Economics, Scarcity, and Choice

This is Unit One of Principles of Microeconomics, part one of two: what economics studies, and the ideas every later unit is built on. Carry one idea through this lecture. Every choice gives something up, and what it gives up is its real cost, whatever the receipt says. That idea is named in the first three entries, tested against the ways economies are organized, and then turned into a rule for choosing how much of anything to do. By the end you will be able to say what scarcity is and name the three questions it forces. To state a choice's opportunity cost and tell it from a purchase price. To explain why dividing work raises output and why it needs a market. To place a transaction in the right market of the circular flow. And to choose a quantity at the margin while leaving sunk costs out.

Three entries on the problem the subject begins with: what economics studies, the condition that forces choosing, and what a choice costs.

What the subject studies.

MIC 0001 What Economics Studies

Economics studies how people choose when they cannot have everything they want, and households, firms and governments all face that problem. A shopper picks a brand, a farm picks a crop, a city picks a budget. It is a set of tools rather than a list of answers: it shows what a choice costs without deciding the choice.

The condition that forces choosing.

MIC 0002 Scarcity and the Three Questions

Scarcity means wants exceed the resources available to meet them, so every society must answer three questions: what to produce, how to produce it, and for whom. A parcel of land can hold houses, a park or a factory, but not all three. Scarcity is not poverty: a rich person still cannot buy every good, and still gets twenty-four hours a day.

What a choice costs.

MIC 0003 Opportunity Cost

The opportunity cost of a choice is the value of the best alternative given up. Every choice has one, and only the single best alternative counts. A year at college costs tuition plus the wages given up while studying. It is not the purchase price: time given up can cost more than money spent, and it never appears on the receipt.

Four entries on the first answer to scarcity: dividing the work, why that raises output, what it depends on, and what an economy produces with.

The first answer to scarcity.

MIC 0004 Division of Labor and Specialization

Division of labor splits production into separate tasks, each done by a different worker. Adam Smith's pin factory of seventeen seventy-six showed ten specialists far outproducing ten working alone. A restaurant has a cook, a server and a cashier rather than three people doing everything. Dividing the work is the first answer to scarcity, because the same resources yield more output.

Why dividing the work produces more.

MIC 0005 Three Reasons Specialization Raises Output

Specialization raises output for three reasons: workers do what suits them best, they improve with practice, and larger scale lowers the average cost of each unit. A plant building fifty thousand cars a year spends less per car than one building a hundred. The first reason previews comparative advantage; the third is called economies of scale and returns in unit six.

What specialization depends on.

MIC 0006 Specialization Needs Markets

A specialist produces one thing and needs everything else, so specialization works only where there is a way to trade, and markets provide that way. A software developer sells code and buys food, clothing and housing from other specialists. The gain from specializing and the gain from trading are one gain, which is why unit sixteen treats them together.

The resources an economy produces with.

MIC 0007 Factors of Production

The factors of production are labor, capital and natural resources. Capital is anything produced in order to produce something else, and human capital is skill gained through education and experience. A drill, a bridge and a spreadsheet program are all capital. Money is not: a firm cannot produce with money, only buy capital with it, so money is financial capital instead.

Two entries on the frame and the method: the two halves of the subject, and how economists reason about any of it.

The two halves of the subject.

MIC 0008 Microeconomics Against Macroeconomics

Microeconomics studies individual decision makers, households, workers and firms, and the markets where they meet. Macroeconomics studies the economy as a whole: output, unemployment, inflation. Why concert tickets cost so much is micro; whether output is rising is macro. The two are not rivals, since every macro total is the sum of millions of micro choices, and this course stays micro.

How economists reason about this.

MIC 0009 Theories, Models and Ceteris Paribus

A theory simplifies how variables interact, and a model puts a theory to work. Ceteris paribus means all other things unchanged, the assumption that isolates one effect. A subway map omits every street and is more useful for it. In the world everything changes at once, so the assumption is never literally met, and every test must work around it.

Two entries on the first model in the course: the circular flow, and how to sort a transaction into its market.

The first model in the course.

MIC 0010 The Circular Flow: Product and Factor Markets

The circular flow puts households and firms in two markets. In the product market firms sell and households buy; in the factor market households sell labor, capital and land for income. Goods travel one way around the circle and payments travel the other. Product markets fill most of this course; factor markets return in units three and thirteen, and both come from this diagram.

Sorting a transaction into its market.

MIC 0011 Which Market Is It?

To place a transaction, ask two questions. What is being bought: a finished good or service, or a factor of production? A finished good runs through the product market; a factor runs through the factor market. And which way does money go? In the product market it flows from households to firms; in the factor market it flows from firms to households. A nurse earning four thousand dollars a month from a clinic is in the factor market; the same nurse paying ninety dollars for a haircut is in the product market. Two traps: a bakery buying flour from a mill stays inside the firm sector, and rent can sit in either market depending on whether housing or land is being bought.

Five entries on how economies organize: three ways, the rule markets need, incentives, placing a real economy, and trade across borders.

Who makes these decisions.

MIC 0012 Three Ways to Organize an Economy

Economies are organized three ways: traditional, where occupations pass down through families; command, where a government decides what is produced and at what price; and market, where decisions are decentralized. Ancient Egypt and the medieval manor are the standard command examples. No real economy is pure, and every market economy still needs rules, the most important of which comes next.

The rule that makes markets possible.

MIC 0013 Property Rights

A property right is the protected power to use, keep and sell a resource, and markets need it first, because nobody invests in what they cannot securely own. A farmer plants a slow orchard only if the land stays hers. Where nobody owns a resource, no one can sell it and no price exists; units eleven and twelve show why that matters.

Why rights change behavior.

MIC 0014 Incentives

An incentive changes the cost or benefit of a choice, and people respond. Ownership is the strongest incentive: an owner gains from using a resource well and loses by wasting it. Drivers paying for parking by the hour leave sooner than those parking free. Incentives work at the margin: a small price change moves the last unit bought, not the whole habit.

Placing a real economy among the three.

MIC 0015 Placing an Economy on the Spectrum

To place an economy, ask three questions. Who owns the resources and the firms, private individuals or the state? Who decides what is produced and at what price? And how heavily does government regulate what private owners may do? Private ownership with decentralized decisions sits at the market end, state ownership with central direction at the command end, and heavy regulation of private owners between, where most economies are. Two cautions. Regulation alone does not make a command economy, since enforcing contracts and preventing fraud are the rules that make trade possible, and every market economy has them. And an economy moves along the range over time, so a placement describes a moment.

The connections between economies.

MIC 0016 Globalization, Exports and Imports

Globalization is the widening of economic connections across borders. Exports are produced at home and sold abroad; imports are produced abroad and sold at home. Cheaper shipping, computing and telecommunications drove most of it. Large economies trade a smaller share of their output than small ones, because a big economy keeps more of its division of labor inside its own borders.

Six entries on choosing: the budget line, a cost read off it, the margin, diminishing utility, sunk costs, and how many.

What one person can afford.

MIC 0017 The Budget Constraint

A budget constraint shows every combination of two goods a person can buy when all income is spent at given prices, and its slope is the price ratio. Points on or inside the line are affordable; points outside are not. The line is straight because prices do not change with the quantity bought; the frontier in part two will not be.

Reading a cost off that line.

MIC 0018 Opportunity Cost from Two Prices

When income is fixed and two goods have fixed prices, the opportunity cost of one good is its price divided by the price of the other. Find the endpoints: income divided by each price gives the most of that good the person could buy alone. The slope joining them is the horizontal good's price over the vertical good's, read as a sentence. A student with forty dollars a week, notebooks at five dollars and pens at one, can buy eight notebooks or forty pens, so one notebook costs five pens and one pen a fifth of a notebook. Double the budget and the endpoints double, but a notebook still costs five pens: income moves the line without tilting it.

How much more, rather than all.

MIC 0019 Marginal Analysis

Marginal analysis compares the benefit and cost of one more unit, or one less, never all or nothing; the margin is the current level of an activity. Nobody decides whether to use water, only whether to take a shorter shower. The rule is to continue while marginal benefit exceeds marginal cost and stop where they meet, and every firm and consumer in this course follows it.

Why the next unit is worth less.

MIC 0020 Diminishing Marginal Utility

Utility is the satisfaction a good gives, and diminishing marginal utility means each added unit brings less added satisfaction than the one before. The first slice of pizza is a meal; the fifth is a chore. Falling marginal utility is why a buyer stops: the next unit is worth less while its price stays the same, so eventually price exceeds benefit.

The cost a decision should ignore.

MIC 0021 Sunk Costs

A sunk cost is money or effort already spent that cannot be recovered, so it should not affect a decision still ahead. Walking out of a bad film does not waste the ticket, which is spent either way. Opportunity cost looks forward at what a choice gives up; sunk cost looks back at what is gone, and only the first belongs in a decision now.

Choosing a quantity with all three ideas.

MIC 0022 How Many: Marginal Benefit Against Marginal Cost

To choose a quantity, compare each additional unit's benefit and cost in turn and stop at the last unit whose marginal benefit is at least its marginal cost. Never compare totals, and never count a cost already sunk. A café deciding how many hours to stay open after six earns thirty dollars an hour, while the cost of staying open rises: twelve, eighteen, twenty-six, then thirty-four. The first three hours each earn more than they cost and the fourth does not, so it stays open three more hours; the month's rent, already paid, changes nothing. Totals, one hundred twenty against ninety, hide the hour that loses money, and adding the rent back in makes a sunk cost argue for staying or closing when it argues for neither.

Look at what you can now do. You can say what scarcity is, wants exceeding the resources available, and name the three questions it forces: what to produce, how, and for whom. You can state a choice's opportunity cost as the best alternative given up, and tell it from a purchase price, which never carries the time given up. You can explain why dividing work raises output, through suitability, practice and scale, and why a specialist needs a market to trade in. You can place a transaction in the circular flow by asking what is being bought, a factor of production or a finished good. And you can choose a quantity by comparing each unit's benefit with its cost, stopping where they meet, and leaving what is already spent out of it. Part two takes the same tradeoff to a whole society, on the production possibilities frontier, and uses it to explain why two producers trade.