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Chapter 1- Scarcity, Opportunity Cost, Trade, and Models

Chapter 1- Scarcity, Opportunity Cost, Trade, Models
Scarcity and Choice
Scarcity: the problem that arises from our limited money, time, and energy.
Economics: how individuals, businesses, and government make the best
possible choices to get what they want, and how they interact in markets.
We all make choices about what we will get and what we give up. For example,
businesses with limited capital must choose between spending more on research
or on marketing.
Opportunity Cost
Opportunity cost: the cost of the best alternative given up.
Weighing the benefits and cost of any alternatives (i.e. sleeping or studying), we
compare what we get from each path and lose from the other.
Often opportunity cost beats money cost.
o A meeting with a client to get a million-dollar contract would beat a free
vacation that you won.
To make smart choices, the value of what you get must be greater than the
value of what you gave up.
Incentives: rewards and penalties
o If the deal with the client was a hundred dollars instead, you would
mostly likely take the free vacation.
Gains from Trade
Specializing and trading makes us better off, its simple self-interest at work.
Trade is key to prosperity; it makes us all better of because trade is voluntary.
Therefore, both sides stand to gain in some way.
Production Possibility Frontier (PPF): shows the maximum combinations of
products or services that can be produced with existing inputs.
It is also possible to work “inside” the PPF. This would mean not spending the
maximum effort (shaded area under the line).
Combinations “outside” the PPF are not possible, as there is not enough energy
or resources to manufacture the product.
Absolute Advantage: the ability to produce a product or service at a lower
absolute cost than another product.
If Marie where to trade with Jill, but Marie had absolute advantage in both
products. It seems that Marie was not gaining anything from the trade.
Comparative Advantage: the ability to produce a product or service at a lower
opportunity cost than another producer.
To compare opportunity costs, it is easier to measure them per unit of the
product chosen.
o (Opportunity cost= Give Up/Get)
Comparative advantage is the key to mutually beneficial gains from trade. Trade
allows us to work smarter and live better.
Thinking Like an Economist
Learning to think like an economist allows the key “roads” to stand out in
making smart decisions.
This kind of mentality makes understating the world around you and making
tough decisions easier.
Model: a simplified representation of the real world, focusing attention on
what’s important for understanding.
Inputs: the productive resources- labour, naturals resources, capital
equipment, and entrepreneurial ability- used to produce products and services.
Households and businesses interact in two sets of markets- input markets
(where businesses buy the inputs, they need to produce products and services),
and output markets (where businesses sell their products and services).
Governments (in the middle) set the rules of the game and can choose to
interact, or not, in almost any aspect of the economy.
Economic models simplify the information, by leaving out unnecessary
information. This can affect our decisions. We assume that things are
“unchanged”, to remove the influence of the factors that are left out.
Positive Statements: about what is; can be evaluated as true or false by
checking the facts.
Normative Statements: about what you believe you should be; involve value
Negative Externalities: costs that affect others external to a choice or trade.
Positive Externalities: benefits that affect others external to a choice or trade.
Models for Microeconomics and Macroeconomics
Microeconomics: analyzes choices that individuals in households,
individual businesses, and governments make, and how those choices
interact in markets.
Microeconomic choices for individuals include whether to go to college or
to get a job, whether to be self-sufficient or to specialize and trade.
Microeconomic choices for businesses include what product or service to
produce, how much to spend on research and development of new
products, or which technology to use.
Microeconomics choices for governments focus on individual industries.
For example, should the government step in and regulate the wireless
phone industry, or let competition determine the winners and losers.
Macroeconomics: analyzes performance of the whole Canadian economy
and global economy, the combined outcomes of all individual
microeconomics choices.
Focuses on the overall outcomes of market interactions, including
Canadian unemployment, inflation rates, government deficits and
surpluses, interest rates set by the Bank of Canada, the value of the
Canadian dollar, and international trade.
Also examines the policy choices governments make that affect the whole
Three Keys to Smart Choices
Key 1: Opportunity Costs Rule
When you weigh benefits against costs, additional benefits must be
greater than additional costs.
Key 2: Look Forward Only to Additional Benefits and Opportunity Costs
o When standing at a fork in the road, do not look back, only look
forward. Your previous decisions, or the money you spent cannot
be undone.
o Marginal Benefits: additional benefits from the next choice.
o Marginal Opportunity Costs: additional opportunity costs from the
next choice.
Key 3: Implicit Costs and Externalities Count, Too
o Implicit Costs: opportunity costs of investing your own money and
o Smart choices must include implicit costs.