Topic 1.1: Scarcity

• The field of economics is the study of how and why people and organizations make the decisions they do to address the gap between limited resources and nearly unlimited desires or wants.

  • Scarcity is a fundamental concept in economics that refers to the limited availability of resources in relation to the unlimited wants and needs of individuals and societies.

  • The fundamental problem of economics is having to choose between alternative uses of resources.

• Economic trade-offs arise from the lack of sufficient resources (scarcity) to meet society’s wants and needs.

  • Essentially, because of the lack of sufficient resources, trade-offs need to be made in which something is obtained at the expense of not obtaining something else.

  • When an individual or organization makes a choice, it has an opportunity cost, or a loss of the benefit that would have been gained from choosing the alternative.

  • When trade-offs occur due to limited funds/time, they can be called constraints. A person, business, or government is constrained from doing something because it lacks funds or time.

• Economists explain why people, businesses, and governments make the choices they do by tracking trends, making forecasts/predictions using those trends, and finally providing guidance in decision-making with those forecasts to firms and governments on how to best use their resources.

• The ingredients that go into the making of goods and services are called economic resources or factors of production; economists identify three types: land, labor, and capital.

  • All natural resources the earth provides and humans use to make goods are referred to as land; not only soil, but water, minerals, and air. All physical goods use some type of natural resource in their production.

  • The people who create goods and services are referred to as labor, “human capital”, or “the workforce.” The amount of workers and their degree of productivity are key factors in making choices about effective uses of resources.

    • The productivity of workers depends on their level of skill, the quantity/quality of tools available to them, and the technology available to them.

    • Economists determine a community’s or country’s productivity by adding up the value of all the goods and services a country produced in a year and dividing it by the number of hours that all employees worked in that year.

  • The tools, machines, buildings, and factories that are used in the creation of goods or services are known as capital. The owners of capital must consider how to make the best, most profitable use of the capital that is available to them

    • For example. a school is capital because it is the site of education, a service industry.

    • One trait that all capital has in common is that it eventually wears out or is used up. If the owner doesn’t replace capital that has been used up, then the amount of goods produced will decline.

    • Human capital refers to the knowledge, skills, abilities, experiences, and creativity, and that help people maintain and increase their productivity

  • Putting together the three factors of production is called entrepreneurship. The person who organizes a business is an entrepreneur and must put together land, labor and capital and take on risks and sometimes reap the rewards.

  • Most products have a rival nature, meaning only one person can consume them at a time; however, there are certain non-rival factors of production.

    • Data, for example, has a non-rival nature because multiple people/businesses can use such information at a time without depleting the supply for others. This does not mean that data is free and available to all.

      • Companies spend huge sums of money on consumer data and thus do not want to share it with the public or rivals. It is not scarce but treated as if it were, leading to data hoarding which can lead to disorganized storage and weak security measures.

    • Established knowledge is publicly available and has been verified by a knowledgeable person or group as true. Being publicly available, it has a non-rival nature and is not scarce.

Topic 1.2: Resource Allocation and Economic Systems

• If the factors of production used to produce goods are scarce, decisions must be made on how those resources will be used to create some amount of goods and services.

  • All societies must ask themselves three questions about how to allocate scarce resources:

    1. What should be produced?

    2. How should things be produced?

    3. For whom should things be produced?

    • The systems or ways in which societies answer these questions are known as economic systems.

• Resource allocation is significantly influenced by the economic system adopted by society. Each system involves a particular set of institutional arrangements and a coordinating mechanism for allocating scarce resources and distributing output.

  • On one hand, the government could be in complete control of resource allocation. On the other hand, the government could be completely uninvolved in resource allocation. Across this spectrum, there are three significant economic systems:

    • In a pure command economy, the government or some central planning authority owns and allocates scarce resources. They decide what, how, and for who things will be produced.

      • (The goal is to promote equality, people are supposed to get no more/no less than they need)

    • In a market economy, the government has no control or ownership over scarce resources, and such decisions are made through voluntary exchange in markets between buyers and sellers.

      • No true market or command economy has ever existed.

    • In a mixed economy, there are characteristics present of the former systems. Resources are privately owned and buyers and sellers determine their allocation but the government still produces some goods and services and interacts within the economy in other ways.

      • Nearly every global system is a mixed economy.

    • In a traditional economy, cultural traditions determine crops grown/animals raised and resource allocation and the means of production and controlled by the community.

Topic 1.3: Production Possibilities Curve

• Considering scarce resources and the trade-offs that follow from making decisions regarding the use of scarce resources, we can model the possible options and trade-offs from choosing one option versus the other.

• The PPC (Production Possibilities Curve) is a mode used to show the trade-offs associated with allocating resources.

  • It can be assumed that:

    • all points along the PPC are only achievable if a country achieves full employment and full efficiency.

    • resources are fixed in quantity and quality.

    • only one country, closed off to trade, is represented by a PPC.

  • Any point along the PPC is desirable because the points represent full employment and efficiency in using available resources.

  • Any point outside the PPC is unattainable because resources are too scarce to produce a point there.

  • Any point inside the PPC is attainable but undesirable because it represents unemployment and inefficiency.

• The PPC can illustrate the concepts of scarcity, opportunity cost, efficiency, underutilized resources, and economic growth/contraction.

  • It can be said that any point along the curve is a fully efficient use of resources, it is productively efficient.

    • However, some points on the graph are more efficient; the single point on the graph that provides the greatest amount of benefit is allocatively efficient.

  • For each point on the PPC, there is an opportunity cost, which is what you have to give up to make a decision, or the value of your next best alternative.

  • The PPC model demonstrates scarcity because it shows we can only produce a combination of goods inside or along the curve as resources are scarce.

  • The PPC can demonstrate the underutilization of resources when the use of resources can be modeled by a point that is inside the PPC.

• The shape of the PPC depends on whether opportunity costs are constant, increasing, or decreasing.

  • A linear PPC has a constant opportunity cost because the resources used are adaptable to the production of both goods.

    • As you add one unit of one good, you must always give up the same amount of another.

  • A PPC curved outward has an increasing opportunity cost because the resources used are not adaptable to the production of both goods.

    • As you add one of the good on the x-axis, you must always give up more of the good on the y-axis.

  • A PPC curved inward (rare) has a decreasing opportunity cost also because the resources used are not adaptable to the production of both goods.

    • As you add one of the good on the y-axis, you must always give up more of the good on the x-axis.

• Economic growth, or when the amount of goods and services a country can produce increases, results in an outward shift of the PPC.

  • Because there is an outward shift, some of the previously unattainable points can now be attained and may even be efficient.

  • The PPC can shift due to changes in factors of production as well as changes in productivity/technology.

    • An increase in the quantity of resources (more workers, machines, etc), technology, or productivity can lead to economic growth.

    • Current production points can also impact future economic growth. Focus on capital goods (machines, tools) will cause future growth because there will be more resources, unlike focus on consumer goods.

Topic 1.4: Comparative Advantage and Trade

• Without achieving more resources or technology, a country is able to produce or gain access to more of each of the goods and services than they could before when they open up to trade.

• Absolute advantage describes a situation in which an individual, business, or country can produce more of a good or service than any other producer with the same quantity of resources.

• On the other hand, comparative advantage describes a situation in which an individual, business, or country can produce a good or service at a lower opportunity cost than another producer, even if it is not as much as the other producer could produce.

  • A country basing its production specialization according to comparative advantage and not absolute advantage results in exchange opportunities that lead to consumption possibilities beyond the PPC as well as increased overall efficiency and total output.

• Comparative advantage and opportunity costs determine the terms of trade for exchange under which mutually beneficial trade can occur.

  • The terms of trade determine how much of each good or service is traded for another. The terms to trade a certain item for another should be lower than the opportunity cost of the receiving country if it were to produce that good but higher than the opportunity cost of the giving country when it does produce that good so that they both benefit, leading to mutually beneficial trade.

Topic 1.5: Cost-Benefit Analysis

Topic 1.6: Marginal Analysis and Consumer Choice

• Consumer choice theory is a series of principles that tries to explain why people buy some goods and services, refuse to buy others, or stop buying the ones that they used to.

  • The first assumption of consumer choice theory is that consumers are rational and that people base their purchases/decisions on a calculation about what will make them happiest.

    • Consumers make choices so as to maximize their total utility.

  • The second aspect of consumer choice theory is that consumers are never fully satisfied.

  • The third aspect of consumer choice theory is that consumers experience diminishing marginal utility, meaning that their satisfaction decreases with each unit of consumption.

• Economists use marginal analysis to balance marginal benefits and marginal costs, which involves comparing the additional benefit of increasing a given activity with the additional cost. Doing this helps individuals (firms) decide whether to increase, decrease, or maintain their consumption (production) levels.

  • The optimal quantity is achieved when marginal benefit is equal to marginal cost or where total benefit is maximized.

  • The optimal quantity at any point in time does not depend on fixed costs (sunk costs) or fixed benefits that have already been determined by past choices.

    • Essentially, when a rational consumer is making a decision, they will not take into account their past investments/spendings (sunk costs), only the marginal costs and benefits.

• Consumers allocate their limited income to purchase the combination of goods that maximizes their utility by equating/comparing the marginal utility of the last dollar spent on each good.

  • Using the utility maximization rule, economists weigh the marginal utility per dollar spent of each unit of each product for each consumer.

    • MU_x / P_x = MU_y / P_y. When the marginal utility of product X divided by the price of product X is equal to the marginal utility of Product Y divided by the price of product Y, the best possible combination is reached.

      • This means that when comparing two products, consumers will keep buying the product with most marginal utility per dollar until they have no more to spend.