Fundamentals of Econ. (High School Lvl.)

1. Free Market Economy

Definition:
A free market economy is one where economic decisions—such as production, investment, and distribution of goods and services—are guided by the price signals created by the supply and demand of goods and services. The government has little or no interference in the market.

Key Features:

  • Private ownership of resources.

  • Supply and demand determine prices.

  • Producers and consumers make decisions based on their self-interest.

  • Minimal government intervention (laissez-faire).

Example:
The U.S. and most Western economies are considered mixed, with elements of a free market system. In pure free markets, like those in some smaller economies, businesses operate with little to no regulation.

2. Centrally Planned (Command) Economy

Definition:
A centrally planned economy is one where the government makes most, if not all, economic decisions. The government controls the production, pricing, and distribution of goods and services.

Key Features:

  • The government owns most, if not all, resources.

  • Centralized decision-making.

  • Prices and wages are set by the government.

  • Limited consumer choice.

Example:
Historically, the Soviet Union had a centrally planned economy. North Korea still operates with a central command structure today.

3. Scarcity

Definition:
Scarcity refers to the fundamental economic problem that arises because resources are limited, while human wants and needs are virtually unlimited. As a result, society must make choices about how to allocate its limited resources to meet the needs of its population.

Key Concepts:

  • Unlimited Wants vs. Limited Resources: There will never be enough resources to produce everything people want.

  • Forces trade-offs in decision-making.

Example:
There is only a limited amount of land for farming, so society must decide whether to use land for agriculture, housing, or conservation.

4. Opportunity Cost

Definition:
Opportunity cost is the value of the next best alternative forgone when a decision is made. In other words, it’s what you give up in order to choose something else.

Key Concepts:

  • Always involves a trade-off.

  • The opportunity cost of a choice is what you sacrifice in making that choice.

  • Can be applied to individual, business, or government decisions.

Example:
If you spend money on a concert ticket, the opportunity cost is the things you could have purchased instead (e.g., a new phone or saving that money for later).

5. Production Possibilities Frontier (PPF)

Definition:
The Production Possibilities Frontier (PPF) is a graphical representation of the maximum combination of two goods or services that can be produced in an economy, given the available resources and technology.

Key Features:

  • The PPF shows trade-offs between two goods.

  • Points on the curve represent efficient use of resources.

  • Points inside the curve indicate inefficiency (resources are not fully used).

  • Points outside the curve are unattainable with current resources.

Key Concepts:

  • Opportunity Cost and the PPF: Moving along the PPF involves sacrificing some amount of one good to produce more of another, showing the opportunity cost.

  • Shifts in the PPF: Changes in resources, technology, or efficiency can shift the PPF outward or inward.

Example:
A country can use its resources to either produce military goods or consumer goods. The PPF illustrates the trade-off between these two goods.

6. The Three Economic Questions

Definition:
Every economy must answer three basic questions in order to determine how to allocate its limited resources:

  1. What to produce?

    • What goods and services should be produced? Should we focus more on consumer goods, military goods, healthcare, or education?

  2. How to produce?

    • How should goods and services be produced? Should labor-intensive or capital-intensive methods be used?

  3. For whom to produce?

    • Who will get the goods and services? How should resources be distributed among the population?

Economic Systems and Their Answers:

  • In a free market economy, these questions are answered by individuals and businesses through supply and demand.

  • In a centrally planned economy, the government answers these questions through central planning.

Example:

  • In the U.S., the decision about what to produce is largely determined by consumer preferences (via demand). How things are produced depends on available technology, labor, and capital. Who gets the goods is often determined by income, social class, or distribution policies.

7. Buying on Margin

Definition:
Buying on margin refers to the practice of borrowing money from a broker to purchase stock or other assets. It allows investors to buy more stock than they could with just their own money, using borrowed funds to amplify potential returns.

Key Features:

  • Initial Margin: The investor must pay a portion of the purchase price with their own money (typically around 50% for stocks in the U.S.).

  • Borrowed Funds: The rest of the money needed to purchase the stock is borrowed from a broker or financial institution.

  • Margin Call: If the value of the stock declines significantly, the investor may be required to deposit more money or sell assets to cover the loan.

How It Works:

  1. Leverage: Buying on margin allows you to leverage your investments. If the price of the stock goes up, you can earn a higher return on your invested capital because you are using borrowed money.

  2. Risk: If the stock price falls, you can lose more money than you originally invested, as you're still required to repay the borrowed funds regardless of how the stock performs.

Example:

  • Let’s say you want to buy 100 shares of a stock priced at $50 each. You would need $5,000 to buy the stock outright. However, if you’re buying on margin and the margin requirement is 50%, you only need to use $2,500 of your own money. The other $2,500 is borrowed from your broker.

  • If the stock price rises to $60 per share, you can sell the stock for $6,000 and repay the $2,500 loan, keeping the profit (in this case, $1,000).

  • However, if the stock price falls to $40, the value of your shares drops to $4,000. You still owe the broker $2,500, which means you would lose money—$500 in this case—plus any interest on the loan.

Risks:

  • Margin Calls: If your stock loses enough value, you might face a "margin call," where the broker demands you repay part of the loan or add more funds to your margin account.

  • Amplified Losses: While buying on margin can lead to higher returns if things go well, it also significantly increases the risk of greater losses.