Chapter 1: Economics—Foundations and Models

People are rational, people respond to economic incentives, and optimal decisions are made at the margin.
Economic agents interact with one another in markets.
Market: a group of buyers and sellers of a good or service and the institution/arrangement by which they come together to trade.
In analysis of markets, we generally assume:
- People are rational.
- People respond to economic incentives.
- Optimal decisions are made at the margin.
Marginal analysis: compare marginal benefits (MB) and marginal costs (MC) to decide on small changes; these are the driving force behind many decisions.
Key terms:
- MB = marginal benefit
- MC = marginal cost
Example: Apple sets iPhone prices to maximize profitability, not randomly.

Scarcity: unlimited wants exceed limited resources; leads to trade-offs.
Trade-off: producing more of one good means producing less of another.
The three fundamental questions:
- What goods and services will be produced?
- How will the goods and services be produced?
- Who will receive the goods and services produced?
Opportunity Cost: the highest-valued alternative that must be given up to engage in some activity.
Example: Increased funding for space exploration may require giving up cancer research funding.

Economists build models to analyze real-world issues by:
- Deciding on assumptions
- Formulating testable hypotheses
- Using data to test the hypotheses
- Revising the model if it fails to explain data well
- Retaining the revised model for future questions
Role of assumptions:
- Consumers maximize well-being
- Firms maximize profits
Hypotheses: about causal relationships between economic variables (e.g., why one variable changes with another).
Testing hypotheses: use statistical methods; correlation ≠ causation not proven; advancing models when hypotheses are confirmed or revised.
Positive vs normative analysis:
- Positive: what is
- Normative: what ought to be
Economists rely on models to analyze policy and outcomes, but value judgments may influence normative conclusions.

Microeconomics: study of
- How households and firms make choices
- How they interact in markets
- How the government tries to influence those choices
Macroeconomics: study of the economy as a whole (inflation, unemployment, economic growth)
Distinction helps organize questions and analyses (micro for individual decisions; macro for aggregate outcomes).

Economics as a career involves describing choices, explaining consequences, and advising on better decisions.
Analogy: just as a home inspector describes problems and costs, an economist describes choices, consequences, and policy implications.
Career examples (types of work):
- Ford Motor Company: forecast demand for electric cars
- Goldman Sachs: forecast future values of interest rates
- McDonald’s: decide on opening additional restaurants in China
- Pfizer: analyze costs/benefits of a new cancer treatment
- Wall Street Journal: report on Federal Reserve policies
- Academia: teach economics, conduct research
- Federal Reserve Bank: forecast regional employment and production
- FTC: analyze merger effects on competition
- The World Bank: evaluate development programs

Technology: the processes a firm uses to produce goods and services.
Capital: manufactured goods used to produce other goods and services.
Scarcity, Trade-off, and Opportunity Cost: core concepts of resource limitation and choice.
Equity: fair distribution of economic benefits; often a government trade-off with efficiency.
Efficiency concepts:
- Productive efficiency: production at the lowest possible cost
- Allocative efficiency: production where MB = MC
Market and voluntary exchange: a transaction where both parties are made better off; markets coordinate decisions.
Marginal concepts: decisions based on the extra (small) change in costs/benefits.
Positive vs normative analysis (revisited): science of what is vs. what ought to be.

Graphs and formulas are simplified models to analyze situations; akin to maps.
Graph types illustrated: bar graphs, pie charts, time-series graphs, demand curves, etc.
Slope concept:
- Slope = $\frac{\Delta y}{\Delta x}$
- For a nonlinear curve, the slope can vary; use tangent lines to approximate at a point.
Key formulas:
- Percentage change: \%
  \Delta x = \frac{\Delta x}{x_{old}} \times 100
- Total revenue: $TR = Q \times P$
- Area relationships:
- Rectangle area (used to illustrate total revenue): base × height
- Triangle area: $A = \frac{1}{2} \times base \times height$
Guidelines for using formulas:
- Understand the concept the formula represents
- Use the correct formula for the problem
- Ensure the calculated number is economically reasonable