of trade offs in everyday life (i.e. for managers, employees,
society)
§ Society faces trade offs between efficiency and equity
§ Efficiency: The property of a society to get the most it can from scarce
resources:
• Technical efficiency: use existing resources to produce more
• Productive efficiency: produce output at the lowest cost
• Allocative efficiency: cost of resources to produce = value placed by
consumers
• Social efficiency: cost of production (pollution) = to social benefit of
consumption
§ Efficiency refers to the size of the economic cake and equity refers to how
the cake is divided
§ Equity: benefits of resources are distributed fairly among9 society’s
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Principle 2
The cost of something is what you give up to get it
§ Making decisions requires you to compare costs and
benefits
• BUT in some cases costs go behind the “pure” monetary cost
§ The opportunity cost is whatever is given up to obtain
something else
• The second best alternative foregone
§ It measures the value of what is foregone/sacrificed (i.e.
time, pleasure, etc)
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Principle 3
Rational people and businesses think at the margin
§ Many decisions are made at the margin
• Eg: working an extra hour, spend a little bit of time with the family,
etc..
§ Marginal change = small incremental adjustments to an
existing plan of action
§ Marginal Costs (MC) versus Marginal Benefits (MB)
• Firms are interested in the marginal costs: the cost of producing an
additional unit of output
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Principle 4
People and businesses respond to incentives
§ People compare the costs (C) and benefits (B) when making
decisions
§ Take an action if and only if the marginal benefits are at least as
great as the marginal costs
§ Their behavior can change if C and B change = > people respond
to incentives
§ Many public policies aim at altering behaviors through incentives
• EG: tax on petrol: Take a bus versus driving the car? Tax on petrol increases
the cost of using the car and incentivizes people to use public transports
• Example of cigarette taxation. 12 of 38
• Effectiveness of interventions from a ‘behavioural economics’ perspective?
How do people and business
interact?
Principles 5-7
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Principle 5
Trade can make everyone better off
§ Trade between two countries can make each
economy better off
§ Countries as well as businesses benefit from the
ability to trade with one another
§ Trade allows business and countries to specialize
in what they do best and to enjoy a greater variety
of goods and services
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Principle 6
Markets are usually a good way to organize
economic activity
§ Communist countries adopted central planning
• government organizes economic activity in a way that promoted economic well-
being
§ In a market economy, the decisions of a central planner are
replaced by the decisions of millions of firms and households
§ So although free markets contain buyers and sellers interested in
their own wellbeing => markets have promoted economic well-being
• Adam Smith’s “invisible hand”: everyone is motivated by self-interest but the
invisible hand guides this self-interest into a general economic well-being
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Principle 7
Governments can improve market outcomes
1. CAN PROMOTE EFFICIENCY
§ Market failure is when the market on its own fails to produce an
efficient allocation of resources
• Externalities are the uncompensated impact of a person or
firm’s action on the well-being of a third party (i.e. pollution,
noise)
• Clearly, we care most about negative externalities. Positive
externalities (eg vaccinations)
• Market power is when an economic agent is able to influence
market prices
§ Governments can intervene to improve markets (eg: by taxing
pollution, or increasing competition in case of market power)
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2. CAN PROMOTE EQUITY (eg: income tax)
How does the economy as a
whole work?
Principles 8-10
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Principle 8
An economy’s standard of living depends on its
ability to produce goods and services
§ Standard of living measured by Gross domestic product per
head (per capita) (GDP) = the amount of final goods and
services produced within a country in a given period of time
divided by the population
§ Variation in living standards is attributable to differences in
countries’ productivity
• i.e. amount of goods and services produced from each hour of a worker’s
time
§ In Nations where workers can produce more, most people
enjoy a higher standard of living overall
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• Note: GDP does not tell us anything about inequalities between people!
GDP per capita
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Principle 9
Prices rise when the government prints too much
money
§ Inflation is the overall increase in prices
§ Printing money leads to price rises, because the value of
money falls
§ Central Banks are responsible for the Money Supply in the
economy
• Independence of Central Bank in order to make more objective
about the state of the economy?
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Principle 10
Society faces a short-run trade-off between
inflation and unemployment
§ In the short-run there is a trade off between unemployment
and inflation as shown in the Phillips curve
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