Unit 1: Basic Principles of Economics
Lesson 1: What is economics?
1. Economics--The social science of decision-making under conditions of scarcity. (p. 3)
 The study of how people seek to satisfy their needs and wants by making choices.
 “Economics is the art of making the most out of life.”
2. Macro vs. Micro (p. 14)
 Macroeconomics—the study of a country’s economy or one sector—all consumers or all producers.
 Microeconomics—the study of one business/consumer or all businesses within a market.
Examples—Cause of the Great Depression: ____________, buying t-shirts at the Gap: ____________,
effect of Pandora on MP3 sales: ________________, effect of tax increase on GDP: ________________,
merger of American and Southwest: __________________
Lesson 2: What is the difference between opportunity cost and tradeoffs? What is scarcity?
3. Scarcity (p. 2)
 Forces us to make ____________________.
 A resource or good/service must meet ONE of the two definitions of scarcity:
1. Limited quantities of resources to meet unlimited demands
2. More than one valuable use
 Is it scarce examples: trash:______, land: _____, pollution: ______, iPads: _________,
unused textbooks:______, unused textbooks that can be recycled: ______, oil in Japan:
_______, oil in Saudi Arabia: _______
4. Opportunity Cost vs. Tradeoffs (p. 11)
 Trade-offs-- an exchange for one thing in return for another
 Opportunity cost—the value of the foregone alternative, i.e. the value of the next best thing
you could have done.
 Example: You have 4 alternatives for this Friday night—going on a date, hanging out with
friends, studying for economics, or going camping with your family. You decide to go on a
date. Hanging out with friends is your next best choice, which is your _______________.
The value of giving up hanging out with friends is the ________________________.
 What’s the point? Your decisions carry with them implicit (hidden) costs far beyond explicit
cost.
Lesson 3: What are the basic principles of economic thinking? (pgs. 10-13)
1. People make choices among tradeoffs.
 Choosing not to do something is still a choice.
 Choices must be made because of __________—limited resources available to fulfill unlimited
demands
 Example:
2. People’s choices involve costs.
i. Costs can be explicit or implicit—opportunity costs.
ii. People are rational—meaning they are____________________—meaning they make choices where
the benefits outweigh the costs.
iii. Some of these costs lie in the future and are difficult to predict.
iv. Example:
3. Rational people think at the margin.
i. Decisions are usually made “at the margin” meaning that you start with the status quo and make
small, incremental changes. To choose something must mean that the marginal benefit outweighed
the marginal cost.
ii. Example
1
4. People respond predictably to incentives—rewards.
i. Economists and policy makers can manipulate the incentive to manipulate behavior.
ii. Example:
5. People gain when they trade voluntarily.
i. Free trade internally (within a country, with your neighbors) and externally (with other countries)
benefits everyone.
ii. Example:
Lesson 4: What are the four major factors of production, and how do they relate to income? (pg. 36-39)
1.
2.
3.
Factors of production= a.k.a. resources—these are scarce.
Land—natural resources, Examples:
___________=income from land resources
Labor—paid human effort, Examples:
___________=income from labor resources
Capital
Physical capital—man-made resources that are used to produce other goods.
Examples:
Human capital—education for the job
Examples:
4.
___________=income from capital resources
Investment in physical and human capital increase future ____________.
NOT ______________capital, stocks, bonds, money
Entrepreneurship—risk taker and combines the other resources to make a good or service,
 Examples:
 __________= income from entrepreneurship
Lesson 5: How do different types of economic systems seek to answer the three basic economic questions?
(pg. 3-4)




Organized way to produce and distribute g/s
Answers 3 Basic economic questions:
o ________ to produce?
o ________ to produce it?
o ________gets it?
Three Major Types
o Market—forces of supply and demand answer the 3 basic Qs, self-interest motivates, competition
regulates
 Examples:
 The Good—flexible, freedom, variety of g/s, growth
 The Bad—inequitable, market failures
o Command—government answers the 3 basic Qs
 Examples:
 The Good—can change drastically fast, may provide for basic necessities
 The Bad—Lacks incentives for hard work, costly to plan, inflexible for small stuff
o Traditional—the past answers the 3 basic Qs
 Examples:
 The Good--Life is predictable, closer to family and community
 The Bad—no growth, low standard of living, discourage new ideas
All economies are a mixture of the above--some more market, some more command. U.S. is the ____ most
market. N.Korea is the most command.
2
1
2
3
4
5
10
8
0
6
Squares
Triangles
Lesson 6: How does the production possibilities curve demonstrate opportunity cost, growth, and
efficiency? (pgs. 62-73, 79)
2
4
Triangles
1
2
3
4
5
Squares







PPC—shows the alternative ways of using resources to produce the maximum amount of goods and services.
Demonstrates ______________ costs. If you increase production of triangles, then you must give up some
production of squares.
What is the opportunity cost of producing one square? _____________ What is the opportunity cost of
producing one triangle? ______________
_________________ Opportunity Cost—graph above, opportunity costs stay the same, the production of each
additional square costs two triangles, if opportunity costs are constant, then resources are easily convertible—
easy to make 2 triangles out of one square.
___________________ Opportunity Costs—graph on bottom, opportunity costs increase (for BOTH goods)
as you produce more of one good. For example, as you produce more pizzas it costs more robots. The 1st
pizza only cost ____robot; when going from point D to point E, the 4th pizza costs_____ robots. This is
because the resources are not easily convertible. MOST COMMON,
Also shows efficiency/inefficiency, full employment/unemployment, growth, and unattainable points.
o All points along the curve are _______________ efficient—making the most goods/services possible.
 _________________ efficiency—type of efficiency where the right mix of g/s is produced.
Shown on only one point on the graph. You will not know which point this is unless other
information is provided.
o Points _____________ the curve are attainable but inefficient. Resources are not fully utilized. Ex.
there is unemployment, discrimination (people discriminated against are not being fully utilized),
factories not operating at full capacity.
o Points _______________ the curve are unattainable with current resources unless the production
possibilities curve shifts outward.
Production Possibility Curve Shifts
o
o
Shifts ___________ if more resources or improved productivity
Shifts ____________ if resources are lost—ex. global warming causes all coastal land to flood 10
miles into the US.
o If you produce more physical capital goods, then PPC will shift out more because physical capital
goods are a resource, more resources=more growth.
5.
6.
7.
3
Lesson 7: How do you compute comparative advantage and terms of trade? (pgs. 81-84)




Theory that demonstrates the benefits of specialization and trade.
_____________ Advantage—the ability to make more stuff with the same amount of resources.
_____________ Advantage—the ability to make stuff with the least amount of opportunity cost.
Finding Comparative Advantage—Output Problems
o Output problems=number of goods/services produced
o Input problems=amount of time or other resources used to produce.
Always put the actors in
this column
Betty
Dishwashing
Sweeping
2 (3/2=1.5)
3 (2/3)
Bert
1 (1)
1 (1)
Step 1: Set up the problem correctly in the above table.
Step 2: Find the opportunity cost for each person and task.
 For output problems ONLY—put the opposite number on top and reduce the fraction (if needed)
 Put the opportunity cost in parentheses
Step 3: Find who has the comparative advantage by looking at who has the lowest opportunity cost for each task.
 Who has the comparative advantage in dishwashing?
o Look at the dishwashing column
o See who has the lowest number as the opportunity cost.
o Do the same for the other good/service
 The stuff can be shown on a graph or a table. Must be able to read both.
 To read the table or graph the easiest approach is to look at the highest numbers. Mexico can
produce 60 avocados OR 15 soybeans, the US can produce 90 avocados OR 30 soybeans.
 Who has the absolute advantage in avocados? ___________
 Who has the absolute advantage in soybeans? ___________
75
60
Un
ite
d
45
es
at
St
Me
o
30
xi c
15
Avocados
90
 If on a graph, whichever country’s PPC is on the right, it has the absolute advantage.
 The comparative advantage must be computed.
5

10
15
20 25 30
Soybeans
Work the avocado/soybean problem in the box above.
1. Who has the comparative advantage in avocados? ___________
2. Who has the comparative advantage in soybeans? ___________
Importing and exporting—Whoever is producing the product will be ____________ it. You
_____________a product if you allow another country to produce it for you.
 ____________ will be exporting and __________ will be importing avocados
 ____________ will be exporting and __________ will be importing soybeans
4


Terms of Trade
 Sometimes problems will ask about what terms of trade (price per good) would be beneficial
to both nations.
 For example—In order to be beneficial to both nations what should the terms of trade be for
1 avocado ?
 The easiest thing to do is to look at the column for avocados and place the terms of trade as
in between the two opp cost. 1 avocado for more than ____of a soybean but less than
_____of a soybean.
 REMEMBER—the seller always benefits from a ___________ price and the buyer benefits
from a ___________ lower price. Mexico is selling avocados. It would benefit as long as the
price is HIGHER than ¼ a soybean. The US can make 1 avocado for the cost of 1/3rd a
soybean, so they only benefit if the price is LESS than 1/3rd.
 What terms of trade would be beneficial to both nations for 1 soybean? _________
 Who would benefit if the terms of trade were 1 soybean for 5 avocados? _________
Input Problems
 Not looking at how much the person (country) can produce, but how much resources it takes
to produce the same good.
 Absolute advantage
o Who has the lower number?
o Why? Because it takes him/her less resources.
 Comparative advantage
o Set up the same way
o EXCEPT switch the order to find the opp. cost—put the same number on top.
 Joe can produce a salad OR a smoothie in only two minutes, but his new trainee Liz takes
much longer to produce salads—10 minutes. However, she has worked on her smoothie
skills and can turn one out in the same time as Joe.
Absolute advantage in smoothies? _______
Joe
Salads (in minutes)
2
(1)
Comparative advantage in salads? _______
Liz
10
Absolute advantage in salads? __________
(5)
Smoothies (in minutes)
2
(1)
2
(1/5)
Comparative advantage in smoothies? ____
Work the following problem.
 Assume that: the US can produce a car in 16 minutes; Japan can produce one in 14 minutes; the US can
produce a computer in 12 minutes; Japan can produce one in 8 minutes.
Absolute advantage in cars? ________________
Absolute advantage in computers? ___________
Comparative advantage in cars? _____________
(in minutes)
(in minutes)
Comparative advantage in computers? __________
Terms of trade advantageous to both? ___________

Winners and Losers of Free Trade
o Who wins?
o Who loses?
5
Lesson 8: What is a market? How do the forces of supply and demand work in a market?
 What is a market? Any arrangement that brings buyers and sellers together.
 The buyers create ____________.
 The sellers create ____________.
 Who sets the price in a competitive market? ___________________________
 How does competition help consumers? ___________________________________________________
 The market is ruled by the forces of SUPPLY and DEMAND.
 Law of supply—as prices ________________, the QUANTITY supplied ________________ OR as
prices_________________, the QUANTITY supplied ____________________.
o This is a _______________ relationship. On a graph, the sUPply line goes ______.
 Law of demand—as prices _______________, the QUANTITY demanded _______________ OR as
prices ________________, the QUANTITY demanded ____________________.
o On a graph, the Demand _____________________.
Lesson 9: What is the difference between a change in demand and a change in quantity demanded? Be
able to graphically apply the determinants of demand. (pgs. 91-96)
Demand—1. _____________ to own 2. ability and willingness to __________
 Law of Demand—as prices increase, quantity demanded decreases; as prices decrease quantity demand increases.
 3 Reasons that explain the slope of the demand curve
 Income Effect—when the price of a good goes down, your money will buy more; therefore, it has
the effect of increasing your real income
 Substitution Effect—If prices go up, the quantity demanded will go down b/c you will begin to
buy substitutes.
 Diminishing Marginal Utility—each additional (marginal) unit purchased will give you less
utility (satisfaction). Therefore, the only way I will buy more is if the producer lowers the price.
Science of Economics (pg. 15)
2.00
$2.00
0
1.00
Quantity
$1.50
1
.50
Price
1.50
Price
 _____________Economics—what is, statements of fact* economist most interested in
 _____________ Economics—what should be, statements of opinion
 Examples: “The number of farms has decreased over the last 50 years.” P or N “The poor pay too much
for housing.” P or N “If income decreases the demand for most goods will decrease.” P or N
 Ceteris Paribus-- a Latin phrase that means all variables other than the ones being studied are assumed
to be constant. “All other things being ____________”
Tools to Show Demand
 Demand Schedule—a ____________ that lists the various quantities demanders will purchase at various
prices.
 Demand Curve—schedule in __________ form
Demand for Pizza
 Individual—one person’s demand for a product
 Market—a group’s demand for a product
$1.00
2
$0.50
3
1
2
3
4
Quantity
6
Difference between QUANTITY DEMAND and DEMAND
 Quantity Demanded—ONE quantity at ONE price
 Demand—List of quantities at different prices illustrated by a demand schedule and a demand curve.
 Change in QUANTITY demanded
o ________________ along the demand curve
o Caused by a change in the _________ of the product
 Change in DEMAND
o __________ of the entire curve
o Caused by one of the_______________ of demand
Changes in Demand
 Shifts the curve LEFT or RIGHT, NOT up or down
 If demand INCREASES, the demand curve shifts to the _____________
 If demand DECREASES, the demand curve shifts to the ____________
 Determinants of Demand
o T--taste and preferences—events, new technology, more information
Example:
o R—related goods
 substitutes—if the price of a substitute goes up, then the demand for the original good will
______________, direct relationship
Example:

complements—if the price of a complementary good increases, then the demand for the
original good will _____________, an inverse relationship
Example:
o I—income
 Normal goods—assume normal unless otherwise stated or unless it is a known inferior
good (ramen/off-brand names); if income ↑, then demand ↑, vice versa
 Inferior goods—if income ↑, then demand ↓.
o B—number of buyers—if the population that demands a particular product increases, then
demand increases
Example:
o E—expectations—if people expect a shortage, then buy today; if people expect a sale tomorrow,
then demand less today—Demand is always for the current time period (today) unless otherwise
stated.
Example:
2.00
1.50
Price
2.00
What happened to
the equilibrium
price? _________
1.00
1.50
1.00
DECREASE
in DEMAND
D
1
2
3
4
Quantity
D
.50
INCREASE
in
DEMAND
Demand for Pizza
D1
.50
What happened to
the equilibrium
quantity? _______
Demand for Pizza
Price
What happened to
the equilibrium
price? _________
D1
1
2
3
What happened to
the equilibrium
quantity? _______
4
Quantity
7
Lesson 10: What is the difference between a change in supply and a change in quantity supplied? Be able
to graphically apply the determinants of supply. (pgs. 98-103)
Supply of Pizza
2.00
Price
1.50
1.00
.50
O—other goods—if the price of another good that the producer sells has gone up, then supply will
decrease for the other good.
Example:

T—Taxes (government) also deals with subsidies—helps businesses, if the government offers a tax
credit for businesses then supply increases, if they eliminate a tax credit for businesses then supply
decreases
Example:

T—Technology
Example:

E—Expectations—if supplier expects prices to rise in the future, then will cut back supply today.
Example:

N—number of sellers
Example:
S1
S
What happened to
the equilibrium
price? _________
1.00
1.50
S1
2.00
Market for Pizza
D
1
2
3
4
Quantity
INCREASE IN SUPPLY
.50
What happened to
the equilibrium
quantity? _______
Market for Pizza
S
Price
What happened to
the equilibrium
price? _________
2.00

Price

1.50

1.00


S
Supply—amount produced for sale.
Law of Supply—as prices increase, quantity supplied increases;
as prices decrease, quantity supplied decrease.
Individual and Market Supply Schedule and Curve
Change in quantity supplied—movement along the curve, caused
by a change in ______________
1
2
3
4
Change in supply—shifts the curve, brought about by determinants of
Quantity
(per slice, in hundreds)
supply
o Shift to the right=______________
o Shift to the left=_______________
Determinants of Supply
 R—resource costs—if the costs to make the good increases, then producers will not be able to
produce as much.
Example:
.50


D
1
2
3
What happened to
the equilibrium
quantity? _______
4
Quantity
DECREASE IN SUPPLY
8
Lesson 11: How does price and quantity change when the equilibrium changes? What happens when the
market is in disequilbrium? (pgs. 105-111)

Equilibrium: Quantity Demand=Quantity Supplied, Happy Place!


Equilibrium changes when demand and/or supply shifts (see examples above)
What happens to EP and EQ when both demand and supply shift at the same time?????
 Shift both curves by the same amount. Either price or quantity will always change, the other
will always be indeterminate, unless you know exactly how much each curve shifted by.
o In this case, I increased both supply and demand, which caused there to be an
increase in quantity and an indeterminate change in price.
.50
1.00
1.50
Price
2.00
Increasing Both D and S
1
2
3
Quantity
4
(per slice, in hundreds)
Disequilibrium
2.00

Price Floor=Shortage
1.50

1.00

QS and QD do NOT equal
A competitive market will self-correct to get back to equilibrium
Shortage: quantity demanded > than quantity supplied
 Seller will _________ the price until it reaches equilibrium
Surplus: quantity supplied > than quantity demanded
 Seller will _________ the price until it reaches equilibrium
Sometimes the government sets prices above and below the market price for equity reasons.
 __________—maximum price the seller can charge, Helps consumers, Causes a shortage, Ex.
rent control apartments
 __________—minimum price that the seller can charge, Helps suppliers, Causes a surplus,
Ex. agricultural goods, minimum wage in the labor market
Calculate the shortage/surplus by finding the difference between the quantity demanded and quantity
supplied at the given price. At $1.75—the surplus is 2: 4 (QS) – 2 (QD)
Supply of Pizza
S
Price Ceiling=Shortage
.50



Price

Draw above a decrease in D and an increase in S. What
happened to EP? ________ What happened to EQ? _________
D
1
2
3
Quantity
4
(per slice, in hundreds)
9