Difficulty: Introductory | Prerequisites: None
Tags: microeconomics, macroeconomics, positive economics, normative economics, opportunity cost, property rights, types of economies, market economy, mixed economy, centrally planned economy, marginal analysis, MB = MC, equity, efficiency
This material covers the foundational concepts that the rest of Intermediate Microeconomics builds on. You are learning the vocabulary and mental models economists use to describe how individuals, households, and firms make decisions, and how those decisions play out in markets. If you cannot define these terms fluently, every later topic (consumer theory, producer theory, market structures) will feel harder than it needs to. The content here overlaps heavily with introductory micro, so treat it as revision with sharper definitions.
Economics studies how people allocate scarce resources. Microeconomics zooms in on individual decision-makers and markets; macroeconomics looks at economy-wide outcomes. The core assumption is that people are rational, respond to incentives, and make optimal decisions at the margin where marginal benefit equals marginal cost.
Microeconomics
The study of how households and firms make decisions and how they interact in markets. In simple terms, it is the close-up lens on individual choices: what you buy, what a firm produces, how a price gets set.
Macroeconomics
The study of economy-wide phenomena, including inflation, unemployment, and economic growth. Think of it as the wide-angle lens: GDP, national unemployment, the overall price level.
Positive economics
Descriptive statements about "what is" in the economy, testable against data. In simple terms, these are factual claims: "the unemployment rate is 4%." No value judgement involved.
Normative economics
Prescriptive statements about "what should be," rooted in values or opinions. In simple terms, these are policy opinions: "the government should raise the minimum wage."
Opportunity cost
The value of the highest-valued alternative you must give up when you make a choice. Think of it as the price you pay in forgone options, not in money. If you spend an hour studying, the opportunity cost is whatever else you would have done with that hour.
Capital
The equipment, tools, and structures used to produce goods and services. This splits into physical capital (machines, factories) and human capital (skills, training).
Property rights
Legal rights over the use, sale, and proceeds of a resource or good, including copyrights and patents. In the US these are guaranteed by the Constitution. Without clear property rights, markets cannot function well because people have no incentive to invest or trade.
Invention
The development of a new good or process. Distinct from innovation, which is bringing an invention to market.
Equity (in economics)
The fair distribution of economic benefits across members of society. Fairness is normative, so economists can describe equity outcomes but cannot say which distribution is "correct" without a value judgement.
Productive efficiency
Producing goods and services at the lowest possible cost. A firm is productively efficient when it cannot produce the same output with fewer resources.
Allocative efficiency
Producing the mix of goods and services that consumers value most. Resources go where marginal benefit equals marginal cost.
Inferior good
A good for which demand falls when income rises. Think of instant noodles: as your income goes up, you switch to something better.
Normal good
A good for which demand rises when income rises. Most goods are normal goods: higher income, more purchases.
People are rational: they weigh costs and benefits before acting.
People respond to incentives: change the payoff and you change the behaviour.
Optimal decisions are made at the margin: keep doing something as long as marginal benefit (MB) equals or exceeds marginal cost (MC). The decision rule is MB = MC.
Every society must answer these, regardless of its economic system:
What goods and services will be produced?
How will they be produced?
Who will receive them?
These three questions are closely related to capitalism and market-based allocation.
Centrally planned economy: The government decides what to produce, how to produce it, and who receives it. Example: North Korea.
Market economy: Decisions are made by individual buyers and sellers through the price mechanism. Example: Italy is used as the textbook illustration.
Mixed economy: Combines elements of both market and central planning. Most real-world economies, including the USA, are mixed.
Direct relationship: When one variable increases, the other also increases (and vice versa). Both move in the same direction.
Inverse relationship: When one variable increases, the other decreases. They move in opposite directions. The demand curve illustrates an inverse relationship between price and quantity demanded.
The division of labour increases productivity. Specialisation lets workers become faster and more skilled at narrower tasks.
The "invisible hand" should manage the economy: individuals pursuing their own self-interest, guided by market prices, tend to produce outcomes that benefit society as a whole.
The distinction between centrally planned and market economies is not abstract. The reason supermarket shelves in market economies carry thousands of products without a central authority coordinating supply is precisely the price mechanism and voluntary exchange that Smith described. Prices transmit information about scarcity, and profit incentives push firms to meet demand.
Students often confuse positive and normative economics. A statement is positive if you can test it with data, regardless of whether you agree with it. "Raising the minimum wage increases unemployment" is positive (testable). "The minimum wage should be higher" is normative (a value judgement).
Opportunity cost is not the same as the monetary price. It is the value of the next-best alternative forgone, which may include time, enjoyment, or other non-monetary factors.
"Mixed economy" does not mean "halfway between capitalism and communism." It means the economy uses markets for most allocation but the government intervenes in specific areas (public goods, regulation, redistribution).
Students sometimes think allocative efficiency and productive efficiency are the same. Productive efficiency is about cost minimisation; allocative efficiency is about producing the right things. A firm can be productively efficient while making goods nobody wants.
⚠️ Be able to distinguish positive from normative statements. This is a common multiple-choice question.
⚠️ Know the three key economic ideas cold, especially MB = MC as the rule for optimal decisions.
⚠️ Be ready to classify goods as inferior or normal based on how demand responds to income changes.
⚠️ Understand the difference between productive and allocative efficiency with a concrete example.
⚠️ Know which type of economy each country example represents (North Korea = centrally planned, USA = mixed, Italy = market).
True or False: "The government should subsidise healthcare" is a positive economic statement.
False. It is normative (a value judgement about what should happen).
Fill in the blank: The decision rule for optimal choices is ______ = ______.
MB = MC (marginal benefit equals marginal cost).
True or False: An inferior good is a low-quality good.
False. "Inferior" refers only to the income-demand relationship, not quality. Demand for an inferior good falls as income rises.
True or False: The USA is classified as a market economy in this course.
False. The USA is classified as a mixed economy.
Fill in the blank: Opportunity cost is the value of the ______ alternative forgone.
Highest-valued (or next-best).
Q: What is the difference between microeconomics and macroeconomics?
A: Microeconomics studies individual decision-makers (households, firms) and how they interact in specific markets. Macroeconomics studies economy-wide phenomena such as inflation, unemployment, and aggregate growth.
Q: A student says, "Unemployment is too high, so the government should create more jobs." Identify the positive and normative components.
A: "Unemployment is too high" could be positive if measured against a specific benchmark (e.g. above 5%), but as stated it implies a value judgement, making it normative. "The government should create more jobs" is normative: it prescribes policy.
Q: Explain why opportunity cost is not always measured in money.
A: Opportunity cost is the value of the next-best alternative you give up. If you spend a Saturday studying instead of working a shift that pays £80, the opportunity cost is £80. But if your next-best alternative was a free concert you value at £100, the opportunity cost is £100 in enjoyment, not money spent.
Q: A country lets the government set all prices and production targets. What type of economy is this?
A: Centrally planned economy. The government, not the market, answers the three fundamental questions (what, how, and for whom to produce).
Q: What condition must hold for a decision to be optimal according to marginal analysis?
A: Marginal benefit must equal marginal cost (MB = MC). If MB > MC, do more. If MB < MC, do less.
The concept of marginal analysis (MB = MC) reappears in consumer theory (where it becomes MU/P equality across goods) and producer theory (where it becomes the profit-maximising output rule). Opportunity cost is the foundation of comparative advantage and trade, covered in the next section of these notes. The distinction between positive and normative economics matters throughout the course whenever you evaluate policy interventions such as price controls or taxes.
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