Microeconomics Fundamentals: Scarcity, Trade, Demand, and Supply

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Scarcity and Opportunity Cost

Scarcity: The Fundamental Economic Problem

Scarcity refers to the inability to satisfy all of our wants due to limited resources such as money, time, and energy. This concept is central to economics and underpins the need for choice and prioritization.

Scarcity: The condition of having unlimited wants but limited resources.
Every choice involves a trade-off or an opportunity cost.
Economics studies how individuals, businesses, and governments make the best possible choices to get what they want and how these choices interact in markets.

Opportunity Cost

Opportunity cost is the value of the best alternative given up when making a choice.

For each choice, the opportunity cost is what you have to give up to get it.
Includes time given up, energy spent, and money spent.
True cost of any choice is its opportunity cost.
For a smart choice, the value of what you get must be greater than the value of what you give up.

Incentives: Rewards (positive incentives) or penalties (negative incentives) for choices.

Gains from Trade

Trade and Specialization

Trade allows individuals and nations to specialize in the production of goods and services in which they have an advantage, leading to increased overall efficiency and gains for all parties involved.

Trade is voluntary; each person feels that what they get is of greater value than what they give up.
Absolute advantage: The ability to produce a product or service at a lower absolute cost than another producer.
Comparative advantage: The ability to produce a product or service at a lower opportunity cost than another producer.
Comparative advantage is the key to mutually beneficial gains from trade.
Opportunity cost is the 'Give up' factor.

Production Possibilities Frontier (PPF): Shows the maximum combinations of products or services that can be produced with existing inputs.

Specialization according to comparative advantage and trade allows each trader to consume outside their PPF, a combination that was unattainable individually.

Economic Systems and Choices

Types of Economic Agents and Inputs

Economic agents make choices about how to allocate resources to produce goods and services.

Households (buyers): Own all inputs of an economy and sell to businesses to produce goods and services.
Businesses (sellers): Pay households for inputs and use them to produce goods and services to sell to households.
Government: Sets the rules of the game for all players in a market economy and can choose to interact.

Inputs: The productive resources used to produce products and services.

Labour (the ability to work)
Natural resources
Capital equipment
Entrepreneurial ability

Positive vs. Normative Statements

Positive statements: Statements about what is; can be checked or tested (objective).
Normative statements: Statements about what ought to be; involve value judgments (subjective).

Microeconomics vs. Macroeconomics

Microeconomics

Microeconomics analyzes the choices made by individuals, households, and businesses, and how these choices interact in markets.

Examples: Choices of individuals (education, jobs), businesses (what to produce, which technology to use), and government policies affecting specific markets.

Macroeconomics

Macroeconomics analyzes the performance of the whole economy, including national and global outcomes.

Examples: Inflation, unemployment, economic growth, and overall economic policy.

Making Smart Choices: Marginal Analysis

Three Keys to Smart Choices

Opportunity cost rule: Additional benefits vs. opportunity costs. Only choose an action if the expected additional benefits are greater than the additional opportunity costs.
Look forward only: Consider only additional benefits and costs from the next hour or unit, not sunk costs.
Implicit costs and externalities: Consider opportunity costs you don’t pay for directly and externalities (costs or benefits that affect others external to a choice).

Marginal: Additional or incremental.
Marginal benefit: Additional benefit from the next choice.
Marginal opportunity cost: Additional opportunity cost from the next choice.
Externalities: Costs or benefits that affect others external to a choice or trade.

The Law of Demand

Definition and Determinants

The law of demand states that, ceteris paribus, as the price of a product or service increases, the quantity demanded decreases, and vice versa.

Demand: Consumers’ willingness and ability to pay for a particular product or service.
Consumers are only smart when expected benefits are greater than costs.

Preferences and Substitutes

Wants are whatever we are willing to give up.
A product becomes a substitute for another when it satisfies the same want.

Marginal Benefit and the Diamond-Water Paradox

Marginal benefit of water is low, even though total benefit is high (water is abundant).
Marginal benefit of diamonds is high, total benefit is low (diamonds are scarce).
Willingness to pay is based on marginal benefit, not total benefit.

Quantity Demanded vs. Demand

Quantity demanded: The amount you are willing and able to buy at a given price (a point on the demand curve).
Demand: The sum of all individuals’ willingness and ability to buy a particular product at every price (the entire demand curve).
As price falls, quantity demanded increases (downward-sloping demand curve).

Shifts in Demand

Five main factors can shift the demand curve:

Preferences: Changes in tastes or popularity.
Income:
- Normal goods: Demand increases as income increases.
- Inferior goods: Demand decreases as income increases.
Prices of related products:
- Substitutes: Increase in price of one increases demand for the other.
- Complements: Increase in price of one decreases demand for the other.
Expected future prices: If consumers expect prices to rise, current demand increases.
Number of consumers: More consumers increase demand.

Reading the Demand Curve

Marginal benefit reading: At any given quantity, consumers are willing and able to pay a higher price.
Demand curve reading: At any given price, consumers plan to buy a larger quantity.

The Law of Supply

Definition and Determinants

The law of supply states that, ceteris paribus, as the price of a product or service increases, the quantity supplied increases, and vice versa.

Supply is the overall willingness of businesses (or individuals) to sell a particular product or service.
Marginal cost is the opportunity cost of producing one more unit.
Supply curves are upward sloping due to increasing marginal opportunity costs.

Marginal Cost and Sunk Cost

Marginal cost: The value of the best alternative use of resources when producing an additional unit.
Sunk cost: Past, already-paid expenses that cannot be recovered; should not affect current decisions.

Shifts in Supply

Six main factors can shift the supply curve:

Technology: Improvements increase supply.
Prices of related products: If the price of a related product rises, supply of the current product may decrease.
Price of inputs: Higher input prices decrease supply.
Expected future prices: If businesses expect prices to rise, current supply may decrease.
Number of suppliers: More suppliers increase market supply.

Reading the Supply Curve

At any given price, the supply curve tells you the minimum price businesses will accept for each quantity supplied.
At any given quantity, the curve tells you the minimum price businesses will accept at that quantity.

Summary Table: Factors Shifting Demand and Supply

Factor	Effect on Demand	Effect on Supply
Preferences	Increase or decrease demand	No direct effect
Income (Normal Good)	Increase in income increases demand	No direct effect
Income (Inferior Good)	Increase in income decreases demand	No direct effect
Price of Related Goods (Substitutes)	Increase in price of substitute increases demand	No direct effect
Price of Related Goods (Complements)	Increase in price of complement decreases demand	No direct effect
Expected Future Prices	Expected increase increases current demand	Expected increase decreases current supply
Number of Consumers/Suppliers	More consumers increase demand	More suppliers increase supply
Technology	No direct effect	Improvement increases supply
Price of Inputs	No direct effect	Increase decreases supply

Key Formulas and Equations

Opportunity Cost:
Marginal Benefit and Marginal Cost: Choose an action if:
Comparative Advantage:

Additional info:

Some explanations and examples have been expanded for clarity and completeness.
Tables and formulas have been logically inferred and formatted for study purposes.