Fundamental
Economic
Concepts
What is Economics?
- The study of mankind’s unlimited desires in a world of limited resources.
-Economics is a social science, dealing with how people
react to changing variables.
-Economists form theories, based on economic models in
which they manipulate variables.
-These theories, models and variables are used to
describe what is (Positive Economics) and what ought to
be (Normative Economics).
Microeconomics deals with individual decisions,
Macroeconomics looks at the economy as a whole
What is the Economy?
Why Do We Study It?
1. Description
2. Analysis
3. Explanation
4. Prediction
What? or How Much?
How? or Why?
When?
OR…
Why do we study Economics?
So
we
don’t
get
screwed.
Book Auction

What economic concepts were
demonstrated by the book auction?
◦
◦
◦
◦
◦
Scarcity
Value
Choices
Rationing
Equity vs. Efficiency
 Which was the sealed auction?
◦ Consumer surplus
Stay
Tuned!
Scarcity
Situation that occurs when wants are greater than
available resources.
Scarcity is the fundamental problem in economics.
In this classroom, is/are _________ scarce?
Wants are satisfied by available resources
Desks?
But not in the hallway…
 Water?
 Books?
No want for it in classroom, but outside… yes
 Gasoline?
Wants exceed available resources
 Jolly Ranchers?
…


Good looking economics instructors?
Good looking economics instructors?
We always assume….

People make decisions based upon
RATIONAL SELF-INTEREST
We must consider…
Examples: Shelter is a need, a mansion is a want.
Food is a need, a large pizza is a want.
Scarcity forces us to ask the
following questions…

WHAT to produce?

HOW to produce?

FOR WHOM to produce?
Imagine a scenario where…
…we take an all-expensespaid class trip to…
Australia!
Our plane is forced to make a “water landing,” and we
are able to swim to an uncharted island.
What will we need to do? What questions will we have
to answer?
Specialization
• Allocating resources toward production for
which they are best suited.
FACTORS OF PRODUCTION
Land – all gifts of nature
 Labor – human efforts and abilities
 Capital – tools, equipment, space
 Entrepreneurship – risk taking, ideas

◦ **The “spark” or driving force of the
economy**
EXAMPLES:
Adam Smith

“Wealth of Nations”
◦ 1776

Invisible hand
◦
◦
◦
◦
Meat
Bread
Candles
How do we decide to provide these?
CIRCULAR FLOW
Utility

The satisfaction that consumption of a
good or service provides
DIMINISHING MARGINAL UTILITY
As you consume additional units of a good, at some
point each additional unit will begin providing less
utility than the one before it.
Paradox of Value
Water vs. Diamonds
 Monetary Value

◦ Must be scarce
◦ Must give utility
Are diamonds scarce?
 Do they give utility?


Conspicuous consumption
◦ Examples?
Cost – Benefit Analysis
Question? :
What do you want
RIGHT NOW?
Cost – Benefit Analysis
Follow up question? :
Why don’t you go
get it?
Cost – Benefit Analysis
• We all make decisions in our own self-interest
• All decisions come with certain trade-offs and
alternatives
• THERE IS NO SUCH THING AS A FREE LUNCH!!!
Seinfeld example
• Opportunity Cost: the next-best alternative given
up when making a choice
Opportunity Cost
VS.
VS.
VS.
Marginal Cost
Marginal = Additional, next
Additional cost vs. additional benefit
We constantly engage in
marginal analysis
Production Possibilities Model
 Illustrate
production choices
 Assumptions:
◦ Full employment
◦ Fixed resources
◦ Fixed technology
◦ Two goods
1-31
Production Possibilities Frontier
All possible combinations of two products that can be produced when
employing 100% of available resources.
Guns (thousands)
80
75
60
30
0
Butter (tons)
0
150
300
400
450
Production Possibilities Frontier
Production Possibilities Table
Production Alternatives
Type of Product
Pizzas
A
B
C
D
E
0
1
2
3
4
10
9
7
4
0
(in hundred thousands)
Industrial Robots
(in thousands)
Plot Points to Create Graph…
1-35
Quick Quiz
Why is the PPF bowed out from the
origin?
◦ Law of increasing opportunity
costs
 What is the marginal opportunity
cost of the 2nd unit of pizza?
◦ 2 units of robots
 Which point(s) on the curve
represent full employment of
resources?
◦ All points ON the curve

Industrial Robots
Production Possibilities Curve
A’
14
13
12
11
10
9
8
7
6
5
4
3
2
1
B’
Unattainable
A
Economic
Growth
C’
B
C
D’
D
Now Attainable
Attainable
E’
E
0
1
2
3
4
5
6
7
8 9
Pizzas
1-37
Industrial Robots
Production Possibilities Curve
A’
14
13
12
11
10
9
8
7
6
5
4
3
2
1
B’
Unattainable
A
Law of Increasing
Opportunity Cost
C’
B
C
D’
Shape of
the Curve
D
Attainable
E’
E
0
1
2
3
4
5
6
7
8 9
Pizzas
1-38
Industrial Robots
Production Possibilities Curve
A’
14
13
12
11
10
9
8
7
6
5
4
3
2
1
B’
Unattainable
C’
U
D’
Under or
Unemployment
E’
0
1
2
3
4
5
6
7
8 9
Pizzas
1-39
How do we know where on the
curve we should be?
As long as the MARGINAL benefit of the
next unit of a good exceeds the
MARGINAL cost, we should continue to
produce an additional unit of the good.
 We should stop producing when the
marginal benefit equals the marginal cost.

Marginal Benefit & Marginal Cost
Optimal Allocation of Resources
15
a
c
MC
MB = MC
e
10
5
b
d
MB
0
1
2
3
Quantity of Pizza
1-41
The Future Economy
 Consequences
of unemployment
 Economic growth
◦ More resources
◦ Better quality resources
◦ Technological advances
1-42
Future
Curve
Current
Curve
P
Goods for the Present
Presentville
Goods for the Future
Goods for the Future
Future Possibilities
Future
Curve
F
Current
Curve
Goods for the Present
Futureville
1-43
Challenge Problem: PPF
Production Alternatives
Type of Product
A
B
C
D
E
Automobiles
0
2
4
6
8
Forklifts
30
27
21
12
0
HW - Pg. 20
#10, 12, 13
Plot Points to Create Graph…
1-44
Individual’s Economizing Problem
 Limited
income
 Unlimited wants
 A budget line
 Tradeoffs & opportunity costs
 Make best choice possible
 Change in income
1-45
A Budget Line
DVDs Books
$20
$10
6
5
4
3
2
1
0
0
2
4
6
8
10
12
12
10
Quantity of DVDs
$120 Budget
Income = $120
=6
Pdvd = $20
8
Unattainable
6
Income = $120
4
Pb = $10
2
0
= 12
Attainable
2
4
6
8
10
12
Quantity of Paperback Books
14
1-46