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Credit Sprint's Guide to Macroeconomics Unit 1: Basic Economic Concepts

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Scarcity forces choices, and every choice has an opportunity cost. The production possibilities curve (PPC) shows those tradeoffs, and comparative advantage explains why trade makes both sides better off. Supply and demand set prices in individual markets.

What you need to know

  • Opportunity cost is the value of the next-best alternative given up, not every alternative.
  • A PPC bowed out from the origin means increasing opportunity cost; a straight line means constant cost.
  • Points inside the PPC mean unemployed or inefficiently used resources; outward shifts mean economic growth.
  • Comparative advantage goes to the producer with the lower opportunity cost, even without an absolute advantage.
  • Mutually beneficial terms of trade fall between the two producers' opportunity costs.
  • A price ceiling below equilibrium causes a shortage; a price floor above equilibrium causes a surplus.
  • A change in a good's own price moves along a curve; anything else shifts the curve.

Formulas

Opportunity cost of X = (units of Y given up) ÷ (units of X gained)

Exam traps

Watch forAbsolute advantage ≠ comparative advantage. The exam almost always asks about comparative.
Watch forWhen supply and demand both shift, one of price or quantity is indeterminate.
Watch for"Change in demand" (shift) is not "change in quantity demanded" (movement along).

Key terms

  • Scarcity: Limited resources relative to unlimited wants. The reason every economy must make choices.
  • Opportunity cost: The value of the next-best alternative given up when a choice is made.
  • Factors of production: Land, labor, capital and entrepreneurship: the resources used to produce goods and services.
  • Production possibilities curve: Shows the maximum combinations of two goods an economy can make with its resources and technology.
  • Increasing opportunity cost: Each extra unit of a good costs more of the other good. Gives a PPC bowed outward.
  • Absolute advantage: Producing more output than another producer with the same resources.
  • Comparative advantage: Producing a good at a lower opportunity cost than another producer. The basis for gains from trade.
  • Terms of trade: The rate at which goods are exchanged. Mutually beneficial terms lie between the two opportunity costs.
  • Law of demand: As price falls, quantity demanded rises, all else equal.
  • Price ceiling: A legal maximum price. Binding when set below equilibrium, causing a shortage.
  • Price floor: A legal minimum price. Binding when set above equilibrium, causing a surplus.
  • Normal vs. inferior good: Demand for a normal good rises with income; demand for an inferior good falls with income.

Practice questions

Five of the 45 Unit 1 questions in Credit Sprint. Every choice is explained in the app.

1. Maya can work a Saturday shift for $120 or go to a free concert. What is her opportunity cost of going to the concert?
  1. $0, because the concert is free
  2. It cannot be determined
  3. $60, half her wages
  4. $120
  5. $120 plus the price of the concert
Show answer

$120. The next-best alternative she gives up is $120 in wages.

2. In Country X, 1 shirt costs 2 hats in opportunity cost. In Country Y, 1 shirt costs 4 hats. Which terms of trade benefit both countries?
  1. 1 shirt for 1 hat
  2. 1 shirt for 3 hats
  3. 1 shirt for 5 hats
  4. 1 shirt for 6 hats
  5. 1 shirt for 2 hats
Show answer

1 shirt for 3 hats. Mutually beneficial terms fall between the two opportunity costs: 2 and 4 hats.

3. A tariff on imported steel will most likely:
  1. Increase the supply of imported steel
  2. Raise the domestic price of steel and reduce steel imports
  3. Have no effect on domestic consumers
  4. Increase steel imports
  5. Lower the domestic price of steel
Show answer

Raise the domestic price of steel and reduce steel imports. A tax on imports makes them pricier, so fewer are bought.

4. Producers expect the price of their good to rise next month. Today's supply:
  1. Doesn't change
  2. Becomes vertical
  3. Increases
  4. Becomes more elastic
  5. Decreases
Show answer

Decreases. Sellers hold back some output to sell later at the higher price.

5. The price of steel, an input for cars, falls. In the car market:
  1. Quantity demanded falls
  2. Demand increases
  3. Price of cars rises
  4. Supply increases
  5. Supply decreases
Show answer

Supply increases. Lower input costs shift supply right.