CHAPTER 1: WHAT IS ECONOMICS?
• Economics as a discipline exists because of material and temporal scarcity. (not enough
“things” to satisfy all wants, and not enough “time” to do everything).
• Because of scarcity, choices must be made (by individuals, by companies, by governments)
• Choices depend benefits and costs (and tradeoffs).
• Benefits (pleasure, profits, votes) are an incentive/ reward that encourages an action. Costs
are a dis-incentive/penalty that discourages an action.
• Most decisions involve more or less, rather than all or none, and involve marginal analysis
Economics is the social science:
1. It is theory and logic based and relies on evidence based analysis.
2. It’s domain (scope of study) is the choices that individuals, businesses, governments,
and entire societies make as they cope with scarcity and the incentives that influence
and reconcile those choices.
3. It pays particular attention to the role of markets and prices as a “form follows
function” human inventions (tools) to assist in choice making.
Microeconomics is the study of choices (individuals, businesses, gov’t) make, the way those choices
interact in markets, and the influence/role of governments.
Example of a microeconomic question: Why are people buying more e-books and fewer hard
copy books, and why are the prices what they are?
Macroeconomics is the study of the performance of the national and global economies at the
Example of a macroeconomic question: Why is the unemployment rate high in Canada?
Two big questions summarize the scope of economics:
How do choices end up determining what, how, and for whom goods and services get
When do choices made in the pursuit of self-interest also promote the social interest?
Issues: Who’s self-interest counts here (the rich?, the homeless?) and who’s definition
of social interest are we to use?
What, How, and For Whom?
Goods and services are the objects that people value and produce to satisfy human wants.
1. What gets produce? At the microeconomic level mainly market forces (& gov’t policy). At the
macroeconomic level mainly levels of affluence and productivity, and foreign trade markets
2. How involves asking what inputs and in what combinations: Economists call inputs factors of
Factors of production are grouped into four categories:
Land (natural resources, “gifts of nature” – land, forest, minerals, etc.) Labour (humans – work time and work effort that people devote to producing goods
and services , skilled labour involves human capital)
Capital (plants and equipment – not financial capital- The tools, instruments, machines,
buildings, and other constructions that businesses use to produce goods and services)
Entrepreneurship (ability to organize and orchestrate activity (entrepreneur is capitalist
owner, but this ability can rest in an agency, or community, or other entity- The human
resource that organizes land, labour, and capital)
3. For Whom? Who gets the goods and services depends on “effective demand” in turn based
on the income and wealth that people have.
Land earns rent. (which differs from “Economic Rent”)
Labour earns wages. (may include Economic Rent)
Capital earns interest.
Entrepreneurship earns profit as a residual
Self-Interest: choices you make in your self-interest —are choices that you think are best for you.
Social Interest: Choices that are best for society as a whole are said to be in the social interest.
Social interest has two dimensions:
Efficiency: the best use of inputs to produce the outputs. Achieved when the available
resources are used to produce goods and services:
1. At the lowest possible input cost, (or price if prices measure real costs) Problem of
2. In quantities that give greatest possible benefit. (How do markets help achieve this, or
prevent this from occurring?)
Equity: Some notion of “fairness” or “social justice” as far as who does the work, and who
It is about fairness.
1. Economics has nothing special to say about this.
2. Individual economists have a variety of views about what is fair.
Big Question? When can choices made in self-interest promote the social interest?
Two Big Economic Question: Four topics that generate discussion and that illustrate tension between
self-interest and social interest are
1. Globalization: Where production and income occur. Expansion of international trade
(goods and services), in the flow and ownership of factors of production, and growth of
global financial markets (borrowing, lending and investment).
Self-interest of consumers who buy low-cost imported goods and services. (What
about “fair trade (coffee); locavour/100 mile diet)
Self-interest of the multinational firms that profit maximize producing in low-cost
regions and selling in high-price regions.
2. The information-age economy: Impact of ICT (information and communication
technology). Expands time and space by adding virtual time/space to literal time/space
to support organizations and processes.
Has created has been called the Information Revolution. Served self-interest: providing affordable cell phone, application, and Internet
Brought wealth to innovators: Entrepreneurs behind Microsoft, Apple, and Intel
have seen their wealth soar.
3. Global warming: Extent, Causes, Effects, Actions
Self-interested choices to use electricity and gasoline contribute to carbon
emissions, and leave a carbon footprint.
The carbon footprint can be reduced by walking, riding a bike, taking cold
showers, or planting a tree.
But can each one of us be relied upon to make decisions that affect the Earth’s
carbon-dioxide concentration in the social interest? What options or
mechanisms are available to make the right (or better) decisions here?
4. Economic instability: Causes, Effects, Actions
From 1993 to 2007 Canada and global economies grew.. Canadian incomes
increased by 30%, China’s tripled.
Banks conducted self-interested borrowing & lending, people made self-
interested home buying decisions.
How did, or did not, this lending and borrowing serve the social interest?
What role did industry driven changes in the “rules of the game” contribute to
this economic mess
Economic Way of thinking: Six key ideas
1. A choice is a tradeoff. The economic way of thinking places scarcity and its
implication, choice, at center stage. Every choice is a tradeoff — giving up one thing
to get something else.
“Tonight, will you study or have fun? You can’t study or have fun at the same time, so
you must make a choice.” Whatever you choose, you could have chosen something
else. Every choice is a tradeoff. When you think you have no choice it is usually
because any other option is too costly.
2. People make rational choices by comparing benefits and costs. Compares costs
and benefits and achieves the greatest total benefit, for those costs, as viewed by
the person making the choice. Only the wants of the person making a choice are
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. Preferences are what a
person likes and dislikes and the intensity of those feelings. (Preferences come from
4. Cost is what you must give up to get something. Relevant Cost: What is best thing
you Must Give Up. Opportunity cost: the highest-valued alternative given up to get it.
“What is your opportunity cost of taking ECON1000?”
• Opportunity cost has two components:
- What you can’t afford to buy if you pay tuition, purchase text books, pay for
transportation, etc. (things foregone). - The things you can’t do with your time if you study and go to class.
5. Most choices are “how-much” choices made at the margin. Choosing at the Margin
“You can allocate the next hour between studying and instant messaging your friends.”
The choice is not all or nothing, but you must decide how many minutes to allocate to
each activity. To make this decision, you compare the benefit of a little bit more study
time with its cost—you make choices at the margin, so marginal analysis is central to
To make a choice at the margin, you evaluate the consequences of making incremental
changes in the use of your time.
The benefit from pursuing an incremental increase in an activity is its marginal benefit.
The opportunity cost of pursuing an incremental increase in an activity is its marginal
If the marginal benefit from an incremental increase in an activity exceeds its
marginal cost, your rational choice is to do more of that activity.
6. Choices involve incentives, constraints, options, and information. A change in
marginal cost or a change in marginal benefit changes the nature/value of the
incentives that we face and leads us to change our choice.
One central idea of economics is that we can predict how choices will change
by looking at changes in incentives.
Incentives are also the key to reconciling self-interest and the social
interest, given the right context and conditions.
A social science and policy tool
Economist as Social Scientist
Economists, Philosophers, Scientists and others distinguish between two types of statement:
Objective “What is” statements called positive statements (term from Logical
Subjective “What ought to be” statements called normative statements
A positive statement can be tested by checking it against facts.(e.g. Falling oil prices will drive
down the Canadian dollar)
A normative statement expresses an opinion and cannot be tested. (e.g. Gasoline prices are too
Economic science: Discover positive statements (relationships/laws) that are consistent with: what
we observe in the world, enable us to understand how the economic world works, and carry out
effective policies at the individual, organizational, and governmental levels.
To do this economists create and test economic models.
Economic model: Description of some aspect the economic world that includes only those features
that are needed for the purpose at hand. (Occum’s Razor)
A model is tested by comparing its predictions with the facts.
But testing economic models is difficult, so economists also use
Natural experiments: Mainly comparative data (US vs Canada contexts, same
variables, different outcomes) Statistical investigations: Work with time-series or cross section data (StatCan data,
survey data, market data)
Economic experiments: Experimental Economics (run subjects through market
scenarios to explore reactions)
Economist as Policy Adviser: Economics is also a toolkit for advising governments and businesses
and for making personal decisions.
All the policy questions involve a blend of the positive and the normative. Economics can’t help
with the normative part—the goal, other than assess marginal tradeoffs between goals. For a given
goal, economics provides a method of evaluating alternative solutions (how to’s)—comparing
marginal benefits and marginal costs.
CHAPTER 2: THE ECONOMIC PROBLEM
Production possibilities and Opportunity Cost: The production possibilities frontier (PPF) is the
boundary between those combinations of goods and services that can be produced and those that
Focus on two goods, and hold the quantities of all other goods and services
PPF for two goods: cola and pizzas. Any point on the frontier such as E and any point inside the PPF
such as Z are attainable. Points outside the PPF are unattainable.
We achieve production
efficiency if we cannot
produce more of one good
without producing less of some
Points on the frontier are
Any point inside the frontier,
such as Z, is inefficient.
At such a point, it is possible to
produce more of one good without producing less of the other good. At Z,
some resources are either unemployed or misallocated.
Tradeoff Along the PPF
Every choice along the PPF involves a tradeoff.
On this PPF, we must give up some cola to get more pizzas or
give up some pizzas to get more cola. In moving from E to F:
The quantity of pizzas increases by 1 million.
The quantity of cola decreases by 5 million cans.
The opportunity cost of the fifth 1 million pizzas is
5 million cans of cola.
One of these pizzas costs 5 cans of cola.
In moving from F to E:
The quantity of cola increases by 5 million cans.
The quantity of pizzas decreases by 1 million.
The opportunity cost of the first 5 million cans of cola is 1 million pizzas.
One of these cans of cola costs 1/5 of a pizza.
Increasing Opportunity Cost
Because resources are not equally productive in all activities, the PPF bows outward.
The outward bow of the PPF means that as the quantity produced of each good increases, so does
its opportunity cost.
All the points along the PPF are efficient.
To determine which of the alternative efficient quantities to produce, we compare costs and benefits.
The PPF and Marginal Cost
The PPF determines opportunity cost.
The marginal cost of a good or service is the opportunity cost of producing one more unit of it.
Preferences and Marginal Benefit
Preferences are a description of a person’s likes and dislikes.
To describe preferences, economists use the concepts of marginal benefit and the marginal benefit
The marginal benefit of a good or service is the benefit received from consuming one more unit of it.
We measure marginal benefit by the amount that a person is willing to pay, or give up, or forego (i.e.
opportunity cost) for an additional unit of a good or service.
It is a general principle that:
The more we have of any good, the smaller is its marginal benefit and …
the less we are willing to pay for an additional unit of it.
We call this general principle the principle of decreasing
The marginal benefit curve shows
the relationship between the
marginal benefit of a good and the quantity
of that good consumed.
Allocative Efficiency When we cannot produce more of any one good without giving up some other good, we have
achieved production efficiency.
We are producing at a point on the PPF.
When we cannot produce more of any one good without giving up some other good that we value
more highly, we have achieved allocative efficiency.
We are producing at the point on the PPF that we prefer above all other points.
The point of allocative efficiency is the point on the PPF at which marginal benefit equals marginal
cost. This point is determined by the quantity at which the marginal benefit curve intersects the
marginal cost curve.
On the PPF at point B, we are producing the
efficient quantities of pizzas and cola.
If we produce exactly 2.5 million pizzas,
marginal cost equals marginal benefit.
We cannot get more value from our
Economic Growth: The expansion of
production possibilities—and increase in the
standard of living,
Two/Three key factors influence economic
Technological change is new goods and better ways of producing new and existing
goods and services.
Capital accumulation is the growth of capital resources, which includes human capital.
Finding/Acquiring additional resources (explore/trade)
The Cost of Economic Growth
To use resources in research and development and to produce new capital, we must decrease
our production of consumption goods and services.
So economic growth is not free.
The opportunity cost of economic growth is less current consumption. (e.g. US housing vs.
Figure 2.5 illustrates the tradeoff we face.
We can produce pizzas or pizza ovens along PPF . 0
By using some resources to produce pizza ovens today, the PPF
shifts outward in the future. Gains from Trade: Comparative Advantage and Absolute Advantage
A person has a comparative advantage in an activity if that person can perform the activity at a
lower opportunity cost than anyone else. A person has an absolute advantage if that person is more
productive than others. Absolute advantage involves comparing productivities while comparative
advantage involves comparing opportunity costs.
Example: Comparative Advantage
Liz’s opportunity cost of a smoothie is 1 salad. Joe’s opportunity cost of a salad is 1/5 smoothie.
Joe’s opportunity cost of a smoothie is 5 salads. Liz’s opportunity cost of a salad is 1 smoothie.
Liz’s opportunity cost of a smoothie is less than Joe’s opportunity cost of a salad is less than
So Liz has a comparative advantage in producing So Joe has a comparative advantage in
smoothies. producing salads.
Joe gives up 6 salads for 1 smoothie, Liz gives up 1 salad for 1 smoothie
Joe gives up 1 smoothie for 6 salads, Liz gives up 1 smoothie for I salad.
Joe has a Comparative Advantage in Salads & Liz in Smoothies.
They trade salads for smoothies along the red “Trade line.”
The price of a salad is 2 smoothies or the price of a smoothie is ½ of a salad.
Joe buys smoothies from Liz and moves to point C—a point outside his PPF.
Liz buys salads from Joe and moves to point C—a point outside her PPF.
To reap the gains from trade, the choices of individuals must be coordinated. To make coordination work, four complimentary social institutions have evolved over the centuries:
Firms- an economic unit that hires factors of production and organizes those
factors to produce and sell goods and services.
Markets- any arrangement that enables buyers and sellers to get information and
do business with each other.
Property rights- the social arrangements that govern ownership, use, and
disposal of resources, goods or services.
Money- any commodity or token that is generally acceptable as a means of
How households and firms interact in the market
Factors of production, goods and services flow in
Money flows in the opposite direction.
Markets coordinate individual decisions through price
CHAPTER 3: DEMAND & SUPPLY
A market is any arrangement (with rules) that enables buyers and sellers to do business with each
Information and/or the lack of is an important factor in market behavior
A competitive market has many buyers and sellers. No single buyer or seller has market power to
influence the price.
The money price of a good is the amount of money (common unit of account) needed to buy it.
The relative price of a good—the ratio of its money price to the money price of the next best
alternative good—is its opportunity cost.
DEMAND & QUANTITY DEMAND
Demand is a relationship between quantities and prices.
QD coffeeF( P coffee| Psubstitutecomplementsincome TtastesW wealth
Quantity Demanded is the outcome of a market equilibrium.
QD coffeeQS coffee
Markets are defined as a particular good, (e.g. coffee, shoes, truck) available during a particular time
period (day, week, month) across a particular space (York U, Toronto, Canada, World) of a good or
service is the amount that consumers plan to buy during a particular time period, and at a particular
The law of demand: Inverse relationship between Price and Quantity demanded.
QD coffeeF( P coffee| Psubstitutecomplementsincome Ttastes ^Other^things^remaining^the^same^ The higher the price, the smaller the quantity demanded
The lower the price, the larger the quantity demanded.
The law of demand results from
Substitution effect (as price falls we substitute away from other goods) - the quantity
demanded of the good or service decreases.
Income effect (as price falls we feel richer and usually can by more. people cannot
afford all the things they previously bought) - the quantity demanded of the good or
service decreases (usually).
Demand Curve and Demand Schedule
Demand refers to the entire relationship between the price of the good and quantity demanded of the
Demand curve shows the relationship between the quantity demanded of a good and its price when
all other influences on consumers’ planned purchases remain the same.
QD coffeeF( P coffee| substitutecomplementsincome Ttastes
Demand Schedule: Just a table of QD coffeeF( P coffee
A rise in the price, other things constant, brings a decrease in the quantity demanded - movement up
along the demand curve.
A fall in the price brings an increase in the quantity demanded - movement down along the demand
A demand curve is also a willingness-and-ability-to-pay marginal benefit curve.
Willingness and Ability to Pay
A demand curve is also a willingness-and-ability-to-pay curve.
The smaller the quantity available, the higher is the price that someone is willing to
pay for another unit.
Willingness to pay measures marginal benefit.
A Change in Demand (i.e., things that shift the demand curve)
When some influence on buying plans other than the
price of the good changes, there is a change in
demand for that good. ( e.g. loss of wealth in family
The quantity of the good that people plan to buy
changes at each and every price, so there is a new demand
When demand increases, the demand curve shifts rightward. (driver is other than own price) When demand decreases, the demand curve shifts leftward. (driver is other than own price)
Six main factors that change demand:
1. Prices of Related Goods: A substitute is a good that can be used in place of another good.
(e.g. transit (TTC vs vehicle). A complement is a good that is used in conjunction with another
good. (e.g. vehicle & fuel )
2. Expected Future Prices: If the expected future price rises, current demand for the good
increases and the demand curve shifts rightward. (why does this exaggerate housing price
swings? - prices rising: get in now; prices falling: what a bit longer)
3. Income (or wealth) When income increases, consumers buy more of most goods and the
demand curve shifts rightward.
Normal good: demand increases as income increases.
Inferior good: demand decreases as income increases
4. Expected Future Income and Credit: When expected future income increases or when credit
is easy to obtain, the demand might increase now and vice versa.
5. Population: The larger the population, the greater is the demand for all goods.
6. Preferences: People with the same income have different demands if they have different
A Change in the Quantity Demanded Versus a Change in Demand
Movement Along the Demand Curve
When the price of the good changes and everything
else remains the same, the quantity demanded
changes and there is a movement along the demand
A Shift of the Demand Curve
If the price remains the same but one of the other
influences on buyers’ plans changes, demand
changes and the demand curve shifts.
SUPPLY: If a firm supplies a good or service, then the
1. Has the resources and the technology to produce it,
2. Can profit from producing it, and
3. Has made a definite plan to produce and sell it.
Resources and technology determine what it is possible to produce.
The supply curve (supply) reflects the quantities the producer would supply across a range of
The quantity supplied is the amount that producers plan to sell during a given time period at a
The Law of Supply states:
Other things remaining the same, the higher the price of a good, the greater is the quantity supplied;
and The lower the price of a good, the smaller is the quantity supplied.
The law of supply results from the general tendency for the marginal cost of producing a good
or service to increase as the quantity produced increases (Chapter 2, page 33).
Producers are willing to supply a good only if they can at least cover their marginal cost of production.
Supply Curve and Supply Schedule
The term supply refers to the entire relationship between the quantity supplied and the price of a
good and can be depicted as a supply curve or a supply schedule (table). (Other influences on
producers’ plans remain unchanged)
A rise in the price of an energy bar, other things remaining the same, brings an increase in the
Minimum Supply Price
A supply curve is also a minimum-
As the quantity produced increases,
marginal cost increases.
The lowest price at which someone is
willing to sell an additional unit rises.
This lowest price is marginal cost…only
in a purely competitive market
A Change in Supply
When some influence on selling plans other than the price of the good changes, there is a change in
supply of (shift in supply curve for) that good.
The quantity of the good that producers plan to sell changes at each and every price, so there is a
new supply curve or supply schedule
When supply increases, the supply curve shifts rightward.
When supply decreases, the supply curve shifts leftward.
Factors that change supply of a good are
The prices of related goods produced
Expected future prices (intertemporal sales strategy)
The number of suppliers (pricing strategy, market power and market structures: pure
competition, monopoly, etc.)
Technology (changing efficiency and production costs) State of nature (e.g. weather as it affects cost: flooding and car parts production in
A Change in the Quantity Supplied Versus a Change in Supply
The distinction between a change in supply
and a change in the quantity supplied.
Movement Along the Supply Curve
When the price of the good changes and other
influences on sellers’ plans remain the same,
the quantity supplied changes and there is a
movement along the supply curve.
A Shift of the Supply Curve
If the price remains the same but some other
influence on sellers’ plans changes, supply
changes and the supply curve shifts.
Market Equilibrium is a situation in a market
when the price balances the plans of buyers
The equilibrium price is the price at which the quantity demanded equals the quantity supplied.
The equilibrium quantity is the quantity bought and sold at the equilibrium price.
Price regulates buying and selling plans.
Price adjusts, and quantities offered and demanded adjust, when plans don’t match.
Price works as a signal (constraint/incentive) and reflects opportunity cost in a common
Price as a Regulator: the equilibrium price and equilibrium quantity.
If the price is $2.00 a bar, the quantity supplied exceeds the quantity demanded.
There is a surplus of
6 million energy bars.
At any price above the equilibrium price, a
surplus forces the price down.
At any price below the equilibrium price, a
shortage forces the price up.
At the equilibrium price, buyers’ plans and
sellers’ plans agree and the price doesn’t
change until some event changes either
demand or supply.
An Increase in Demand Demand increases the demand curve shifts rightward.
At the original price, there is now a shortage.
The price rises, and the quantity supplied increases along the supply curve.
An Increase in Supply
Figure 3.9 shows that when supply increases the
supply curve shifts rightward.
At the original price, there is now a surplus.
The price falls, and the quantity demanded
increases along the demand curve.
All Possible Changes in Demand and Supply
A change demand or supply or both demand and
supply changes the equilibrium price and the
Increase in Both Demand and Supply (Q up &
An increase in demand and an increase in supply
increase the equilibrium quantity.
The change in equilibrium price is uncertain because the
increase in demand raises the equilibrium price and the
increase in supply lowers it. Decrease in Both Demand and Supply (Q down & P ?)
A decrease in both demand and supply decreases the
The change in equilibrium price is uncertain because the
decrease in demand lowers the equilibrium
price and the decrease in supply raises it.
Decrease in Demand and Increase in Supply
A decrease in demand and an increase in supply
lowers the equilibrium price.
(P down & Q ?)
The change in equilibrium quantity is uncertain because
the decrease in demand decreases the equilibrium
quantity and the increase in supply increases it.
Increase in Demand and
Decrease in Supply
An increase in demand and a decrease in supply
raises the equilibrium price.
( P up & Q ?)
The change in equilibrium quantity is uncertain because
the increase in demand increases the equilibrium
quantity and the decrease in supply decreases it.
CHAPTER 4: ELASTICITY Elasticity: An economist's tool that measures the responsiveness of demand (or supply) to price
- The Percentage Change in Quantity divided by the Percentage Change in Price
Price Elasticity of Demand
An increase in supply brings
A large fall in price
A small increase in the quantity
i.e. inelastic demand
An increase in supply brings
A small fall in price
A large increase in the quantity