Essential Economics Laws
The
Foundations of
Market
Behavior and
Global
Finance
A. Basic Economic Laws
1. Law of Demand: States that, all else being
equal, as the price of a good increases, the quantity demanded decreases, and
vice versa.
2. Law of Supply: States that, all else being
equal, as the price of a good increases, the quantity supplied increases, and
vice versa.
3. Law of Diminishing Marginal Utility: As a
consumer consumes more units of a good, the additional satisfaction (utility)
from each additional unit decreases.
4. Law of Diminishing Returns: In production, adding
more of a variable input (like labor) to a fixed input (like capital) will
eventually result in smaller increases in output.
5. Law of Comparative Advantage: Countries (or
individuals) will benefit by specializing in the production of goods for which
they have a comparative advantage and trading for others.
6. Law of Absolute Advantage: Countries (or
individuals) should produce goods for which they are the most efficient (i.e.,
where they can produce more output with the same input).
B. Laws in Microeconomics
1. Gresham’s Law: Bad money (currency of lesser
value) drives out good money (currency of higher value) when both are in
circulation.
2. Say’s Law: Supply creates its own demand, meaning
production is the source of demand in the economy.
3. Engel’s Law: As income rises, the proportion
of income spent on food falls, even if absolute expenditure on food increases.
4. Price Elasticity Law: The responsiveness of the
quantity demanded or supplied of a good to changes in its price is quantified
by the elasticity of demand or supply.
5. Law of One Price: In an efficient market, all
identical goods must have only one price, after accounting for currency
exchange rates.
6. Law of Substitution: Consumers will substitute a
cheaper good for a more expensive one, as long as the cheaper good satisfies
the same need or desire.
7. Law of Diminishing Marginal Productivity: In
production, as one input increases (with other inputs fixed), the incremental
gains in output from additional units of the input will eventually diminish.
C. Laws in Macroeconomics
1. Okun’s Law: There is an inverse relationship between
unemployment and GDP growth, typically suggesting that a 1% increase in
unemployment leads to a 2% decrease in GDP.
2. Phillips Curve: Suggests an inverse
relationship between unemployment and inflation, where lower unemployment is
associated with higher inflation and vice versa.
3. Fisher Effect: The real interest rate equals
the nominal interest rate minus the expected inflation rate.
4. Tobin’s q Ratio: The market value of a company
divided by the replacement cost of its assets; if q > 1, companies are
overvalued.
5. Quantity Theory of Money: An increase in the money
supply will lead to an increase in prices, assuming velocity and output remain
constant.
6. Law of Diminishing Returns to Scale: Over
time, increasing all inputs in a production process by the same percentage will
eventually lead to less than proportional increases in output.
7. Keynes' Law: In the short run, aggregate
demand, rather than aggregate supply, drives economic activity, especially in a
recession.
D. International Economics
Laws
1. Heckscher-Ohlin Theorem: Countries will export goods
that use their abundant resources more intensively and import goods that use
their scarce resources more intensively.
2. Stolper-Samuelson Theorem: An increase in the price
of a good raises the income of the factor used intensively in its production
and reduces the income of the other factor.
3. Ricardian Law of Comparative Advantage: Even if
a country is less efficient in producing all goods, it can benefit from trade
by specializing in goods where it has the lowest opportunity cost.
4. Balassa-Samuelson Effect: Countries with rapidly
growing productivity in tradable goods will experience higher inflation in
non-tradable goods, which leads to real exchange rate appreciation.
5. Law of International Trade: International trade is
beneficial when countries specialize based on their comparative advantages and
engage in trade.
6. Purchasing Power Parity (PPP):
Exchange rates between currencies are in equilibrium when their purchasing
power is the same in both countries.
7. Interest Rate Parity: The difference in interest
rates between two countries is equal to the difference between the forward and
spot exchange rates.
E. Financial Economics
Laws
1. Modigliani-Miller Theorem: In an efficient market,
the value of a company is unaffected by its capital structure (how it is
financed by debt and equity).
2. Law of Large Numbers: Over time, the average of the
results obtained from a large number of trials should be close to the expected
value.
3. Efficient Market Hypothesis (EMH):
Financial markets are efficient, and asset prices reflect all available
information at any given time.
4. Jensen’s Inequality: In finance, convex functions of
random variables increase in expectation when the random variables become more
volatile.
5. Minsky’s Financial Instability Hypothesis:
Financial markets tend to move from stability to fragility and eventually to
crisis, driven by over-borrowing and speculative activity.
6. Law of Risk and Return: Higher levels of risk are
typically associated with the potential for higher returns, and vice versa.
7. Capital Asset Pricing Model (CAPM): The
expected return of an investment is proportional to its systematic risk (beta).
F. Labor Economics Laws
1. Wagner's Law: As an economy grows, the share
of public expenditure in national income tends to increase.
2. Efficiency Wage Theory: Paying workers higher than the
equilibrium wage may lead to increased productivity and reduced turnover,
compensating for the higher wage costs.
3. Wealth Effect: Consumers tend to spend more as
the value of their assets increases, which stimulates the economy.
4. Becker’s Law of Human Capital:
Investment in education and training improves an individual's skills and
productivity, leading to higher wages over time.
5. Clark's Law of Wages: Wages tend to correspond to the
marginal productivity of labor.
6. Beveridge Curve: Shows the relationship between
unemployment and job vacancy rates in an economy, often reflecting the
efficiency of the labor market.
G. Environmental Economics
Laws
1. Coase Theorem: If property rights are
well-defined and transaction costs are low, private negotiations will lead to
the efficient resolution of externalities, regardless of the initial allocation
of property rights.
2. Environmental Kuznets Curve (EKC): As a
country develops, environmental degradation initially increases but eventually
decreases as income grows and environmental concerns become more important.
3. Pigou’s Law: Imposing taxes on activities
that generate negative externalities (Pigovian taxes) will internalize the
external costs and lead to more efficient market outcomes.
H. Behavioral Economics
Laws
1. Prospect Theory: People value gains and losses
differently, and losses typically have a greater emotional impact than an
equivalent amount of gains.
2. Loss Aversion: Individuals prefer avoiding
losses to acquiring equivalent gains (i.e., it's better not to lose $5 than to
find $5).
3. Endowment Effect: People ascribe more value to
things merely because they own them.
4. Status Quo Bias: People tend to prefer things to
stay the same by doing nothing or by sticking with a decision made previously.
5. Hyperbolic Discounting: People tend to prefer smaller, immediate
rewards over larger, delayed ones, even if the delayed reward is significantly
better.
I. Other Important
Economic Laws
1. Laffer Curve: Describes the relationship
between tax rates and tax revenue. It suggests that there is an optimal tax
rate that maximizes revenue, and beyond that, higher tax rates may reduce
revenue.
2. Say's Law of Markets: Supply creates its own demand,
meaning the production of goods will lead to the consumption of goods.
3. Pareto Principle (80/20 Rule): Roughly
80% of the effects come from 20% of the causes, often applied in economic
efficiency contexts.
4. Law of Unintended Consequences:
Actions, especially in policy or economics, may have effects that are
unanticipated or unintended, often due to complexity in systems.
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