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EconomicsEconomics is about choices, alternatives. Human wants are unlimited, but recources are not.
Economics = the study of how individuals and societies choose to use the scarce recources
that nature and previous generations have provided.
1. The Scope and Method of Economics
1.1 Why study economics
▪ Opportunity cost: the full cost of a decision includes what we give up by not making the
best alternative choice
▪ Marginalism: only weigh the costs and benefits that arise from the decision itself
(additional cost)
▪ Efficient markets – no free lunch: profit opportunities are always eliminated almost
instantaneously in efficient markets
1.2 Microeconomics vs macroeconomics
▪ Micro-economics: individual industries, firms, households
→ individual decision-making units
▪ Macro-economics: economy as a whole
→ behavior of aggregates (national output, national income, overall price level, the
general rate of inflation)
2. The Economic Problem: Scarcity and Choice
2.1 The economic problem
The three basic questions:
▪ What gets produced? Recources (primary recources: land, labor, capital) Allocation of recources
▪ How is it produced? Producers Mix of output, distribution
▪ Who gets what is produced? Households of output
Every society has some system or process that transforms its scarce resources into useful
goods and services. In doing so, it must decide what gets produced, how it is produced, and
to whom it is distributed. The primary resources that must be allocated are land, labor, and
capital.
Production: process that transforms scarce recources (input) into useful goods and services
(output)
▪ Capital goods
, o Used for producing other goods (production lines, inventory,..)
▪ Consumer goods: for consumption purposes can be durable and non-durable
o E.g. clothes = durable and bread = non-durable)
2.1.1 Scarcity and choice in a one-person economy
▪ One-person economy
o Think : stranded on a deserted island
o Rare, but useful for study,because basic decisions are the same of more complex
economies
▪ Basic decisions
o What that person wants to produce (output)
o Possibilities (what can the person do to satisfy his wants given the limits =
scarcity)
o How to (best) use resources (or inputs)
2.1.2 Scarcity and choice in an economy of 2 or more
▪ Basic decisions
o What they want to produce (output)
o Possibilities (what is possible given the limited resources = scarcity)
o How to (best) use resources (or inputs)
=> They will benefit from specializing in what they do best! (comparative advantage)
Scarcity: what can the person do to satisfy his wants given the limits
2.1.3 Absolute advantage – comparative advantage – opportunity cost
▪ Absolute advantage: who can produce the most, best in both products
▪ Comparative advantage: who has the lowest opportunity cost, compare how much
better it is, less worse
▪ Specialization: opportunity costs are higher, both equally important
2.1.4 Production possibility frontier (PPF)
▪ Illustrates the principle of constrained choice, opportunity cost and scarcity
o Scarcity: negative slope (constrained by available recources)
o Opportunity cost: trade-off between two goods (increasing opportunity cost =
PPF bowed out)
▪ = all combinations of goods and services that can be produced if all of society’s
recources are used efficiently
▪ Economic growth => PPF shifts to the right (more resources, more production with
existing resources)
,▪ All points below and to the left of the curve (the
shaded area) represent combinations of capital and
consumer goods that are possible for the society
given the resources available and existing technology
▪ Points above and to the right of the curve, such as
point G, represent combinations that cannot be
reached
▪ Points on the PPF represent full resource employment
and production efficiency
China and Japan try to get the maximum out of their recources, very close to the frontier,
capital goods will make you more efficient
Best economical option: change to your consumer needs and use the left-overs to invest in
the future
Ppf shifts to the right if you have more resources (f.e. more technology, work forces, new
land) leads to more possibilities
▪ Points outside the curve represent combinations that
cannot be reached
▪ Points on the ppf represent full resource employment
and production efficiency
▪ All points to the left of the curve (shaded area)
represent combinations of capital goods and
consumer goods that are possible for the society
given the resources available and existing technology
▪ Although an economy may be operating with full
employment of its land, labor and capital resources, it
may still be operating inside its ppf, at a point such as
D. The economy could be using those resources
inefficiently
▪ Periods of unemployment also correspond to points inside the ppf, such as point D
▪ Moving onto the frontier from a point such as D means achieving full employment of
resources
Move towards the ppf = use more recourses
Move the ppf to the upper right = have more resources
Exercices:
Ceteris paribus: all else equal
Marginal cost: the additional cost
The concept of opportunity cost is based on the principle of scarcity
To the theory of comparative advantage, trade and specialization raise productivity by
lowering opportunity costs
If the unemployment rate increases from 10% to 14%, the economy will move away from
the ppf toward the origin
, Economic growth is represented by a shift of the frontier to the right
Unemployment does not move the ppf
If you increase knowledge, you increase resources
3. Demand, Supply and Market Equilibrium
3.1 Firms and households: the basic decision-making units
3.2 Input markets and output markets: the circular flow
Output (product) market
Law of supply Law of demand
Factors impacting supply FIRMS
Circular flow of HOUSEHOLDS Factors impacting demand
economic activity
Market supply Market demand
Input (factor) market
MARKET EQUILIBRIUM
3.3 Demand in product/output markets
The decision upon what you buy and how much depends on:
• Price of the product
• Income available
• Amount of accumulated wealth
• Prices of other products (substitutes & complementary goods)
• Tastes and preferences
• Expectations about future income, wealth & prices
➔ Quantity demanded = The amount of a product that a household would buy in a given
period if it could buy all it wanted at the current market price (< > availability)
3.3.1 The law of demand
The relationship between the price and quantity demanded presented graphically is called a
demand curve.
Demand curves have a negative slope, indicating that lower prices cause quantity demanded
to increase (the higher the price, the lower the quantity).
Law of demand
• =negative relationship between price and quantity demanded
• =negative slope => law of diminishing marginal utility
Intersection Y axis (price)
• There is a price above which no demand is left (limited income & wealth)
Intersection X axis (quantity)
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