Chapter 5: Basic Economic Concepts

5.1 Scarcity

Scarcity: occurs because unlimited desire for goods and services exceeds limited ability to produce them due to constraints on time and resources

Resources

• Also sometimes called inputs or factors of production
• Examples
  • Capital (physical capital): manufactured goods that can be used in the production process
  • Ex) Tools, machinery, equipment
  • Labor: physical and mental effort of people
  • Includes human capital: knowledge and skill acquired through training and experience
  • Entrepreneurship: ability to identify opportunities and organize production, and willingness to accept risk to pursue rewards
  • Natural resources: refers to any productive resource existing in nature
  • Ex) Wild plants, wind, water
  • Acronym: Crazy Leopards Envy Narwhals → Capital, Labor, Entrepreneurship, Natural resources/land
• Energy and technology are considered to be byproducts
• Production models often just includes labor and capital

5.2 Resource Allocation and Economic Systems

• Economics: study of how societies allocate scarce resources among competing ends
• Positive economics: describes the way things are
  • Ex) “The unemployment rate hit a three-year high”
• Normative economics: way things should be
  • Ex) “The Fed should lower the federal funds rate”

5.3 The Production Possibilities Curve

• Opportunity cost: value of the best alternative sacrificed compared to what actually takes place

  • Ex) Opportunity cost of studying is losing sleep

  

• Production-possibilities frontier: illustrates the opportunity cost of making one good rather than another one

  • Abbreviated as PPF
  • Frontier: curve that represents all of the combinations that could be produced using available resources
  • If a point is outside the frontier, the good cannot be produced since it needs more resources than the economy has
  • If a point is inside the frontier, it can be obtained but is inefficient
  • Efficiency: all of the resources are used productively
  • Resources are wasted
  • Can determine opportunity cost from PPF
  • Greater absolute value of slope = greater opportunity cost

• Consumer goods: products for sale in a retail or consumer market used directly by consumers

• Capital goods: things purchased to produce other goods

5.4 Comparative Advantage and Gains From Trade

• Specialization
  • More efficient → increases productivity
• Division of labor: allows people to develop expertise in certain tasks, where practice improves performance
• Absolute advantage: when a country can produce a good using fewer resources per unit of output compared to another country
• Comparative advantage: when a country can produce a good at a lower opportunity cost compared to another country
• Consumption possibilities frontier
  • With trade, countries can have a consumption possibilities frontier that exceeds its own production possibilities frontier
  • Slope is determined by terms of trade

5.5 Cost-Benefit Analysis

Business project factors

• Cost of implementing project
• Resulting benefits

Cost-benefit analysis: comparing value of cost vs. benefits

5.6 Marginal Analysis and Consumer Choice

• Distributive efficiency (efficiency in exchange): those who place the highest relative value on goods should receive them
  • Ex) Auctions
  • Achieved when marginal rate of substitution is equal for every consumer
  • Marginal rate of substitution: ratio of marginal utility for two goods