Principles of Macroeconomics / Dual Enrollment Class / Fall 2014
Unit 1” Introduction to Economics”
Key Concepts and Terms / Summary
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Resources are limited, so people must make choices. Societies do not have enough productive
resources to satisfy everyone’s wants and needs.
 Because you must choose among limited alternatives, the true cost of anything is what you must
give up to get it (opportunity cost).
 Economists use economic models for both positive economics, which describes how the economy
works (facts, evidences), and for normative economics (rules, goals), which prescribes how the
economy should work.
 Microeconomics is the branch of economics that studies how people make decisions and how
those decisions interact.
 Macroeconomics is concerned with the overall ups and downs of the economy, and focuses on
economic aggregates such as the unemployment rate, gross domestic product (GDP), and inflation
rate, that summarize data across many different markets.
 Four factors of production (or economic resources) can be classified as land, labor, capital, and
entrepreneurs. They are inputs and must be present to produce goods and services.
 The production possibility frontier (or curve) illustrates different combinations of goods and
services that can be produced in a fully employed economy, assuming that resources quantity,
resources quality, and technology are fixed. To be efficient an economy must produce as much of
each good as it can, given the production of other goods, according to a technological level and
the among of factor of production (disposable resources)
 The production possibility curve or frontier (PPC/PPF)) represents the trade-off facing an
economy that produces only 2 goods. It shows the maximum quantity of one good that can be
produced for each possible quantity of the other good produced.
 The slope of the PPF tells the opportunity cost for increasing the production of item X in one unit
 An economy is efficient if there are no missed opportunities; it means that there is no way to make
anyone better off without making at least one person worse off.
 The PPF is useful for illustrating the general economic concept of efficiency. Any point on the
curve means that economy is not missing the opportunity to produce more of both goods.
 To be efficient an economy must produce as much of each good as it can, given the production of
other goods, according to a technological level and the amount of factor of production (disposable
resources).
 There are two basic sources of growth in the production possibility curve: an increase in resources
and improved technology.
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An economic system represents the structure of methods and principles that a society uses to produce
and distribute goods and services. The market system and the command system are two fundamental
types of economic systems to address the economizing problem (scarcity). Every economic system has
problems. Traditional economies have little potential for growth or change. Centrally planned
economies asphyxiate innovation, do not adequately meet consumer needs, and limit freedom. Even
free market economies, with all their advantages, have drawbacks (reasons for Government
involvement).
Each society faces basic questions about the production and consumption of goods and services.
Five fundamental economic questions:
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What goods and services will be produced?
How will these goods and services be produced?
Who will get (consume) these goods and services?
How will the system accommodate change?
How will the system promote the progress?
Advantages of the Free Market / Market System :
o Economic Efficiency: Because it is a self-regulating, a free market economy
responds efficiently to any condition change. Producers produce only the goods
and services that consumers want, in general at prices consumers are willing to
pay.
o Economic freedom. The market system has the highest degree of economic
freedom of any system. As a concept, workers work where they want, firms
produce what they want, and individuals consume what they want.
o Economic growth come the competition. It encourages innovation. Businesses are
looking for profit contributing new ideas and innovations.
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Disadvantages of centrally planned economies / Command System
o The government owns all production factors. Since Government fixes wages,
workers lack the motivation to work faster or produce more.
o Traditionally, command economies sacrifice individual freedoms in order to
follow collective goals.
o Command economies do not tend to reward innovation. Everybody must follow
an approved government plan.
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A Circular Flow model shows the interactions between households and firms in the free market.
o A dynamic market economy creates continuous and repetitive flows of
goods and services, resources, and money.
o The circular flow diagram represents a complex, interrelated web of
decision makers and economic activities involving businesses and
householders (both are buyers and sellers).
o The diagram groups private decision markets into Businesses (firms) and
Households (people), participating in the resources market (factor of
production market) and the products and services market.
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How does the RESOURCES MARKET work?
o The resources market (upper part of the circular flow diagram) represents the
place where resources or the services of resource suppliers are bought and sold.
o In the resources market, HOUSEHODLS own all economic resources :
 Directly as workers or Entrepreneurs or
 Indirectly as ownership of business corporations
o The funds that business pay for resources are COSTS to businesses but are FLOW
of WAGE, RENTS, INTEREST, and PROFIT INCOME to the households
O PRODUCTIVE RESOURCES FLOW from householders to businesses and
MONEY FLOW FROM BUSINESSES TO HOUSEHOLDERS.
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How does the PRODUCT and SERVICE MARKET work?
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The product market is the place where goods and services produced by businesses
are bought and sold.
Businesses combine resources to produce and sell goods and services.
Households (people) use the limited income they have received from the sale of
resources to buy goods and services
The monetary flow of consumer spending on goods and services yields sales
revenues for businesses.
Businesses compare COSTS and REVENUE to determine PROFIT, and to decide
whether or not a particular good should continue to be produced.
Specialization: people have different abilities, so, they are relatively good to do something. The
society gains (more efficient) when each person contribute by using his/her “best abilities” to
produce. This is because the division of labor permits people develops expertise (skills) in the task(s)
that they concentrate on.
A country has Absolute Advantage in the production of a good when it can produce that good using
fewer resources per unit of output than another country.
A country has Comparative Advantage in the production of a good when it can produce that good at
a lower opportunity cost (a smaller loss in terms of the production of another good) than another
country.