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Macroeconomics Unit 1: Basic economic concepts

Macroeconomics starts with scarcity, tradeoffs, gains from trade and how supply and demand set prices.

Covers: Scarcity and opportunity cost, the PPC, comparative advantage, demand, supply and market equilibrium

Study guide

Macroeconomics studies the economy as a whole: total output, unemployment, inflation and growth. It starts with the same foundation as microeconomics. Scarcity forces choices, and every choice has an opportunity cost. The production possibilities curve (PPC) shows the tradeoffs an economy faces: points on the curve are efficient, points inside reflect unemployment or inefficiency, and points outside are unattainable. A bowed-out PPC reflects increasing opportunity costs, and economic growth shifts the curve outward. In macroeconomics, the PPC is also a way to picture recessions (moving inside the curve) and long-run growth.

Comparative advantage explains why nations trade. A country should specialize in goods it can make at a lower opportunity cost than its trading partners, then trade; both sides can consume beyond their own PPCs. This idea underlies the study of international trade and finance at the end of the course.

Supply and demand determine prices in individual markets. Demand slopes downward, supply slopes upward, and equilibrium is where they cross. Shifts in demand or supply change equilibrium price and quantity, and binding price controls cause shortages or surpluses. Macroeconomics applies similar reasoning to whole-economy models: aggregate demand and aggregate supply, the money market, the loanable funds market and the foreign exchange market all work like supply-and-demand graphs.

In a command economy, a central government decides what to produce, how and for whom. In a market economy, those decisions come from prices and private choices. Most real economies are mixed. With output data, the opportunity cost of one unit of a good equals the units of the other good given up divided by the units gained. Mutually beneficial terms of trade lie between the two countries' opportunity costs.

Key ideas

• Macroeconomics studies output, unemployment, inflation and growth.
• The PPC shows tradeoffs, inefficiency and growth.
• Specialization by comparative advantage creates gains from trade.
• Supply and demand determine market prices.
• Later macro models use the same supply-and-demand logic.

Formulas and rules

Common mistakes

• Confusing a movement along the PPC with a shift of it.
• Confusing a change in demand with a change in quantity demanded.

Words to know

Macroeconomics

The study of the economy as a whole.

Scarcity

Limited resources relative to unlimited wants.

Opportunity cost

The value of the next-best alternative given up.

PPC

A curve showing the combinations of two goods an economy can produce.

Economic growth

An increase in an economy's ability to produce, shifting the PPC outward.

Comparative advantage

Producing at a lower opportunity cost than others.

Specialization

Focusing production on what you make most efficiently.

Demand

The quantities buyers are willing and able to buy at each price.

Supply

The quantities sellers are willing and able to sell at each price.

Market equilibrium

Where quantity demanded equals quantity supplied.

Shortage

Quantity demanded exceeds quantity supplied.

Surplus

Quantity supplied exceeds quantity demanded.

Sample practice questions

5 more questions like these, from level 1 to 5, are in the practice set.