Economics Key Concepts: Scarcity, Incentives, and Market Equilibrium

Economics

The study of how individuals, businesses, and governments make the best decisions given scarce resources.

Scarcity

Situation where resources needed to fulfill wants are limited.

Trade-offs

Choosing one option means giving up others due to limited resources.

Rational behavior assumption

People use all available information to achieve their goals and make the best decisions possible.

Incentive

Something that motivates an individual to take action.

Direct incentive

Immediate motivation to act (e.g., joy of learning).

Indirect incentive

Secondary motivation (e.g., doing homework because it appears on exams).

Optimal decision rule

Decisions are made at the margin — compare marginal benefit (MB) to marginal cost (MC).

Marginal cost (MC)

Cost of doing one more unit of an activity.

Marginal benefit (MB)

Additional gain from doing one more unit of an activity.

Optimal decision condition

MB = MC (if MB > MC → do it; if MB < MC → don't).

Opportunity cost

Value of the next-best alternative given up when a choice is made.

No free lunch concept

Even free goods have opportunity costs — you give up time or another activity.

Microeconomics

Study of how households and firms interact in markets and make choices.

Macroeconomics

Study of the economy as a whole — total output, employment, and price level.

Positive analysis

Describes 'what is' — factual, objective statements.

Normative analysis

Describes 'what should be' — value-based, subjective judgments.

Efficiency

Producing what people want at the lowest possible cost.

Equity

Fairness in economic outcomes.

Growth

Increase in total output of the economy.

Stability

Output grows steadily with low inflation and full employment.

Recession

Economic decline lasting two consecutive quarters of falling GDP.

Expansion

Period of economic growth and rising industrial activity.

Output

Total quantity of goods and services produced in a given period.

Unemployment rate

Percentage of the labor force that is unemployed.

Inflation

Overall increase in the price level.

Quantity demanded

Amount consumers are willing and able to buy at a given price.

Demand schedule

Table showing relationship between price and quantity demanded.

Demand curve

Graph of price vs. quantity demanded (downward sloping).

Law of demand

As price ↑ → QD ↓ ; as price ↓ → QD ↑.

Movement along demand curve

Caused only by a price change.

Shift in demand

Caused by changes in income, tastes, related goods, expectations, or population.

Normal good

Demand ↑ when income ↑ ; demand ↓ when income ↓.

Inferior good

Demand ↓ when income ↑ ; demand ↑ when income ↓.

Substitute goods

Price of A ↑ → Demand for B ↑ (used instead).

Complement goods

Price of A ↑ → Demand for B ↓ (used together).

Quantity supplied

Amount producers are willing and able to sell at a given price.

Law of supply

Price ↑ → QS ↑ ; Price ↓ → QS ↓.

Movement along supply curve

Caused by price change.

Shift in supply

Caused by changes in input costs, technology, expectations, or number of sellers.

Equilibrium price

Price where QD = QS.

Equilibrium quantity

Quantity bought and sold at equilibrium price.

Surplus

QS > QD → downward pressure on price.

Shortage

QD > QS → upward pressure on price.

Price adjustment process

Prices fall when surplus exists; rise when shortage exists until equilibrium.

Gross Domestic Product (GDP)

Market value of all final goods and services produced within a country in a given time period.

Final goods

Goods ready for final use by consumers.

Intermediate goods

Inputs used to produce other goods; excluded from GDP to avoid double counting.

Used goods & financial assets

Not included in GDP.

Broker fees

Counted since they're new services.

Gross National Product (GNP)

Market value of all final goods/services produced by a nation's citizens anywhere.

Difference: GNP - GDP

GNP = GDP + factor income from abroad - to abroad.

Nominal GDP

Measured in current prices.

Real GDP

Measured in base-year prices (adjusts for inflation).

Base year

Year whose prices are used for real GDP comparison.

Growth rate formula

((New - Old)/Old) × 100%.

Value added

Value of output - value of intermediate goods.

GDP formula (Expenditure)

GDP = C + I + G + (X - M).

Consumption (C)

Household spending on goods/services.

Durable goods

Last > 3 years (e.g., cars, appliances).

Nondurable goods

Used quickly (e.g., food, clothing).

Services

Non-physical items (e.g., healthcare, education).

Investment (I)

Spending on new capital, inventories, and housing.

Change in inventories

Included in GDP; represents goods produced but not yet sold.

Depreciation

Decrease in capital value over time.

Net investment

Gross investment - depreciation.

Government spending (G)

All government purchases of goods/services, not transfer payments.

Net exports (NX)

Exports - Imports.

Income approach

GDP = Wages + Rent + Interest + Profits (+ adjustments).

National income (NI)

Total income earned by factors of production.

NNP (Net National Product)

GNP - Depreciation.

Disposable personal income

Personal income - taxes; income available to spend/save.

Personal saving rate

(Saving ÷ Disposable Income) × 100%.

Limitations of GDP

Ignores non-market work, leisure, inequality, informal economy, environmental factors.

Production function

Relationship showing how capital (K) and labor (L) combine to produce total output (Y).

Factors of production

Capital (K): tools, machines, buildings; Labor (L): human work time.

Constant returns to scale

Increasing all inputs by z% → output increases by z%.

Marginal product of labor (MPL)

Additional output from one more worker (holding K constant).

Diminishing MPL

Each extra worker adds less output as more labor is used.

Marginal product of capital (MPK)

Extra output from one more unit of K (holding L constant).

Diminishing MPK

Each additional capital unit adds less output.

Technological progress

Allows more output from same inputs.

Profit maximization goal

Firms hire inputs until profit is maximized (MB = MC).

Revenue formula

Price × Quantity = P × Y.

Hiring rule for labor

Hire workers until P × MPL = W.

Hiring rule for capital

Hire capital until P × MPK = R.

Real wage (W/P)

Purchasing power of nominal wage.

Equilibrium condition

Labor is paid its productivity: W/P = MPL.

Real rental rate

Payment to capital = MPK.

How to increase real wages

Increase productivity (MPL).

Working-age population

People 16+ years old, not institutionalized, not in the military.

Labor force

Employed + Unemployed.

Employed

Works full-time or part-time (including temporary work).

Unemployed

Has no job, is available to work, and has actively searched in the last 4 weeks.

Discouraged workers

Stopped looking for work but would accept a job if offered.

Labor-force participation rate (LFPR)

(Labor force ÷ Working-age population) × 100%.

Unemployment rate (u)

(Unemployed ÷ Labor force) × 100%.

U1-U6 unemployment measures

Broader definitions adding long-term, discouraged, marginally attached, and involuntary part-time workers.

Procyclical variable

Moves with business cycle (e.g., GDP).

Countercyclical variable

Moves opposite to business cycle (e.g., unemployment).