Economics - the study of how individuals and societies make decisions about ways to use scarce resources to fulfill

wants
and needs.
Macroeconomics - The big picture: growth, employment, etc.; Choices made by large groups (like countries)
Microeconomics - How do individuals make economic decisions
ECONOMICS: 5 Economic Questions
 WHAT to produce (make)
 HOW MUCH to produce (quantity)
 HOW to Produce it (manufacture)
 FOR WHOM to Produce (who gets what)
 WHO gets to make these decisions?
What are resources (inputs)? The things used to make other goods; Anything provided by nature or previous
generations that can be used directly or indirectly to satisfy human wants.
SCARCITY: unlimited wants and needs but limited resources
outputs Usable products
Because ALL resources, goods, and services are limited –WE MUST MAKE CHOICES!!!!
We make choices about how we spend our money, time, and energy so we can fulfill our NEEDS and WANTS.
NEEDS ––“stuff” we must have to survive, generally: food, shelter, clothing
WANTS – “stuff” we would really like to have (Fancy food, shelter, clothing, big screen TVs, jewelry, conveniences . . . Also
known as LUXURIES
TRADE-OFF - decisions involve picking one thing over all the other possibilities
The result of your Trade-Off is the OPPORTUNITY COST = The Value of the Next Best Choice; The best alternative that we
give up, or forgo, when we make a choice or decision.
when you choose to do ONE thing, its value (how much it is worth) is measured by the value of the NEXT BEST CHOICE.
This can be in time, energy, or even MONEY
theory of comparative advantage - Ricardo’s theory that specialization and free trade will benefit all trading parties,
even those that may be absolutely more efficient producers.
absolute advantage A producer has an absolute advantage over another in the production of a good or service if it can
produce that product using fewer resources.
comparative advantage A producer has a comparative advantage over another in the production of a good or service if
it can produce that product at a lower opportunity cost.
Production is how much stuff an individual, business, country, even the WORLD makes.; The process that transforms
scarce resources into useful goods and services.
STUFF –Goods and Services.
Goods –tangible (you can touch it) products we can buy
Services –work that is performed for others
Capital Goods –goods used to provide services or to make money;
Capital Goods: are used to make other goods
Consumer Goods: final products that are purchased directly by the consumer; Goods produced for present consumption.
4 Factors of Production:
 LAND –Natural Resources - Water, natural gas, oil, trees (all the stuff we find on, in, and under the land)
 LABOR –Physical and Intellectual; Labor is manpower
 CAPITAL -Tools, Machinery, Factories; The things we use to make things
 Human capital is brainpower, ideas, innovation
 ENTREPRENEURSHIP –Investment $$$Investing time, natural resources, labor and capital are all risks associated with
production
investment The process of using resources to produce new capital.

THREE parts to the Production Process:

 Factors of Production –what we need to make goods and services
 Producer – company that makes goods and/or delivers services
 Consumer –people who buy goods and services (formerly known as “stuff”)
CHANGES IN PRODUCTION:
 Specialization - dividing up production so that Goods are produced efficiently
 Division of Labor–different people perform different jobs to achieve greater efficiency (assembly line).
 Consumption–how much we buy (Consumer Sovereignty)
The Circular Flow Model – Economic model illustrating the flow of goods and services though the economy.

production possibility frontier (ppf) - A graph that shows all the combinations of goods and services that can be
produced if all of society’s resources are used efficiently.
marginal rate of transformation (MRT) The slope of the production possibility frontier (ppf).
Cost –the total amount of money it takes to produce an item (to pay for ALL Factors of Production).
Revenues –the total amount of $ a company or the government takes in.
Fixed Costs–the amount of money a business MUST pay each month or year (like rent and Capital expenses).
Variable Costs–the amount of money a business pays that changes over time (Labor and Raw Materials).
Marginal Costs–the additional Cost of the NEXT UNIT produced.
Profit –the difference between Total Costs and Revenues. This is WHY you’re in BUSINESS (Profit Motive!)
Profit Motive=why you are in business---to make MONEY
  Total Costs= Fixed + Variable Costs.
 Profit=Revenues-Total cost
Cost Benefit Analysis - weighing the Marginal Costs vs. the Marginal Benefits of producing an item or making any
economic decision. If the Benefit is GREATER than the Cost, then business does it.
Traditional Economies - Economic Questions answered by custom; Developing or “3rd World”; Trade and barter oriented;
Low GDP & PCI (per capita income = avg. inc.)
Command Economies - Economic questions answered by the government; Very little economic choice; No private
ownership; Communism; Old Soviet Union, old Communist China, Cuba and North Korea; An economy in which a central
government either directly or indirectly sets output targets, incomes, and prices.
Karl Marx - 19thcentury German economist; Author of “Communist Manifesto” and “ Das Kapital” Government should
control economy and distribute goods and services to the people; Founder of revolutionary socialism and communism
Communism Falls - Market reforms in China in the mid 1970s.; Fall of the Berlin Wall in 1989.; Collapse of the Soviet
Union 1991.; Free Market Capitalism (w/ some Mixed Economies) the only show in town.
Free Market (Capitalist) Economies - Economic questions answered by producers and consumers; Limited government
involvement; Private property rights; Wide variety of choices and products; U.S., Japan
Adam Smith - 18thcentury Scottish economist; Published “The Wealth of Nations” in 1776; Explained the workings of the
free market within capitalist economies; Invisible hand of the market; Laissez-faire -Government stays out of business
practices “hands off” to let the market place determine production, consumption and distribution.; Individual freedom
and choice emphasized.
free enterprise The freedom of individuals to start and operate private businesses in search of profits.
laissez-faire economy Literally from the French: “allow [them] to do.” An economy in which individual people and firms
pursue their own self-interests without any central direction or regulation.

Principles of Capitalism:
 Competition –more businesses means lower prices and higher quality products for consumers (US!) to buy.
 Voluntary Exchange –businesses and consumers MUST be free to buy or sell what and when they want.
 Private Property –Individuals and businesses MUST be able to get the benefits of owning their OWN property.
Government doesn’t control it.
 Consumer Sovereignty –consumers get to make free choices about what to buy and this helps drive production
(Demand drives Supply).; The idea that consumers ultimately dictate what will be produced (or not produced) by
choosing what to purchase (and what not to purchase).
 Profit Motive –people want to make or save $$$$. Their “Self Interest” motivates Capitalism.
 Social Safety Net –“Mixed Economy” idea that says the government should NOT allow people to suffer in
economic crisis (natural part of Capitalism’s “Business Cycle”), but provide security instead –Social Security,
Unemployment Insurance, etc.
Mixed Economy/Socialism - Government involvement and ownership and control of property, of decision making, and
companies.; Government control of business; Social “safety net” for people; Socialism; Common in Europe, Latin
America, and Africa
John Maynard Keynes - The Invisible Hand doesn’t always work.; “The long run is a misleading guide to current affairs. In
the long run we are all dead.” or . . . the trouble is people eat in the short run.
Keynesian Economics - Government should intervenein economic emergencies through tax and spending (Fiscal Policy)
and changing the money supply (Monetary Policy).; This is done to smooth out the business cycle (expansion and
recession) and keep inflationlow.
Wages –what companies pay employees for their labor (usually based upon an hourly rate).
Salary –the amount of pay a person gets over a year (especially for “professional” jobs).
Income is the amount that a household earns each year. It comes in a number of forms: wages, salaries, interest, and
the like.
Wealth is the amount that households have accumulated out of past income through saving or inheritance.
Blue Collar - Manufacturing, work with hands; Usually the ‘labor’ in production
White Collar - ‘Office’ jobs; Usually control production
When Production Decreases:
 Downsizing–laying off employees to save costs.
 Outsourcing–sending jobs and manufacturing overseas or contracting to outside companies to save money.
 Bankruptcy–government allows business to restructure it’s debt, but now all profits go to paying off debt rather
than to the owners/investors.
 Out of Business–lose all your business, money, and profits.
 The current trend in the U.S. is that manufacturing jobs are declining
Labor Unions: organization of workers who have banded together to achieve common goals
– Wage protection
– Workplace safety
– Benefits
– Job protection
Collective Bargaining –Representatives of the Union and the company negotiate a contract for the workers; usually they
rely on compromise
Strikes – When an agreement can’t be reached, workers stop working to try to force the hand of the company
economic growth An increase in the total output of an economy. It occurs when a society acquires new resources or
when it learns to produce more using existing resources.
market The institution through which buyers and sellers interact and engage in exchange.
perfect knowledge The assumption that households possess a knowledge of the qualities and prices of everything
available in the market and that firms have all available information concerning wage rates, capital costs, and output
prices.
perfect competition An industry structure in which there are many firms, each small relative to the industry and
producing virtually identical products, and in which no firm is large enough to have any control over prices.
homogeneous products Undifferentiated outputs; products that are identical to or indistinguishable from one another.
The Determinants of Household Demand:
 The price of the product
 The income available to the household
 The household’s amount of accumulated wealth
 The prices of other products available to the household
 The household’s tastes and preferences
 The household’s expectations about future income, wealth, and prices
budget constraint The limits imposed on household choices by income, wealth, and product prices.
choice set or opportunity set The set of options that is defined and limited by a budget constraint.
real income Set of opportunities to purchase real goods and services available to a household as determined by prices
and money income.

utility The satisfaction, or reward, a product yields relative to its alternatives. The basis of choice.
marginal utility (MU) The additional satisfaction gained by the consumption or use of one more unit of something.;
Marginal utility is the additional utility gained by consuming one additional unit of a commodity—in this case, trips to the
club. When marginal utility is zero, total utility stops rising.
total utility The total amount of satisfaction obtained from consumption of a good or service.
law of diminishing marginal utility The more of any one good consumed in a given period, the less satisfaction (utility)
generated by consuming each additional (marginal) unit of the same good.
utility-maximizing rule Equating the ratio of the marginal utility of a good to its price for all goods.
diamond/water paradox A paradox stating that (1) the things with the greatest value in use frequently have little or no
value in exchange and (2) the things with the greatest value in exchange frequently have little or no value in use.
The change in consumption of X due to this improvement in well-being is called the income effect of a price change.
A fall in the price of product X might cause a household to shift its purchasing pattern away from substitutes toward X.
This shift is called the substitution effect of a price change.
“Buying” more leisure, however, means reallocating time between work and nonwork activities. For each hour of leisure
that I decide to consume, I give up one hour’s wages. Thus the wage rate is the price of leisure.
labor supply curve A curve that shows the quantity of labor supplied at different wage rates. Its shape depends on how
households react to changes in the wage rate.
financial capital market The complex set of institutions in which suppliers of capital (households that save) and the
demand for capital (business firms wanting to invest) interact.
Supply and demand are the forces that make market economies work.
According to the Law of Supply: Firms are willing to produce and sell a greater quantity of a good when the price
of the good is high. This results in a supply curve that slopes upward.
The economic goal of the firm is to maximize profits.
Total Revenue – The amount a firm receives for the sale of its output.
Total Cost – The market value of the inputs a firm uses in production.
Profit is the firm’s total revenue minus its total cost.
•Profit = Total revenue -Total cost
A firm’s cost of production includes all the opportunity costs of making its output of goods and services.
The production functions show the relationship between quantity of inputs used to make a good and the quantity of
output of that good.
The marginal product of any input in the production process is the increase in output that arises from an additional unit
of that input.
Diminishing marginal product is the property whereby the marginal product of an input declines as the quantity of the
input increases.
Costs of production may be divided into fixed costs and variable costs.
Fixed costs are those costs that do not vary with the quantity of output produced.
Variable costs are those costs that do vary with the quantity of output produced.
Total Fixed Costs (TFC)
 Total Variable Costs (TVC)
 Total Costs (TC)
 TC = TFC + TVC
The average cost is the cost of each typical unit of product.
Average costs can be determined by dividing the firm’s costs by the quantity of output it produces.
 Average Fixed Costs (AFC)
 Average Variable Costs (AVC)
 Average Total Costs (ATC)
 ATC= AFC+ AVC

Marginal cost (MC) measures the increase in total cost that arises from an extra unit of production.
–Marginal cost helps answer the following question: How much does it cost to produce an additional unit of
output?

Marginal cost rises with the amount of output produced.

Cost Curves and Their Shapes:
  The average total cost curve is U shaped.
 At very low levels of output, average total cost is high because fixed cost is spread over only a few units.
 Average total cost declines as output increases.
 Average total cost starts rising because average variable cost rises substantially.

Relationship between Marginal Cost and Average Total Cost

 Whenever marginal cost is less than average total cost, average total cost is falling.
 Whenever marginal cost is greater than average total cost, average total cost is rising.

Relationship between Marginal Cost and Average Total Cost

 The marginal-cost curve crosses the average-total-cost curve at the efficient scale.
 Efficient scale is the quantity that minimizes average total cost.

Economies of scale refer to the property whereby long run average total cost falls as the quantity of output
increases.
Diseconomies of scale refer to the property whereby long run average total cost rises as the quantity of output
increases.
Constant returns to scale refers to the property whereby long run average total cost stays the same as the
quantity of

A firm’s costs reflect its production process.