Economics Foundations and Consumer Choice: Key Concepts and Models

Economics / Scarcity

The study of how people make choices under conditions of scarcity (limited resources). Scarcity forces trade-offs.

Microeconomics

Focuses on individual units (households, firms, workers) and specific markets. Deals with supply, demand, pricing, and resource allocation.

Macroeconomics

Studies the economy as a whole: inflation, unemployment, growth, and government policies.

Households

A person or group of people who share their income.

Firms

Any organization that produces goods or services for sale.

Factors of Production

The economy's resources used to produce goods and services. Four factors: Land (natural resources), Labor (work effort), Capital (tools/machines), Entrepreneurship (risk-taking, innovation).

Opportunity Cost

The value of the next best alternative you give up when making a choice.

Marginal Analysis

Decision-making at the margin: comparing additional (marginal) benefits vs additional (marginal) costs.

Positive vs Normative Economics

Positive = 'what is' (objective, testable). Normative = 'what ought to be' (subjective, value-based).

Three Basic Economic Questions

1. What to produce? 2. How to produce? 3. For whom to produce?

Economic Systems

Traditional: customs/traditions guide choices. Market/Capitalist: decentralized, prices from supply & demand. Command: government makes all key decisions. Mixed: blend of market and government roles.

Incentives

Rewards or punishments that shape behavior (e.g., profit motive, property rights).

Economic Models

Simplified representations of reality used to test theories, predict outcomes, and understand relationships.

Production Possibilities Curve (PPC)

Graph showing maximum combinations of goods with current resources. Demonstrates scarcity, trade-offs, and opportunity cost. On the curve = efficient use. Inside = inefficiency. Outside = unattainable without growth.

What are the two types of efficiency, and what do they represent

Productive efficiency: using all resources fully. Allocative efficiency: producing the mix of goods society most wants.

Economic Growth

Occurs when resources increase or technology improves, shifting the PPC outward.

Comparative Advantage

The ability to produce a good at lower opportunity cost than another. Basis for trade.

Absolute Advantage

Producing more of a good with the same resources (not the basis for trade).

Specialization

Focusing on producing certain goods to increase efficiency. Usually leads to trade.

Trade

Exchanging goods based on comparative advantage allows consumption beyond the PPC.

Utility

Satisfaction or benefit from consuming goods/services. Marginal Utility: extra satisfaction from one more unit. Law of Diminishing Marginal Utility: satisfaction decreases with each additional unit consumed.

Cost-Benefit Analysis

Comparing costs and benefits of an action to decide if it's worthwhile.

Sunk Cost

A past cost that cannot be recovered. Should not affect current decisions (sunk cost fallacy = when it does).

Budget Constraint

Consumers cannot spend more than their income allows.

Budget Line

Graph showing all consumption bundles affordable with full use of income.

Consumption Bundle

A specific combination of goods/services chosen under the budget constraint.

Spending the Marginal Dollar

Allocating each additional dollar of spending where it yields the highest marginal utility.

Marginal Utility per Dollar

Marginal utility of a good ÷ its price. Guides how spending should be reallocated.

Optimal Consumption Rule

Utility is maximized when MU per dollar is equal across all goods (MUc/Pc = MUt/Pt).

Marginal Utility

Extra satisfaction from one more unit.

Law of Diminishing Marginal Utility

satisfaction decreases with each additional unit consumed.