Foundations of Economics
Chapter 1: Foundations of Economics
Economics is the study of choice. Because resources are limited while human desires are infinite, we study how to solve the problem of Scarcity efficiently.
1. The Essence of Economics and Choice
(1) The Principle of Scarcity
This refers to the state where resources are relatively insufficient compared to human desires. It is important to note that scarcity is not just about a small quantity, but about being insufficient ‘relative to desire’.
(2) Opportunity Cost
The value of the best alternative foregone when making a choice.
- Explicit Cost: Actual out-of-pocket cash expenditures.
- Implicit Cost: Potential income foregone.
- Opportunity Cost = Explicit Cost + Implicit Cost
Sunk Cost: Costs that have already been incurred and cannot be recovered. When making rational decisions, sunk costs should be ignored.
2. Methodology of Economics
| Category | Description | Key Question |
|---|---|---|
| Positive Economics | Analyzes facts as they are (Objective) | “What is” |
| Normative Economics | Involves value judgments (Subjective) | “What ought to be” |
3. Production Possibilities Frontier (PPF)
A curve showing the maximum combinations of two goods that a society can produce using all its available resources and technology.
(1) Characteristics
- Efficiency: All points on the curve represent efficient use of resources.
- Increasing Opportunity Cost: The curve is typically bowed-out (concave) from the origin because as production of one good increases, the amount of the other good that must be sacrificed (opportunity cost) increases.
(2) Shifts of the Curve
- Economic Growth: Technological progress or an increase in resources shifts the PPF outward.
4. Economic Systems and Efficiency
- Market Economy: Resource allocation is determined by the price mechanism (the ‘Invisible Hand’). (Emphasis on efficiency)
- Planned Economy: Resource allocation is determined by government instructions and control. (Emphasis on equity)
Key Checklist
- Should sunk costs be included when calculating opportunity cost? (Answer: No)
- What does a point inside the PPF indicate? (Answer: Inefficiency or unemployment)
- How does the PPF change when the amount of resources increases?
- Is “The government should work to lower the unemployment rate” a statement of positive or normative economics? (Answer: Normative)
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