Ch1. Foundations of Economics — Scarcity, Opportunity Cost & Economic Systems

What Is Economics?

Economics: the study of how individuals, firms, and societies allocate scarce resources.

The Three Fundamental Questions:
① What goods and services should be produced,
  and in what quantities? (What)
② How should they be produced? (How)
③ Who receives the output? (For Whom)

Microeconomics: decisions of individuals,
  households, firms, and markets
Macroeconomics: national output, price level,
  unemployment, interest rates, and exchange rates
  (the domain of the Fed, BLS, and BEA)

Scarcity and Choice

Scarcity:
  Human wants are unlimited; resources are finite
  The root cause of every economic problem

The Necessity of Choice:
  Scarcity forces trade-offs
  Every choice means giving something up

Cost Concepts:
  Explicit cost: actual cash outlay
  Implicit cost: value of the best forgone alternative
  Economic cost = explicit + implicit cost

Opportunity Cost and Sunk Cost

Opportunity Cost

Opportunity Cost: the value of the single best
  alternative you give up when making a choice

Example:
  Going to college vs. working full-time
  → Opportunity cost of college
    = forgone after-tax salary + tuition paid

Key Rule:
  Opportunity cost = the ONE best forgone option
  (not the sum of all forgone options)

Sunk Cost

Sunk Cost: a cost already incurred and
  unrecoverable — irrelevant to future decisions

Sunk-Cost Fallacy:
  "We've already spent $30,000 on this project,
   so we can't quit now."
  → The $30,000 is sunk → consider only
    future benefits vs. future costs

Rational Decision Rule:
  Continue if marginal benefit > marginal cost
  Stop if marginal benefit < marginal cost

Production Possibilities Frontier (PPF)

PPF: the maximum combinations of two goods
  an economy can produce given its resources
  and technology

Points on the curve: productively efficient
Points inside: inefficient (idle resources)
Points outside: currently unattainable
  (reachable through growth or technology)

Slope of PPF = opportunity cost
Bowed-out (concave) PPF:
  → Law of increasing opportunity cost
  → As more of Good X is produced,
    ever-larger amounts of Good Y must be sacrificed

Economic Systems

Market Economy (Capitalism):
  Resource allocation via the price mechanism
  Private property and profit motive
  Strengths: efficiency, innovation
  Weaknesses: inequality, market failures

Planned Economy (Command):
  Government directs resource allocation
  Strengths: equity, public-good provision
  Weaknesses: inefficiency, weak incentives

Mixed Economy (Reality):
  Market foundation + government intervention
  All modern economies — US, EU, Japan — are mixed
  The US: market-dominant with social safety net,
    antitrust enforcement, and regulatory agencies
    (FTC, EPA, FDA, SEC)

Opportunity Cost = Best Forgone Alternative ★★★★★ : Among all the options you give up, only the single best one counts as the opportunity cost. Includes both explicit and implicit costs. Memory hook: opportunity cost = the ONE best thing you didn’t choose

Ignore Sunk Costs ★★★★★ : Once spent and unrecoverable, a sunk cost is irrelevant. Compare only marginal benefit vs. marginal cost going forward. Memory hook: sunk cost = ancient history — don’t let it trap you

PPF Slope = Opportunity Cost ★★★★☆ : A bowed-out PPF reflects increasing opportunity cost. Producing more of X requires sacrificing increasing amounts of Y. Memory hook: concave PPF = rising opportunity cost

Practice Questions

Q. A startup has spent $30,000 and incurred$ 5,000 in losses so far. Investing an additional $2,000 is projected to generate$ 4,000 in revenue. Should the company continue?

Yes. Ignore the sunk costs ( $35,000 total spent). The relevant comparison: additional cost$ 2,000 vs. additional revenue $4,000 → net gain +$ 2,000. Marginal benefit ( $4,000) > marginal cost ($ 2,000) → continue.

Q. Which of the following is included in opportunity cost? ① Textbook purchase ② Forgone part-time wages ③ Last semester’s tuition

① and ②. ③ is a sunk cost (already paid, unrecoverable). ① is an explicit cost; ② is an implicit cost — both are part of the true economic opportunity cost of the decision.