Basic Economic Concepts

Scarcity means people want more than the available resources can produce, so individuals, businesses and whole societies have to choose how to use them. Economists sort those resources into four factors of production: land (natural resources), labor (human work), capital (tools, machines and buildings used to make other things) and entrepreneurship (the risk-taking that combines the other three).

The production possibilities curve (PPC) shows the most an economy can make of two goods, with one good on each axis. Points on the curve are efficient, points inside it mean some resources are unemployed or wasted, and points outside it can't be reached with today's resources. Moving along the curve shows the opportunity cost of making more of one good: a bowed-out curve means increasing opportunity cost, and a straight line means constant cost. The whole curve shifts outward with more resources or better technology (economic growth) and inward when resources are lost.

You have an absolute advantage when you can produce more of something with the same resources. You have a comparative advantage when you can produce it at a lower opportunity cost than someone else. If each side specializes in its comparative advantage and they trade at a price (the terms of trade) that falls between their two opportunity costs, both can end up consuming combinations outside their own PPCs.

The law of demand says that when a good's price rises, people buy less of it, so the demand curve slopes downward on a graph with price on the vertical axis and quantity on the horizontal axis. A change in the good's own price moves you along the curve (a change in quantity demanded). A change in income, tastes, the prices of substitutes or complements, expectations or the number of buyers shifts the whole curve (a change in demand): right for an increase, left for a decrease.

The law of supply says that when a good's price rises, producers offer more of it, so the supply curve slopes upward. A change in the good's own price moves along the curve (a change in quantity supplied). A change in input prices, technology, taxes or subsidies, producers' expectations, the prices of other goods they could make, or the number of sellers shifts the whole curve (a change in supply).

Equilibrium is the price where quantity demanded equals quantity supplied, the point where the demand and supply curves cross (often labeled Pe and Qe). Above that price there's a surplus, which pushes the price down; below it there's a shortage, which pushes the price up. When a curve shifts, find the new crossing. For example, if demand increases (D1 shifts right to D2), both the equilibrium price and the equilibrium quantity rise.