Economics Basics ( source: www.investopedia.com/university/economics, Economics by McConnell,
What is economics?
- Refers to the tension between our limited resources and our unlimited wants and needs.
o For individuals, resources include time, money and skills.
o For a country, limited resources include natural resources, capital, labor force and
- Individuals and nations have to make decisions regarding what goods and services they can buy
and which ones they must forgo.
- Each individual and nation will have different values, because each will have different levels of
resources. Some of these values are formed as a result of the particular scarcities with which
they are faced.
- Therefore, because of scarcity, people and economies must make decisions over how to allocate
Economics aims to study why we make these decisions and how we allocate our resources most
- Human behavior reflects “rational self-interest”
- Individuals look for and pursue opportunities to increase their utility (pleasure, happiness or
satisfaction) obtained from consuming a good or service.
- Decisions are based on costs and benefits and are therefore purposeful and rational.
- People make decisions with some desired outcome in mind.
Marginal cost and benefit
- The Law of Diminishing Marginal Utility.
o marginal utility: the increase in satisfaction from consuming one additional unit of the
o The Law of Diminishing Marginal Utility states that as each additional unit of a good is
consumed, the amount of marginal (incremental) utility will decrease.
- The consumer will compare the additional (marginal) utility to be achieved by consuming one
more unit of the good, to the additional (marginal) utility that must be given up (buying power)
in order to obtain the good.
- At any particular price, the consumer will continue to buy units of the good as long as the
marginal benefit exceeds the price.
- Marginal benefit refers to what people are willing to give up in order to obtain one more unit of
- Marginal cost is the value of what is given up in order to produce that additional unit
Theories, Principles, and Models
- Economics relies on the scientific method:
o Observation - real world behavior and outcomes
o Hypothesis – forming a possible explanation of cause and effect (hypothesis)
o Testing – Comparing the outcomes of specific events to the outcome predicted by the
o Evaluation - Accepting, rejecting and modifying the hypothesis based on the testing
o Continue testing – more favourable results turn the hypothesis into a theory.
o Principle – well tested and widely accepted theories are referred to as economic law or
o Model – simplified representation of a combination of laws to show how a section of
the economy works.
- Economic principles are:
o Generalizations: reflect general or typical behavior
o other things equal assumption: factors apart from those being considered in the
principle do not change
o graphical representation: many economic models are represented graphically
Macro and Microeconomics
- Macro and micro are the two vantage points from which the economy is observed.
- Macroeconomics looks at
o Total output of a nation
o The way the nation allocates its limited resources of land, labor and capital in order to
maximize production levels and
promote trade and growth
o Adam Smith noted that there was an “invisible hand” turning the wheels of the
economy; a market force that keeps the economy functioning.
- Microeconomics looks into similar issues on the level of individuals and firms within the
o Studies the parts that make up the whole economy
o Analyzes certain aspects of human behavior and shows us how:
Individuals and firms respond to changes in price
Why they demand what they do at particular price levels
Economic systems: market economic system and command economic system
The systems by which nations allocate their resources can be put on a scale with the market economic
system on one end and the command economic system on the other end.
- Market economic system
o Advocates forces within a competitive market which constitute the invisible hand
- Command economic system
o Relies on the government to decide the allocation of resources
A Budget Line
- Also called budget constraint
- Curve that shows various combinations of two products a consumer can purchase with a specific
- The graph may show two products but the analysis can be generalized to the full range of
products available to the customer.
The budget line illustrates:
- Attainable and unattainable combinations
o All combinations on or inside the line are attainable
o To achieve maximum utility, the consumer will want to spend the full available income.
o All combinations beyond the budget line are unattainable
- Trade offs and opportunity costs
o To obtain more of one good, the consumer has to give up certain quantities of the other
o Straight line budget constraint indicates constant opportunity cost. This means that the
opportunity cost of one more unit of a good remains the same.
o Limited incomes force consumers to make choices.
o Consumers will evaluate marginal costs and benefits to determine the best combination
to maximize satisfaction.
- Income Changes
o Increase in money income shifts the budget line to the right
o Decrease in money income shifts the budget line to the left
Society’s Economizing Problem
- Scare Resources
o Society has limited or scarce economic resources
o This includes all natural, human and manufactured resources that go into the
production of goods and services
o Resource categories:
Land. Includes all natural resources used in the production process.
Labor. Physical actions and mental activities that people contribute to the
production of goods and services.
Capital. All manufactured aids used in producing consumer goods and services.
Investment refers to spending that pays for the production and accumulation of
Consumer goods satisfy wants directly
Capital goods satisfy wants indirectly by aiding the production of
Economists do not count money as an economic resource because
money produces nothing.
Money is just a means for purchasing goods and services, including