Economics: Canada in the Global Environment October 10, 2012
Midterm 1 Review Chapter 1 to 4
Chapter 1: What is Economics?
Economics: the study of how individuals, businesses, governments, and entire societies make
choices as they cope with scarcity and the incentives that influence and reconcile those choices
Scarcity: the inability to get everything we want.
- All economic questions arise from scarcity
- Wants exceed the resources available
- We have limited resources and unlimited wants
- We must make choices which depend on incentives
Incentive: rewards that encourage actions or a penalties that discourage action
- In making a choice, we forgo other alternatives, and the opportunity cost of
any choice is highest valued alternative forgone.
Economics is also a social science
Microeconomics studies choices of individuals and businesses. Ex: studies decisions od
individual firms, effects of government safety regulations on the price of cars, prices of
individual goods and services, effects of taxes on the price of beer.
Macroeconomics studies national and global economies. Ex; studies global economy as
Two Big Economic Questions
Summarize the scope of economics
1. How do choices determine what, how, and for whom goods and services are produced,
and in what quantities.
2. How can choices made in pursuit of self-interest also promote the social interest?
Goods/services are objects that people value and produce to satisfy wants.
Choices made in self-interest are best for the person making them.
Choices made in social-interest are best for society as a whole
- Society tries to achieve Efficiency and Equity.
- Efficiency is achieved when the available resources are used to produce
goods/services at the lowest cost.
Markets provide incentives so that pursuit in self-interest also promotes the social
Self-interest and social interest sometimes conflict
Economic principles allow us to understand when self-interest promotes the social
interest, when they conflict, an policies reduce these conflicts. Economics: Canada in the Global Environment October 10, 2012
The Four Factors of Production used to produce goods/services
Land: (Natural Resources) Ex; minerals, oils, gas, coal, etc. Earns Rent
- Non-renewable resources include oil and Renewable is forest
Labour: (Human Capital) the work time and effort people devote. The knowledge
and skills that people obtain from education. Earns Wages
- Earns the most income
Capital: (machinery) the tools and instruments and other constructions that businesses
use. Earns Interest.
Entrepreneurship: human resources that organize labours, land, capital. Come up with
ideas about what and how to produce, make decisions, and bear he risks. Earn Profit.
Globalization: the expansion of international trade, borrowing and lending and investment.
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.
Information Revolution: serves self-interest of people with cell phones, laptops, etc in the past
50 years. Self-interest and social interest conflict.
The trends over the past 60 years in what we produce show that services has expanded
and agriculture has shrunk.
The Economic Way of thinking; A choice is a trade-off, Making a rational choice, benefit; what
you gain, cost: what you must give up, how much? Choosing at the margin, and choices
respond to incentives.
A choice is a trade-off; we give up one thing to get something else—and the
opportunity cost of any action is the highest valued alternative forgone.
- Opportunity cost is the most important concept for making a choice
- Increased production of one good= decrease production of another good
Rational Choice: compares costs and benefits and achieves the greatest benefit over
Benefit: gain or pleasure of a choice, is determined by a person’s preferences; likes and
dislikes and their intensity
Margin choices made in small steps by comparing a little more of something with its
cost. The choices are influenced by incentives.
- Marginal analysis is a fundamental tool economists use to predict peoples
Economic choices are made by comparing the additional benefit marginal benefit( the
benefit that a person receives from consuming one more unit of a good/service) and Economics: Canada in the Global Environment October 10, 2012
additional opportunity cost marginal cost. Of small increase in an activity. If marginal
benefit exceeds marginal cost, we choose to increase the activity.
The common element to making personal, business, and government policy decisions is
to evaluate marginal benefits and marginal costs to find the greatest gain.
By choosing only activities that bring greater benefits than costs, we use our scarce
resources in the way that makes us as well of as possible.
Economist assume people act in their self-interest, but self-interest actions are not
necessarily selfish actions, if what makes you happy is to help others.
- Incentives are key in reconciling self-interest and the social interest
―There’s no such things as a free lunch‖ best describes opportunity cost.
Positive Statements: statements about what is, they can be tested by checking them against
the facts. Capable of evaluating as true or false by observing and measurement.
Ex: Low rents will restrict the supply of housing. T/F question
Economics is concerned with positive statements that are consistent with observed facts
- Unscrambling cause and effect
- Creating Economic models a simplified description of economic world that
includes only features needed for purpose of explanation. Includes only relevant
aspects and ignores others.
- Testing economic models, comparing predictions with facts, using
Natural Experience where one factor is different in real world; other things are
Statistical Investigation correlations between variables
Economic Experience putting people in decision making situations and
changing one variable to see the response
Economists test positive statements about how the world works to weed out those that
Normative Statements: statements about what ought to be; they depend on values and can’t
Ex; Scientist should not make normative statments
For objectives, economics provide a method of evaluating alternative solutions-
evaluate marginal benefits and marginal costs to find solutions that make the
best use of resources.
Economics is a useful toolkit for;
Advising businesses on economic policy Economics: Canada in the Global Environment October 10, 2012
Advising government on economic policy
Purpose of studying economics is to learn how to think about economics
The value of economic education is the ability to think critically about economic
problems and to understand how an economy works.
Unemployment decreases expected average income from working. Higher
opportunity cost for men may not be fair but is a fact.
Chapter 2: The economic Problem
The Production Possibility Frontier (PPF): is the boundary between unattainable and
attainable production possibilities. Shows maximum combinations of output(goods/services)
that can be produced with given resources and technology.
Scarcity is shown when we cannot attain the points outside the frontier
Production Efficiency outputs produced at the lowest possible cost. Produce more of
one good without producing less of the other good.
- Points inside the PPF are inefficient- attainable, but not maximum
combinations of output; they represent unused or misallocated resources. (we
give up more than necessary of one good to produce a given quantity of
another.) Inefficient because we can produce more. Resources are unused or
- Points outside the PFF are unattainable
Choosing among efficient points on PPF involves an opportunity cost( highest valued
opportunity foregone) and a tradeoff. Opportunity cost = Give up/ Get
- Opportunity cost is a ratio
- The decrease in quantity produced of one good divided by increase in quantity
produced of another good.
- For 0 opportunity cost, production is inside the PPF
- Constant opportunity cost will mean the PPF will be a straight linr
PPFs are generally bowed outward(concave), reflecting increasing opportunity costs as
more of a good is produced
- Bowed outward because resources are not equally productive in all activities
(nonhomogeneous). Resources most suitable for a given activity are the first to
- Also represents increasing opportunity cost; opportunity cost of good increases as
its quantity produced increases.
- In moving between two point on PPF more of good X can be obtained only by
producing less of good Y. Opportunity cost on PPF of additional X is amount of
- Shifts in preferences for Good x. good y. will not shift the frontier.
- There is no opportunity cost in moving from point inside PPF to point on PPF. Economics: Canada in the Global Environment October 10, 2012
- Constant opportunity cost means resources are equally productive for
producing all goods.
To choose among points on PPF, compare
Marginal Cost: the opportunity cost of producing one more unit of a good.
- Marginal cost curve slopes upwards because of increasing opportunity cost
- Calculated by the slope of PPF?????
- If MC exceeds MB, production of good decreases
- If MB exceeds MC, production increases
Marginal Benefit: the benefit(measure in willingness to forgo other goods) from
consuming one more unit of a good.
- Depends on preferences (likes,dislikes)
- Marginal benefit curve slopes downwards because of decreasing marginal
benefit. Is unrelated to PPF and can’t be derived from it
- More goods/srvices = less marginal benefit = less payment Principle of decreasing
- Marginal benefit decreases because we like variety
If you are willing to pay less for a good than it is worth to you but you are not willing to pay
more; The most you are willing to pay for something is its marginal benefit
Production Efficiency: when we cannot produce more of any one good without giving up some
All points on the PPF, efficient use of resources.
Allocate Efficiency: when goods/services are produced at the lowest possible cost and in
quantities that provide greatest possible benefit.
Marginal Benefit = Marginal Cost
Economic Growth: the expansion of productive possibilities- an outward shift of PPF
Comes from technological change and capital accumulation.
- Technological change is the development of new goods and of better ways of
- Capital accumulation is the growth of capital resources including human capital
- The higher the proportion of resources devoted to technological research in an
economy, the faster the PPF shifts outward.
Opportunity cost of increased goods/services in future (economic growth through
capital accumulation and technological progress) is decreased consumption today.
- Points with more capital good yield faster growth.
- Opportunity cost of pushing the PPF outward reduces current consumption. Economics: Canada in the Global Environment October 10, 2012
Production increases if people specialize in the activity in which they have a comparative
A shift of PPF results from technological change, change in the stock of capital, change in
Comparative Advantage: if a person can perform the activity at a lower opportunity cost
than anyone else
Difference in opportunity costs a