Unit 1: Basic Economic Concepts

Define resources and the cause(s) of their scarcity.

• Economic trade-offs arise from the lack of sufficient resources (scarcity) to meet society’s wants and needs.
• Most factors of production (such as land, labor, and capital) are scarce, but some factors of production (such as established knowledge) may not be scarce due to their non-rival nature.
• Enduring understanding MKT-1: Most resources are scarce, and in most cases the use of resources involves constraints and trade-offs.

Define how resource allocation is influenced by the economic system adopted by society.

• Resource allocation involves answering three basic questions: What goods and services to produce? How to produce those goods and services? And who consumes those goods and services?
• Resource allocation is significantly influenced by the economic system adopted by society, such as command economy, market economy, or mixed economy. Each system involves a particular set of institutional arrangements and a coordinating mechanism for allocating scarce resources and distributing output.
• Enduring understanding MKT-1: Most resources are scarce, and in most cases the use of resources involves constraints and trade-offs.

a. Define (using graphs as appropriate) the production possibilities curve (PPC) and related terms. b. Explain (using graphs as appropriate) how the production possibilities curve (PPC) illustrates opportunity costs, trade-offs, inefficiency, efficiency, and economic growth or contraction under various conditions. c. Calculate (using data from PPCs or tables as appropriate) opportunity cost.

• The PPC is a model used to show the trade-offs associated with allocating resources.
• The PPC can be used to illustrate the concepts of scarcity, opportunity cost, efficiency, underutilized resources, and economic growth or contraction.
• The shape of the PPC depends on whether opportunity costs are constant, increasing, or decreasing.
• The PPC can shift due to changes in factors of production as well as changes in productivity/technology.
• Economic growth results in an outward shift of the PPC.
• Enduring understanding MKT-1: Most resources are scarce, and in most cases the use of resources involves constraints and trade-offs.

a. Define absolute advantage and comparative advantage. b. Determine (using data from PPCs or tables as appropriate) absolute and comparative advantage.

• Absolute advantage describes a situation in which an individual, business, or country can produce more of a good or service than any other producer with the same quantity of resources.
• Comparative advantage describes a situation in which an individual, business, or country can produce a good or service at a lower opportunity cost than another producer.
• Enduring understanding MKT-2: The consequences of scarcity can be mitigated through specialization in production and by exchange.

a. Explain (using data from PPCs or tables as appropriate) how specialization according to comparative advantage with appropriate terms of trade can lead to gains from trade. b. Calculate (using data from PPCs or tables as appropriate) mutually beneficial terms of trade.

• Production specialization according to comparative advantage, not absolute advantage, results in exchange opportunities that lead to consumption possibilities beyond the PPC.
• Comparative advantage and opportunity costs determine the terms of trade for exchange under which mutually beneficial trade can occur.
• Enduring understanding MKT-2: The consequences of scarcity can be mitigated through specialization in production and by exchange.

a. Define opportunity cost. b. Explain the opportunity costs associated with choices. c. Calculate the opportunity costs associated with choices.

• Rational agents consider opportunity costs, whether implicit or explicit, when calculating the total economic costs of any decision.
• Total benefits form the metric “utility” for consumers and total revenue for firms.
• Enduring understanding CBA-1: Rational economic decisions require the evaluation of costs and benefits.

a. Explain a decision by comparing total benefits and total costs (using a table or a graph when appropriate). b. Calculate total benefits and total costs (using a table or graph where appropriate).

• Total net benefits, the difference between total benefits and total costs, are maximized at the optimal choice.
• Some decisions permit rational agents to look at only marginal benefit and marginal cost. Other decisions cannot be broken down into increments in this way and must be evaluated by looking at total benefits and total costs.
• Enduring understanding CBA-1: Rational economic decisions require the evaluation of costs and benefits.

a. Define the key assumptions of consumer choice theory. b. Explain (using a table or graph as appropriate) how a rational consumer’s decision making involves the use of marginal benefits and marginal costs. c. Calculate (using a table or a graph when appropriate) how a rational consumer’s decision making involves the use of marginal benefits and marginal costs.

• Consumers face constraints and have to make optimal decisions accounting for these constraints.
• In a model of rational consumer choice, consumers are assumed to make choices so as to maximize their total utility.
• Consumers experience diminishing marginal utility in the consumption of goods and services.
• Consumers allocate their limited income to purchase the combination of goods that maximizes their utility by equating/comparing the marginal utility of the last dollar spent on each good. Exclusion: Indifference curves are beyond the scope of the course and the AP Exam, but equating the ratios of marginal utility to price is within the scope.
• Enduring understanding CBA-2: To determine the optimal level at which to pursue an activity whose total benefits exceed total cost, rational economic agents compare marginal benefits and marginal costs.

a. Define marginal analysis and related terms. b. Explain a decision using marginal analysis (using a table or a graph when appropriate).

• Marginal analysis involves comparing the additional benefit of increasing a given activity with the additional cost. Comparing marginal benefit (MB) with marginal cost (MC) helps individuals (firms) decide whether to increase, decrease, or maintain their consumption (production) levels.
• The optimal quantity at any point in time does not depend on fixed costs (sunk costs) or fixed benefits that have already been determined by past choices.
• The optimal quantity is achieved when marginal benefit is equal to marginal cost or where total benefit is maximized.
• Enduring understanding CBA-2: To determine the optimal level at which to pursue an activity whose total benefits exceed total cost, rational economic agents compare marginal benefits and marginal costs.