Microeconomics Chapter 1

What is Economics?

• the study of choices and their consequences, focusing on how people make and spend money, business, government, jobs, and the disparity in wealth among individuals and nations.

What is scarcity?

The condition where unlimited wants exceed limited resources.

What is opportunity cost?

The highest-valued alternative given up when making a choice.

Define microeconomics.

The study of individual and business decisions, market interactions, and government influence. (e.g., how taxes affect small businesses).

What are the four main components of economic thinking?

A: Trade-offs, rational choices, marginal analysis, and incentives.

Explain what it means when we say "economics is a social science."

• studying choices under scarcity constraints by developing theories, collecting data, and analyzing it to understand economic behavior and trends.

Define macroeconomics

• Examines the overall performance of national and global economies. Examples include unemployment rates and the effects of central bank policies on inflation.

What are the two big economic questions economists seek to answer?

→ (1) How do choices determine what, how, and for whom goods and services are produced?
→ (2) Do choices made in self-interest also promote social interest?

Give an example of how self-interest can also promote social interest.

→ A pizza delivery business exists for profit (self-interest) but also feeds people and creates jobs (social interest).

Give an example of how self-interest may conflict with social interest.

→ Driving a large gas-guzzling car benefits the driver (self-interest) but harms the environment (conflicts with social interest).

What is a trade-off? Provide an example from your daily life.

→ Giving up one thing to get another. Example: Studying instead of watching Netflix.

Define opportunity cost and explain how it differs from just "cost."

Opportunity cost is the potential benefit or value that is lost when you choose one option over another.

Cost measures the money actually spent on production, while opportunity cost measures the lost benefit of the option not chosen.

Example, If you choose to attend college, the actual cost is tuition, books, and living expenses. The opportunity cost is the salary you could have earned by working full-time instead.

What does it mean to make a rational choice?

• Comparing costs and benefits to make decisions and choosing the option with the greatest net benefit. It answers the question of what goods and services will be produced and in what quantities: those that people rationally choose to buy.

What role do marginal benefit and marginal cost play in decision-making?

• You compare the marginal benefit and marginal cost to decide how to allocate your time. If the marginal benefit exceeds the marginal cost, you choose to increase the activity. If the marginal cost exceeds the marginal benefit, you do not increase the activity. Ex. A coffee shop considers staying open one extra hour. The marginal benefit (extra sales) is $100, and the marginal cost(wages, utilities) is $60. Since $100 > $60, the shop decides to stay open.

How do incentives influence economic behavior? Provide an example.

→ Incentives are rewards/penalties that motivate choices. Example: Higher wages encourage people to work more hours.

What are the four factors of production? Define each and state the type of income they earn.

• Land → natural resources → earns rent

• Labour → human effort/skills → earns wages

• Capital → tools, buildings, machines → earns interest

• Entrepreneurship → organizing land, labour, and capital → earns profit

How does the production structure of Canada differ from Ethiopia?

→ Canada: Services dominate (70%), agriculture is small (2%).
→ Ethiopia: Agriculture is much larger (35%), services smaller (44%).
→ This shows Canada is more developed and industrialized.

What role does human capital play in the quality of labour?

→ the knowledge and skills obtained from education, training, and work experience.  Albert Einstein example: Genius-level human capital worth significantly more than average labor input due to knowledge/skills

Why is financial capital not considered a factor of production?

→ Because it is money used to buy resources, not a resource itself.

Explain the difference between self-interest and social interest.

→ Self-Interest: Choices are made based on what individuals believe is best for them. For example, you order a pizza because you're hungry, not to provide a job for the delivery person.
→ Social Interest: An outcome is in the social interest if it benefits society as a whole. For instance, Ted's business benefits him, his employees, and his customers, making it in the social interest.

What role does physical capital play in the quality of labour?

 Physical capital tools, instruments, machines, buildings, and other constructions used to produce goods and services. Capital generates interest/return income for investors, creating purchasing power in economy

What role does land play in the quality of labour?

• Natural resources used to produce goods and services, for example farmers need actual land, IT businesses need technology infrastructure as their “land” asset.

• Generates rent income for owners, contributing to consumer purchasing power for produced goods/services. 

What role does entrepreneurship play in the quality of labour?

• Entrepreneurs develop new ideas, make business decisions, and bear the risks. Organizational capability to coordinate land, labor, and capital efficiently for maximum output

Why is the concept of fair shares considered subjective?

Because people have different views on what is “fair” distribution of income/wealth.

How does globalization create both benefits and risks for a country like Canada?

→ Benefits: wider markets, trade, technology transfer, tourism.
→ Risks: dependence on U.S. trade, job losses from outsourcing, vulnerability to tariffs.

What is globalization

Globalization involves international trade and investment, benefiting consumers and multinational firms.

How do tech monopolies raise questions about self-interest vs. social interest?

The big five tech companies (Google, Apple, Facebook, Amazon, and Microsoft) have significant market power, allowing them to sell products at high prices and generate large profits. This benefits the owners and users (self-interest) but raises questions about whether they serve the social interest by offering better services at lower prices (may harm social interest).

How does climate change present a conflict between self-interest and social interest?

→ Self-interest = using cheap fossil fuels.
→ Social interest = reducing pollution to fight global warming.

• The dilemma is whether individuals can be trusted to make socially beneficial choices or if government intervention is necessary to align self-interest with social interest.

What are the main causes of the gender pay gap?

→ Job type differences, hours worked, and unexplained factors (e.g., bias/discrimination).

Define market capitalism

• an economic system where individuals own land and capital and can freely buy and sell these resources and goods/services in markets. Example, combine private ownership and free markets with some government regulation

Define centrally planned socialism

government ownership, government decides production. Example, In the former Soviet Union, the government decided how many cars, clothes, and loaves of bread would be produced each year.

Define mixed economy

The current system, combining market capitalism with government regulation.

According to Karl Marx and modern protesters, what are the main problems with market capitalism?

• Inequality, excessive corporate power, government capture by big business.

What was Adam Smith’s idea of the “invisible hand”?

• The self-interest of corporations aiming for maximum profit unintentionally promotes the social interest through an "invisible hand."

• A baker doesn’t bake bread because they want to feed people; they bake it to earn a living. But by doing so, they provide fresh bread for the community. In this way, the baker’s self-interest (making money) also benefits society (people getting bread).

Why do economists argue that market transactions are usually win-win?

buyers get what they want for less than they are willing to pay, and sellers earn a profit.

• You’re willing to pay up to $6 for a latte because you really want one. The shop sells it for $4.50.

✅ You “win” because you got the latte for less than you were willing to pay.
✅ The coffee shop “wins” because it cost them only $2 to make the latte, so they earned a $2.50 profit.

What is the difference between a positive statement and a normative statement? Give one example of each.

→ Positive = A factual statement that describes "what is" and can be tested (e.g., "Canada’s GDP grew by 2%").
→ Normative = A value-based opinion that expresses "what ought to be" and cannot be tested (e.g., "The government should increase GDP growth").

What is an economic model and why do economists use them?

A simplified representation of the real economy used to explain, predict, or analyze economic behaviour and outcomes. Includes only the most relevant factors and leaves out unnecessary details to focus on specific relationships (e.g., price, supply, and demand in a market).

Economists use models to:

• Understand complex economic systems

• Test hypotheses about cause and effect

• Predict outcomes of economic decisions or policy changes

• Explain patterns in data and guide decision-making

• Example: A smartphone network model might include call prices, user numbers, and call volumes - because they bring revenue, but exclude colours and ringtones - because they don’t matter for analyzing network performance or pricing.

How do natural experiments, statistical investigations, and economic experiments help economists test their theories?

→ They isolate variables, measure relationships, and test cause-effect outcomes.

Q: What are three methods used to test economic models? and examples

A:

• 1. Natural experiments:

  • A study of real-world events where external factors create conditions similar to a controlled experiment (e.g., comparing regions with different minimum wages after a policy change).

  2. Statistical investigations:

  • The collection and analysis of data to find patterns, test hypotheses, and draw conclusions about economic relationships. (Economists analyze decades of data on housing prices and interest rates to see how changes in rates affect home buying.) This uses real-world data to test predictions.

  3. Economic experiments:

  • A controlled test, often in a lab or field, where economists manipulate variables to study decision-making and economic behavior (e.g., testing how people bid in auctions). This controlled setup tests economic theories about markets and incentives.

How do economists contribute as policy advisers?

→ Economists analyze data, evaluate costs and benefits, and recommend policies to improve efficiency, growth, and well-being.

Example: An economist might study raising Example: An economist might analyze the effects of raising the minimum wage and advise policymakers on how it could impact employment and income distribution.

Provide a real-life example of a tradeoff you made recently.

→ Example: Choosing to spend money on textbooks instead of clothes.

What is the opportunity cost of attending college? List at least 3 components.

→ Tuition/fees, foregone job income, lost leisure time. (It’s what I gave up to go to college)

Give an example of a decision you made at the margin.

→ Studying one extra hour instead of going to bed earlier.

Why are institutions (laws, property rights, markets) important for aligning self-interest with social interest?

→ They ensure fair exchange, protect ownership, and create incentives that benefit both individuals and society.

What skills are essential for an economist in the workplace?

→ Critical thinking, analytical, math, writing, and oral communication skills.

What barriers currently exist to increasing diversity in economics?

→ Implicit gender/racial bias, lack of role models, underrepresentation in graduate programs and faculty.

Define Marginal Benefit

Marginal benefit is the additional satisfaction or gain a person receives from consuming one more unit of a good or service.

Example:
your first slice provides great satisfaction (high marginal benefit), but each subsequent slice offers progressively less additional satisfaction and you're willing to pay less for it,

Define Marginal Cost

• Refers to the opportunity cost of producing one additional unit of a good or service. It helps businesses understand how their total costs change as they increase production. For example, a toy factory produces 100 toys at a total cost of $1,000, and producing 101 toys raises the total cost to $1,010, then the marginal cost of producing the 101st toy is $10.

Rational Choice

• Comparing costs and benefits to make decisions.

Efficiency vs. Equity

• Efficiency = Resource use is efficient if it is impossible to make someone better off without making someone else worse off. Ted's business is efficient because everyone benefits.

• Equity = Refers to fairness or how resources and wealth are distributed, and it’s subjective because people have different ideas of what’s “fair.” Example: Even if Ted’s business is efficient, some believe it’s unfair if the profits go only to Ted while employees earn very little.

Institutions & Incentives

• Institutions: Rules, laws, and organizations that shape economic behavior (e.g., government, courts, banks).

• Incentives: Rewards or penalties that influence decisions (e.g., taxes, subsidies, fines, bonuses).
  Key idea: Institutions set the “rules of the game,” and incentives guide how people act within them. ✅

For example, in Canada, carbon pricing laws make it costly for companies to emit greenhouse gases. This incentivizes businesses to adopt cleaner technologies, aligning their self-interest (avoiding fines) with the social interest of reducing climate change.

Q: What does Marginal Private Cost (MC) include?

A: Costs directly borne by the producer for making an extra unit, such as materials and labor. Example: If a factory spends $100 on extra raw materials and $50 on extra labor to make one more widget, the marginal private cost of that widget is $150.

Q: What is Marginal External Cost?

A: Costs that affect others outside the producer, like pollution impacting nearby residents.

Q: How is Marginal Social Cost (MSC) calculated?

A: MSC = Marginal Private Cost + Marginal External Cost; it represents the total cost to society of producing one more unit.

What does it mean to say that trade-offs aren’t always “black and white”?

It means that choices don't always require giving up one option completely; partial allocation is possible (e.g., studying part of the day and socializing later).

What is a major limitation of rational choice theory in real life?

Humans don’t always make rational decisions, especially in areas like financial planning and investing, due to biases and emotions.

Whose preferences determine whether a choice is rational in economics?

Only the preferences of the decision-maker determine rationality, regardless of how others view the choice.

What is marginal analysis in economics?

It is the process of evaluating the additional benefit and additional cost of a small (marginal) change in an activity.

Give an example of marginal benefit and marginal cost in a real-life decision.

Marginal benefit: lifelong experience from a concert.
Marginal cost: credit card interest if the concert tickets aren’t paid off immediately.

How do incentives influence economic behavior?

They change the marginal benefits or costs of actions, influencing decisions. If the benefit increases or cost decreases, people are more likely to act.

What role do incentives play in aligning self-interest with social interest?

Choices respond to incentives. They help encourage individuals to make choices that benefit society while pursuing personal goals.

Why must economists distinguish between positive and normative statements in policy advising?

To avoid mixing facts with opinions and to provide clear, evidence-based recommendations.

Six key ideas define the economic way of thinking:

• a choice is a tradeoff

• people make ration choices by comparing benefits and cost

• benefit is what you gain from something

• most choices are “how-much” choices made at the margin

• choices respond to incentives

What is the central idea of economics?

Is that we can predict how choices will change by looking at changes in incentives