Economics: Foundations and Models

Basic Economic Concepts

• Economics is the study of choices people make to attain their goals, given scarce resources.
• Scarcity: Unlimited wants exceed limited resources.

Core Economic Ideas:

• Rational choice: Using available resources to best achieve objectives.
• Cost-Benefit Principle: Take action if extra benefits are at least as great as extra costs.
• Opportunity cost: The best thing you give up to get something.
• Sunk cost: Previously incurred and irreversible cost (not part of opportunity cost).
• Marginal analysis: Comparing marginal benefits and marginal costs.
• Incentive: A reward or penalty that encourages or discourages an action.

Economics Defined

• Economics studies choices of individuals, businesses, governments, and societies in coping with scarcity and incentives.
• Two big questions:
  • How choices determine what, how, and for whom goods/services are produced.
  • When self-interested choices promote social interest.

Economic Problem

• Trade-off: Producing more of one good means producing less of another.
• Three fundamental questions:
  • What goods/services will be produced?
  • How will goods/services be produced?
  • Who will receive the goods/services produced?

Economic Systems

• Centrally planned economy: Government decides resource allocation.
• Market economy: Decisions of households and firms allocate resources.
• Mixed economy: Combination of market decisions and government role.

Efficiency and Equity

• Productive efficiency: Producing at the lowest possible cost.
• Allocative efficiency: Production reflects consumer preferences; marginal benefit equals marginal cost.
• Voluntary exchange: Both buyer and seller benefit from the transaction.
• Equity: Fair distribution of economic benefits.

Economic Models

• Simplified version of economic life to analyze issues.
• Steps:
  • Decide on assumptions.
  • Formulate a testable hypothesis.
  • Use data to test the hypothesis.
  • Revise the model if needed.
  • Retain the revised model.
• Economic variable: Something measurable with different values.

Micro vs. Macroeconomics

• Microeconomics: Study of choices of households and businesses, their interactions in markets, and government influence.
• Macroeconomics: Study of the economy as a whole (inflation, unemployment, growth).

Positive vs. Normative Analysis

• Positive statements: What is.
• Normative statements: What ought to be.

Unscrambling Cause and Effect

• Ceteris paribus: "Other things being equal."
• Methods: natural experiments, statistical investigations, economic experiments.
• Correlation: Tendency for variables to move predictably.

Graphs

• Graphs of One Variable: Bar graph, Pie chart.
• Time-Series Graphs.
• Graphs of Two Variables: Plotting Price and Quantity.
• Slope of a line formula: $Slope = {Δy \over Δx} = {Rise \over Run}$
• Positive and negative relationships.
• Slopes of Nonlinear Curves.

Formulas

• Percentage change formula: $Percentage\ change = {Value\ in\ second\ period - Value\ in\ the\ first\ period \over Value\ in\ the\ first\ period} * 100$
• Area of a rectangle formula: $Area = base * height$
• Area of a right triangle formula: $Area = 1/2 * base * height$