Unit 1: Basic Economic Concepts

Unit 1 Updates

• Economic systems are not included in the new Course and Exam Description (CED).

  • Teachers can mention the difference between free market and centrally planned economies.

  • No questions on the AP exam about economic systems.

• The Circular Flow Model has been moved to Unit 2.

• Macro teachers do not need to cover elasticity when teaching demand and supply.

• Price controls are not specifically mentioned but are included in the resources.

• Online “Personal Progress Check” includes 20 multiple-choice questions and 2 FRQs.

Topic 1.1 - Scarcity

• Economics is about making choices and the economic way of thinking.

• Economics is the science of scarcity.

• Scarcity: Unlimited wants but limited resources.

• Choices must be made on how to use resources due to scarcity.

• Economics studies the choices of individuals, firms, and governments.

Textbook Definition of Economics

• Economics: Social science concerned with the efficient use of scarce resources to achieve maximum satisfaction.

• Study of how individuals and societies deal with scarcity.

• Examples:

  • Choosing between buying jeans or shoes.

  • Businesses choosing how many people to hire.

  • Governments choosing how much to spend on welfare.

Microeconomics vs. Macroeconomics

Microeconomics

• Study of small economic units such as individuals, firms, and markets.

• Examples:

  • Supply and demand in specific industries.

  • Production costs.

  • Labor markets.

Macroeconomics

• Study of the large economy as a whole or economic aggregates.

• Examples:

  • Economic growth.

  • Government spending.

  • Inflation.

  • Unemployment.

  • International trade.

Positive vs. Normative Statements

Positive Statements

• Based on facts.

• Avoids value judgments (what is).

Normative Statements

• Includes value judgments (what ought to be).

How Economics is Used

• Economists use the scientific method to make generalizations and abstractions to develop theories (theoretical economics).

• These theories are applied to fix problems or meet economic goals (policy economics).

Examples of Positive and Normative Statements

1. The rising price of crude oil will lead to an increase in gas prices. (Positive)

2. A rise in average temperatures will increase the demand for sunscreen. (Positive)

3. Pollution is the most serious economic problem. (Normative)

4. The government should ban smoking in public places. (Normative)

5. Unemployment is more harmful than inflation. (Normative)

5 Key Economic Assumptions

1. Society has unlimited wants and limited resources (scarcity).

2. Due to scarcity, choices must be made, and every choice has a cost (trade-off).

3. Everyone’s goal is to make choices that maximize their satisfaction. Everyone acts in their own “self-interest.”

4. Everyone makes decisions by comparing the marginal costs and marginal benefits of every choice.

5. Real-life situations can be explained and analyzed through simplified models and graphs.

Thinking at the Margin

• Marginal = additional

• Marginal analysis: Making decisions based on increments.

• Example: Deciding whether to go to the mall involves considering the additional benefit and the additional cost (opportunity cost).

• Continue doing something as long as the marginal benefit is greater than the marginal cost.

Analyzing Choices

• Rational choice is made in one's self-interest, holding everything else constant.

Trade-offs vs. Opportunity Cost

• All decisions involve trade-offs.

• Opportunity cost: The most desirable alternative given up when making a choice.

• Trade-offs: All the alternatives that are given up when making a choice.

Example: Going to the movies

• Trade-offs: ALL the things you could have done instead of going to the movies.

• Opportunity cost: The ONE thing that you would have done if you didn't go to the movies.

Guns and Butter

• Addresses the trade-offs between military spending (guns) and domestic needs (butter).

• Spending on military signifies a theft from those who hunger and are not fed, those who are cold and not clothed.

Economic Terminology

• Utility = Satisfaction

• Marginal = Additional

• Allocate = Distribute

Price vs. Cost

• Price: Amount buyer (or consumer) pays.

• Cost: Amount seller pays to produce a good.

Investment

• Money spent by businesses to improve production.

• Example: $1 Million$ for a new factory.

Consumer Goods vs. Capital Goods

• Consumer Goods: Created for direct consumption (e.g., pizza).

• Capital Goods: Created for indirect consumption; goods used to make consumer goods (e.g., oven, blenders, knives).

The 4 Factors of Production

1. Land: All natural resources used to produce goods and services (e.g., water, sun, plants, animals).

2. Labor: Any effort a person devotes to a task for which they are paid (e.g., manual laborers, lawyers, doctors, teachers, waiters).

3. Capital:

   • Physical Capital: Any human-made resource used to create other goods and services (e.g., tools, tractors, machinery, buildings, factories).

   • Human Capital: Skills or knowledge gained by a worker through education and experience.

4. Entrepreneurship: Ambitious leaders that combine the other factors of production to create goods and services.

   • Examples: Henry Ford, Bill Gates, Inventors, Store Owners.

   • Qualities of Entrepreneurs:

     • Take The Initiative

     • Innovate

     • Act as the Risk Bearers

   • Profit = Revenue - Costs

Productivity

• Productivity = A measure of efficiency that shows the number of outputs per unit of input.

• Example: Bob can make 10 pizzas in 1 hour; Stan can make 5 pizzas in 1 hour. Bob is more productive.

• Improving productivity allows producing more with fewer resources.