Basic Economic Concepts

Question 1

DEFINE SCARCITY

Answer 1

SCARCITY is the fundamental concept that not enough resources are available to produce all goods and services.

Economics is the study of the science of SCARCITY.

We have unlimited wants but unlimited resources, and economics is about studying the choices that societies and individuals make to deal with that scarcity.

Question 2

WHAT IS THE DIFFERENCE BETWEEN MICROECONOMICS AND MACROECONOMICS?

Answer 2

MICROECONOMICS is the study of small economic units (individuals, markets, firms, industries, etc.).

MACROECONOMICS is the the study of the larger economy as a whole, or of economic aggregates.

Question 3

WHAT IS THE DIFFERENCE BETWEEN A TRADE-OFF AND AN OPPORTUNITY COST?

Answer 3

TRADE-OFFS are all the alternatives that we give up when we make a choice.

The OPPORTUNITY COST is the most desirable alternative that is given up when you make a choice.

Question 4

WHAT ARE THE 5 KEY ASSUMPTIONS OF ECONOMICS?

Answer 4

SCARCITY - Society has unlimited wants and limited resources.

TRADE-OFFS - Choices must be made due to scarcity, and so every choice has a cost.

SELF-INTEREST - Everyone responds to incentives and acts to maximize their own benefits.

MARGINAL COSTS AND MARGINAL BENEFITS - Everyone compares the costs and benefits of every choice.

GRAPHS AND MODELS - These can explain life and real-life situations.

Question 5

WHAT IS INVESTMENT?

Answer 5

Money spent by businesses to improve their own production

Question 6

WHAT IS THE DIFFERENCE BETWEEN A CONSUMER AND CAPITAL GOOD?

Answer 6

CONSUMER GOODS are goods which are created for direct consumption.

EXAMPLES: Pizza, hamburgers, clothing, homes, etc.

CAPITAL GOODS are created for indirect consumption, and are used to MAKE consumer goods.

EXAMPLES: Lumber, factory parts, ovens, cardboard boxes, etc.

Question 7

WHAT IS HUMAN CAPITAL?

Answer 7

HUMAN CAPITAL refers to any skills or knowledge gained by a worker through education and experience.

Question 8

WHAT ARE THE FACTORS OF PRODUCTION?

Answer 8

LAND
LABOUR
CAPITAL

Question 9

WHAT ARE THE THREE MAIN ECONOMIC QUESTIONS EVERY SOCIETY HAS TO ANSWER THAT DETERMINE THEIR ECONOMIC SYSTEM?

Answer 9

1) What goods and services should be produced?
2) How should these goods and services be produced?
3) Who consumes these goods and services?

Question 10

WHAT ARE THE THREE MAIN ECONOMIC SYSTEMS THAT EXIST AND HOW ARE THEY DIFFERENT?

Answer 10

A CENTRALLY-PLANNED (COMMAND ECONOMY) is one in which the government owns all resources and controls production.

A FREE MARKET (CAPITALIST) ECONOMY is one in which the “invisible hand” of capitalism means that society’s goals will be met as individuals seek their own self-interest, and in which competition and self-interest regulate the market.

A MIXED ECONOMY is one in which many or most things are regulated by the free market, but there is also some government intervention.

Question 11

WHAT IS A PRODUCTION POSSIBILITIES CURVE (OR BOUNDARY OR FRONTIER)?

Answer 11

It is a model that shows alternative ways that an economy can use scarce resources.

It demonstrates scarcity, trade-offs, opportunity costs, and efficiency.

It has one good along the x-axis, and another good on the y-axis, with each point on the graph representing a specific combination of goods that can be produced given full employment of resources.

Question 12

HOW DOES A PRODUCTION POSSIBILITIES CURVE REPRESENT SCARCITY AND TRADE-OFFS?

Answer 12

Any point OUTSIDE of a Production Possibilities Curve indicates a combination of goods that is unattainable given current resources.

Any point ALONG the curve represents the most efficient usage of resources.

Any point INSIDE of the curve represents an inefficient usage of resources, or reflects unemployment.

Question 13

WHAT IS THE DIFFERENCE REFLECTED BY A STRAIGHT PRODUCTION POSSIBILITIES CURVE VS. A CONCAVE CURVE?

Answer 13

A STRAIGHT CURVE represents a CONSTANT OPPORTUNITY COST. This is a situation in which resources are easily adaptable for producing either good.

A CONCAVE CURVE represents an INCREASING OPPORTUNITY COST. This is a situation in which as you produce more of any good, the opportunity cost (foregone production of another good) increases. This is because resources are not easily adaptable between the production of two goods.

Question 14

WHAT HAPPENS TO THE PRODUCTION POSSIBILITIES CURVE WITH THE INTRODUCTION OF NEW TECHNOLOGIES OR INCREASED PRODUCTIVITY?

Answer 14

The curve actually shifts fully to the right, as the better technology or increased productivity results in economic growth, and what once was unattainable becomes attainable.

If this productivity or technology impacts a CAPITAL good vs. only CONSUMER goods, there will also be a larger increase in the consumer good that makes the curve stretch further forward, because capital goods are both produced goods, but also a resource for even further growth.

Question 15

WHAT IS THE DIFFERENCE BETWEEN ABSOLUTE AND COMPARATIVE ADVANTAGE?

Answer 15

In ABSOLUTE ADVANTAGE, a producer can produce the most output (or requires the least amount of inputs).

In COMPARATIVE ADVANTAGE, a producer has the lowest opportunity cost.

The idea is that countries should specialize in trade if they have a relatively lower opportunity cost.

Question 16

HOW DO YOU CALCULATE COMPARATIVE AND ABSOLUTE ADVANTAGE?

Answer 16

First, convert all the numbers on the graph into a table showing the absolute production of each group for each good.

Then, you need to calculate the PER UNIT opportunity cost for each group and each item.

The formula is OPPORTUNITY COST GOOD / PRODUCED GOOD on an output question.

The group with the lower opportunity cost of producing something has the comparative advantage.

Question 17

WHAT ARE TERMS OF TRADE?

Answer 17

TERMS OF TRADE refers to the agreed upon conditions that would benefit two countries based upon comparative advantage.

It is calculated after you understand the comparative advantage and per unit opportunity costs,

Question 18

EXPLAIN THE DEMAND CURVE

Answer 18

The DEMAND CURVE graphs quantity demand against the price of a good.

It is always DOWNWARD SLOPING, because of the law of demand, which states that there is an inverse relationship between price and quantity demanded. As prices go down, quantity demanded will go up.

When PRICE changes, the point along the demand curve will move and change QUANTITY DEMANDED.

Increases in demand will shift the curve right. Decreases will shift the curve left.

Question 19

WHAT ARE THE FIVE SHIFTERS OF THE DEMAND CURVE?

Answer 19

Shifts along the DEMAND CURVE happen based on the following determinants:

1) Tastes and preferences of consumers (based on studies, advertising campaigns, etc.)
2) Number of consumers (there are more customers willing to buy things based on a population increase, etc.)
3) Price of related substitute or complementary goods
4) Income changes
5) Future expectations

Question 20

WHAT IS THE RELATIONSHIP BETWEEN SUBSTITUTE AND COMPLEMENTARY GOODS AND DEMAND?

Answer 20

When the price of a substitute good (a good which can be a one to one replacement) goes up, demand for the good in question will go up, and vice versa.

When demand for or the price of a complementary good (a good which is tied to the one in question, for example the relationship between milk and cereal), it will impact the good in question accordingly.

Question 21

WHAT IS THE RELATIONSHIP BETWEEN NORMAL OR INFERIOR GOODS, INCOME, AND DEMAND?

Answer 21

NORMAL GOODS are those where the income and the demand for the product are directly related. Increase in income means that demand rises, while decrease in income means demand falls. People buy these because they WANT to and need them.

INFERIOR GOODS are those where the income and demand for the product are inversely related. Increase in income means the demand falls, while decrease in income means demand rises. People buy these because they are inferior and they would not buy them if they could.

Question 22

EXPLAIN THE SUPPLY CURVE

Answer 22

The SUPPLY CURVE graphs quantity supplied against the price of a good.

It is always UPWARD SLOPING, because of the law of supply, which states that there is a direct relationship between price and quantity supplied. As prices go up, quantity supplied will go up, and vice versa.

When PRICE changes, the point along the supply curve will move and change QUANTITY SUPPLIED.

Increases in supply will shift the curve right. Decreases will shift the curve left.

Question 23

WHAT ARE THE FIVE SHIFTERS OF THE SUPPLY CURVE?

Answer 23

Shifts along the SUPPLY CURVE happen based on the following determinants:

1) Price and availability of resources (inputs)
2) Number of sellers (more sellers increases supply)
3) Technology changes (more can be produced by existing sellers)
4) Government action: Taxes and Subsidies (tax cuts and subsidies increase supply, higher taxes decrease it)
5) Expectations of future profit

Question 24

EXPLAIN THE CONCEPT OF EQUILIBRIUM PRICE AND QUANTITY?

Answer 24

That is the price and quantity that should happen in the market at any given time to be the most efficient, and is represented or calculated by looking at where the supply and demand curves intersect on the graph.

When supply or demand shifts, this will shift the equilibrium, and will tell you what then happens to the price level and quantity.

When two curves shift at the same time, either price or quantity will be indeterminate afterwards.

Question 25

HOW DO YOU CALCULATE SHORTAGES AND SURPLUSES ON A SUPPLY AND DEMAND GRAPH?

Answer 25

When prices rise ABOVE the equilibrium, it creates a SURPLUS.

When prices fall BELOW the equilibrium, it creates a SHORTAGE.

To calculate the amounts of a shortage or surplus, you look at the difference between the supply and demand curve points at the price level on the graph.

SURPLUS: QS - QD
SHORTAGE: QD - QS

When there is a surplus, producers lower prices. When there is a shortage, producers raise prices. This then corrects things back to equilibrium.

Question 26

WHAT ARE THE THREE THINGS THAT CAN SHIFT A PRODUCTION POSSIBILITIES CURVE?

Answer 26

A shift in technology

A shift in quantity or quality of resources

Specialization and trade