Chapter 1 — Introduction

Every economy must decide (1) what to produce and in what quantities — food, luxury goods, education, or investment goods; (2) how to produce — which resources and technologies to use; and (3) for whom to produce — how the final goods and services are distributed among individuals.

The PPF is a curve showing all combinations of two goods — for example, corn and cotton — that an economy can produce when all its resources are fully utilised. Points on the curve are efficient; a point strictly below the curve means some resources are underemployed or used wastefully.

Opportunity cost is the amount of one good that must be given up in order to produce an additional unit of another good. Because scarce resources have alternative uses, producing more of one good always means forgoing some of another. The chapter notes that opportunity cost is also called economic cost.

The production possibility set is the collection of all possible combinations of goods and services that can be produced from a given amount of resources and a given stock of technological knowledge. The PPF is the outer boundary of this set, representing fully-utilised, efficient production.

In a centrally planned economy, the government or central authority makes all important decisions about production, exchange, and consumption. In a market economy, these activities are organised through the free interaction of individuals, with prices coordinating decisions. The chapter cites China (for much of the 20th century) as the closest example of a centrally planned economy and the USA as having minimal government intervention.

A mixed economy combines market mechanisms with government intervention. The chapter states that in reality all economies are mixed economies; the difference lies only in the extent of the government's role. India, for instance, has seen the government's role reduced considerably in the last couple of decades after playing a major role since Independence.

In a market system, all goods and services come with a price mutually agreed upon by buyers and sellers. The price reflects, on average, society's valuation of the good. If buyers demand more of a good, its price rises, signalling producers to increase output. Prices thus send important information to all individuals and help achieve coordination without central direction.

Positive economics studies how different economic mechanisms function — it analyses how a particular mechanism works without making value judgements. Normative economics evaluates whether those mechanisms and their outcomes are desirable. The chapter notes that the distinction is not very sharp, as the two are closely related and a proper understanding of one is not possible in isolation from the other.

Microeconomics studies the behaviour of individual economic agents in markets for different goods and services, and how prices and quantities are determined through their interaction. Macroeconomics focuses on the economy as a whole, studying aggregate measures such as total output, employment, and the aggregate price level, and how these change over time.

No individual has unlimited resources relative to their needs. Because resources are limited, producing or consuming more of one thing means giving up something else. The chapter illustrates this with a family farm that can have a bigger house only by giving up additional arable land, or better education for children by giving up some luxuries. The same logic applies to societies as a whole.

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