Unit 1 Basic Concepts (Micro)

Unit 1 Overview & Video Lessons: Top 10 things you must know for the first unit in any introductory economics class. This video lecture is geared toward college-level principles of Macro and Micro courses and students enrolled in AP Economics & IB classes. Below the Top 10 video, you will find short recap lessons, essential questions, graphs and models on specific concepts. Take notes and pause when necessary.

Top 10 Basic Concepts covered in video: 

#1. Scarcity

#2. Opportunity Cost

#3. Production Possibilities Curve

#4. Law of Increasing Opportunity Cost

#5. Absolute Advantage vs. Comparative Advantage

#6. Diminishing Marginal Utility

#7. Supply and Demand

#8. Shortage vs. Surplus

#9. Shifts in Demand and Supply

#10. Dual Shifts of Demand and Supply

NB1. Scarcity, Resources, & Opportunity Costs (Micro)

What is scarcity?

Scarcity is the economic problem resulting from the limited nature of the four economic resources (factors of production). The scarce economic resources are land, labor, capital, and entrepreneurship. Every society must determine how it will allocate these scarce economic resources.

What is a command economy? (Yuck!)

A command economy occurs when central planners (not markets) make all of the economic decisions. The planners determine what will be produced, how many units will be produced, and for whom the goods will be produced for. Command economies in practice are highly inefficient compared to market economies. In basic economics courses we downvote these systems hard.

What is a market economy? (Yay!)

A market economy exists when buyers and sellers allocate scarce economic resources. The laws of supply and demand decide what goods are produced, how goods are produced, and for whom the goods are produced for. The market decides the prices and quantities of goods and services. This is most efficient when markets are competitive.

What is an opportunity cost?

An opportunity cost is the value of the next best alternative, like the benefits one is losing due to whatever they are doing at the moment. For example, right now you are looking at my website MrMedico.info. This is the best thing that you can be doing at the moment. If you had something better to do, you would be doing it! Your opportunity cost is the value of the next best thing that you could be doing instead of reading about opportunity costs on my website. That's kind of sad if you think about it (lol, jk)

NB1. Models, Theories, Marginal Thinking (Micro)

Why study economic theories and models? 

When you learn economics for the first time, you are really learning a new way of thinking about the world. Economic theories and models can help us understand peoples' behaviors and how to approach and solve all kinds of problems. Let's start with the production possibilities frontier.

Learning objectives:

1. Students will be able to define Economics.

2. Students will be able to explain the economic problem of scarcity.

3. Students will be able to list and explain the 4 factors of production.

4. Students will be able to identify the resource payments for the factors of production.

5. Students will be able to determine an opportunity cost.

6. Students will be able to explain how the studies of Macroeconomics and Microeconomics differ.

7. Students will be able to identify the significance of marginal thinking in economic models.

NB1. Production Possibilities Frontier (Micro)

What are the assumptions of a production possibilities frontier?

The production possibilities model illustrates opportunity costs graphically. In this simplified model, we make the following assumptions:

1. Only two goods are produced

2. Resources are fixed

3. Technology is fixed

4. Full employment exists on the curve

5. Productive efficiency (producing at lowest cost) exists on the curve

6. Cannot produce beyond the curve in the present

7. Production inside the curve indicates that there are unemployed resources 

What is the law of increasing opportunity cost?

The law of increasing opportunity cost applies to a production possibilities curve (PPC) that bowed outward from the origin. This occurs when resources are specialized. For an economy to produce more of one good, it must sacrifice increasing quantities of the other good.

If opportunity costs are constant, then the PPC will be a straight line. This occurs when resources are perfectly substitutable.

Learning objectives:

1. Students will be able to understand the simplified assumptions of an economy's production possibilities curve.

2. Students will be able to explain the concept of productive efficiency and how it relates to the production possibilities frontier.

3. Students will be able to illustrate unemployment using a PPC.

4. Students will be able to explain why it is possible for an economy to produce beyond its PPC in the present.

5. Students will be able to show economic growth using a PPC.

6. Students will be able to explain how the shape of a PPC reflects opportunity cost.

NB1. Comparative Advantage and Trade (Micro)

How do you find the absolute advantage?

To determine which country or economy has the absolute advantage in the production of a good, you simply look to see which country can produce more. If Nobully can produce 120 yak skin coats and Medicoa can only produce 60 yak skin coats, then Nobully has the absolute advantage in yak skin coats. You can also determine absolute advantage by seeing which country can produce one unit faster or one unit with the least amount of economic resources.

How do you find the comparative advantage?

To determine which country has the comparative advantage in the production of a good, you must determine which country has the lower opportunity cost (smallest sacrifice) in producing the good. This can lead to specialization and trade.

For example: If Nobully can produce 120 yak skin coats or 60 glockenspiels, then its opportunity cost of producing 1 yak skin coat is 1/2 glockenspiel (60 glockenspiels divided by 120 yak skin coats). 

If Medicoa can produce 60 yak skin coats or 120 glockenspiels, its opportunity cost of 1 yak skin coat is 2 glockenspiels (120 glockenspiels divided by 60 yak skin coats). Nobully has the comparative advantage in yak skin coat production because its opportunity cost (1/2) is less than Medicoa's opportunity cost (2).

Make yourself a chart like the ones in the video above or images below to show the relative opportunity costs, specialization, and how each party can benefit from trade.

Learning objectives:

1. Students will be able to explain what a straight-line production possibilities frontier indicates. 

2. Students will be able to determine which economy has an absolute advantage in production. 

3. Students will be able to calculate the opportunity cost of producing a good using a straight-line PPF.

4. Students will be able to determine which country has a comparative advantage.

5. Students will be able to determine what good an economy will specialize in the production of and Export / Import. 6. Students will be able to determine whether an economy will benefit from a trade.

NB1. Supply and Demand (Micro)

How do the laws of supply and demand work?

In a market, buyers and sellers come together to establish prices and corresponding quantities of goods and services. The law of supply consists of a direct relationship between price and quantity and the law of demand consists of an inverse relationship between price and quantity. When the supply and demand curves intersect, a market equilibrium is established. Assuming no externalities exists, the intersection of supply and demand is allocatively efficient (socially optimal).

Why does the demand curve slope downward?

The demand curve slopes downward for the following three reasons:

1. Law of diminishing marginal utility - As you purchase an additional unit, your additional satisfaction decreases. Therefore, the price must fall for you to want to purchase more.

2. Substitution effect - As the price of a good increases, you look for cheaper alternatives to purchase.

3. Income effect - As the price of a good increases, your income has less purchasing power and you cannot afford to purchase as much.

Learning objectives:

1. Students will be able to explain why the demand curve downward sloping.

2. Students will be able to explain why the supply curve upward sloping.

3. Students will be able to identify a temporary surplus in a market.

4. Students will be able to identify a temporary shortage.

5. Students will be able to determine how a market will respond to a surplus or shortage.

NB1. Shifting Supply and Demand (Micro)

How is a change in quantity demanded different from a change in demand?

The law of demand states that as the price decreases, the quantity demanded will increase. A change in quantity demanded occurs when the price of the product changes. This means that you move point-to-point along the demand curve. A change in demand refers to a shift of the entire demand curve. This is caused by the non-price determinants of demand (shift factors).

Change in quantity demanded: point-to-point movement along demand curve

Change in demand: shift of the demand curve

What are the shift factors of the demand curve?

The demand curve will shift if there is a change in the determinants of demand. Here are the shift factors of demand:

1. Tastes and preferences

2. Income of buyers

3. Number of buyers

4. Expectations of prices in the future

5. Substitute good prices

6. Complementary good price

How is a change in quantity supplied different from a change in supply?

The law of supply states that as the price increases, the quantity supplied will increase. A change in quantity supplied occurs when the price of the product changes. This means that you move point-to-point along the supply curve. A change in supply refers to a shift of the entire supply curve. This is caused by a change in the non-price determinants of supply (shift factors).

Change in quantity supplied: point-to-point movement along supply curve

Change in supply: shift of the supply curve

What are the shift factors of the supply curve?

A change in any of the following will cause the supply curve to shift to the right or to the left:

1. Resource prices

2. Alternative output price changes

3. Technology and productivity

4. Number of sellers

5. Expectations of future prices

6. Per-unit subsidies to producers

7. Per-unit taxes on production

What happens when the supply and demand curves shift at the same time? 

When the supply and demand curves shift at the same time, the change in market price or quantity will be indeterminate (increase, decrease, or stay the same). For example: when supply and demand both increase (shift to the right), the equilibrium quantity will increases, but market price will be indeterminate. This is assuming that we do not know the relative magnitudes of the shifts.

Learning objectives:

1. Students will be able to list and explain the determinants (shift factors) of demand.

2. Students will be able to determine what will happen to the price and quantity of good Good B when the price of substitute Good A increases.

3. Students will be able to list and explain the determinants of supply.

4. Students will be able to determine what will happen to market price and quantity when resource prices increase.

5. Students will be able to explain possible outcomes supply and demand curves shift at the same time.

NB1. Price Ceilings (Micro)

What are the effects of a price ceiling?

A price ceiling is a price control set by the government. A ceiling is a legal maximum price that must be below the free market equilibrium to have an impact. The government's intent is to help consumers with low incomes. An effective price ceiling leads to a shortage of goods (quantity demanded is greater than the quantity supplied). It causes a misallocation of economic resources and deadweight loss (inefficiency). In the long run, the shortage worsens as producers exit the industry. Sometimes illegal markets (black markets) will develop to attempt to satisfy the high quantities demanded.

Learning objectives:

1. Students will be able to illustrate an effective price ceiling using supply and demand models.

2. Students will be able to explain the effects of a price ceiling in a given market. 

3. Students will be able to identify the changes in consumer surplus and producer surplus that result from a ceiling price. 

4. Students will be able to discuss how government price controls lead to misallocations of economic resources and create deadweight loss.

NB1. Price Floors (Micro)

What are the effects of a price floor? 

A price floor is a government price control that should be placed above market clearing equilibrium price to be effective. A floor price is a legal minimum price that aims to help low income producers. A price floor is inefficient because it misallocates economic resources and leads to a surplus of goods (the quantity supplied is greater than the quantity demanded). It creates deadweight loss (inefficiency). The area of consumer and producer surplus is no longer maximized as a result of a price floor.

Learning objectives:

1. Students will be able to illustrate an effective price floor using supply and demand models.

2. Students will be able to explain the effects of a price floor in a given market. 

3. Students will be able to identify the changes in consumer surplus and producer surplus that result from a floor price. 

4. Students will be able to discuss how government price controls, such as price floors, lead to misallocations of economic resources and create deadweight loss.