Key Concepts in Economics: Foundations and Principles
Economics: The Five Foundations
The five foundations of economics are: Incentives, Trade-offs, Opportunity cost, Marginal thinking.
Trade Creates Value
The principle that trade creates value.
MB = MC Rule
Marginal decision rule: You should engage in any activity so long as the MB > MC. The optimal level of activity is where MB = MC. When MC > MB, you should not undertake the activity.
Production Possibility Frontier (PPF)
In macroeconomics, the production possibility frontier (PPF) represents the point at which a country’s economy is most efficiently producing its goods and services and, therefore, allocating its resources in the best way possible. The PPF drives home the idea that opportunity costs normally come up when an economic organization with limited resources must decide between two alternatives. The PPF is depicted graphically as an arc, with one commodity on the X axis and the other commodity on the Y axis. At each point on the arc, there is an efficient number of the two commodities that can be produced with available resources. Therefore, it’s up to the organization to look at the PPF and decide what number of each commodity should be produced to maximize the overall benefit to the economy.
If, for example, a government organization is deciding between the production mix of textbooks and computers, and it can produce either 40 textbooks and 7 computers or 70 textbooks and 3 computers, it’s up to that organization to determine what it needs more. In this example, the opportunity cost of producing an additional 30 textbooks is 4 computers.
Ceteris Paribus
In summary, ceteris paribus is the commonly used Latin phrase meaning ‘all other things remaining constant.’ The concept of ceteris paribus is important in economics because in the real world, it is usually hard to isolate all the different variables that may influence or change the outcome of what you are studying.
Economic Growth in the PPF
The second meaning of economic growth is an increase in what an economy can produce if it is using all its scarce resources. An increase in an economy’s productive potential can be shown by an outward shift in the economy’s production possibility frontier (PPF).
Comparative Advantage
Comparative advantage is an economic term that refers to an economy’s ability to produce goods and services at a lower opportunity cost than trade partners.
Competitive Markets
A competitive market is one in which a large number of producers compete with each other to satisfy the wants and needs of a large number of consumers.
Monopoly
A market structure characterized by a single seller, selling a unique product in the market.
Law of Demand
The law of demand states that quantity purchased varies inversely with price. In other words, the higher the price, the lower the quantity demanded.
Shifts in the Demand Curve
Increases in demand are shown by a shift to the right in the demand curve. This could be caused by a number of factors, including a rise in income, a rise in the price of a substitute, or a fall in the price of a complement.
Supply
Supply is a fundamental economic concept that describes the total amount of a specific good or service that is available to consumers. Supply can relate to the amount available at a specific price or the amount available across a range of prices if displayed on a graph.
Surplus
A surplus is used to describe many excess assets including income, profits, capital, and goods. A surplus often occurs in a budget, when expenses are less than the income taken in or in inventory when fewer supplies are used than were retained. Economic surplus is related to supply and demand.
Shortage
A shortage is a situation in which demand for a good or service exceeds the available supply. Possible causes of a shortage include miscalculation of demand by a company producing a good or service, resulting in the inability to keep up with demand, or government policies such as price fixing or rationing.