Key Economic Concepts

Key Economic Concepts

Fundamental Economic Problem

  • Economic resources are the factors of production: land, labour, capital, and entrepreneurship.
  • The fundamental economic problem is the issue of scarcity in the face of infinite wants, resulting in the need for choice.
  • Opportunity cost represents the next best alternative forgone as a result of making a decision.
  • Production possibility curves illustrate the concept of opportunity cost and the choices an economy has to make.

Market Systems

  • The market mechanism is how resources are allocated in a free market through supply and demand.
  • Perfect competition is a market structure with a large number of small firms, no barriers to entry, and a homogeneous product.
  • Market failure occurs when the price mechanism fails to allocate scarce resources efficiently, leading to a loss of economic and social welfare.

Demand, Supply and Market Equilibrium

  • Demand is the quantity of a good or service that consumers are willing and able to buy at any given price in a given period.
  • Supply represents how much the market can offer at any given price in a given period.
  • The point where demand equals supply is known as the market equilibrium. At this point, the allocation of goods is most efficient.


  • Price elasticity of demand measures how responsive demand is to a change in price.
  • Income elasticity of demand measures how much demand changes in response to a change in income.
  • Price elasticity of supply measures the responsiveness of the quantity supplied to a change in the price of the good.

Externalities and Public Goods

  • Negative externalities occur when the consumption or production of a good has a harmful effect on a third party.
  • Positive externalities occur when the consumption or production of a good benefits a third party.
  • Public goods are non-excludable and non-rival in consumption, leading to free riders and under-provision.

Government Intervention

  • Government intervention is used to correct market failure, regulate monopolies, and to redistribute income.
  • This intervention can occur in the form of taxes, subsidies, laws, and regulations.
  • Indirect taxes are used by the government to reduce consumption of demerit goods, whilst subsidies are used to promote production and consumption of goods with positive externalities.
  • The government also uses regulation to control negative externalities and safeguard social welfare.