Chapter 1- First Principles

12 General Principles underlying the study of economics; describe how individuals make
choices and how individual choices interact:
1. Resources (land, labor, capital, and human capital) are scarce. Thus, individuals and societies
must make choices about how to use these resources.
2. The opportunity cost (the real cost of something) is what you must give up to get it.
3. Decisions about how much to produce and how much to consume are made at the margin.
These decisions invariably involve a trade off, or a comparison of the costs and benefits of
producing more or consuming more.
4. People usually exploit opportunities to make themselves better off- in other words, people
respond to incentives.
5. There are gains from trade.
6. Markets move toward equilibrium, a situation in which no individual would be better off
doing something different.
7. Resources should be used as efficiently as possible. However- there is a trade-off between
efficiency and equity: decisions based solely on efficiency may be highly inequitable.
8. Markets usually lead to efficiency.
9. When markets fail to achieve efficiency, government intervention can improve societys
welfare.
-Markets may fail due to:
1) The existence of side effects from individual actions.
2) The prevention of mutually beneficial trades by an individual or individuals so they
can capture a greater share of resources.
3) The inability of the market to efficiently produce some goods, due to the nature of
these goods.
10. One persons spending is another persons income.
11. Spending sometimes gets out of line with the economys capacity to produce goods and
services. It is possible for the economys spending to be less than, or greater than, the current
level of production.
12. Government policies can change the level of spending in an economy.

Chapter 2- Economic Models: Trade-offs and Trade

Objective 1. Model= a simplified representation of reality that is used to better understand reallife situations. Underlying every model is a set of assumptions.
Objective 2. Production Possibility Frontier= a model that represents the production possibilities
available to an individual to an individual or an economy.
-ASSUMES: That the individual/country has a set amount of resources, a set level of
technology, and a set amount of time.
-Delineates a set of points that indicate the maximum amount of two goods that can be produced
by individual/country given their resources, technology, and available time.
FIGURE 2.1:
Objective 3. Simplest version of PPF model assumes: Frontier is linear and thus has a constant
slope.
-Implies that the opportunity cost of producing another unit of the good measured on the x-axis
stays the same as you move along the PPF.
FIGURE 2.2:
Objective 4. A more realistic PPF is one that is bowed out from the origin, which implies that as
the country produces more and more of one of the goods, the opportunity cost of producing this
good increases.
-PPF has this shape because of specialization of resources- some of the resources available to the
country are more suited to produce good X than they are to produce good Y.
-When the country decides to increase the production of one type of good, the first few units can
be produced at relatively low opportunity cost, since resources can be shifted from the
production of one good to the production of the other good better suited to be produced in that
respective country.
FIGURE 2.3:
Objective 5. Two types of efficiency: 1) productive efficiency and 2) allocative efficiency.

1) Producing at a point that lies on the PPF. Points that lie inside the frontier are
inefficient, since it is possible to increase the level of production from the given set of resources.
2) Producing the right mix of goods from available resources. This means an economy
must allocate its resources in such a way as to make consumers as well off as possible.
Objective 6. For an economy to be efficient, it must achieve productive and allocative efficiency;
it must not waste resources and it must produce the right mix of goods.
Objective 7. PPF illustrates scarcity in that there are points of production that cannot be produced
because the level of resources and/or technology constrain production. PPF illustrates trade offs:
getting more of good X requires giving up some of good Y.
Objective 8. Economic growth can be illustrated with the PPF model. When frontier shifts away
from the origin, this means that the represented economy can now produce more of good X and
good Y. PPF shifts out when there are increases in resources or increases in the available level of
technology.
Objective 9. PPF model can be used to illustrate gains from trade (model of comparative
advantage).
Model ASSUMES:
-There are 2 countries and two goods that the countries produce and that each country has
a set amount of resources, technology, and time available to them.
-That each country has different opportunity costs of production.
-Countries benefit from specializing in the production of the good for which they have a
comparative advantage or lower opportunity cost of production, and then trade with each other.
Objective 10. The simple circular flow diagram of the economy can be used to describe the
relationship between firms and households.
-Households provide: factors of production to firms.
-Firms provide: goods and services to households.
Objective 11. Positive economics vs. Normative economics.
-Positive economics= factual and descriptive; objective and can be tested for accuracy;
often involving forecasting.
-Normative economics= About what ought to be or what should be; subjective and
prescriptive; value based.
Objective 12. Economists may come to different conclusions because they have different values
or because they use different economic models.