Chapter 1: An Introduction to Economic Analysis

Micro/Macro Economics, Scarcity, Opportunity Cost, Government Role

A Structure (Micro vs. Macro)


Study of markets, consumers, firms, sellers, workers and the governmental influence on outcomes of the market on an individual basis.


Study of the whole economy, by combining all decisions made by individuals into a big picture. Includes analyzing unemployment, inflation, economic growth, & policies affecting the economy.

The Beginning of Economic Analysis

Economists are interested in efficiency: Producing goods/services that will maximize our satisfaction, given existing amount of resources. Resources such as labour, capital, time and natural resources (sometimes economists will simply group all natural resources and call it land).

Economics is about studying the allocation of scarce resources that have alternative uses to satisfy unlimited human wants. If we don’t want anything, then there’s no allocation required. If something isn’t scarce, then there’s no need to study is. Clean air in Northern Canada, for example, is not scarce so economics has nothing to say about clean air in Northern Canada.

Limited Resources and Large Desires Lead to Scarcity

The whole reason economics exists is because of scarcity: our desires, wishes and wants are larger than our economic resources are able to produce. Since we can’t always get exactly what we want, we have to make choices and trade-offs to maximize our satisfaction. Studying these choices and desires and resources is what economics is all about.

Anything becomes scarce if it has alternative uses. This is how scarcity is different than shortage. Shortage is a lack of resources, scarcity is a forced choice of how to use resources.

Scarcity leads us to specialize. Specialization means we focus on producing specific sets of goods/services, instead of producing all of our needs and desires.

Specialization only works if we can trade our excess goods/services for goods and services we need/want. This is where trading comes in. One form of trading is bartering, where you trade goods and services for other goods and services. This is not effective because it’s not necessary that the producer of the goods/services we desire will want our goods/services. Currencies that have a certain value help us trade our goods/services with anybody who wants it smoothly without having to hope that we want their goods/services.

Markets are we trade, either using currency or by bartering. Markets are where buyers and sellers can come together and negotiate a transaction.

Choosing What to Produce, How to Produce, and for Whom to Produce

The purpose of any economic system is to choose what to produce, how to produce and for whom to produce.

What about where to produce or when to produce? Is that implicitly part of an economic system?

The ‘how’ question is the choice between possible technologies and resources. Should we use labour to produce the good, or an automated machine?

All these questions are answered through the market system that most of the world has adopted. But not all goods and services are produced in markets, some are made by governments (such as fire protection, roads, police, etc.).

Opportunity Cost – The Result of Scarcity

The opportunity cost is the value of the next best alternative opportunity that we have decided to forgo. This is significant, because it means that everything has a cost (even ‘free’ things).

Sunk Costs

A cost that has already been paid for and cannot be recovered. In a rational decision, sunk costs would NOT be considered.

Fixed Costs

A cost that does not change as we make a decision. No matter where you go, college or university or get a job, you will pay the same fixed amount of money on food. In a rational decision, fixed costs would NOT be considered at all.

Rational Decisions

Marginal (Additional) Benefit

The increase in benefit resulting from an action, or the increase in benefit resulting from producing one more unit of output.

Marginal (Additional) Cost

The increase in costs resulting from an action, or the increase in costs resulting from producing one more unit of output.

Rational Decisions

Decisions that make us better off than we were before the decisions were made. The Decision-Making Rule is: if the marginal benefit of a potential action is greater than the marginal cost, the decision should be positive, and should be taken.

Economic Role for Governments in Markets

Primary Economic Roles for Government

  • Private property rights and contract enforcement: Provide a basic set of laws protecting the right of private property and have an enforcement mechanism for contracts.
  • A monetary system: Establish a currency that is widely accepted, accessible and used. Printing too much money can cause inflation, however.
  • Increase resource utilization: Governments can help unused resources become utilized, such as training unemployed people, or incentivizing development on unused land.
  • Competition: Increase competition by incentivizing it (by making barrier of entry into certain industries as low as possible, for example). Governments can also produce goods or services that the market otherwise will not pursue (libraries, for example).
  • Incentives: Create the right incentives for markets to pursue beneficial avenues. For example, reduce taxes in under-developed communities to incentivize development.
  • Fairness: Markets may not produce fair outcomes, and governments may level the playing field by providing opportunities to those lower on the socio-economic ladder.

It seems like the primary economic role for government is provide & enforce a legal system. Is that true?

Does redistributing wealth disincentivize providing valuable goods/services?

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