Chapter 5: Fundamentals of Economic Analysis

Economics

The study of how society uses scarce resources to produce and distribute goods and services. It involves analyzing the behavior of individuals, businesses, and governments in making decisions about how to allocate resources.

Resources

The materials, tools, and information used to accomplish a task or achieve a goal. Examples include natural resources like water and minerals, human resources like skills and knowledge, and physical resources like computers and machinery. Efficient use of resources is important for successful completion of projects.

Scarcity

The condition where there are limited resources to fulfill unlimited wants and needs.

Trade-offs

Making a trade-off involves giving up something in order to gain something else. It is the act of choosing between two options, where selecting one option means sacrificing the benefits of the other. Trade-offs are an essential aspect of decision-making, and they are important in personal, business, and political contexts.

Opportunity cost

The cost of an alternative that must be forgone in order to pursue a certain action. It is the value of the next best alternative that must be given up to engage in an activity.

Cost-benefit analysis

A method used to evaluate the potential gains and losses of a project or investment. It compares the cost of implementing a decision with its expected benefits, allowing decision-makers to determine whether the benefits outweigh the costs.

Total Cost

The sum of all costs incurred by a company to produce and sell a product or service, including both fixed and variable costs. It is calculated by adding up the total variable costs and total fixed costs. Understanding the total cost is important for determining the profitability of a product or service.

Explicit cost

The cost of resources that a firm uses and pays for in its production process. These costs are directly accounted for in the firm's accounting statements.

Implicit cost

The opportunity cost of using a resource for a particular purpose, measured by the value of the benefit foregone from the next best alternative use.

Total benefit

The sum of all the gains and advantages obtained from a particular activity or decision.

Marginal

The next unit or increment of an action

Marginal social benefit

 The additional benefit that society receives from the consumption of the next unit of a good or service

Marginal social cost

The additional cost that society incurs from the production of the next unit of a good or service

Marginal analysis

Making decisions based upon weighing the marginal benefits and costs of that action. The rational decision maker chooses an action if the MB ≥ MC

Production possibilities

Different quantities of goods that an economy can produce with a given amount of scarce resources. Graphically, the trade-off between the production of two goods is portrayed as a production possibility curve or frontier (PPC or PPF)

Production possibility curve or frontier (PPC or PPF)

A graphical illustration that shows the maximum quantity of one good that can be produced, given the quantity of the other good being produced.

Law of increasing costs

The more of a good that is produced, the greater the opportunity cost of producing the next unit of that good

Absolute advantage

This exists if a producer can produce more of a good with the same quantity of resources, or the same quantity of goods with fewer resources, than all other producers

Comparative advantage

A producer has comparative advantage if it can produce a good at lower opportunity cost than all other producers

Specialization 

When firms focus their resources on production of goods for which they have comparative advantage, they are said to be specializing

Productive efficiency

Production of maximum output for a given level of technology and resources. All points on the PPF are productively efficient

Market failure

A market outcome for which the quantity produced is not allocatively efficient (MSB ≠ MSC) and either too many or too few units are produced

Allocative efficiency 

Production of the combination of goods and services that provides the most net benefit to society. The optimal quantity of a good is achieved when the MSB = MSC of the next unit. This only occurs at one point on the PPF

Economic growth

This occurs when an economy’s production possibilities increase. It can be a result of more resources, better resources, or improvements in technology

Market economy (capitalism)

An economic system based upon the fundamentals of private property, freedom, self-interest, and prices