Unit 1: Basic Economic Concepts

Economics

The systematic study of choice: how people, firms, and societies use scarce productive resources to satisfy unlimited wants.

Choice

Decision-making under scarcity, requiring selection among alternatives because you cannot have everything at once.

Scarcity

The condition that resources are limited relative to human wants, forcing trade-offs.

Trade-off

The need to give up one thing to get another because resources and time are scarce.

Opportunity Cost

The value of the next best alternative that is given up when a choice is made (not just money).

Factors of Production

Productive resources used to make goods and services: land (natural resources), labor, capital (physical tools/equipment—not money), and entrepreneurship.

Human Capital

The education, training, and skills that make labor more productive.

Macroeconomics

The study of the economy as a whole, focusing on aggregates like output, inflation, unemployment, and money supply effects.

Microeconomics

The study of individuals, firms, and specific markets, while recognizing the broader economic environment.

Marginal Analysis

Decision-making by comparing the additional (marginal) benefits and additional (marginal) costs of one more unit or action.

Marginal Benefit (MB)

The additional benefit received from consuming or producing one more unit of a good or activity.

Marginal Cost (MC)

The additional cost incurred from consuming or producing one more unit of a good or activity.

Incentive

Anything that motivates behavior (e.g., prices, wages, taxes, subsidies, fines, or social rewards); people respond to incentives.

Ceteris Paribus

“All else equal”—the assumption used to isolate the effect of one change while holding other factors constant.

Positive Statement

A descriptive, testable claim that can be evaluated as true or false (e.g., “If interest rates rise, borrowing tends to fall.”).

Normative Statement

A value judgment about what should be done (e.g., “The government should raise the minimum wage.”).

Production Possibilities Curve (PPC)

A graph showing the maximum combinations of two goods an economy can produce using resources fully and efficiently, given current technology.

Productive Efficiency

Producing the maximum output possible with available resources and technology; points on the PPC are productively efficient.

Allocative Efficiency

Producing the mix of goods and services that provides the most net benefit to society; depends on preferences, not just the PPC.

Law of Increasing Opportunity Cost

As more of one good is produced, the opportunity cost of additional units typically rises; this makes the PPC bowed outward.

Economic Growth (Outward PPC Shift)

An increase in an economy’s productive capacity, shown by an outward shift of the PPC due to more/better resources or improved technology.

Absolute Advantage

The ability to produce more output with the same resources (or produce a unit using fewer inputs) than another producer.

Comparative Advantage

The ability to produce a good at a lower opportunity cost than another producer; it determines specialization and gains from trade.

Demand

The relationship between the price of a good and the quantity consumers are willing and able to buy over a period of time.

Law of Demand

As price rises, quantity demanded falls (and as price falls, quantity demanded rises), ceteris paribus.

Substitution Effect

When a good’s price rises, consumers switch toward relatively cheaper substitutes, reducing quantity demanded of the now-higher-priced good.

Quantity Demanded

The specific amount of a good consumers are willing and able to buy at a particular price (a point on the demand curve).

Demand Shift (Change in Demand)

A shift of the entire demand curve caused by factors other than the good’s own price, changing quantity demanded at every price.

INSECT (Demand Determinants)

Mnemonic for demand shifters: Income, Number of buyers, Substitutes’ prices, Expectations, Complements’ prices, Tastes/preferences.

Normal Good

A good for which demand increases when income increases (and decreases when income decreases).

Inferior Good

A good for which demand decreases when income increases (and increases when income decreases).

Supply

The relationship between the price of a good and the quantity producers are willing and able to sell over a period of time.

Law of Supply

As price rises, quantity supplied rises (and as price falls, quantity supplied falls), ceteris paribus.

Quantity Supplied

The specific amount of a good producers are willing and able to sell at a particular price (a point on the supply curve).

Supply Shift (Change in Supply)

A shift of the entire supply curve caused by factors other than the good’s own price, changing quantity supplied at every price.

ROTTEN (Supply Determinants)

Mnemonic for supply shifters: Resources (input prices), Other good prices, Taxes/subsidies, Technology, Expectations, Number of sellers.

Equilibrium (Market-Clearing)

The price and quantity where quantity demanded equals quantity supplied (Qd = Qs), so the market tends to clear.

Surplus (Excess Supply)

A situation where quantity supplied exceeds quantity demanded (Qs > Qd) at the current price, putting downward pressure on price.

Shortage (Excess Demand)

A situation where quantity demanded exceeds quantity supplied (Qd > Qs) at the current price, putting upward pressure on price.

Consumer Surplus (CS)

The difference between what consumers are willing to pay and what they actually pay; the area below demand and above price up to the quantity traded.

Producer Surplus (PS)

The difference between the price sellers receive and the minimum price they would accept; the area above supply and below price up to the quantity traded.

Price Control

A legal minimum or maximum price set by the government (includes price floors and price ceilings).

Price Ceiling

A maximum legal price; if binding (set below equilibrium), it causes a shortage.

Price Floor

A minimum legal price; if binding (set above equilibrium), it causes a surplus.

Binding Price Control

A price ceiling or floor that is set so it actually changes the market outcome (ceiling below equilibrium or floor above equilibrium).

Deadweight Loss (DWL)

The lost gains from trade (reduced total surplus) that occur when policies like binding price controls prevent mutually beneficial trades.

Circular Flow Model

A macroeconomic model showing how resources, goods/services, and money payments move between households and firms through markets.

Factor Market (Resource Market)

The market where households supply factors of production and firms demand them; households receive wages, rent, interest, and profit.

Product Market (Goods and Services Market)

The market where firms supply goods/services and households demand them; firms receive revenue from consumer spending.

Real vs. Money Flows

Real flows are physical resources and goods/services; money flows are payments for them (e.g., labor is a real flow, wages are a money flow).