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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