• Unlimited human wants and needs vs. limited resources
• The fundamental economic problem that all societies face
• Resources include land, labor, capital, and entrepreneurship
• Forces societies to make choices about resource allocation
• Scarcity exists even in wealthy societies

• Land: Natural resources (water, minerals, timber, oil, forests)
• Labor: Human effort, physical and mental, used in production
• Capital: Physical tools, machinery, buildings, equipment used to produce goods and services
• Entrepreneurship: Innovation and risk-taking in organizing production

• Physical capital: Tangible tools, machines, buildings used in production
• Human capital: Knowledge, skills, education, training of workers
• Both increase productivity and economic growth
• Investment in human capital: education, healthcare, on-the-job training

• Central authority (government) makes production decisions
• Government determines what to produce, how to produce, and for whom
• Also called planned economy or centrally planned economy
• Examples: North Korea, former Soviet Union
• Can lead to inefficiency due to lack of price signals and incentives

• Decentralized decision-making through markets
• Prices and profits guide resource allocation
• Individuals and firms make choices based on self-interest
• Also called capitalism or free market economy
• Examples: United States (mostly), Hong Kong, Singapore

• Combination of market and command elements
• Most economies today are mixed economies
• Government intervenes to correct market failures, provide public goods, redistribute income
• Examples: Most Western democracies, including US, UK, France
• Balance between market efficiency and government intervention varies by country

• A graph showing maximum combinations of two goods an economy can produce with full employment of resources
• Points on the curve: Efficient production (all resources used)
• Points inside the curve: Inefficient production (unemployment or underutilization)
• Points outside the curve: Unattainable with current resources
• Assumes: fixed resources, fixed technology, full employment, two goods

• The value of the next best alternative that must be forgone when making a choice
• On PPC: Opportunity cost = amount of one good given up to produce more of another
• Calculated as: slope of PPC = DeltaY / DeltaX
• Example: If producing 1 more car requires giving up 3 computers, opportunity cost of 1 car = 3 computers

• As production of one good increases, the opportunity cost of producing additional units increases
• Resources are not perfectly adaptable to producing both goods
• Explains the concave (bowed outward) shape of the PPC
• Results from specialization of resources
• Example: Moving from agriculture to manufacturing may require retraining workers

• Opportunity cost remains constant as production changes
• Resources are perfectly adaptable to producing both goods
• Results in linear (straight line) PPC
• Rare in real world but useful for simplification
• Example: Two goods requiring identical resources and production techniques

• Economic growth: PPC shifts outward
• Increase in quantity of resources (labor force growth, capital accumulation)
• Improvement in quality of resources (education, training)
• Technological advancement
• Institutional improvements (property rights, rule of law)
• Economic contraction: PPC shifts inward (war, natural disaster, resource depletion)
• Sector-specific growth: Only one axis extends (improvement in one industry)

• The ability to produce more of a good or service than another producer using the same amount of resources
• Determined by comparing absolute output per unit of input
• Example: Country A produces 10 cars/hour, Country B produces 6 cars/hour -> A has absolute advantage in cars
• Not the basis for mutually beneficial trade

• The ability to produce a good at a lower opportunity cost than another producer
• Basis for mutually beneficial trade
• Determined by comparing opportunity costs
• Even if one country has absolute advantage in all goods, both can benefit from trade
• Countries should specialize in goods where they have comparative advantage

• Output method: Compare output per unit of input
• Higher output = absolute advantage
• Lower opportunity cost = comparative advantage
• Input method: Compare input required per unit of output
• Lower input required = absolute advantage
• Lower opportunity cost = comparative advantage
• Choose method based on information given in problem

• The rate at which two goods can be exchanged in trade
• Must fall between the opportunity costs of the two trading partners
• Example: If US opportunity cost of 1 car = 3 computers, and Japan's = 5 computers, terms of trade between 1 car for 3-5 computers benefit both
• Determines how gains from trade are distributed
• Negotiated based on relative bargaining power

• Absolute Advantage: Produces more output with same resources
• Comparative Advantage: Has lower opportunity cost of production

Basis for trade: Comparative advantage, not absolute advantage

Steps to determine:

1. Calculate opportunity cost of each product
2. Country/individual with lower opportunity cost has comparative advantage
3. Specialization + trade allows both parties to consume beyond their PPF

Example:

• OC of apple (in bananas): A = 5/10 = 0.5; B = 4/6 = 0.67 -> A has comparative advantage in apples
• OC of banana (in apples): A = 10/5 = 2; B = 6/4 = 1.5 -> B has comparative advantage in bananas
• Input vs Output Problems
• Terms of Trade

• Examining additional benefits and costs of a specific decision
• "At the margin" means considering one more unit
• Decision rule: Take action if Marginal Benefit ≥ Marginal Cost
• Fundamental to economic decision-making
• Applies to consumers, firms, and policymakers

• Marginal Benefit (MB): Additional benefit from consuming/producing one more unit
• Typically decreases as consumption increases (diminishing marginal utility)
• Marginal Cost (MC): Additional cost from consuming/producing one more unit
• Typically increases as production increases (diminishing returns)
• Optimal decision: Where MB = MC
• If MB > MC: Do more (benefit exceeds cost)
• If MB < MC: Do less (cost exceeds benefit)

• Total satisfaction from consuming a given quantity of a good
• Measured in hypothetical units called "utils"
• Increases with consumption but at a decreasing rate
• Sum of marginal utilities from each unit consumed

• Additional utility from consuming one more unit of a good
• Formula: MU = DeltaTU / DeltaQ (change in total utility ÷ change in quantity)
• Can be positive, zero, or negative
• Key determinant of how much consumers choose to buy

• As consumption of a good increases, marginal utility eventually decreases
• First units consumed provide high utility, later units provide less
• Explains why demand curves slope downward
• Example: First slice of pizza brings great satisfaction, fifth slice brings little
• Universal principle across goods and consumers

• Consumers maximize utility when marginal utility per dollar is equal across all goods
• Formula: MU1/P1 = MU2/P2 = MU3/P3 = ...
• If MU1/P1 > MU2/P2: Buy more of good 1 (gives more satisfaction per dollar)
• If MU1/P1 < MU2/P2: Buy more of good 2
• Consumer equilibrium reached when ratios are equal
• Explains how consumers allocate limited budget across goods

• Utility: Satisfaction, wellbeing
• Marginal Utility (MU): Additional utility from consuming one more unit
• Law of Diminishing Marginal Utility: As consumption increases, MU eventually decreases

Consumer Equilibrium (utility maximization): $\frac{MU_A}{P_A} = \frac{MU_B}{P_B}$

(Marginal utility per dollar spent must be equal across goods)