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Summary of economics for CAB2 exam
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This summary covers the economics content for the CAB2 exam
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Chapter 1Definition of economics
▪ Economics: the social science that studies the choices that individuals, businesses, governments, and entire
societies make as they cope with scarcity and the incentives that influence and reconcile those choices.
There are two parts:
1. Microeconomics: The study of choices that individuals and businesses make, the way these choices
interact in markets, and the influence of governments.
2. Macroeconomics: The study of the performance of the national economy and the global economy.
▪ Scarcity: the inability to get everything we want. Is universal. What society can get is limited by the productive
resources available.
▪ Incentive: A reward that encourages an action, or a penalty that discourages one.
▪ Goods and services are the objects that people value and produce to satisfy wants. Goods are physical objects
and services are tasks performed for people.
▪ How we produce is described by the technologies and resources that we use. The resources used to produce
goods and services are called factors of production, which are grouped into four categories:
1. Land: The “gifts of nature” that we use to produce goods and services. Also called natural resources.
2. Labor: The work time and effort that people devote to producing goods and services. Mental and physical.
Quality of labor depends on human capital, which is the knowledge and skill that people obtain from
eduction, on-the-job training, and work experience.
3. Capital: The tools, instruments, machines, buildings, and other constructions that businesses use to
produce goods and services. Financial capital plays an important role in enabling businesses to borrow the
funds that they use to buy physical capital, is not a factor of production.
4. Entrepreneurship: The human resource that organizes labor, land and capital.
▪ Who consumes the goods and services that are produced depends on the incomes that people earn.
▪ People earn their incomes by selling the services of the factors of production they own:
1. Land earns rent.
2. Labor earns wages.
3. Capital earns interest.
4. Entrepreneurship earns profit.
▪ Labor earns the most income.
Do choices made in the pursuit of self-interest also promote the social interest?
▪ Self-interest: You make a choice in your self-interest if you think that choice is the best one available for you.
▪ Social interest: An outcome is in the social interest if it is best for society as a whole. Two dimensions:
1. Efficiency: resource use is efficient if it is not possible to make someone better off without making
someone else worse off.
2. Fair shares: no clear definition of fairness to match that of efficiency. What is fair?
▪ Four topics that generate discussion and that illustrate tension between self-interest and social interest are:
1. Globalization: The expansion of international trade, borrowing and lending, and investment. Globalization
is in the self-interest of those consumers who buy low-cost goods and services produced in other
countries, and it is in the self-interest of the multinational firms that produce in low-cost regions and sell
in high-price regions.
2. Information-age monopolies: Technological change of the past 40 years is the Information Revolution.
3. Climate change: Can each one of us be relied upon to make decisions that effect the Earth’s carbon-
dioxide concentration in the social interest?
4. The Covid pandemic: People choose their degree of social isolation in their self-interest.
,The economic way of thinking
▪ Six key ideas that define the economic way of thinking:
1. A choice is a tradeoff: You can think about choices as tradeoffs. A tradeoff is an exchange, giving up one
thing to get something else.
2. People make rational choices by comparing benefits and costs: A rational choice is one that compares
costs and benefits and achieves the greatest benefit over cost for the person making the choice.
3. Benefit is what you gain from something: The benefit of something is the gain or pleasure that it brings
and is determined by preferences. Economists measure benefit as the most that a person is willing to give
up to get something.
4. Cost is what you must give up to get something: The opportunity cost of something is the highest-valued
alternative that must be given up to get it. Most situations involve choosing how much of an activity to do.
5. Most choices are “how-much” choices made at the margin: When a choice is made by comparing a little
more of something with its cost, the choice is made at the margin. The benefit that arises from an increase
in an activity is called marginal benefit. The opportunity cost of an increase in an activity is called marginal
cost. To make a decision, you compare marginal benefit with marginal cost.
6. Choices respond to incentives: Economists take human nature as given and view people as acting in their
self-interest. A self-interested act gets the most benefit for you based on your view about benefit. The
central idea of economics is that we can predict the self-interested choices that people make by looking at
the incentives they face. People undertake those activities for which marginal benefit exceeds marginal
cost, they reject options for which marginal cost exceeds marginal benefits. When our choices are not in
the social interest, it is because of the incentives we face.
Economics as social science and policy tool
▪ Economists distinguish between positive and normative statements:
1. Positive statement: Is about what is. It says what is currently believed about the way the world operates. A
central task of economists is to test positive statements about how the economic world works and to
weed out those that are wrong.
2. Normative statement: Is about what ought to be. It depends on values and cannot be tested. Policy goals
are normative statements.
▪ Economists are particularly interested in positive statements about cause and effect.
▪ An economic model is a description of some aspect of the economic world that includes only those features
that are needed for the purpose at hand. A model is tested by comparing its predictions with the facts. Testing
an economic model is difficult because we observe the outcomes of the simultaneous change of many factors.
Economists in the economy
▪ Five skill requirements for economics jobs stand out:
1. Critical-thinking skills: Ability to clarify and solve problems using logic and relevant evidence.
2. Analytical skills: Use of economic ideas/tools to examine data, notice patterns, reach a logical conclusion.
3. Math skills: Ability to use mathematical and statistical tools to analyze data and reach valid conclusions.
4. Writing skills: Ability to present ideas, conclusions, reasons in brief written reports for the target audience.
5. Oral communication skills: Ability to explain ideas, conclusions, and reasons to people with a limited
background in economics.
,Graphing Data
▪ Vertical is y-axis, horizontal is x-axis. Zero point in the middle is called the origin.
▪ The lines in the graph are called coordinates. Y-coordinate corresponds with the value on the y-axis and the x-
coordinate corresponds with the value on the x-axis.
▪ Scatter diagram is a graph that plots the value of one variable against the value of another variable for a
number of different outcomes. It reveals whether a relationship exists between two variables and describes
their relationship. You can see if there is a strong or weak relation according to the dots in the diagram. If they
are ‘scattered’ there is no relation.
▪ Breaks in the axes (//) indicate that there are jumps from the origin, 0, to the first values recorded. Putting a
break in one or both axes brings the relationship into the center of the graph.
▪ A scatter diagram that shows a clear relationship between two variables tells us that the two variables have a
high correlation. Correlation does not imply causation!
▪ High correlation can mean that two variables have a common cause.
Graphs used in economic models
▪ Graphs used in economics are not always designed to show real-world data. Often they are used to show
general relationships among the variables in an economic model.
▪ The patterns to look for in graphs are the four cases in which:
1. Variables move in the same direction:
- A relationship between two variables that move in the same direction is called a positive relationship or a
direct relationship. In that case the line slopes upward.
- Line on a graph is called a curve.
- A relationship shown by a straight line is called a linear relationship.
2. Variables move in opposite directions:
- A relationship between variables that move in opposite directions is called a negative relationship or an
inverse relationship.
3. Variables have a maximum or a minimum.
4. Variables are unrelated:
- No matter what happens to the value of one variable, the other variable remains constant.
The slope of a relationship
▪ The slope of a relationship is the change in the value of the variable measured on the y-axis divided by the
change in the value of the variable measured on the x-axis. Slope = Δy/Δx.
▪ The slope of a straight line is the same regardless of where on the line you calculate it. It’s constant.
▪ The slope of a positive relationships is positive and the slope of a negative relationship is negative.
▪ Slope of a curved line is not constant. Two ways to calculate
the slope of a curved line:
1. Calculate the slope at a point:
- Construct a straight line that has the same slope as the
curve at the point in question.
- The line you draw should only touch point A, then the
curve and line have the same slope. If the line cuts the
curve, the slope is not the same.
- Now, you can calculate the slope of the straight line.
, 2. Calculate the slope across an arc (boog) of the curve:
- The slope will be calculated across the arc from point B
to point C. When you calculate the slope across an arc,
you calculate the average slope between two points.
- It approximates the average slope!
Graphing relationships among more than two variables
• To graph a relationship that involves more than two variables, we use the ceteris paribus assumption.
• Ceteris paribus means ‘if all other relevant things remain the same’.
• To graph a relationship among three variables, the value of one variable is held constant.
• A cet par change in the value of a variable on an axis of a graph brings a movement along the curve.
Mathematical note
• The equation that describes a straight-line relationship between x and y is: y = a + bx.
• A and B are fixed numbers and are called constants.
• Values of x and y vary, these are the variables.
• The equation describes a straight line, so it is called a linear equation.
• It tells that when the value of x is 0, the value of y is a (this is the point where the line intercepts the y-axis).
• The constant b tells by how much y increases above a as x increases. Constant b is the slope of the line.
• The value of the y-axis intercept does not influence the slope of the line.
• All negative relationships have a slope that is negative. Constant b will be negative.
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