Unit 1: Introduction to Economics

1a. Explain the economic way of thinking

  • What is economics?
  • What is the tension between scarce resources and unlimited wants?
  • What are scarcity and the market?
  • What is the difference between microeconomics and macroeconomics?
  • What is opportunity cost and the concept of forgone activity and/or forgone time?
  • How does the division of labor and specialization increase production and reduce cost per unit to achieve economies of scale?

Economics is the social science that studies how economic agents (consumers, firms, and the government) make choices so as to administer the allocation of resources in the face of scarcity. Scarcity exists when there is not enough of something (product, service, resource) to satisfy everyone's wants at no cost. Even if the desired item were free, enough would not be available to satisfy its demand.

The concept of opportunity cost is essential to economics. It is the cost of the next best alternative (the choice forgone, or the option you did not choose) to the one you selected. We must often make economic decisions that require choosing between two paths. Perhaps you had to decide whether to enroll in college without the full required tuition and costs in hand. You may have decided to take one or two courses while working part-time. Or you may have decided to take out student loans to study full-time so you could begin your career sooner and hopefully earn a higher salary. Unfortunately, this option requires you to pay off a significant debt after graduation.

What questions help you decide? What do you give up when you choose one path? What do you gain? Given your resource constraints, you should consider the cost of your next best alternative to optimize the return on your time and money. This is an opportunity cost.

Find an example of opportunity cost that works for you in real life and review it a few times. Try to use this same example to review other economic concepts such as scarcity, incentives, marginal cost, marginal benefit, willingness to pay, allocation of resources, etc.

This concept map illustrates how the conflict between scarce resources and unlimited wants gives rise to economic agents' choices. Microeconomics involves the analysis of the consequences of these choices at the economic agents level (consumers, firms, and governments). Macroeconomics, on the other hand, examines the impact of the choices at the national and international levels.


One way to address the tension between scarce resources and unlimited wants is to increase production through the division of labor and specialization. By dividing the labor force into specialized workers, each individual can produce more units with higher quality. As each worker increases production using the same amount of inputs, the company achieves economies of scale: the average cost to produce each unit declines as the production level increases.

You need some basic mathematics skills to complete this course successfully. We have included plenty of resources to help you get ready. 

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1b. Identify how individual economic agents make rational choices and optimize the use of scarce resources by responding to incentives and calculating opportunity costs

  • What is a rational choice? How do economic agents make rational choices?
  • How is the budget constraint related to choices?
  • How do economic agents calculate opportunity costs based on the budget constraint?
  • How does scarcity affect prices?

When facing limited resources, making rational choices is essential. Scarcity prompts economic agents to engage in rational decision-making to allocate resources efficiently. A rational choice means making decisions based on preferences, budget constraints, and available information. You are picking the best option among different choices, considering what you want and what you know to make a smart decision.

Obviously, your budget constraint limits what you can buy. Let's say a Chromebook costs $400 and a holiday weekend $600. The slope of your budget line (representing this budget constraint with Chromebooks in the x-axis and holiday weekends in the y-axis) is $400/$600. It shows how much holiday you give up for each Chromebook. This reasoning should sound familiar: the slope reflects the opportunity cost of a Chromebook. So, the budget constraint's slope illustrates the trade-off and will help guide your choices.

Prices also limit what you can buy. In a capitalist economy, the market distributes scarce resources according to the price system. Prices signal the existence of scarcity.

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1c. Apply marginal analysis to make optimal choices by identifying whether choices are efficient

  • What are marginal analysis, marginal cost, and marginal benefit?
  • How can you analyze resource allocation based on making decisions at the margin?
  • What is the sunk cost fallacy?

How do you make choices, such as how much food to buy, how many hours to study, how many vacation days to take, and how many hours to work? You probably make adjustments based on small changes rather than make all-or-nothing decisions. People and societies rarely make all-or-nothing choices. 

Marginal analysis examines the cost and benefits of choosing a little more or a little less. Specifically, marginal cost is the increase in total cost that arises from producing one additional unit of a good or service. Marginal benefit, on the other hand, is the increased satisfaction a consumer gains from consuming one additional unit of a good or service. Imagine you are deciding whether to extend your streaming service subscription. As a rational consumer, you will only decide to renew it if the utility you derive from one more unit (one more month) exceeds the extra cost – the marginal cost and marginal benefit. To make smart decisions at the margin, we must shift our focus from past investments to present and future factors. Holding onto past decisions, known as the sunk cost fallacy, can hinder rational decision-making. It may help to think of a personal example to grasp this concept better.

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1d. Identify basic economic models related to the circular flow of resources and the production possibilities frontier

  • Why do economists need to work with models?
  • What is ceteris paribus, and how do economists use it?
  • What is the circular flow model of production, resources, and money?
  • What is the production possibilities frontier model?

Like other scientists, economists use models to simplify reality to make it easier to analyze. These models often include the ceteris paribus assumption, which holds everything else equal to focus on the impact of just one specific factor. For example, if you want to focus on how the number of hours you study microeconomics impacts your final grade, you would hold other factors that affect your grade constant, such as the quality of your instructor's explanations, the difficulty level of the exam, your prior knowledge of the subject. 

In this course, we introduce simple but powerful economic models. The circular flow model is essential for understanding the fundamental interactions between households and businesses that drive economic activity. It describes how money, resources, and goods and services flow among different sectors of the economy.

This diagram is a simplified version of the circular flow model. It does not include the role the government, financial system, international trade, and international finance play. However, even this simplified version demonstrates the crucial role of trade – the process where individuals and societies exchange goods and services based on their needs and specializations.

What goods or skills do you specialize in and trade with others? For example, do you work in a certain profession because you have skills or talents your employer values and is willing to pay you to do? Do you use the income you earn to purchase goods and services you need from others? Trade is an integral component of every economic analysis.

The production possibilities frontier (PPF) model is another powerful economic model. It helps us visualize all of the potential production combinations of two goods when all of the production factors are completely or fully and efficiently used. The PPF incorporates the economic principles of allocative efficiency, opportunity cost, productive efficiency, and resource scarcity.

The graph below shows a PPF of a basic economy that produces food and clothing. Why are points A, B, and C efficient? At Point D, all of the available resources are not completely used, or they are used inefficiently, i.e., it is inefficient. All the points on the curve or inside the curve are attainable. Points outside the curve are not attainable because additional resources are needed to produce more food and/or clothing.

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Unit 1 Vocabulary

Be sure you understand these terms as you study for the final exam. Try to think of the reason why each term is included.

  • budget constraint
  • ceteris paribus
  • choice forgone
  • circular flow model
  • division of labor
  • economics
  • economies of scale
  • macroeconomics
  • marginal analysis
  • marginal benefit
  • marginal cost
  • market
  • microeconomics
  • models
  • opportunity cost
  • production possibilities frontier (PPF)
  • rational choice
  • scarcity
  • specialization
  • sunk cost fallacy
  • utility