1.1 The Complexity of the Modern Economy
Economy: a system (typically very complex) where resources - such as
land, labour and machines – are allocated among competing uses.
An economy based on free-market transactions is self-organizing.
Self-interest is the foundation of economic order as our actions are
motivated primarily by it and not by benevolence.
Main characteristics of market economies:
o Market prices and quantities
1.2 Scarcity, Choice, and Opportunity Cost
Economics: study of the use of scarce resources to satisfy unlimited
Society’s resources (factors of production):
o Land: Natural resources
o Labour: Human resources (management skills, entrepreneurial
o Capital: Capital resources (tools, machinery etc.)
What is produced is separated into two categories:
o Goods (what is tangible)
o Services (what is intangible)
We live in a world of scarcity.
Scarcity implies that choices must be made, and making choices implies
the existence of costs.
Opportunity cost: what is given up in making a choice (i.e. choosing pizza
over a hotdog; the hotdog is the opportunity cost).
Production possibilities boundary: a curve showing which alternative
combinations of commodities can be attained if all available resources
are used efficiently (boundary between attainable/unattainable)
o Scarcity (unattainable combinations)
o Choice (need to choose among the alternative combinations)
o Opportunity Cost (negative slope of the boundary)
Negative slope because making more of one item yields less that could be
made of another(s).
Four key economic questions:
o What is produced and how? Concerning the allocation of
resources, which then determines the quantities of various goods
that are produced. o What is consumed and how? Economists seek to understand what
determines the distribution of a nation’s total output among its
These two questions fall within the realm of
Microeconomics (study of the decisions of
individual households and firms in each market)
o Why are resources sometimes idle? When the economy is
operating inside its PPB.
o Is productive capacity growing? The capacity to produce
goods/services can grow and is represented by an outward shift
of the PPB (making once unattainable combinations, now
These two questions fall within the realm
of Macroeconomics (study of the economy
as a whole and not the outcome in any particular
1.3 Who Makes the Choices and How?
Individuals sell the services of the factor they own in the factor markets
and are paid by firms.
Firms sell their outputs of goods and services in goods markets and are
paid by individuals.
Distribution of income: how a nation’s total income is divided amongst its
citizens (largely determined by the price that each type of factor service
receives in factor markets).
People are assumed to be maximizers.
Assumed individuals make choices designed to maximize their well-being
Assumed firms make choices designed to maximize profit.
Consumers and firms must weigh the marginal cost against the marginal
benefit (benefit must exceed cost for both).
Consumers/firms who are maximizers make marginal decisions. (i.e.
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