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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

SZ

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