Chapter 2

Thinking like an economist key ideas.

When we make choices we make tradeoffs that give up one thing to get something else.
We as economists must recognize that there are limits

People make rational choices by looking if the benefits outweigh the costs.
Economists assume they make choices in a predictable way. We model how people behave
and let the math prove everything.

The benefit is what you gain from your choice, which is determined by your preferences.
There are two sides to an economy. The preference is for the consumers.

The opportunity cost is what you must give up to get something. You don’t need money for
an economy, it's not about money, it's about the decision to pick something over something
else.

Most choices are “how much” choices. These choices are made at the margin.
What's the benefit if one buys a product a little bit more? For example if you buy a phone
you really appreciate that one phone and it becomes valuable. If you buy a second one it is a
little bit less valuable and if you buy a third it is not valuable at all. This is called marginal
benefit.

Optimal choices are influenced by incentives.

For example if you don’t smoke your chances of getting cancer is lower. Which means the
government has to pay less for your health. Which is why they put taxes on cigarettes so
then there is a less chance of you buying it.

Normative Statements: Statements that contain the words “should” or “must” or anything that
implies to do something. For example “they should reduce interest rates.”.

Positive Statements: Statements that can be checked against facts. For example “Higher
interest rates decrease house prices.”.

Counterfactual: Relating to what has not happened in a situation. For example how much
would one make if they didn’t go to university vs how much would they make if they went to
university.

PPF (Production Possibilities Frontier): The PPF shows the total amount of x and y that can
be produced in Canada in a month given the total resources which are land, labour, capital,
and entrepreneurship. The PPF reflects the scarcity of x and y. We can make any
amount/combination of x and y within the PPF but not outside it. For example if you make 5
million pizzas you can only make around 0 cans of cola. If you make 3 million pizzas you can
make around 8 million cans of cola. It all depends on the resources we have. If you are
making 8 million cans of cola you are using that much of your resources to make the cola,
which only leaves a certain amount of resources to make pizza. So the PPF looks at the
possible combinations that we can make with our resources. If you make x and y inside the
PPF you are not using all your resources. The opportunity cost for this example is that if you
want to make more cans of cola you lose out on the pizzas. The opportunity cost for making
more pizzas is that you have to make less cans of cola. Depending on the graph the
opportunity cost can be more or less. For example if the graph is curved it will vary but if it is
linear it will all be the same opportunity cost. The opportunity cost on a linear graph can be
calculated through the slope or rise/run or y/x.

Marginal Cost: The opportunity cost of an increase in an activity from a point is the marginal
cost. It is the slope of the tangent at a point. An increasing opportunity cost of pizza
means an increasing marginal cost of pizza. The slope of the production possibility
frontier. How much more it costs to produce one more of that good or service.

Using resources efficiently: We achieve production efficiency at every point on the

PPF. The preference will affect what resources are used on the PPF.

Marginal Benefit Curve: This is the principle of decreasing marginal benefit which
reflects our tendency to prefer variety as overconsumption of any single good leads
to satiation. Marginal Benefits tend to decrease as we are satiated.

Diminishing marginal utility: Each additional unit of gains leads to an ever smaller
increase in subjective value,

Who decides how much to make of a product? Everyone in the economy decides, the
producers, the customers, the consumers, etc.

Allocative efficiency: The production of a good or product is aligned with consumer

preferences. The production of goods has a marginal benefit which is equal to the marginal
cost of production. For example, if there a pizza place makes 30 pizzas for the day and there
are 30 people who want a pizza, that is allocative efficiency because the pizza place has
made enough pizzas to satisfy the demand but not made too much where they have to throw
it out. Marginal cost = marginal revenue.

Absolute advantage: Absolute advantage is the ability to produce a good or product at a

lower absolute cost using a more efficient process than another entity producing the same
good. An example is that the smoothie businesses may produce the same thing. One
business might have a better blender and will be able to produce more smoothies in the
same time frame as compared to the other business, this is called an absolute advantage.

Comparative advantage: Being able to produce something at the lowest cost possible
compared to anyone else. For example if one business sucks at making smoothies but is
really good at making salads, that business doesn’t have to give up a lot to make that salad,
whereas the other business who was good at making smoothies, if they want to make salads
they have to give up a lot (a lot of smoothies) to make those salads. Usually comparative
advantage is when one's production opportunity cost is lower than someone else's.

Gains from trade: Can be achieved if factors of production specialise in the production of
goods and services in which they have a comparative advantage. If that happens they can
also engage in trade that way the business isn’t a one trick pony.
Through specilization these two businesses can expand their combined PPF.

What determines how big an economy is?

Economic growth can come from technological change and capital accumulation.
Technological changes: the development of new goods and services and more efficient
ways of producing it.
Capital Accumulation: The growth of capital resources including human capital. Human
capital is your skills.
The more capital accumulation that is invested in an economy the higher the PPF will
become. For example Hong Kong people were saving more money, so interest rates were
low so people were taking out loans for businesses more and there was a lot of innovation
whereas Canada spent more than saved, 50 years later Hong Kong overtook Canada's PPF.

When a country is poor usually a lot of their production is focused on agriculture so then they
can keep up with food demands. In order for the country to grow its economy they have to
move production to industry, and technological advances.

Coordination in a capitalist market economy:

Firms: A unit that employs factors of production to produce goods/services
Markets: A place for buyers and sellers to come together to get information and do business
with each other
Property Rights: Regulations that govern ownership, allows people to own things
Money: A commodity that is universal that allows us to trade things.

Households make two types of choice

1) How much labour, land, capitals, and entrepreneurship to sell to firms
2) What how many goods/services to consume

Households are people in a house, it could be a couple and their children, or one person
alone.
Firms are businesses that sell something or a service

Firms also make two types of choices

1) How much labour, land, capital, and entrepreneurship to employ
2) What and how many goods/service to produce

Households can also be sellers as well. Everyone can be both a seller or a buyer.