Chapter 1

Key Definitions:
- Economics - study of choices made under scarcity

- Microeconomics - study of individual/business choices

- Macroeconomics - study of the overall economy (statistical indices: GDP,GNP,CPI…, phenomena:

unemployment, growth, inflation)

- Scarcity - inability to meet all wants given the limited resources

- Incentive - reward or penalty that influences choices (it drives behaviour)

Core Concepts:
- Choices involve tradeoffs

- Opportunity cost is what must be given up

- Choices made at the margin, weighing marginal costs and benefits

- Economic models simplify reality to clarify concepts

What/How/For Whom:

- What? Goods and services produced

- How? Using factors of production (land, labor, capital, entrepreneurship)

- For Whom? Distribution based on factor incomes (rent, wages, interest, profit)

Two Big Questions of Economics

1. How do choices determine:

o What goods/services are produced? (free economy, the market makes the decision)

 Composition changes over time based on wants (e.g. farm to services, or %

of the GDP)

o How are they produced?

 Using factors of production: land, labor, capital, entrepreneurship

 Land = natural resources

 Labor = human effort enhanced by education/training

 Capital = tools, machinery, factories

 Entrepreneurship = organizing the other factors

o For whom are they produced?

 Distribution based on factor incomes (rent, wages, interest, profit)

2. When do choices made in self-interest promote social interest?

 o Self-interest = make choices providing greatest benefit to yourself

o Social interest = choices that benefit society as a whole

o Tension between self-interest and social interest in real world (e.g. privatization,
globalization, corporate behavior)

Economic Way of Thinking

 Focus on scarcity requiring choices/tradeoffs

o Opportunity cost = highest valued alternative given up

o guns vs. butter trade-off example (Having to make a choice between two
desirables but competing alternatives because of limited resources.” Guns" is
military spending/weapons production. "Butter" is consumer goods
production. since resources like labor, factories, raw materials are limited or
scarce, using more for one purpose (military) means having less available for
the other purpose (bread).)

 Make decisions by evaluating at the margin (rational people think at the margin)

o Marginal benefit = gain from incremental increase in activity

o Marginal cost = opportunity cost of incremental increase

 Economic models simplify reality to isolate key variables (ceteris paribus)

Challenges as a Social Science

 Difficult to conduct true experiments

 Many variables influencing economic phenomena

 Analyze logical cause-and-effect using ceteris paribus assumption (fancy way of saying we
assume all other factors to be constant, in our regression model we turn all other X’s into 0,
basically isolating one factor and studying it while assuming the others don’t have any effect
even if they do it’s damn assumption what u except u dumb dumb)

Chapter 2 :

Production Possibilities Frontier (PPF):

- Illustrates scarcity by showing the maximum attainable combinations of two goods that can be
produced with available resources and technology, holding all else constant (ceteris paribus)

- Uses example of CDs and pizza to demonstrate the concept

- Points inside the frontier like Z are inefficient, as more of one good could be produced without
decreasing the other

- Points on the frontier like A, B, C are productively efficient

- The PPF is concave/bow-shaped because of increasing opportunity costs as more of one good is
produced

Opportunity Cost (machi tradeoffs different concepts even tho close definition):

- The cost of anything is the next best alternative given up

- Along the PPF, opportunity cost is measured as the decrease in the other good

- Opportunity costs rise as more of a good is produced due to transferring the best resources to that
use first

- Achieved when production is at the PPF point that aligns with consumer preferences

- Occurs where the marginal benefit (MB) curve intersects the marginal cost (MC) curve

- MB curve slopes down due to diminishing marginal benefit as more is consumed

- MC curve is the opportunity cost curve derived from the PPF

Preferences and Marginal Benefit:

- Preferences describe likes/dislikes and willingness to pay (demand)

- Marginal benefit is the added benefit from one more unit

- Follows law of diminishing MB - each additional unit is valued less

Economic Growth:

- Allows outward shift of the PPF over time

- Driven by technological advances and capital accumulation FBCF

- Example of trading off current pizza production to invest in new ovens

- Allows higher future production possibilities at cost of temporary reduction

Comparative Advantage:

- Person/country can produce a good at a lower opportunity cost than others

- Allows specialization in one's comparative advantage good

- Example of Tom (lower opp cost in discs) and Nancy (lower for cases)
Gains from Trade:

- By specializing per comparative advantages and trading, total output is higher than if producing
independently

- Illustrated by Tom producing 4000 discs, Nancy 4000 cases, trading to both end up with 2000 of
each

Property Rights and Markets:

- Property rights define ownership, incentives to trade/produce

- Markets enable buyers and sellers to exchange information, goods/services

- Illustrated with circular flow model between households, firms, government

Quiz:

1. What is the definition of economics?

2. Differentiate between microeconomics and macroeconomics.

3. Explain the concept of scarcity and how it relates to economics.

4. What are the two big questions of economics mentioned in the document?

5. Describe the concept of the production possibilities frontier (PPF).

6. What is the economic significance of the shape (concavity) of the PPF?

7. How is the concept of comparative advantage defined, and why is it important?

8. Explain the relationship between preferences, marginal benefit, and consumer choice.

9. How does economic growth affect the production possibilities frontier?

10. What role do property rights and markets play in an economy?

Answers:

1. Economics is the study of choices made under scarcity.

2. Microeconomics studies individual/business choices, while macroeconomics studies the overall

economy (GDP, GNP, CPI, unemployment, growth, inflation).

3. Scarcity refers to the inability to meet all wants given the limited resources available. It
necessitates making choices and tradeoffs.

4. The two big questions are: 1) How do choices determine what is produced, how it is produced,
and for whom it is produced? 2) When do choices made in self-interest promote social interest?

5. The production possibilities frontier (PPF) illustrates the maximum attainable combinations of two
goods that can be produced with available resources and technology, holding all else constant.

6. The concave/bow shape of the PPF reflects the increasing opportunity costs as more of one good
is produced, due to transferring the best resources to that use first.
7. Comparative advantage refers to a person/country's ability to produce a good at a lower
opportunity cost than others. It allows for specialization and gains from trade.

8. Preferences describe likes/dislikes and willingness to pay (demand). Marginal benefit is the added
benefit from one more unit, and it follows the law of diminishing marginal benefit as more is
consumed. Consumer choice aligns marginal benefit with marginal cost.

9. Economic growth, driven by technological advances and capital accumulation, allows an outward
shift of the PPF over time, enabling higher future production possibilities.

10. Property rights define ownership and incentives to trade/produce. Markets enable buyers and
sellers to exchange information, goods, and services.

Quiz 2:

1. According to the economic way of thinking, choices should be made by evaluating:

a) Sunk costs

b) Fixed costs

c) Opportunity costs

d) Marginal costs and benefits

2. Macroeconomics analyzes statistical indices such as:

a) Consumer price index and money supply

b) Productivity and market share

c) Elasticity of demand and game theory

d) Auction theory and bargaining models

3. The "guns vs. butter" example illustrates the concept of:

a) Absolute advantage

b) Opportunity cost

c) Economies of scale

d) Diminishing returns

4. If choices made in self-interest always promoted social interest, which would be eliminated?

a) Market failures

b) Government intervention

c) Externalities

d) All of the above

5. Which of these is not a factor of production?

a) Land

b) Labor

c) Capital

d) Monopoly power

6. If the economy is operating inside the production possibilities frontier, it is considered:

a) Efficient

b) Inefficient

c) At full employment

d) Unsustainable

7. The basis for gains from trade between individuals or nations is:

a) Absolute advantage

b) Comparative advantage

c) Economies of scale

d) Monopolistic competition

8. As consumer preferences shift towards a good, the marginal benefit curve will:

a) Shift left

b) Shift right

c) Become flatter

d) Become steeper

9. An increase in capital accumulation and technological progress allows:

a) Movement along the PPF

b) An inward PPF shift

c) An outward PPF shift

d) None of the above

10. Well-defined property rights provide incentives for:

a) Free riding

b) Producing public goods

c) Negative externalities

d) Economic exchange and investment

Answers:

1. d) Marginal costs and benefits

2. a) Consumer price index and money supply

3. b) Opportunity cost

4. d) All of the above

5. d) Monopoly power

6. b) Inefficient

7. b) Comparative advantage

8. b) Shift right

9. c) An outward PPF shift

10. d) Economic exchange and investment