Overview
This lecture reviews foundational economic concepts from Chapters 1–3, focusing on opportunity cost, economic systems, production possibilities frontiers, and the basics of supply and demand.
Core Economic Concepts
- Opportunity cost is the value of the best alternative forgone.
- Economics studies how humans make choices under scarcity.
- Scarcity means unlimited wants exceed limited resources.
- Four resource types: land (natural resources), labor (human effort), capital (manufactured resources), and entrepreneurship (organizing other resources).
- Division of labor splits work among workers; specialization focuses workers on tasks they do best, increasing efficiency.
- Macroeconomics studies the whole economy; microeconomics examines individual consumers and firms.
Types of Economic Systems
- Command economy: government controls most economic decisions.
- Market economy: buyers and sellers make most decisions.
- Traditional economy: customs dictate economic activity.
- Heavily regulated economies may create underground economies.
Key Economic Principles
- Ceteris paribus means holding all other variables constant.
- The three main macroeconomic goals are economic growth, price stability, and full employment.
- Economies of scale: higher production leads to lower average costs.
Production Possibilities Frontier (PPF)
- PPF shows maximum efficient production combinations of two goods.
- Points on the PPF are efficient; inside are inefficient; outside are unattainable.
- Bowed-out PPF reflects increasing opportunity costs; straight line means constant opportunity costs.
- Comparative advantage means producing at a lower opportunity cost.
- Specialization and trade allow consumption beyond a country’s PPF.
- Sunk costs are irrecoverable and should not affect future decisions.
Marginal Analysis & Utility
- Marginal means additional.
- Decisions at the margin compare extra benefits and costs.
- Law of diminishing marginal utility: extra satisfaction from more units declines.
- Law of diminishing marginal returns: more resource input yields less extra output.
Supply and Demand
- Demand: willingness/ability to buy at various prices; Law of Demand—price up, quantity demanded down.
- Supply: willingness/ability to sell at various prices; Law of Supply—price up, quantity supplied up.
- Change in demand/supply shifts the whole curve; change in quantity demanded/supplied moves along the curve.
- Surplus: price above equilibrium, excess supply; shortage: price below equilibrium, excess demand.
- Equilibrium is where supply and demand curves intersect.
Determinants of Demand and Supply
- Demand shifts (PRIME): Preferences, Related goods (complements/substitutes), Income, Market size, Expectations.
- Supply shifts (RATNEST): Resource prices, Alternate goods, Technology, Number of sellers, Expectations, Subsidies, Taxes/regulations.
- Fixed supply means a vertical supply curve.
Key Terms & Definitions
- Opportunity Cost — the value of the next best alternative forgone.
- Scarcity — the condition where wants exceed available resources.
- Division of Labor — splitting production into tasks for efficiency.
- Specialization — focusing resources on specific tasks.
- PPF — a graph showing efficient output combinations.
- Comparative Advantage — lower opportunity cost in production.
- Sunk Costs — past costs that cannot be recovered.
- Marginal Utility — the extra satisfaction from one more unit.
- Law of Demand/Supply — price changes inversely/directly affect quantity demanded/supplied.
- Equilibrium — the price/quantity where supply equals demand.
- Surplus/Shortage — excess supply/demand relative to equilibrium.
Action Items / Next Steps
- Review examples of labeled PPF, demand, supply, and equilibrium graphs.
- Memorize PRIME and RATNEST factors for demand and supply shifts.
- Be able to distinguish between positive and normative statements.