Core Economic Concepts: Systems, Models, Production, and Demand

Posted on Aug 7, 2025 in Economics

Economic Systems and Resource Allocation

An allocation of resources answers three fundamental economic questions: what to produce, how to produce, and for whom to produce.
Societies employ different processes to answer these questions, varying in the degree of centralized decision-making.
The optimal process for allocating resources depends on a society’s specific goals.
The method a society uses to answer these three economic questions defines its economic system. Economic systems are identified by who owns and controls scarce resources.
Under capitalism, individuals own and control scarce resources.
Under communism, the government owns and controls resources.
Under socialism, some resources are owned by individuals, and some by the government.
The circular flow model illustrates how, in capitalism, resource owners sell their resources to businesses to obtain income, which is then used to purchase the output produced by businesses.

Social science studies aspects of human behavior through the application of the scientific method. Models are a major tool for economists.
To understand the real world, economists rely on models. Models are a simplification of reality, providing a manageable way to think about the world.
Models are composed of logical reasoning, leading from assumptions to conclusions. These conclusions are predictions about the world.
Models can be divided into different kinds. In economics, models are either macroeconomic (about the whole economy) or microeconomic (about individual behavior).
Models can also be positive (descriptive) or normative (prescriptive, indicating what should be).

The production possibilities model shows all possible combinations of two different outputs a society can produce with a fixed amount of resources and unchanging technology.
Movement along the production possibilities curve means getting more of one good and less of the other. Opportunity cost of one good can be calculated in terms of the amount of the other good given up.
A bowed-out production possibilities curve indicates increasing opportunity cost.
The law of increasing costs states that each additional unit of one good requires greater sacrifices of the other good.
The law of increasing costs exists because resources are not equally effective substitutes in the production of goods.
Positions inside the production possibilities curve result from unemployed or underemployed resources.
Positions outside the production possibilities curve are unattainable.
Production possibilities increase when new resources or technology are discovered.

Demand indicates how much of a good a consumer is willing and able to purchase at each price.
Demand and quantity demanded are distinct concepts. Quantity demanded refers to the specific quantity a consumer is willing and able to buy at a particular price.
The law of demand states there is an inverse relationship between price and quantity demanded. Income and substitution effects support the law of demand when prices change.
Movement along the demand curve is caused only by a change in the good’s price.
The demand curve shifts only if a determinant of demand changes. Determinants of demand include consumer tastes, income, prices of related goods, and expectations of future price changes.
Two goods are substitutes if one can be used in place of the other. If the price of a good increases, its quantity demanded decreases, and the demand for a substitute increases.
Two goods are complements if they are typically used together. If the price of a good increases, its quantity demanded decreases, and the demand for its complement also decreases.