Unit 1: Basic Economic Concepts

Scarcity

The condition that human wants are unlimited while the resources available to satisfy those wants are limited, forcing choices.

Economics

The study of how individuals, firms, and other organizations manage and allocate scarce resources.

Microeconomics

The study of decision-making by individual households and firms and how those choices interact in markets.

Macroeconomics

The study of the economy as a whole, focusing on economy-wide outcomes (e.g., how money supply changes affect imports/exports).

Factors of Production

The four categories of scarce resources used to produce goods and services: land, labor, capital, and entrepreneurship.

Land (Factor of Production)

Natural resources and raw materials used in production (e.g., water, oil, minerals, forests, energy sources).

Labor (Factor of Production)

Human effort, skills, and time used to produce goods and services, including education and training brought to work.

Capital (Factor of Production)

Productive resources made by humans that help produce other goods and services (e.g., machines, tools, factories, software); not money itself.

Physical Capital

Tools, machines, equipment, factories, and infrastructure used to produce goods and services.

Human Capital

The education, training, and skills that increase a worker’s productivity.

Entrepreneurship

Coordinating resources, taking risks, innovating, and creating new products or production methods.

Trade-off

The idea that choosing more of one thing requires giving up some of another because resources are scarce.

Opportunity Cost

The value of the next best alternative that is forgone when a choice is made (not the total of all alternatives).

Incentive

Anything that motivates action by changing perceived costs and benefits; people respond to incentives.

Economic Model

A simplified representation of reality used to highlight key relationships and support cause-and-effect reasoning.

Ceteris Paribus

A modeling assumption meaning “all else equal,” where other relevant factors are held constant to isolate a relationship.

Positive Statement

A testable, evidence-based claim about what is (often cause-and-effect) that can be evaluated with data.

Normative Statement

A value-based claim about what ought to be, based on opinions or judgments rather than testable facts.

Resource Allocation

How a society decides to distribute scarce resources among alternative uses.

Three Basic Economic Questions

The core resource-allocation questions: what to produce, how to produce, and for whom to produce.

Command (Centrally-Planned) Economy

An economic system in which the government makes most economic decisions, including many prices and wage rates.

Market Economy

An economic system in which resource allocation is guided by price changes as buyers and sellers interact.

Mixed Economy

An economic system combining market forces with government involvement; private property is generally protected but government may intervene to pursue societal goals.

Production Possibilities Frontier (PPF)

A curve showing the maximum combinations of two goods an economy can produce with current resources and technology, assuming efficient use of resources.

Productive Efficiency

Producing the maximum output possible from available resources (on the PPF), often described as producing at the lowest feasible cost for those outputs.

Inefficiency (Inside the PPF)

A situation where production is feasible but resources are underused or misallocated (e.g., unemployment), so output is inside the PPF.

Allocative Efficiency

Producing the mix of goods and services that best matches what society wants; cannot be determined from the PPF alone without preference information.

Slope of the PPF

A measure of opportunity cost along the PPF; the trade-off rate between the two goods (|slope| = ΔY/ΔX).

Increasing Opportunity Cost (Bowed-Out PPF)

A PPF shape showing that as more of one good is produced, larger amounts of the other good must be given up because resources are not perfectly adaptable.

Outward Shift of the PPF (Economic Growth)

An increase in productive capacity (more potential output), caused by improved technology/productivity or increases in the quantity/quality of resources.

Consumer Goods

Goods that satisfy current wants (e.g., food, clothing, entertainment).

Capital Goods

Goods used to produce other goods and services (e.g., machinery, tools, factories; often includes investment in education/infrastructure).

Absolute Advantage

The ability to produce more of a good with the same resources (higher productivity).

Comparative Advantage

The ability to produce a good at a lower opportunity cost than another producer; the basis for gains from trade.

Specialization

Concentrating production on the good in which one has comparative advantage (lowest opportunity cost).

Gains from Trade

The increase in total output and improved consumption possibilities that result when parties specialize by comparative advantage and then trade.

Explicit Cost

A direct out-of-pocket payment made to others (e.g., wages, rent, materials).

Implicit Cost

An opportunity cost of using resources you already own, including non-monetary sacrifices like time, foregone wages, or foregone enjoyment.

Marginal Analysis

Decision-making based on comparing the additional (marginal) benefits and additional (marginal) costs of the next unit of an action.

Marginal Benefit (MB)

The additional benefit received from consuming or producing one more unit.

Marginal Cost (MC)

The additional cost incurred from consuming or producing one more unit (often an opportunity cost).

Optimal Marginal Decision Rule

Do more of an activity if MB > MC, do less if MC > MB, and stop at the quantity where MB = MC (or closest possible) to maximize net benefit.

Sunk Cost

A past cost that cannot be recovered and should be ignored in current decisions because it does not change with the choice made now.

Utility

A measure of personal satisfaction or happiness from consuming goods and services (sometimes measured in “utils”).

Marginal Utility (MU)

The change in total utility from consuming one additional unit of a good or service.

Diminishing Marginal Utility

The principle that as more units of a good are consumed, each additional unit typically adds less to total utility than the previous unit.

Marginal Utility per Dollar (MU/P)

Marginal utility gained from a good divided by its price; used to compare the “bang for the buck” across goods.

Optimal Consumption Rule

To maximize utility, allocate spending so that MU/P is equal across goods in the chosen bundle (e.g., MUc/Pc = MUt/Pt).

Terms of Trade

The rate at which one good exchanges for another; mutually beneficial terms lie between the two parties’ opportunity costs.

Transaction Costs

The costs of making a trade (e.g., shipping, time, information, enforcement) that can reduce or eliminate gains from trade.