Key Concepts: The Central Idea

Economics mantra: people make choices with scarce resources, and they interact with others
when they make these choices.

Opportunity cost is the value of the next-best forgone alternative to making a choice. Economists
consider this the real cost of a decision; for example, if a baseball player decides to attend college
on a scholarship instead of entering the MLB draft, then even if he is going to school for free, the
opportunity cost of that decision is the salary he could be making as a professional.

Gains from trade are improvements in income, production, or satisfaction owing to the exchange
of goods or services.

This economic interaction can lead to the following:

 Specialization: a concentration of production effort on a single specific task.

 Division of labor: the division of production into various parts in which different groups of
workers specialize.

 Comparative advantage: a situation in which a person or group can produce one good at a
lower opportunity cost than another person or group.

These can lead to greater production due to greater efficiency which can make all actors better
off.

Trade can make two individuals or firms better off than if the trade did not happen. Because of
this, in this framework, an important role of government is to ensure that trade can happen. There
are five main components to this:

 Predictable policy framework: the government needs to be predictable in its decision-making

process.

 Rule of law (e.g. property rights): property rights need to be clearly defined and enforced.

 Reliance on market economy: the government needs to allow the market to determine prices
and quantities produced.

 Good incentives: the government needs to provide good incentives for economic activity, such
as patents to encourage innovation.

 Specific role of government: the government needs to be able to intervene in the case of
market failure, when the market would fail to reach the efficient outcome.
Key Concepts: Production Possibilities and Economic Growth
The production possibilities curve (or production possibilities frontier) is a graph which
illustrates the tradeoffs that an economy faces when deciding what to produce. It has a bowed-out
shape, implying that opportunity costs increase as production increases. The curve below
illustrates a hypothetical tradeoff between computers (on the y-axis) and movies (on the x-axis).

Points on the curve are considered to be efficient levels of production. Points below the curve
are inefficient, because the economy could produce more of one good without sacrificing
production of the other. Points outside the curve are impossible; given its current capabilities, the
economy cannot reach those levels of production. Note that the production possibilities curve does
not indicate which good we prefer, or the optimal point on the curve; it merely indicates what
amounts of production it is possible to achieve.

Over time, the production possibilities curve shifts out. The magnitude of this shift depends on
investment in the economy; more investment will eventually lead to greater growth, and less
investment will lead to slower growth.
Key Terms

-Microeconomics: the study of individual firms and households in specific industries and markets

-Macroeconomics: the study of the entire economy of a region, a country, or the entire world

-Opportunity Cost: is the value of the next-best forgone alternative to making a choice
-Gains from Trade: improvements in income, production, or satisfaction owing to the exchange of
goods or services
-Specialization: a concentration of production effort on a single specific task
-Division of Labor: the division of production into various parts in which different groups of
workers specialize
-Comparative Advantage: a situation in which a person or group can produce one good at a lower
opportunity cost than another person or group

-Production Possibilities Curve: a graph illustrating the tradeoffs an economy faces when
producing two different goods

-Increasing Opportunity Costs: the idea that as production of a good increases, the opportunity
cost of producing that good becomes higher