Economics: Core Principles and Applications

Economics

Definition

Derived from the Greek word ‘oikonomos,’ meaning “one who manages a household,” economics studies how societies allocate scarce resources to satisfy unlimited wants and needs.

Core Principles

1. Trade-offs: Acquiring something necessitates forgoing something else (e.g., watching TV versus studying).
2. Opportunity Cost: The cost of something is the value of the next best alternative forgone.
3. Marginal Thinking: Rational individuals make decisions by comparing the additional benefits and costs of an action.
4. Incentives: People's behavior is influenced by incentives, such as price changes (e.g., lower prices may increase consumption).
5. Benefits of Trade: Specialization and trade allow individuals and nations to achieve higher levels of well-being.
6. Market Organization: Free markets, with numerous buyers and sellers, effectively coordinate economic activity.
7. Government Intervention: Governments can intervene to improve market outcomes and address market failures.
8. Standard of Living: A nation's standard of living depends on its productivity (ability to produce goods and services).
9. Inflation: Excessive money creation by governments can lead to inflation (a general increase in prices).
10. Inflation and Unemployment: A short-run trade-off often exists between inflation and unemployment (Phillips Curve).

Production Possibility Frontier (PPF)

The PPF is a graphical representation showing the maximum output combinations of two goods or services an economy can produce with efficient resource utilization.

Total Revenue and Elasticity

If demand is inelastic, a price increase raises total revenue. Conversely, if demand is elastic, a price increase lowers total revenue.

OPEC Example

In the short run, both oil supply and demand are relatively inelastic. Supply is limited by existing reserves and extraction capacity, while demand adjusts slowly to price changes. Over the long run, higher prices incentivize non-OPEC producers to increase exploration and production, and consumers to conserve. Consequently, long-run supply and demand are more elastic. OPEC's supply reductions, while initially profitable, become less so as long-run adjustments occur.