Economics: the study of how human beings coordinate their wants and desires, given the decision-
making mechanisms, social customs, and political realities of society
Two defining principles:
Our society has limited resources
Our society has unlimited wants and desires
How can we as efficiently as possible utilize our scarce resources in order to satisfy as many wants
and desires as possible?
Opportunity cost: In economics, it is the cost of the choice we make in a decision making process
over another choice.
Basis of cost/benefit reasoning
What must be given up in order to get something else
They are often hidden, and all must be taken into consideration before making a decision
Economic theory is divided in two broad categories – microeconomics and macroeconomics.
Microeconomic theory: considers economic reasoning and behavior of individuals and firms
Macroeconomics: studies the economy as whole and broad economic aggregates such as inflation,
unemployment, business cycles, and economic growth.
Three central coordination problems any economy must solve are:
1. What to produce
2. How to produce it
3. For whom to produce it
*Most economic coordination problems involve scarcity.
Economic decision rule:
If the marginal benefits of doing something exceed the marginal costs, do it.
If the marginal costs of doing something exceed the marginal benefits, don’t do it.
Marginal or “extra” benefits (MB)
Marginal or “extra” costs (MC) of a course of action
If MB > MC do more of it, because it’s worth it
If MB < MC do less of it, because it’s not worth it
Economic reality is controlled by economic forces, social forces and political forces.
Economic forces (the invisible hand); these are the market forces of demand, supply, and
Social and cultural forces; social forces can prevent economic forces from becoming market
Political and legal forces; political and legal forces affect decisions too
Positive economics: is the study of what is, and how the economy works
Normative economics: is the study of what the goals of the economy should be
(Subjective analyses) Art of economics: the application of the knowledge learned in positive economics to the
achievement of the goals determined in normative economics.
Sometimes referred to “policy economics”
“good” policy tries to be objective, tries to weigh all the benefits and costs associated with
all policy options and chooses that option in which the benefits outweigh the costs to the
2 types of relationships:
1. Direct (positive) relationship: expressed as an upward sloping curve
2. Inverse (negative) relationship: expressed as a downward sloping curve
Chapter 2: the economic organization of society
1. What and how much to produce
2. How to produce it
3. For whom to produce it
How these economic problems are dealt with depends on the type of economic system that has
been adopted by each society
Two of the most important economic systems are capitalism and socialism.
Capitalism: (“market oriented economy”) is an economic system based on private property and
the market. It gives property rights to individuals, and relies on market forces to coordinate
Characterized by mainly private ownership of resources
And market system solves the what? How? And For whom? Problems.
Capitalism’s solutions to the central economic problems:
What to produce: what businesses believe people want, and what is profitable
How to produce: businesses decide how to produce efficiently, guided by their desire to
make a profit
For whom to produce: distribution according to individuals’ ability and/or inherited wealth
Socialism: (“government-controlled economy”) is an economic system that tries to organize
society in the same way as most families are organized – all people should contribute what they
can, and get what they need.
Characterized by government control over resources
Government solves the what? How? And for whom? Problems.
Soviet-style socialism’s solutions to the three problems: What to produce: what central planners believe is socially beneficial
How to produce: central planners decide, based on what they think is good for the country
For whom to produce: central planners distribute goods based on what they determine are
Capitalism and socialism haven’t existed forever.
In the 8 century, feudalism – an economic system based upon tradition – dominated.
In the 15 century, feudalism gave way to mercantilism – an economic system in which
government doles out the right to undertake certain economic activities.
In the 18 century, mercantilism gave way to capitalism
The production possibilities curve is useful in illustrating many important economic concepts
such as opportunity cost, scarcity, choice, and the principle of increasing marginal opportunity cost.
It shows the trade off (or opportunity cost) between two things.
The slope tells you the opportunity cost of good X in terms of
good Y. (how much Y do you give up to get how much X or
The principle of increasing marginal opportunity cost