Chapter 8. Economics: Choices, Markets and Development

Economics studies how people, firms and societies make choices with scarce resources. Microeconomics studies individual decisions and markets; macroeconomics studies the whole economy [21].

Core ideas [21]:

Scarcity and opportunity cost: resources are limited, so every choice means giving up the next-best alternative.

Incentives: people respond to costs and benefits.

Trade-offs and marginal thinking: decisions are made by comparing additional costs and benefits.

Trade creates value: countries and people gain by specializing in what they do at lower opportunity cost (comparative advantage).

Supply and demand. The law of demand: as price rises, quantity demanded generally falls. The law of supply: as price rises, quantity supplied generally rises. The market equilibrium price is where the two are equal. Elasticity measures how strongly quantity responds to price changes [21].

Market structures: perfect competition, monopolistic competition, oligopoly and monopoly.

Market failures. Markets may fail because of externalities (such as pollution), public goods (such as national defence), imperfect information and market power. Governments may respond with taxes, subsidies, regulation or provision of services [21].

Macroeconomic measures

GDP (gross domestic product): the market value of final goods and services produced in a country in a period. In expenditure form, GDP = C + I + G + (X − M).

Inflation: a rise in the general price level, measured by changes in a price index such as the Consumer Price Index (CPI). Inflation rate = ((CPI new − CPI old) / CPI old) × 100.

Unemployment rate: the share of the labour force that is jobless and looking for work [21].

Economic policy. Fiscal policy uses government spending and taxation; monetary policy is managed by the central bank, which influences interest rates and the money supply [21][23].

Key thinkers. Adam Smith wrote about the division of labour and markets [22]; Karl Marx criticized capitalism [10]; John Maynard Keynes argued that governments can help stabilize demand in recessions [23].

Inequality and development. The Gini coefficient measures income inequality from 0 (perfect equality) to 1 (maximum inequality). Piketty has documented long-run patterns of wealth and income inequality [24]. Development involves growth, but also health, education and freedom to choose a life one values, as stressed by Sen [25].

Review: If the CPI rises from 200 to 210, what is the inflation rate? (Answer: (210 − 200)/200 × 100 = 5%.)