1. Chapter 1 Economics and the Economy
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2. The subject area of economics
Every group of people must solve three basic problems of daily living:
what goods and services to produce
how to produce them
for whom to produce them
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3. An example: Oil price fluctuations
The price of oil tripled in , and doubled again in It rose sharply again in 2008.
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Higher oil prices
make the economy produce in a way that uses less oil
reduce the demand for oil-related commodities encouraging consumers to purchase substitute commodities
make the world economy produce more for OPEC and less for the big oil importers (e.g., Germany and Japan)
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5. The Distribution of World Population and Income
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6. The law of diminishing returns
Each extra worker adds less to output than the previous extra worker added.
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7. The production possibility frontier (1)
This tells us the maximum amount the economy can produce using all available resources. A is impossible. B inefficient.
Film output A 
Food output 14
Production
possibility
frontier B
See Section 1-2 in the main text, and Figure 1-2. 7

8. The opportunity cost  Food output (F) Production possibility frontier
The opportunity cost of a good is the quantity of other goods that must be sacrificed.
Begin from point A with 14 units of food and 6 films.
Moving from A to B, we gain 8 films but lose 4 units of food.
Thus, 4 units of food is the opportunity cost of producing an additional 8 films.
F/G = opportunity cost (=1/2)
Film output (G)
F= 4
G = 8 B A 
Food output (F)
Production
possibility
frontier 10 14 6
See Section 1-2 in the main text, and Figure 1-2. 8

9. Comparative advantage
An individual has a comparative advantage compared to another in the production of a good if he/she has a lower opportunity cost in producing it.
This is different to absolute advantage. An individual has an absolute advantage in producing a good if he/she is more efficient at producing that good compared to someone else.
In determining possible benefits from trade it is the concept of comparative advantage that matters not the absolute one.
Comparative advantage also applies to countries.
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10. Markets are central to economics
They are the process by which …
households’ decisions about consumption of alternative goods
firms’ decisions about what and how to produce
and workers’ decisions about how much and for whom to work
… are all reconciled by the adjustment of prices
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The command economy
Is an alternative to the market economy
A government planning office decides:
what will be produced,
how it will be produced,
for whom it will be produced.
Detailed instructions are then issued to households, firms and workers.
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The invisible hand
The command economy has tended not to perform well.
In contrast, Adam Smith in the Wealth of Nations (1776) argued that individuals pursuing their self-interest would be led ‘as by an invisible hand’ to do things that are in the interests of society as a whole.
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A mixed economy
In a mixed economy the government and private sector jointly solve economic problems.
The government influences decisions through taxation, subsidies, and provision of free services such as defence and the police.
It also regulates the extent to which individuals may pursue their own self-interest.
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14. Market orientation China Sweden USA Hungary UK Cuba Command economy
Free
market
See Section 1-3 in the main text, and Figure 1-3. 14

15. Positive and normative
Positive economics studies objective or scientific explanations of how the economy works.
Normative economics offers recommendations based on personal value judgments.
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Microeconomics
Microeconomics offers a detailed treatment of individual decisions about particular commodities
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Macroeconomics
Macroeconomics emphasizes interactions in the economy as a whole.
It deliberately simplifies the individual building blocks of the analysis in order to retain a manageable analysis of the complete interaction of the economy.
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