Key Economic Concepts: Scarcity, Markets, and Systems
Key Economic Concepts
Scarcity: There is not enough of an item to satisfy everyone who wants it.
Steps to the Scientific Method
Observe a problem; make assumptions; develop a model, theory, hypothesis, or law; make predictions; test model & predictions.
Common Fallacies
- Fallacy of Composition: Wrongly concluding that what’s right for one person is right for everyone.
- Fallacy of Association/Causation: Wrongly concluding that what’s happening is based off something else.
- Fallacy of Division: Wrongly concluding that what’s true for the whole is true for everything.
Positive vs. Normative Analysis
Positive Analysis: Studies what is. Deals with facts/evidence. Objective. While Normative Analysis: studies what ought to be. Opinion or value judgment (must, should, have to). Subjective.
Microeconomics vs. Macroeconomics
Microeconomics is the study of one thing, while Macroeconomics is the study of something as a whole, such as the whole economy.
Definition of Economics
Economics is the social science that studies how individuals & societies make decisions or choices about the allocation of their limited resources to satisfy their unlimited wants.
Types of Goods
- Free Good: A good for which there is no scarcity. Unlimited items.
- Economic Good: Any item that is scarce & for which we would have to pay a positive price to get more of it.
- Economic Bad: Any item for which we would have to pay a positive price to get less of it (disease, pollution, etc.).
Types of Resources (WRIP)
- Land (Rent Income): All resources of the land.
- Labor (Wages Income): All physical or mental effort.
- Capital (Interest Income): Human-made tangible goods that are in turn used to make other goods.
- Entrepreneurship (Profits Income): Taking a risk to recognize a consumer need & put that need into action.
Scarcity, Efficiency, and Trade
Scarcity requires efficiency in the allocation/use of resources. Efficiency requires specialization (production) & trade (exchange) according to the law of comparative advantage.
Benefits of Specialization & Trade
- Increased output (economic growth).
- Greater efficiency in the use of a fixed quantity of resources.
- Greater variety of goods available for consumption.
Costs of Specialization & Trade
Greater interdependence, risk, monotony in production.
Assumptions of PPC (Production Possibilities Curve)
- Only 2 goods are produced.
- Given or fixed quantity of resources.
- Given or fixed quality of resources.
- Full & efficient employment of all resources.
- Given or fixed technology.
PPC Points
A point lying on the PPC indicates full & efficient employment of resources & represents an output combination that is both possible & desirable. A point lying on the inside or to the left of the PPC indicates unemployment or inefficient employment of resources & represents an output combination that is possible but undesirable. A point lying on the outside or to the right of the PPC represents an output combination that is impossible but desirable.
Types of PPC
- Straight Line PPC: Constant slope. Constant marginal opportunity costs; resources are equally suited to both productive activities.
- Bowed-Out/Concave PPC: Increasing slope. Increasing marginal opportunity costs. Resources are not equally suited to both productive activities. Illustrates the law of increasing costs: as successive equal amounts of a good are produced, its marginal opportunity cost rises.
- Bowed-In/Convex PPC: Decreasing slope. Decreasing marginal opportunity costs. Resources are more suited to one productive activity.
Shifts of PPC
- Rightward Shift of PPC – Economic Growth (more output): Increase in quantity of resources; increase in quality of resources; improvement in technology.
- Curve Shifts to the Left of PPC (less output): Decrease in quantity of resources; decrease in quality of resources; decrease in technology.
Allocative Mechanisms
Brute force; tradition; queuing; random selection; the market system; government.
Law of Demand
An inverse relationship between price & quantity demanded, all things equal (ceteris paribus); represented by a downward sloping demand curve.
Perfectly Competitive Market
Many buyers & sellers where no one can control the outcome; no barriers to entry or exit; identical or standardized good; perfect information (no inside info).
Law of Supply
A direct relationship between price & quantity supplied, all things equal (ceteris paribus); represented by an upward sloping supply curve.
Determinants of Demand
o = other (weather, laws); pr = price of related goods; e = buyers expectations; n = number of buyers; i = income; t = tastes
Determinants of Supply
o = other (weather, laws); pr = price of related goods; e = sellers expectations; n = number of supplies; i = input prices; t = technology
Changes in Demand and Quantity Demanded
Change in demand is caused by a change in any of the 6 determinants of demand & is illustrated by a shift of the entire demand curve. Change in quantity demanded is illustrated by a movement along a given demand curve & is caused by a change in the price of the good, assuming all other factors constant.
Changes in Supply and Quantity Supplied
Change in supply is caused by a change in any of the 6 determinants of supply & is illustrated by a shift of the entire supply curve. Change in quantity supplied is illustrated by a movement along a given supply curve & caused by a change in the price of the good, assuming all other factors constant.
Market Equilibrium and Disequilibrium
Market equilibrium exists when the demand (buyers) price equals the supply (sellers) price, & quantity demanded equals quantity supplied (no shortage or surplus). Market disequilibrium: 1. If price is less than equilibrium price, then a shortage is created. 2. If price is greater than equilibrium price, then a surplus is created. An upward (downward) adjustment of the price eliminates the shortage (surplus).
Cost of Production and Supply
An increase in the cost of production (higher resource prices) will shift the supply curve leftward: a decrease in the cost of production (lower resource prices) will shift the supply curve rightward.
Price Ceilings and Floors
- Ceiling Price: A legislated maximum price below the equilibrium price; creates a shortage; leads to the use of non-price allocative mechanisms; inefficiency & inequity.
- Price Floor: A legislated minimum price above the equilibrium price; creates a surplus; leads to the use of non-price allocative mechanisms; inefficiency & inequity.
Economic Systems
- Capitalism: Decentralized decision making; private, individual property rights; information mechanism is market; incentives are monetary & material; philosophy of government is laissez faire.
- Socialism: Centralized decision making; public, collective property rights; information mechanism is national planning; incentives are non-monetary (political, moral, religious, etc.); philosophy of government is government knows best.
Mixed Economy
A mixed economy is an economic system variously defined as containing a mixture of markets & economic planning, in which both the private sector & state direct the economy; or as a mixture of public ownership & private ownership; or as a mixture of free markets with economic interventionism.
The U.S. is called a mixed economy because it uses a mixture of the 2 basic types of economic systems. When the government is involved, what you can do is limited.
Opportunity Cost
Opportunity cost: The highest-valued alternative that must be forgone when a choice is made. Total cost = explicit cost + opportunity cost.
Technological Change
Technological change: The whole curve shifts. Productivity & supply increases.
Market Shifts
D down with no change on supply side. Causes pe down & qe down. Left shift of d curve; d up with no change on supply side. Causes p up, qd down, qs up, pe up, & qe up. Right shift of the d curve; s down with no change in d. pe up & qe down; s up with no change in d. pe down & qe up. Rightward shift; d down & s down equals pe uncertain & qe down; d up & s up equals pe uncertain & qe up; d down & s up equals pe down & qe uncertain; d up & s down equals pe up & qe uncertain.
Substitute and Complementary Goods
- Substitute Goods: If the price of one rises/decreases, the price of the other rises/decreases.
- Complementary Goods: If the price of one rises, the demand for the other one falls.
Cost of Production and Equilibrium
Cost of production: An increase in will shift the supply curve leftward, causing a lower equilibrium. A decrease will shift the supply curve rightward, causing a higher equilibrium.
Basic Economic Questions
3 basic economic questions: What is to be produced; how are the goods to be produced; for whom are the goods produced.
Direct and Inverse Relationships
- Direct Relationship: When both dependent & independent variables go up.
- Inverse Relationship: When one of the two variables go in the opposite direction. One up, one down.
