Fundamental Economic Concepts and Systems

Fundamental Economic Concepts

• Scarcity: Unlimited wants clash with limited resources, a fundamental economic problem.
• Opportunity Cost: The value of the next best alternative forfeited when choosing one option.
• Implicit Costs: Costs not requiring direct payment (like forgone wages).
• Marginal Costs: The additional cost of producing/consuming one more unit.
• Marginal Benefits: The added benefit from producing/consuming one more unit.
• Economic Decision Rule: If marginal benefit exceeds marginal cost, undertake the action; otherwise, don't.
• Sunk Costs: Costs already incurred and unrecoverable; irrelevant to future decisions.

Economic Systems

• Market Economy: Decisions based on supply and demand (e.g., U.S.).
• Command Economy: A central authority (government) controls all economic decisions (e.g., North Korea).
• Traditional Economy: Decisions adhere to customs and traditions (e.g., some indigenous communities).

Choice in a World of Scarcity

• Budget Constraints: Limited income sets spending limits.
• Opportunity Costs: Trade-offs from choosing one option over another.
• Marginal Analysis: Analyzing small, incremental changes for economic decisions.
• Utility: Satisfaction derived from consuming goods/services.
• Law of Diminishing Marginal Utility: Each extra unit consumed yields less additional satisfaction.
• PPF (Production Possibilities Frontier): A graph showing maximum output combinations.
• Law of Diminishing Returns: Adding more of one input, while holding others constant, yields smaller output increases.
• Productive Efficiency: Producing goods at lowest possible cost.
• Allocative Efficiency: Producing goods most desired by society.
• Absolute Advantage: Producing more of a good with the same resources compared to others.
• Comparative Advantage: Producing a good at a lower opportunity cost than others.
• Specialization: Concentrating resources on goods with comparative advantage.
• Gains from Trade: Increased total output from specialization and trade.
• Mutually Beneficial Trade: Trade benefits both parties.
• Trade Ratios (Terms of Trade): Exchange rate of goods between countries (e.g., 1 car for 2 tons of steel).

Supply and Demand

• Demand Schedule (Demand Curve): Table/graph showing quantity demanded at various prices.
• Price vs. Quantity Demanded: Price changes along the demand curve, other factors shift it.
• Ceteris Paribus: "All other things being equal" assumption in economics.
• Law of Demand: Inverse relationship—price decreases, quantity demanded increases.
• Law of Diminishing Marginal Utility: Successive units of a good hold less additional satisfaction.
• Substitution Effect: Consumers switch to cheaper alternatives when prices rise.
• Income Effect: Lower prices raise purchasing power, allowing more consumption.
• Determinants of Demand: Factors that shift the demand curve.
• Income: Normal goods (demand rises with income), inferior goods (demand falls with income).
• Price of Related Goods: Complements (used together) and substitutes (alternatives).
• Preferences: Changes in consumer taste and preferences.
• Expected Future Prices: Anticipated price increases boost current demand.
• Population: More consumers mean higher demand.
• Supply Schedule (Supply Curve): Table/graph showing quantity supplied at various prices.
• Price vs. Quantity Supplied: Price changes along the supply curve, other factors shift it.
• Law of Supply: Direct relationship—price increases, quantity supplied increases.
• Determinants of Supply: Factors that shift the supply curve.
• Factors of Production: Input costs affect supply.
• Number of Suppliers: More suppliers mean higher supply.
• Expected Future Prices: Anticipated price increases reduce current supply.
• Price of Related Goods: Complements and substitutes in production.
• Market Equilibrium: Intersection of supply and demand curves, where quantity demanded = quantity supplied.
• Surplus: Quantity supplied exceeds quantity demanded; leads to price decreases.
• Shortage: Quantity demanded exceeds quantity supplied; leads to price increases.
• Inefficiency from Government Intervention: Price ceilings (below equilibrium) create shortages, price floors (above equilibrium) create surpluses.
• Surplus Measures & Trade: Consumer surplus, producer surplus, gains from trade (social surplus), deadweight loss.
• Government Surplus: Revenue from taxes/subsidies.
• Taxes & Subsidies: Taxes reduce supply and demand, subsidies increase them.
• World Trade: Exchange of goods/services across international markets.
• World Trade with Tariffs/Quotas: Tariffs (taxes on imports) and quotas (limits on imports) protect domestic industries.