Basic Economic Concepts

What is economics?

The study of choice under scarcity

Two categories of economics:

1. Microeconomics

2. Macroeconomics

Microeconomics

The study of choices made by households and firms and how these choices affect particular markets

-Environmental economics is part of it

Macroeconomics

The study of the overall or whole economy

-topics include GDP, inflation, unemployment, business cycle

A. Every choice has a cost

Every economic decision means trading off one thing for another

B. People make better choices by thinking at the margin

People decide what to do by making small changes in their activities

C. Rational self-interest

People are involved in maximizing behavior and respond predictably to opportunities for gain

D. Economic models

Simplified representations of the real world that help understand, explain and predict economic phenomena

Positive economics

Description of the economy or explains how the economy works

-Includes economic facts and theories

-Statements can be empirically tested

Normative economics

How the economy should or ought to be

-Involve value or ethical judgements

-Statements cannot be tested empirically

-Economic policy is closely related to it

Scarcity

There are not enough goods and services to satisfy the wants of everyone

Source of scarcity

There are limited resources to satisfy unlimited material wants

Goods

Tangible items that have value

Services

Intangible activities that have value

Resources or factors of production

These are used to produce goods and services

Land

This category includes land and natural resources

-Natural resources are unimproved or unaltered by other factors of production

Labor

All physical and mental efforts that people make available for production

Capital

Goods used to produce other goods and services

-Also called investment goods

-Includes machinery, tools, factories, computers, buildings and roads

Does not include financial capital: examples of financial capital are stocks, bonds and money

Entrepreneurship

A person who organizes, manages and assembles factors of production, take risks, invents and creates new products or way of doing things

Opportunity cost

The value of the best alternative sacrificed

-example is college education

Opportunity cost includes:

-Includes tuition, fees, textbooks and foregone earnings

-Does NOT include room and board

Production Possibilities Curve (PPC)

The maximum combination of two goods and economy can produce

Assumptions of the PPC

A. Fixed resources

B. Fully employed resources (no unemployed resources)

C. Technology is fixed

Scarcity causes the PPC to be negative-sloped or downward-sloping

-Means there is a trade-off between the two good, i.e, producing more of one good means less of another good can be produced

-This trade-off shows there is an opportunity cost for each combination of goods chosen

Law of increasing opportunity cost

-This law states that as more of a good is produced, more and more of the other good must be sacrificed

-This law is shown by the BOWED-OUT shape of the PPC

-Why does this Law occur? Resources are not completely adaptable to alternative uses

Three fundamental economic questions:

Every society must answer these 3 questions:

1. What? A society must decide which goods and services will be produced and in what quantities

2. How? A society must decide how to combine resources and technology in the most efficient way to produce goods and services

3. For whom? A society must decide how to distribute the goods and service it has produced