lOMoARcPSD|16341119
ECON1001 - Key concepts
Scarcity - the problem of relative scarcity arises due to humans having unlimited wants but only
having limited resources to satisfy these wants.
Three basic economic questions: What to produce; how to produce; for whom to produce.
Opportunity cost - the value of the next best alternative forgone when a decision is made.
- Opportunity costs include both explicit cost (costs that involve direct payment) and
implicit costs and Implicit costs (oopportunities that are forgone that do not involve an
explicit cost.)
- opportunity cost only includes costs that could change if a different decision were made.
The opportunity cost does not include sunk costs which have been incurred and
cannot be recovered no matter what.
- Eg. opportunity cost of missing the lecture: the cost of one lecture is $100
(nonrefundable -> sunk cost, refundable -> explicit cost), the dollar-equivalent cost of
psychological pain for missing a lecture is $150 (implicit), the dollar-equivalent value of
happiness if lecture is taken in $200 (implicit cost)
Marginal analysis - a way to maximize benefits and minimize cost by considering the additional
benefit and cost.
- Marginal benefit - additional benefit received from consuming an extra unit.
- Marginal cost - additional cost incurred through buying one more unit.
- If the MB > MC -> agent better off doing the activity; MB < MC -> worse off
Correlation refers to a situation in which two or more factors are observed to move together (or
in opposite directions).
Causation refers to a situation where a change in one factor brings about, or causes, a change
in something else.
Ceteris paribus - to examine the impact of one change at a time by holding everything else
constant.
PPF and Trade
Production Possibility Frontier
PPF - graphs the variations in the amount of two products that can
be produced given the current availability of resources in the
economy. PPF illustrates the inverse relationship between producing
two products, and increasing production of good A would result in
trading off the production of good B.
, lOMoARcPSD|16341119
The slope of the PPF measures the
opportunity cost of producing an extra unit
of a good (in terms of the other), for a particular
point on the frontier.
-> A concaved curve means: the opportunity
cost of each good increases with the level of
output of that good. This is because resources
are not perfectly substitutable.
Changes in PPF
- With a boost to the production of both goods (increase production efficiency), the PPF
will shift outwards on both axis. This is due to a positive productivity shock.
- With a boost in the production of good X only, the PPF will shift outwards on the X axis
only.
, lOMoARcPSD|16341119
Absolute and Comparative advantage
- For Party A to have an absolute advantage over Party B in the production of a good, A
must produce a greater number of that good than B
- For Party A to have a comparative advantage over Party B, A’s opportunity cost of
producing this good must be lower than B’s opportunity cost.
To determine Absolute advantage:
1. Table of production volumes
- Hence Chris has Absolute advantage in both pepper mills (8>2) and salt shakers (8>4)
To determine Comparative advantage:
1. Table of Opportunity cost
- Opp cost of x = y/x, Opp cost of y = x/y
- Hence May has a Comparative advantage in producing salt shakers (½<1)
- Chris has a Comparative advantage in producing pepper mill (1<2)
Range of possible prices of good A in terms of good B
- Each individual will only be willing to trade if they can either buy a good for a lower price
than their opportunity cost, or if they are selling a good, they must receive a price that is
at least as large as their opportunity cost.
- -> The minimum price a seller will accept/ the maximum price a buyer will accept of one
good A is X (opp cost of good A) units of good B
Gains of Specialisation and Trade
- Differences in opportunity costs of production create gains from specialisation and trade
- Generally, trade occurs when the buyer’s valuation of the good exceeds buyer’s
valuation of the good
- Each Party specialises in the good in which they have a comparative advantage
- Because:
-> trade allows parties to specialise in producing the good in they have the lower
Opp cost in (comparative advantage) and trade with others for things that would cost
them more to produce personally
-> economic pie increased in size (each party can consume more than the amount they
could produce alone)
, lOMoARcPSD|16341119
-> total output increase -> which can be shared so as to make everyone better off.
- This principle holds even if one party has the adbolute advantage in the production of
both goods; as what matters is the comparative advantages.
Production and Cost
- A firm uses inputs or factors of production (labour, capital, land etc.) in order to produce
output (i.e. goods or services). Their goal is to maximise profit.
Production Function
A production function shows the relationship between quantity of inputs used and the
(maximum) quantity of output produced, given the state of technology.
- Y (total output) = A (the level of technology) F(K(capital), L(labour))
- F(K(capital), L(labour)) = the function of inputs.
Short run - the period of time during which at least one of the factors of production is fixed. (An
input is ‘fixed’ if it cannot be changed regardless of the output produced.)
- In the above production function, A and K are likely to be fixed in the short-run, L is
variable.
Long-run - the time frame in which all input factors are variable
The short run and the long run is not defined in relation to a set period of time, but rather in
relation to how long it takes for all of a firm’s inputs to become available – this will differ between
industries.
Short-run production function
Marginal product (MP) - the change in output when one or more input is used. The slope/
derivative of the production.
Average product of labor - average output each worker can produce.
- APL = total output/ L
Marginal product of labour - the additional output when employing one more worker
- MPL = dQ/ dL
● When MPL > APL, average is increasing with L
ECON1001 - Key concepts
Scarcity - the problem of relative scarcity arises due to humans having unlimited wants but only
having limited resources to satisfy these wants.
Three basic economic questions: What to produce; how to produce; for whom to produce.
Opportunity cost - the value of the next best alternative forgone when a decision is made.
- Opportunity costs include both explicit cost (costs that involve direct payment) and
implicit costs and Implicit costs (oopportunities that are forgone that do not involve an
explicit cost.)
- opportunity cost only includes costs that could change if a different decision were made.
The opportunity cost does not include sunk costs which have been incurred and
cannot be recovered no matter what.
- Eg. opportunity cost of missing the lecture: the cost of one lecture is $100
(nonrefundable -> sunk cost, refundable -> explicit cost), the dollar-equivalent cost of
psychological pain for missing a lecture is $150 (implicit), the dollar-equivalent value of
happiness if lecture is taken in $200 (implicit cost)
Marginal analysis - a way to maximize benefits and minimize cost by considering the additional
benefit and cost.
- Marginal benefit - additional benefit received from consuming an extra unit.
- Marginal cost - additional cost incurred through buying one more unit.
- If the MB > MC -> agent better off doing the activity; MB < MC -> worse off
Correlation refers to a situation in which two or more factors are observed to move together (or
in opposite directions).
Causation refers to a situation where a change in one factor brings about, or causes, a change
in something else.
Ceteris paribus - to examine the impact of one change at a time by holding everything else
constant.
PPF and Trade
Production Possibility Frontier
PPF - graphs the variations in the amount of two products that can
be produced given the current availability of resources in the
economy. PPF illustrates the inverse relationship between producing
two products, and increasing production of good A would result in
trading off the production of good B.
, lOMoARcPSD|16341119
The slope of the PPF measures the
opportunity cost of producing an extra unit
of a good (in terms of the other), for a particular
point on the frontier.
-> A concaved curve means: the opportunity
cost of each good increases with the level of
output of that good. This is because resources
are not perfectly substitutable.
Changes in PPF
- With a boost to the production of both goods (increase production efficiency), the PPF
will shift outwards on both axis. This is due to a positive productivity shock.
- With a boost in the production of good X only, the PPF will shift outwards on the X axis
only.
, lOMoARcPSD|16341119
Absolute and Comparative advantage
- For Party A to have an absolute advantage over Party B in the production of a good, A
must produce a greater number of that good than B
- For Party A to have a comparative advantage over Party B, A’s opportunity cost of
producing this good must be lower than B’s opportunity cost.
To determine Absolute advantage:
1. Table of production volumes
- Hence Chris has Absolute advantage in both pepper mills (8>2) and salt shakers (8>4)
To determine Comparative advantage:
1. Table of Opportunity cost
- Opp cost of x = y/x, Opp cost of y = x/y
- Hence May has a Comparative advantage in producing salt shakers (½<1)
- Chris has a Comparative advantage in producing pepper mill (1<2)
Range of possible prices of good A in terms of good B
- Each individual will only be willing to trade if they can either buy a good for a lower price
than their opportunity cost, or if they are selling a good, they must receive a price that is
at least as large as their opportunity cost.
- -> The minimum price a seller will accept/ the maximum price a buyer will accept of one
good A is X (opp cost of good A) units of good B
Gains of Specialisation and Trade
- Differences in opportunity costs of production create gains from specialisation and trade
- Generally, trade occurs when the buyer’s valuation of the good exceeds buyer’s
valuation of the good
- Each Party specialises in the good in which they have a comparative advantage
- Because:
-> trade allows parties to specialise in producing the good in they have the lower
Opp cost in (comparative advantage) and trade with others for things that would cost
them more to produce personally
-> economic pie increased in size (each party can consume more than the amount they
could produce alone)
, lOMoARcPSD|16341119
-> total output increase -> which can be shared so as to make everyone better off.
- This principle holds even if one party has the adbolute advantage in the production of
both goods; as what matters is the comparative advantages.
Production and Cost
- A firm uses inputs or factors of production (labour, capital, land etc.) in order to produce
output (i.e. goods or services). Their goal is to maximise profit.
Production Function
A production function shows the relationship between quantity of inputs used and the
(maximum) quantity of output produced, given the state of technology.
- Y (total output) = A (the level of technology) F(K(capital), L(labour))
- F(K(capital), L(labour)) = the function of inputs.
Short run - the period of time during which at least one of the factors of production is fixed. (An
input is ‘fixed’ if it cannot be changed regardless of the output produced.)
- In the above production function, A and K are likely to be fixed in the short-run, L is
variable.
Long-run - the time frame in which all input factors are variable
The short run and the long run is not defined in relation to a set period of time, but rather in
relation to how long it takes for all of a firm’s inputs to become available – this will differ between
industries.
Short-run production function
Marginal product (MP) - the change in output when one or more input is used. The slope/
derivative of the production.
Average product of labor - average output each worker can produce.
- APL = total output/ L
Marginal product of labour - the additional output when employing one more worker
- MPL = dQ/ dL
● When MPL > APL, average is increasing with L
