Chapter 1 Flashcards
What is economics?
Economics is the study of the management of scarce resources to satisfy unlimited human wants.
In other words, economics is the study of the use of scarce resources to satisfy unlimited human wants.
What are the five factors of production?
- Capital (plant, equipment, inventory, residential cost)
- Land (natural resources, natural capital)
- Labour (human resources, human capital)
- Technology (change in the productive process)
- Entrepreneurship (innovation, invention)
How are produced goods divided?
Goods (tangible - e.g., car) and services (intangible - e.g., haircut)
Define production.
Transforming inputs into outputs.
Define consumption.
The using up of production to satisfy human wants.
What is scarcity? [5]
- Scarce - limited, bounded, inadequate (Qd > Qs at P=0)
- Factors of production are limited
- Desires are unlimited (i.e., relative to our desires, existing resources are scarce)
- Economics manages these scarce factors to satisfy unlimited human desires
- Politics decides among the unlimited desires or ends (i.e., scarcity implies the need for choice)

What is the scarcity principle?
Stuff is scarce!
What is the choice principle?
People make decisions as tradeoffs.
What is the difference between a free good and a scarce good?
scarce good = limited supply
free good = unlimited supply (e.g., ideas - entrepreneurship input)

What does scarcity imply?
The need for choice - made by evaluating costs.
Every choice has an associated cost - opportunity cost.
What is opportunity cost?
The value of the next best alternative that is forgone when one alternative is chosen. (value/benefit)
In other words, the value of what you give up to have the the item to the value of what you would have had: a ratio.
What are the four elements of opportunity cost?
- value: subjective; benefit
- next-best: what you would have chosen
- forgone: what you give up
- alternative: choice
What is the opportunity cost principle?
The cost of something is what you give up to get it.
Opportunity cost includes costs affected by the choice including sunk cost.
True or false?
False.
Opportunity cost includes only those costs affected by the choice.
Exclude sunk cost (= cost incurred in the past, cannot be recovered, thus irrelevant; no resale or salvage value)
What is sunk cost?
Cost incurred in the past, cannot be recovered, thus irrelevant; no resale or salvage value.
“No sense crying over spilt milk.”
What is a PPC? (a.k.a. PPB)
Production possibility curve (a.k.a. boundary): shows all possible combinations of production, if all inputs are fully and efficiently employed.

What does a PPC/PPB illustrate? [4]
A production possibilities boundary/curve illustrates:
-
scarcity: right of line
- PPC is maximum output of given inputs
- ‘possible’ boundary
- point on line - inputs fully and efficiently employed
- point inside the line - inputs underused or inefficiently used
-
choice: negative slope
- cannot produce more of both
- Production efficiency - cannot produce more of one without less of the other
- “Trade-off”
-
opportunity cost: value of slope
- opportunity cost of producing one more unit rises as more is produced
- Producer chooses the lowest cost input first
- Producer chooses the most efficient input first
- Opportunity cost is a ratio
- MRT = marginal rate of transformation = slope of PPC
-
efficiency: shift of PPC
- same inputs, greater outputs - PPC shifts right - more efficient

What is MRT?
Marginal rate of transformation = slope of PPC
Why is the PPC concave to the origin?
- High comparative advantage inputs used first
- assume the most efficient factors are used first and the most inefficient resources are switched out first
- Law of increasing marginal opportunity cost = the opportunity cost of X increases as the production of X inccreases. Thus, to increase the production of X, one must give up ever increasing amounts of Y.
What is the increasing opportunity cost principle?
Rational producers use the lowest opportunity cost input first.
What is the law of increasing marginal opportunity cost?
The opportunity cost of X increases as the production of X increases.
In order to increase production of X, one must give up ever increasing amounts of Y.
(i.e., the PPC is concave to the origin)
What is the effect of increased productivity?
Increased productivity = increased efficiency = output/input
Increased productivity shifts PPC outward.

How do we decide where to be on the PPC?
Society equates SMC = SMB
(social costs/benefits - will return to this concept later in the course)
What are the four key economic problems for any economy?
Microeconomics:
- Production - What will be produced and by whom? (i.e., allocation of resources)
- Consumption - What will be consumed and by whom? (i.e., distribution of income)
Macroeconomics
- Idle capacity - output gaps (Why are resources idle? Why is the economy below PPC?)
- Increase capacity - I.R. growth (How to increase productive capacity? How to shift PPC outward?)




