Praxis Economics (5911)

Economics begins with one unavoidable fact: human wants are unlimited, but the resources available to satisfy them are limited. This condition is scarcity, and it applies to every society, every business, and every person, rich or poor. A wealthy nation still has only so many workers, acres, and machines, and a wealthy person still has only 24 hours in a day.

Because of scarcity, every use of a resource is a choice to not use it somewhere else. Economics is therefore the study of how individuals, businesses, and societies make choices about the use of scarce resources. Notice that scarcity is different from a shortage. A shortage is a temporary market condition in which quantity demanded exceeds quantity supplied at the current price; it disappears when the price adjusts. Scarcity never disappears.

The opportunity cost of a choice is the value of the next best alternative given up. It is not the sum of every alternative, only the single best one forgone. Opportunity cost includes both money spent (explicit costs) and the value of time or other resources used (implicit costs).

Economists summarize this reasoning with the idea that there is no such thing as a free lunch. Even a good offered at a zero price uses resources that could have produced something else, and the time spent consuming it has an opportunity cost.

The resources used to produce goods and services are called the factors of production. Each factor earns a characteristic payment, a fact the exam often tests in circular-flow questions.

In economics, capital (or capital goods) means manufactured items used to produce other goods and services rather than being consumed directly: machinery, tools, factories, delivery trucks, computers, and infrastructure. A factory building supports production for decades; a pizza oven turns flour and labor into pizzas year after year. The same physical item can be a consumer good or a capital good depending on its use. A car driven for family errands is a consumer good; the same car used by a taxi company is capital.

Capital formation happens when a society produces capital goods instead of consuming all of its current output. That requires saving: resources used to build a machine today cannot also satisfy consumption today. This is the basic tradeoff behind long-run growth, and it appears on the production possibilities curve as a choice between consumer goods and capital goods.

• Gross investment is total spending on new capital goods in a period, including replacement of worn-out equipment.
• Depreciation is the loss of capital through wear and tear (physical) or obsolescence (newer technology makes a working machine less valuable).
• Net investment = gross investment − depreciation. If gross investment is $500 billion and depreciation is $200 billion, the capital stock grows by $300 billion.
• Firms invest when the expected return on a capital good exceeds its cost, including the interest rate. Higher interest rates make fewer projects worthwhile.
• Capital is subject to diminishing marginal returns: adding more machines to a fixed number of workers raises output by smaller and smaller amounts.

Capital markets, including stock markets, bond markets, and banks, channel saving from households to businesses that want to buy capital. When these markets direct funds toward the most productive projects, the economy grows faster.