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Key concepts
Keyconceptsarethebigideasandunderstandingsthatwehopewillremainwithourstudentslongaftertheyhave
leftschool.

Key concepts or big ideas in economics

Thefollowingarekeyconcepts/bigideasineconomics:
Scarcityresultsinchoiceswithopportunitycosts
Valuesinfluenceeconomicchoices
Marketsprovideincentivesandrationscarceresources
Perfectlycompetitivemarketsareefficient
Marketfailuremayrequiregovernmentintervention
Thebenefitsofmarketactivitiesmaynotbeequitable
Governmentinterventionmayinvolveanequityefficiencytradeoff
Interdependenceresultsinflowoneffects
Marginalanalysiswillmaximiseresults
Economicindicatorsaideconomicanalysis
Inflationcandistorteconomicindicators
Economicmodelsaideconomicanalysis
Microandmacroeconomics
Scarcityresultsinchoiceswithopportunitycosts
Resourcesarescarcewhenunlimitedwantsexceedthecapabilityoftheavailableresourcestosatisfythem,so
thateconomicchoicesmustbemade.
Resourcesareusedwhenaneconomicdecisionismade,meaningthatacostisincurred.
Theopportunitycostisthenextbestalternativeuseofthoseresources.
Opportunitycostcanbeusedtoevaluatedecisions.Ifthenetbenefitsfromachoicearegreaterthanthenextbest
alternative,thenasensibleeconomicchoicehasbeenmade.
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Scarcity
Economicgrowthreducesscarcity

Economicgrowthoccurswhentherealvalueofthegoodsandservicesproducedbyaneconomyenablesmore
wantstobesatisfied.
Accordingly,societiesstriveforeconomicgrowthasawayofreducingscarcity.
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Economicgrowth
Fullemploymentreducesscarcity

Fullemploymentoccurswhenallresourcesarefullyutilised.
Ifresourcesarefullyemployed,thenmorecanbeproduced.Societiesthereforestriveforfullemploymentasaway
ofreducingscarcity.
Learnmore:
Unemployment
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Internationaltradereducesscarcity

Countriestradingproductsandservicestheyarecomparativelybetteratproducingwillbeabletosellthem
overseasforahigherpricethantheysellthemlocally.Theywillbeabletobuyotherimportsforalowerpricethan
theycanbeproducedlocally.Thisenablesmorewantstobesatisfiedandreducesscarcity.
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Internationaltrade
Valuesinfluenceeconomicchoices
Valuesarethecorebeliefsthatpeoplehold.Thedifferentvaluesorperspectivesheldbyindividualsandgroups
influencetheeconomicchoicestheymake.
Valuesaffecttheimportance(orweighting)peoplegivetothedifferentfactorstheyconsiderinmakingachoice.
Groupsandindividualswiththesameinformation,butdifferentvalues,maymakedifferentchoices.
Forexample,Morimaybelievethattheirtraditionsandvaluesbestsuitthemtoconservenaturalresourcesand
thattheyshouldbegiventheresponsibilitytomanagethestretchesoftheNewZealandforeshoretheyown.
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Scarcity
Marketsprovideincentivesandrationscarceresources
Marketsareplacesorsituationswhereproducersandconsumersexchangegoodsandservices.
Infreemarketeconomies,thepricessetbytheinteractionofsupplyanddemandallocatesscarceresources.
Wheneverresourcesareparticularlyscarce,demandexceedssupply,andpricesaredrivenup.Theeffectofhigher
pricesistodiscouragedemandandconserveresources.
Thegreaterthescarcity,thehighertheprice,andthemoretheresourcewillbeconserved.Forexample,asoil
slowlyrunsoutanditspricerises,demandwillbediscouraged,leadingtomoreoilbeingconservedthanatlower
prices.
Anincentiveissomethingthatmotivatesaproducerorconsumertofollowaparticularcourseofactionortochange
it.
Higherpricesresultingfromincreasedconsumerdemandareanincentiveforproducerstosupplymoreofagoodor
servicebecausetheymayearnmoreprofit.
Forexample,asworlddemandfordairyproductsrises,NewZealandfarmersareswitchingtodairying.Similarly,
studentsarelikeliertoworkhardtodevelopskillstheyrecogniseasrequiredforthehighpayingjobtheyaspireto.
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Supply/demandmodel
Microeconomicconcepts
Perfectlycompetitivemarketsareefficient
Efficiencyisaneconomicconceptrelatedtohowwellaneconomyallocatesscarceresourcestomeetstheneeds
andwantsofconsumers.
Efficientmarketsallocatescarceresourcessothatthepriceconsumersarepreparetopayforagoodequalsthe
marginalcostoftheresourcesusedtoproducethatgood.
AdamSmith(widelycitedasthefatherofmoderneconomics)arguedthatifconsumersareallowedtofreely
choosewhattobuyandifproducerschoosefreelywhattosellandhowtoproduceit,afreemarketwill,asifledby
aninvisiblehand,settleonproductsandpricesthatmakebothconsumersandproducersbothbetteroff.
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Forexample,marketequilibriumoccursatthepricewherethequantitiesdemandedbyconsumersequalsthe
quantitysuppliedbyproducers,meaningthatjusttherightamountofresourcesareused,sincethereareneither
shortagesnorsurpluses.
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Perfectlycompetitivemarkets(forprivategoodsandservicesatequilibrium)areefficient
Marketfailuremayrequiregovernmentintervention
Marketfailureoccurswhenfreemarketsfailtoallocateresourcesefficiently.
Forexample,inthecigarettemarket,consumersdecisionscanimpactnegativelyonotherpeopleinavarietyof
ways.
Onesuchnegativeimpactisthehealthproblemscausedbyinhalingsecondhandsmokeindomesticsettingsor
publicareas.
Whenthesmokerpaysonlythepriceatwhichtheproducersellsthecigarettes,theyarenotpayingforthecostof
thesenegativeimpacts.
Thegovernmentintervenesbyapplyinganexcisetaxontobaccoproductstodeliveramoreefficientandequitable
outcome.
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Marginalanalysisofmonopolyfirms
Governmentinterventionsforcommoncausesofmarketfailure
Thebenefitsofmarketactivitiesmaynotbeequitable
Equityisaneconomicobjectiverelatingtofairnessorevenness.
Amarketmaybeefficient,butsocietymaybeconcernedthatthebenefitsfrommarketactivityareunfairlyshared
out.
Forexample,freemarketsinevitablydistributeincomesunevenlybecausetheincomeearneddependsonsupply
anddemandforlabourresources,whicharedifferentindifferentmarkets.
Ifagovernmentbelievesthegapbetweenrichandpooristoogreat,itwillredistributewealthbygivingbenefitsto
thepoor,forexample,unemploymentbenefits,andtaxingtherichathigherrates.
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Economicissueofspecialinterest
Governmentinterventionsforcommoncausesofmarketfailure
Governmentinterventionmayinvolveanequityefficiencytradeoff
Governmentinterventionstoimproveequitymaysometimesdiminishefficiency.
Forexample,highermarginaltaxratesmaydiscouragehighincomeearnersfromworkingharderorlongerifthey
feelthatmoreoftheirincomegoestothegovernment.Asaresult,productivityfalls.
Somegovernmentsseektohelplowincomefamiliesbyadoptingpoliciestostimulateeconomicgrowth.They
believethatthebenefitsofhighergrowthwilltrickledowntothelowincomefamilies.
Othergovernmentsrecognisethatreducingpovertywillimproveeconomicefficiency.
Forexample,reducingpovertytendstoreducelevelsofillness,whicharelinkedtopoorhousingandnutrition.
Improvedpublichealthreducesdemandformorehospitalservicesandtheneedformorehospitalstobebuilt.
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Improvedeconomicefficiencyalsogivesagovernmenttheopportunitytocanspendmoreondeveloping
infrastructuretoimproveproductivity.
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Economicissueofspecialinterest
Governmentinterventionsforcommoncausesofmarketfailure
Interdependenceresultsinflowoneffects
Thedifferentsectorsofaneconomy(households,producers,financial,government,overseas)relyoneachother
(areinterdependent).
Eventsimpactingononesectorwillflowontoaffectothersectors.
Forexample,whenoverseascountriesthattradewithNewZealandgointorecessionandreducetheirspending,
theflowoneffectforNewZealandisfewerexportreceiptsandlowerlevelsofeconomicgrowth.
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Interdependence
Marginalanalysiswillmaximiseresults
Marginalanalysiscomparestheadditionalbenefitofanactivitywithitsadditionalcost.
Aneconomistwouldrecommendtheuseofscarceresourcestosatisfywantsonlywhentheextrabenefitgained
fromusingthescarceresourcesexceedstheextracostassociatedwithusingthem.
Forexample,astudentwithanafterschooljobcouldusemarginalanalysistooptimisethenumberofhours
worked.Howmuchthestudentvaluestheirtimenotworking(theopportunitycost)representsthemarginalcost.
Theamounttheyarepaidisthemarginalbenefit.
Althoughthemarginalcostofthefirstorsecondhourworkedmaybelow(thestudentstillhasplentyoftimestodo
otherthings),thecostoffurtherhoursbeginsincrease.
Ifthestudentispaid$15anhour,butvaluesthemarginalcostofathirdhourspentworkingatmorethan$15
theyreallywanttouseitforstudyortobewithfriendsthenthemosthourstheyshouldworkaretwo.
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Marginalanalysisofmonopoly
Economicindicatorsaideconomicanalysis
Economicindicatorsareusuallyeconomicstatistics,suchastheunemploymentrate,realGDP,ortheinflation
rate.
Thesestatisticsareimportantforeconomists.Theyuseindicatorstoestimatehowwelltheeconomyisdoingand
tohighlighttrendsincontemporarymacroeconomicissues,suchaseconomicgrowth,employment,international
trade,inflation,andequity.
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Economicindicators
Inflationcandistorteconomicindicators
Nominalindicatorshavenotaccountedfortheeffectsofinflation.
Realindicatorsaccountfortheeffectsofinflation.
Forexample,nominalnationalincomeisthedollarvalueofaneconomysincomeinaparticularyear.Realnational
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incomeistheincomewiththeeffectsofinflationremoved,therebyindicatingtheactualpurchasingpowerofthe
income.
Economistsuseincreasesinrealincometoidentifyeconomicgrowthincreasingrealincomeshowsthata
country,withitsresources,isnowabletosatisfymorewantsandneeds.
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Inflation
Economicmodelsaideconomicanalysis
Economicmodelsaresimplificationsoftherealworld.Theyaredevelopedtoaidanalysisandsupportpredictions
abouteconomicbehaviourandperformance.
Economistshavedevelopedavarietyofmodelstoaidanalysisofbothmacroeconomicandmicroeconomicissues.
Asupplyanddemandmodel

Microeconomicsusesasupplyanddemandmodel.Thismodelcombinesproducersupplyandconsumerdemandto
supportanalysisoftheeffectsofchoicesonpriceandtheflowoneffectsofdecisionsonothers.
Moresophisticatedapplicationsallowuserstomakepredictionsabouteconomicefficiency.
Learnmore:
Supply/demandmodel
Competitivemarkets
Anaggregatesupplyandaggregatedemand(ASAD)model

ThemacroeconomicASADmodelaidsanalysisofchangesintheinternalandexternalinfluencesaffectingan
economy,inparticular,theirimpactoninflation,economicgrowth,andemployment.
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Macroeconomicsinfluences
Microandmacroeconomics
Economicsistraditionallydividedupintotwobranchesmicroeconomicsandmacroeconomics.Micromeans
smallandmacromeansbig.
Microeconomicsisthebranchofeconomicsthatexaminesindividualdecisionmakingbyfirmsandhouseholdsand
thewaytheyinteractinspecificindustriesandmarkets.Amongeconomists,themostcommonlyacceptedsetof
ideasabouthowtheeconomyworksiscalledneoclassicaleconomics.Keyconceptsoutlinedabove,including,
opportunitycost,thinkingatthemargin,incentivesinconsumer/producerdecisionmaking,marketsefficiency,and
whymarketsfailareallbasedonneoclassicalideasandformthebasisofmicroeconomictheory.
Macroeconomicsisthebranchofeconomicsthatexaminestheworkingsandproblemsoftheeconomyasa
whole.Itisconcernedwithaggregatesupply(totalnationaloutputofgoodsandservices)andaggregatedemand
(thetotalspendingofthewholeeconomy)andissuessuchaseconomicgrowth,inflation,unemployment,and
economicfluctuations.Macroeconomicpolicysuggestionsthereforetendtofocusonthebalanceofaggregate
demandandaggregatesupply.Demandsidepoliciesseektoinfluencethelevelofspendingintheeconomy.This
inturnindirectlyaffectsthelevelofproduction,prices,andemployment.Supplysidepoliciesaredesignedto
influenceproductiondirectly.
Learnmore:
Microeconomicconcepts
Macroeconomicsinfluences
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LastupdatedMay13,2013

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