Chapter 1.1 Complexity of the Modern Economy
What is an economy? An economy is a system in which scarce resources are allocated among
Why are free market economies based on self-organizing? There is a spontaneous economic order.
When individuals and consumers act independently to pursue their self-interests, responding to prices in
the market, the collective outcome is coordinated.
Adam Smith`s important insight
- Self-interest, not benevolence, is the foundation of economic order
- Free market economies are relatively efficient
What is laissez-faire?
- Individual freedom and conduct, where the government should not interfere in business
What is the invisible hand?
- The free market works automatically as if an invisible hand was guiding it. People pursue
their best interests and end up benefiting the society as well
What does an efficient economy mean?
- An economy that produces all the goods and services that people want and to produce them
with the least amount of resources
Summary: What are the main characteristics of market economies?
Self-interest: people pursue their own self-interest, buying and selling what is best for them and their
Incentives: people respond to incentives, sellers wish to sell more when prices are high; buyers wish to
buy more when prices are low
Market prices and quantities: buyers and sellers negotiate the exchange of commodities in markets via
Institutions: governed by rules of the game - private property rights, freedom of choice, freedom of
enterprise, freedom of contract
Chapter 1.2 Scarcity, Choice and Opportunity Cost
Define economics – the study of the use of scarce resources to satisfy unlimited human wants
Resources (inputs) -> Goods and Services (outputs) -> Consumption (satisfaction) How is scarcity a fundamental problem faced by all economies?
- Relative to people’s unlimited desires, existing resources are inadequate
What does scarcity imply?
- Scarcity implies choices because when resources are scarce, societies must decide what to
produce and how much for each person
- Choice implies the existence of costs because to have more of something requires a decision
to have less of something else
What are the five factors of production (input)?
- Capital: Plant, Equipment, Inventory, Residential construction
- Land: natural capital, natural resources
- Labour: human capital, human resource
- Technology: changes in the productive process
- Entrepreneurship: innovation, invention
What is opportunity cost?
- A cost that is measured in terms of the best alternative that could have been obtained
What three concepts does a production possibilities boundary illustrate?
- Scarcity by the unattainable points outside the boundary, choice by the need to choose
among the alternative attainable points along the boundary, and opportunity cost by the
negative slope of the boundary
Why is the production possibilities boundary slope negative?
- Because when all resources are being used efficiently, producing more of one good requires
producing less of others
What does a straight-line boundary indicate?
- The opportunity cost of one good stays constant, not matter how much of it is produced
Why is the shape of the production possibilities curve concave?
- Each factor of production is better suited to producing one good than another good. The
opportunity cost of producing one good rises as more of that good is produced. For
example, if the two goods are food and clothes, then in order to produce more and more
clothes, eventually the most productive farm land must be allocated to clothes production.
As a result, the opportunity cost of producing ever larger quantities of clothes rises as more
clothes are produced. Four Key Economic Problems
- Production: What is produced and how? The allocation of scarce resources among alternative
uses and what method of production is used and which are not.
- Consumption: What is consumed and by whom? The distribution of a nation’s total output
among its people.
- Idle capacity? Why are resources sometimes idle? Why are there unemployed people, inactive
factories, unused capital? Why is the economy below PPC?
- Increase capacity? Is productive capacity growing?
1.3 Who makes the Choices and How?
What is a factor market?
- This is where individuals sell the services of the factor that they own (labor)
What is a goods market?
- This is where producers sell their outputs of goods and services. (places like Walmart, Zara)
How is the distribution of income determined?
- It is determined by the price that each type of factor service receives in factor markets.
People who get high prices for their factor services(job) earn high incomes, vice versa
What is the definition of a maximizer?
- When consumers/producers make decisions that will maximize their well-being and utility
How does the flow of income and expenditure work?
A model that indicates how money moves throughout an economy, between businesses and
individuals. Investors spend their income by consuming goods and services from businesses,
paying taxes and investing in the stock market. Businesses use the money spent by individuals
while consuming and the money raised from selling stock to pay for capital to run their business,
purchase material to manufacture products and to pay employees. All expenditures from
individuals become the income of the businesses, and the expenditures of the businesses
become the income of the individuals.
Chapter 3.1 What is the difference between quantity demanded and demand?
- Demand refers to the entire relationship between the quantity demanded and the
price of the product, quantity demanded refers to a specific quantity desired given
the price over some time period
How is the quantity demanded and the price of a product related?
- They are related negatively, as the price of a product goes up, the quantity
demanded goes down, vice versa.
What are some of the ceteris paribus variables for demand?
- Income, Price of other goods, tastes, Expectations
What happens to the demand of a complement product when the price of a product goes up?
- Demand decreases for both products
What happens to the demand of a substitute