Main economic schools and their key features: formula sheet

Key formulas

Opportunity cost

Opportunity cost = value of the best forgone alternative

Only the next best option counts, not every option given up. Include implicit costs such as forgone salary.

Marginal cost

MC = ΔTotal cost ÷ ΔQuantity

For a one-unit change, MC is the extra cost of that unit.

Marginal benefit

MB = ΔTotal benefit ÷ ΔQuantity

Extra benefit from one more unit.

Optimal decision rule

Increase activity while MB > MC; stop where MB = MC

MB usually falls and MC usually rises as quantity increases, but MC can dip at first. With whole-unit data, apply the rule unit by unit: produce while MB > MC and stop before the first unit where MB < MC. Ignore sunk costs.

Economic cost

Economic cost = explicit cost + implicit cost

Explicit costs are actual payments. Implicit costs are the value of owned resources used, such as the owner's own time.

Say's Law (idea)

Aggregate supply creates its own aggregate demand

Income from production is spent, so general overproduction cannot persist. Money is only a medium of exchange.

Saving-investment equilibrium

Saving (S) = Investment (I), adjusted by the interest rate

Classical view: a rise in saving lowers the interest rate, which raises investment and keeps total demand intact.

Labour market clearing

Labour demand = Labour supply at the equilibrium real wage

Flexible wages remove unemployment. Any remaining unemployment is voluntary or frictional.

Long-run aggregate supply

LRAS is vertical at the full-employment output Yf

Output depends on resources and technology, not on the price level. Demand changes affect only prices.

Quantity theory link

M × V = P × T

With V and T fixed, changes in money supply M change only the price level P. Money is neutral.

Marx's value of a commodity

Value = c + v + s

c = constant capital (machinery, materials used up), v = variable capital (wages), s = surplus value.

Rate of surplus value (rate of exploitation)

s' = s ÷ v

Surplus value divided by variable capital. Also equals surplus labour time ÷ necessary labour time.

Organic composition of capital

OCC = c ÷ v

Ratio of constant to variable capital. Marx argued it tends to rise as firms mechanise.

Rate of profit

r = s ÷ (c + v)

Profit relative to total capital advanced. If OCC rises while s' stays the same, r falls.

Consumer equilibrium (equimarginal rule)

MUx ÷ Px = MUy ÷ Py

Holds for two goods when the consumer spends the whole budget and maximises utility. Extends to all goods.

Marginal utility

MU = change in total utility ÷ change in quantity consumed

Diminishing marginal utility means MU falls as consumption rises.

Profit maximisation

MR = MC

The firm produces where marginal revenue equals marginal cost, with MC rising through MR.

Market equilibrium

Quantity demanded = Quantity supplied

The price at which this holds is the market-clearing price.

Aggregate demand

AD = C + I + G + (X − M)

C is consumption, I investment, G government spending, X exports, M imports.

Marginal propensity to consume

MPC = ΔC ÷ ΔY

Share of an extra rupee of income that is spent. MPC + MPS = 1 when income is either consumed or saved.

Simple multiplier (no taxes, no imports)

k = 1 ÷ (1 − MPC) = 1 ÷ MPS

Change in income = k × change in autonomous spending.

Multiplier with taxes and imports

k = 1 ÷ (1 − MPC(1 − t) + m)

t is the marginal tax rate and m the marginal propensity to import. Leakages reduce the multiplier. Use only if the question gives t and m.

Change in equilibrium income

ΔY = k × ΔA

ΔA is the change in autonomous spending, such as investment or government spending.

Equation of exchange

MV = PT

M = money supply, V = velocity, P = price level, T = volume of transactions. It is an identity; it becomes a theory when V and T are assumed stable.

Growth-rate form

%ΔM + %ΔV ≈ %ΔP + %ΔT

An approximation for small changes. If V is constant, inflation ≈ money growth − output growth.

Monetarist inflation rule

Inflation ≈ money supply growth − real output growth (with V constant)

Holds only if velocity is constant.

Expectations-augmented Phillips curve

Actual inflation = expected inflation + f(unemployment gap from natural rate)

At the natural rate, actual inflation equals expected inflation. There is no long-run trade-off.

Money growth rule

Money supply growth = target growth in real output (steady rate)

Friedman's rule to give stable prices and predictability.

Rational expectations

Expected value = actual outcome + random error, with the error having mean zero and being unrelated to available information

Forecast errors are not systematic. This does not mean people are always right.

Policy ineffectiveness proposition

Output deviation from natural level arises only from unanticipated shocks: Y − Y* = f(actual price level − expected price level)

This is the Lucas-type supply idea. Anticipated policy changes Y − Y* by zero when prices are flexible.

Menu cost condition

Firm leaves price unchanged if the profit gain from changing it < menu cost

Individually small gains can mean large aggregate effects through demand spillovers.

School comparison rule

New classical: rational expectations + flexible prices. New Keynesian: rational expectations + sticky prices. Austrian: credit-driven cycle + market knowledge

Use this one-line summary to place any question quickly.

Rational choice benchmark

Choose the option with the highest expected utility: EU = Σ p × U(outcome)

Behavioural economics tests this benchmark. It does not abandon it as a reference point.

Stagflation condition

Stagflation = high inflation + high unemployment + weak output growth at the same time

A supply shock moves short-run aggregate supply inwards. Price level rises and output falls.

Expectations-augmented Phillips curve

π = πᵉ − b(u − uₙ)

π is inflation, πᵉ expected inflation, u unemployment, uₙ the natural rate. If expectations adjust fully, there is no long-run trade-off.

Loss aversion (idea)

|Value of a loss of x| > |Value of a gain of x|

A conceptual statement from prospect theory, not a fixed number.

Quick revision

• Scarcity forces choice, and opportunity cost is the value of the best alternative given up.
• Positive statements describe what is; normative statements say what ought to be.
• Classical economics: markets self-correct, government should be limited.
• Marxian economics: focuses on class conflict between capital and labour, and critiques capitalism.
• Neoclassical economics: uses marginal analysis and rational choice to explain prices and allocation.
• Keynesian economics: total demand drives output, and markets can stay below full employment, so government demand management can help.
• Monetarism: money supply growth is the key driver of inflation, and policy should follow rules.
• The Chicago School generally favours free markets and limited intervention.
• New Classical economics: rational expectations make systematic policy less effective.
• New Keynesian economics: wage and price stickiness can justify policy action.
• Austrian school: stresses individual choice, entrepreneurship and distrust of central planning.
• Behavioural economics: real people show biases and use rules of thumb, not perfect rationality.

Common mistakes

• Adding up all alternatives forgone to get opportunity cost. Fix: Opportunity cost is the value of only the single best alternative given up.
• Treating a normative statement as positive because it sounds factual or includes numbers. Fix: Look for value words like 'should', 'unfair' or 'best'. A positive statement can be wrong but is still testable.
• Saying Say's Law means no product can ever go unsold. Fix: Say that there can be temporary mismatches in particular markets, but no lasting general glut across the whole economy.
• Describing the invisible hand as a real planner or as government action. Fix: Define it as the unintended social benefit that arises from individuals pursuing self-interest in competitive markets.
• Saying surplus value is the same as profit in the accounting sense. Fix: Surplus value is a Marxian concept based on labour. Profit is the money form that surplus value takes, after it is shared with rent and interest.
• Using total capital instead of wages as the base for the rate of surplus value. Fix: s' = s ÷ v. The rate of profit is s ÷ (c + v). Check which one the question asks for.
• Saying neoclassical economics rejects free markets or is the same as Keynesian thinking. Fix: Remember neoclassical economics supports market-based allocation and is built on classical foundations, with a new focus on marginal analysis.
• Stating that classical economists ignored value and price. Fix: Say classical writers explained value mainly through cost of production, while neoclassical writers added marginal utility and demand.
• Using k = 1 ÷ MPC instead of 1 ÷ (1 − MPC). Fix: Remember k = 1 ÷ MPS. If MPC = 0.8, MPS = 0.2 and k = 5, not 1.25.
• Saying Keynes believed markets never work or that government should always run deficits. Fix: Say that markets can be slow to adjust in the short run, so stabilisation helps in slumps. Keynes did not call for permanent deficits.

Exam tips

• In MCQs, one option is often a total or average figure. Check whether the question asks for marginal values.
• Define terms in one precise line, then apply them to the scenario. Written answers earn marks for application, not definition alone.
• For positive vs normative, quote the key word that decides it, such as 'should' or a measurable claim.
• Always show the best forgone alternative explicitly when asked for opportunity cost, and say that sunk costs are ignored if relevant.
• Link the idea to an actuarial or business setting, such as insurer pricing or capital allocation, when the question gives that context.
• Write definitions in one line, then add the assumption behind them. Examiners reward the link between idea and assumption.
• In comparison questions, use a short contrast: classical means flexible prices and supply-led output; Keynesian means sticky prices and demand-led output.
• Name the thinker with the idea: Smith for invisible hand and division of labour, Say for the market law, Ricardo for comparative advantage.