Basic economic concepts

1. THE TASK VERB SETS THE RESPONSE JOB

The official verbs describe what a complete response must do.

2. SCARCITY, RESOURCES, AND WHAT “FULL EMPLOYMENT” MEANS ON A GRAPH

Resources — the factors of production — are what an economy has to work with: land (natural resources), labor (human effort), capital (tools, machines, buildings: things made in order to make other things), and, in most courses, entrepreneurship, the organizing and risk-taking that combines the rest. Follow the convention a prompt establishes.

Scarcity is the condition that resources are limited while wants are not, and it is why every society has to choose: what to produce, how, and for whom. It is not a shortage — a shortage is a market at the wrong price, and it goes away when the price moves. Scarcity never goes away; it is the reason the subject exists.

The macro reading. For a whole economy, “every scarce resource at work” has a name: full employment. That is exactly what a point on the production possibilities curve means, and it is why the College Board’s own description of this unit’s first big idea is that the PPC “is used to demonstrate the full employment level of output.” A point inside the curve is an economy with idle resources — unemployed workers, silent factories — and Unit 2 will measure that idleness as an unemployment rate and an output gap. The picture in this unit and the numbers in the next are the same fact.

A trade-off is what scarcity produces at the level of one decision: to have more of one thing you must accept less of another. Put a number on the trade-off and you have an opportunity cost, which is the next card.

3. OPPORTUNITY COST — THE DEFINITION, AND THE RATIO WITH UNITS

The opportunity cost of a choice is the value of the next-best alternative you gave up to make it. Not everything you gave up — the next-best thing. A country that builds a dam gives up the best other use of that concrete, labor and land, once, not every use it can imagine.

On a PPC and in a comparative-advantage table, opportunity cost is a ratio: the amount of the other good surrendered per unit of this one. The units are the whole answer. “The opportunity cost of a machine tool is 2” means nothing; “the opportunity cost of one thousand machine tools is 2 million consumer units” is a claim someone can check. Write the sentence in that shape every time:

The two costs are reciprocals. If a thousand machine tools cost 2 million consumer units, then a million consumer units cost half a thousand machine tools — $\frac{1}{2}$ per million, the flip of $2$. That is not a coincidence; it is the same trade read from the other side, and it is the check that catches an upside-down ratio before it costs a point.

4. THE PRODUCTION POSSIBILITIES CURVE: READING A POINT

A production possibilities curve (PPC) shows every combination of two goods an economy can produce when all of its resources are fully employed and its technology is fixed. In macroeconomics the two goods are usually capital goods and consumer goods — the choice between building for tomorrow and consuming today — because that is the choice that decides how fast the curve itself moves, which is card 6.

Where a point sits relative to the curve is the whole of the reading.

5. THE SLOPE’S MAGNITUDE IS THE OPPORTUNITY COST — SO THE SHAPE IS THE STORY

Moving rightward along a downward-sloping PPC, the numerical slope $\mathrm{\Delta }Y∕\mathrm{\Delta }X$ is negative while opportunity cost is a positive amount forgone, so

when the axes increase in the usual directions. The curve’s shape is a statement about how that magnitude behaves.

Both panels show the same measurement taken twice: advance one unit along the horizontal axis, read how far the curve falls. The straight PPC drops the same amount in both places; the bowed one drops further the second time, which is what “each additional X costs more Y than the one before” looks like.

Why an economy’s PPC bows outward. Because its resources are not equally suited to both goods. Start at the top, making only capital goods. To make the first consumer goods, you move over the workers and land that were worst at machine tools and best at food — you lose almost no capital output. Keep going and you run out of those, so you start moving resources that were genuinely good at capital goods, and each one costs more. The bow is what specialized resources look like when you plot them. It is the common case for a whole economy, not an AP default: compute the cost at two places and let the numbers say the shape.

When a PPC is straight, the resources are perfectly adaptable between the two goods, and the trade-off never changes — the case every comparative-advantage table in this unit assumes. The Course and Exam Description also names a third case, decreasing opportunity cost, a curve bowed inward; you will meet it rarely, and if a table hands you a falling cost, draw the shape you find.

6. MOVEMENT ALONG THE CURVE, A SHIFT OF THE CURVE, AND THE CHOICE THAT MOVES IT

These are different events with different causes, and the exam’s own note on this unit says students confuse them. A graph that moves the curve when only the mix changed makes a different economic claim from the one in the prompt.

Movement along = the economy reallocated resources it already had. The curve does not move, and the move has a real opportunity cost — the point slides down one axis as it slides up the other.

Shift = the economy’s capacity changed. Outward: more or better resources (a larger workforce, new capital, discovered land), better technology or productivity. Inward: a disaster, a war, a workforce leaving. Outward is economic growth; inward is contraction. This is the CED’s own list — “changes in factors of production as well as changes in productivity/technology.”

A move from inside the curve to the curve is not growth. Idle workers going back to work takes the economy from a point like B to the frontier. Output rises, and nothing about capacity changed: the curve is where it was. The exam likes this one in a sentence — “the economy moved from inside its PPC to a point on it” describes falling unemployment, and the correct name is a recovery or a move toward full employment, never economic growth. Growth is the curve itself moving out.

The shift that only moves one axis. A better wheat variety helps consumer goods and does nothing for machine tools: the consumer-goods intercept moves out, the capital-goods intercept stays. The curve pivots. Ask: could the economy now make more of the good on the other axis than before? If not, that intercept does not move.

The choice on this year’s curve decides next decade’s curve. Capital goods are resources for the future — every machine tool built this year is a factor of production next year. So an economy that chooses a point high on the capital-goods axis today is choosing a bigger outward shift tomorrow, and it pays for that with consumer goods it does not have now. That is the macro question hiding in every PPC in this unit, and it is Problem 2.

7. ABSOLUTE ADVANTAGE, COMPARATIVE ADVANTAGE, AND WHICH NUMBER GOES ON TOP

Absolute advantage — who can produce more of a good with the same resources (or one unit of it with fewer resources). A comparison of productivity, one good at a time.

Comparative advantage — who gives up less to produce it. A comparison of opportunity costs. This is the one that decides who should specialize in what, and the only one that determines the pattern of trade.

A country can be better at making everything and still should not make everything, because its resources spent on one good are resources not spent on the other, and that forgone output is the real cost.

Output table — “per worker-year, Kestrel makes 8 tons of steel or 40 tons of wheat.” Fix the resource, compare the goods:

— five tons of wheat per ton of steel. The other good’s output goes on top: other over own.

Input table — “a solar panel takes 6 hours, a bicycle takes 3.” Fix the good, compare the resource each consumes:

Now the own good’s input goes on top — own over other, exactly reversed.

You do not have to memorize which is which. Build the units chain and the units settle it:

Hours cancel; bicycles per panel survives. Set the second fraction up so the resource cancels, and there is only one way the numbers can go. Problems 3 and 4 are the same question in both formats.

The third format: two PPC graphs. An intercept is an output table in disguise — how much of one good the country makes when it makes nothing else — so the opportunity cost of the good on the horizontal axis is the vertical intercept over the horizontal one, the slope’s magnitude, and the comparative advantage in that good goes to the flatter curve.

Two checks that catch every wrong answer. In a two-country, two-good problem with different opportunity costs, each country has the comparative advantage in exactly one good — the costs are reciprocals, so if mine is lower in steel, yours is lower in wheat. An answer that gives one country both is an arithmetic error. And if the two countries’ opportunity costs are identical, neither has a comparative advantage in anything and there are no gains from trade; the exam does hand out that table, and the right answer is that no mutually beneficial trade exists.

8. TERMS OF TRADE, AND CONSUMING BEYOND YOUR OWN CURVE

Autarky means no trade — each country consumes only what it makes. Terms of trade is the exchange rate two countries agree on: how many bicycles change hands per solar panel.

Nobody trades to be worse off, so each side has a walk-away number, and both are opportunity costs the country already knows: the exporter of panels will not accept fewer bicycles than a panel costs it at home (its cost is the floor); the importer will not pay more bicycles than a panel costs it at home, because it would just make its own (its cost is the ceiling). For both to gain strictly:

— simply between the two countries’ opportunity costs for that good. At an endpoint one side gains nothing and is indifferent; outside the range one side refuses. A range of 2 to 5 bicycles per panel is the same range as $\frac{1}{5}$ to $\frac{1}{2}$ panels per bicycle: reciprocals, inequality flipped. Say which good you are pricing.

Gains from trade. When each country specializes according to comparative advantage and trades inside the range, both can consume a bundle outside their own PPC. Neither curve moved — production possibilities are what they were — but consumption possibilities grew. Specialization and exchange do not make anyone more capable; they stop capable resources being spent on the wrong things.

Complete or partial? With a straight-line PPC — as in the trade examples in this unit — the cost is constant, so a country with the comparative advantage keeps it at every quantity and specializes completely. On a bowed curve its cost rises as it specializes, and it stops where its cost climbs to its partner’s: partial specialization. The exam works with the straight case.

9. DEMAND: THE LAW, THE REASONS, AND WHAT MOVES THE CURVE

The law of demand. Other things equal, a higher price of a good lowers the quantity of it demanded; a lower price raises it. This is a movement along the demand curve, and the thing that changes is called quantity demanded.

Why the curve slopes down. The substitution effect: when the price rises, other goods look cheaper by comparison and buyers move toward them. The income effect: at a higher price a given income buys less, so buyers can afford less of everything, this good included. Either answers “explain why the demand curve is downward sloping.”

What shifts demand. Anything other than the good’s own price that changes how much buyers want at every price. Right when they want more at each price; left when they want less.

The one thing that never shifts demand: the good’s own price. A price change moves the buyer along the curve that is already there. “The price fell, so demand rose” describes a shift that did not happen; the sentence that scores is “the price fell, so quantity demanded rose.”

10. SUPPLY: THE LAW, AND WHAT MOVES THE CURVE

The law of supply. Other things equal, a higher price raises the quantity supplied; a lower price lowers it — a movement along an upward-sloping supply curve. Read vertically, the supply curve is a cost curve: at each quantity its height is the least a seller would accept for that unit, because that is roughly what the unit costs to make, and each additional unit costs more to coax out of a fixed set of resources — the same increasing cost the PPC’s bow was showing.

What shifts supply. Anything other than the good’s own price that changes what sellers will offer at every price. Right when producing is cheaper or easier; left when it is costlier.

And the one thing that never shifts supply: the good’s own price. A higher price moves sellers along the curve — quantity supplied rises. “Supply rose because the price rose” is the same error as its demand-side twin, and it is scored the same way.

11. EQUILIBRIUM, DISEQUILIBRIUM, AND CHANGES IN EQUILIBRIUM

Equilibrium is the price at which quantity demanded equals quantity supplied — the market clears: every buyer willing to pay the price finds a seller, every seller willing to accept it finds a buyer, and there is neither a shortage nor a surplus.

Finding it. From two schedules, scan for the price where the quantities match. From two equations, set them equal and solve: with $Q_d=190-15P$ and $Q_s=10+15P$, $190-15P=10+15P$ gives $P=6$ and $Q=100$. Check by putting $P=6$ into both equations; if they disagree, the algebra slipped.

A price that is not the equilibrium price. Above it, sellers offer more than buyers take: a surplus of $Q_s-Q_d$, and unsold goods push the price down. Below it, buyers want more than sellers offer: a shortage of $Q_d-Q_s$, and unmet buyers bid the price up. Market forces drive the price back to equilibrium. Read $Q_d$ and $Q_s$ off the two curves at the stated price; the difference is the surplus or shortage, in the quantity’s units, and the smaller of the two is what actually trades.

One curve shifts. Four cases, and each has a determinate answer for both price and quantity.

Read them as a rule rather than four pictures: a demand shift moves price and quantity the same way; a supply shift moves them opposite ways. Which way is decided by whether the curve moved right or left.

Both curves shift. Now one of the two outcomes is determinate from the directions alone and the other depends on how far each curve moved.

On the exam, “indeterminate” is a full-credit answer when you say why: “price could rise, fall, or stay the same, depending on the relative sizes of the shifts.” Guessing a direction is the way to lose the point. If the prompt gives magnitudes, the numbers decide; Problem 6(e) is a case where they land the quantity exactly where it started.

12. THE CORRECTLY LABELED GRAPH

A correctly labeled graph must communicate the model and the requested change. Use the checks below to make it readable; the question’s rubric determines which features earn credit.

For a PPC the same rule applies with the goods on the axes: name both goods, name the curve (${\mathrm{\text{PPC}}}_1$, ${\mathrm{\text{PPC}}}_2$), and mark any point the question asks about with its coordinates. Problem 7 is a full free-response graph worked against this list.