1.1 The Definition of Economics
Economics – The social science that studies choices that individuals, businesses, governments,
and entire societies make as they cope with scarcity, and incentives that influence and reconcile
these choices.
o Individuals, businesses and governments all have “wants.”
Ex.: Governments want lower inflation, lower national unemployment, and
increases in secondary school attainment rates.
o We do not have unlimited resources to meet their unlimited wants, known as scarcity.
Ex.: Governments are limited by budgets, the tax base, and population
demographics.
o When things are scarce, the consumer must make a choice that is often influenced by
incentive, be it positive or negative incentive.
o Incentives are important in understanding how markets operate. They are viewed as the
key to reconciling self-interest and social interest.
Rational individuals will likely select choices that favour positive incentives.
o As a social science, economics studies the behaviour of individuals in the face of scarcity
Ex.: Why an ill patient may opt for one medication versus another.
o Distinguishes between positive statements and normative statements:
Positive Statement – “What is”; testable and agreed upon by economists.
Ex.: Raising taxes on cigarettes will raise the price of cigarettes, which
will lead more individuals to reduce smoking and in turn reduce health
care costs.
Normative Statement – “What ought to be”; opinion, not necessarily testable,
not agreed upon by economists.
Ex.: Taxes on cigarettes should be raised.
o To test statements, economists must use economic models to explain how the economy
works.
Economic Models – Focus on what is important for the task at hand and are
abstract depictions of the real world; judged by their ability to predict outcomes
Models are tested for accuracy through:
Natural Experiments – A situation that arises in the ordinary course of
economic life in which the one factor of interest is different and other
things are equal (or similar).
Statistical Investigations – Looks for correlations.
Economic Experiments – Puts people in a decision-making situation and
varies the influence of one factor at a time to discover how they
respond.
Microeconomics – Study of the choices that individuals and businesses make, the way they
interact with markets and influence governments
Macroeconomics – Study of the performance of the national economy and the global economy.
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, 1.2 Economic Questions
How do choices end up determining what, how and for whom goods and services
are produced?
1. What – What goods and services do we produce to satisfy the wants of individuals
2. How – How they are produced through resources (factors of production), specifically land,
labour, capital, and entrepreneurship
3. For Whom – Who consumes the good/services that are being produced. Dependent on income.
People earn income by selling the services of the factors of production: land earns rent, labour
earns wages, capital earns interest, and entrepreneurs earn profit. NOTE: In this case, the
“who” can also be the recipient who earns a good or service
How can choices made in the pursuit of self-interest also promote social interest?
Efficient – Not possible to make someone better off without making someone else worse off.
Ex.: Pursuing higher education for the self-interest of earning money can promote social
interest; those who are higher educated increase output, provide a stronger tax base, and
generally treat the environment with increased respect.
1.3 The Economic Way of Thinking
Choice and Trade-Offs – When making a choice, an individual is choosing one item over another,
which is a trade-off.
o Ex.: When governments redistribute income, they answer the “for who” question, but
income distribution does have a trade-off. Taxing workers and transferring those tax
dollars to lower income individuals in society is considered a deterrent to working more
hours, which means that less goods and services will be produced. As a trade-off, the
efficiency/output reduced, but wealth is shared more evenly.
Choice and Change – Choices evolve over time, and for various reasons. As such, our
preferences change, and our choices follow suit.
Choice and Opportunity Cost –Every item has an associated cost, and as such, the opportunity
cost is the highest associated cost of an item that is given up to get something else.
o Ex.: Choosing to attend university instead of entering the work force. Students are losing
potential income and leisure time. Forgone income and leisure times are opportunity
costs.
Choice and Margin – Comparing marginal benefits to marginal costs when making a choice
(trade-off). The average individual strives for choices where the marginal benefit is greater than
the marginal cost. Working at a margin is an economic way of thinking.
o Benefit – Measured by the most a person is willing to give up to get something else.
Choice and Incentive – Individuals respond to rewards or penalties when considering choices.
Changes in incentives, and changes in marginal benefit and marginal cost will influence
decisions.
1.4 Economic Coordination
Historically, there are two major forms of economic coordinated systems: central economic
planning and decentralized economic planning. Presently, many economies operate as a
combination of the two (e.g.: China)
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, Circular Flow in the Market Economy provides a general understanding of how decentralized
economic systems work:
Firms – An economic unit that hires and organizes factors of production to produce and sell
goods/services
Market – An arrangement that enables buyers and sellers to get information and to do business
with one another
o Factors Market – Refers to factors of production, specifically land, labour, capital, and
entrepreneurship.
Households – An economic unit of one or more persons that provides the economy with
resources. Will also aim to satisfy wants by purchasing goods/services with money.
o Ex.: Households are exchanging labour, land, capital, and entrepreneurship with firms in
return for wages, rent, interest, and profits.
These interactions with markets determine what will be produced, how it will be produced, and
who will get what is produced
Markets will coordinate decisions through price adjustments:
o Ex.: Suppose that more hamburgers are available than people want to buy. In this case,
more hamburgers must be bought, or fewer hamburgers must be offered (or both). A
fall in the price of hamburgers achieves this outcome. It encourages consumers to buy
more, while discouraging firms from producing more.
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, 1.5 Production Possibility
Frontier
Shows the various combinations of
goods/services (output) that can and
cannot be produced, given the
factors of production (input)
available
Ex.: If zero butter is produced, then
600 guns are produced; but if 500
guns are produced, then 200 butter
is produced
Unattainable – Points beyond the
PPF due to scarcity of resources
Frontier – Points on the PPF, such as A, B, C, and D are attainable; the production is efficient,
meaning resources are well-allocated, and goods/services are being produced at the lowest
possible cost
Inefficient – Point G inside the PPF; resources are unused, misallocated, or both, resulting in
lower production
PPF illustrates a trade-off; gaining an item at the opportunity cost of losing another. The curve
illustrates increasing opportunity costs. NOTE: Not all resources are homogeneous.
o Ex.:
What we give up Rise
Opportunity Cost = =
What we get Run
Moving from point B to point C …
150 guns
Opportunity Cost = =0.75 gun /butter
200 butter
NOTE: PPF slope is negative, but economists always document the term as positive.
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