Principles of Economics and Management I

Session 1 · Economic Thinking and Scarcity

Authors

Affiliation

Introduction

ℹ️ About This Course

Principles of Economics and Management I · Master in Applied Mathematics for Economics and Management.

Course Instructor: Paulo Fagandini.

We are not going to turn you into economists. We are going to build economic intuition and vocabulary, useful for anyone heading into banking, insurance and investment. 🎯

📚 Bibliography

Nothing here is required reading. The slides are the primary reference; these are for when you want more.

Introductory, open access (CC BY):

1. OpenStax, Principles of Microeconomics, 3rd ed. (Shapiro, MacDonald, Greenlaw).
2. OpenStax, Principles of Macroeconomics, 3rd ed. (Greenlaw, Shapiro et al.).

Formal treatment, for going deeper:

3. Varian, Intermediate Microeconomics: A Modern Approach, 9th ed.
4. Blanchard, Amighini and Giavazzi, Macroeconomics: A European Perspective, 3rd ed.

The syllabus maps every session to chapters in all four. Inside the decks, a 📖 note at the foot of a slide tells you exactly which section an example came from, and links straight to it in the free online book. 🔖

🧾 Assessment, Weights and Dates

Periodic assessment, two in-person written tests:

Test	Date	Content	Weight
Midterm	04/11/2026, session 7	Block 1, Microeconomics	50%
Final	normal exam period, 5 to 19 January 2027	Block 2, Macroeconomics	50%

To pass: at least 10 out of 20, the weighted average rounded to the nearest integer, so a 9.50 average already passes.

Skipping periodic assessment means a single exam (100%) on that same January date. The resit period (22/01 to 05/02/2027) is open to everyone, including anyone who took the tests and did not pass. 📅

⚠️ Rules in the Room

🧮 Calculator: basic scientific only. Graphing calculators are not allowed.

📵 Devices: earphones, a smartwatch, a smartphone or any electronic device during a test counts as fraud.

The full rules, the reading map and the calendar are in the syllabus, on the course page. 🔗

🗓️ What the Course Covers

#	Block 1 · Microeconomics	#	Block 2 · Macroeconomics
1	Economic thinking and scarcity	8	GDP, measurement and growth
2	Consumer choice	9	Unemployment, inflation, labor
3	Demand and elasticity	10	Money, banking and inflation
4	Production, costs, market structures	11	Monetary policy
5	Market equilibrium and taxes	12	Fiscal policy
6	Uncertainty, risk and information	13	The open economy

Session 7 is the midterm, so there is no session 7 deck. One theme per session, and every part of every session ends in exercises. 🧩

🗺️ Today’s Map

We will build the foundation for everything else, piece by piece:

1. 🤔 What is economics?
2. ⚖️ Scarcity: the central problem
3. 🧩 Division of labor and specialization
4. 🔬 Microeconomics and macroeconomics
5. 💶 The budget constraint and opportunity cost
6. ➕ The marginal principle and the optimal decision
7. 📉 The Production Possibilities Frontier
8. 🤝 Trade, and consuming beyond the frontier

Each piece answers a question raised by the one before it. 🧱

Part 1 · What Is Economics?

🤔 Let Us Start With a Question

You have 24 hours in a day. Not one more.

You want to study, sleep, work, see your friends, train.

Does it all fit?

No. You have to choose.

Hold on to that feeling. All of economics grows out of it. 👇

⚖️ Scarcity

If you could have everything you wanted, there would be nothing to decide.

Scarcity: human wants for goods, services and resources exceed what is available.

Resources (labor, time, land, raw materials) exist in limited quantity. Wants, on the other hand, look unlimited.

⏳ The Scarcest Resource

Time is the purest example of scarcity.

Rich or poor, everyone has exactly 24 hours a day.

Every hour spent studying is an hour not spent sleeping. Scarcity forces a choice, always.

💡 The Definition

So we arrive at what economics really is:

Economics: the study of how people make decisions under scarcity.

Decisions by individuals, households, firms, society. Notice: it is not about money, nor about finance, nor about mathematics. It is about choice. 🧠

🧩 How Do We Deal With Scarcity?

Nobody produces everything they consume. Why not?

Imagine having to grow your own wheat, build your own house and repair your own phone. Impossible.

Adam Smith’s answer (1776): the division of labor. 🏭

🏭 The Pin Factory

Smith observed a pin factory. Making a pin involves about 18 distinct tasks.

One worker alone: maybe 20 pins a day.

Ten workers, each specialized in one task: 48,000 pins a day. 🤯

That is 4,800 per worker, against 20. How?

📖 Source: OpenStax Micro 3e, §1.1, “The Division of and Specialization of Labor”. Smith’s own account is in The Wealth of Nations (1776), Book I, ch. 1.

📈 Why Specialization Produces More

Smith gave three reasons:

1. 🎯 Advantage: each person focuses on what they do best.
2. ⚡ Practice: repeating a task makes it faster and better.
3. 📦 Economies of scale: producing at scale lowers the average cost of each unit.

The division of labor is our greatest weapon against scarcity. ⚔️

📖 Source: OpenStax Micro 3e, §1.1, “Why the Division of Labor Increases Production”, where the three reasons are set out one by one.

🔄 Specialization Requires Exchange

If I specialize in just one thing, how do I get everything else?

I trade. I use what I earn from my work to buy what others have produced.

Specialization and the market always come together. You cannot build a phone, but you can buy one. 📱

Smith’s own limit: the division of labor is limited by the extent of the market. A specialist needs enough buyers to be worth being a specialist. 📏

📖 Source: OpenStax Micro 3e, §1.1, “Trade and Markets”. The limit itself is Smith’s own, and it is the title of The Wealth of Nations (1776), Book I, ch. 3.

🔬 Two Levels of Analysis

Economics looks at the world at two scales:

🔎 Microeconomics: the decisions of individual agents. A household, a firm, a specific market.

🌍 Macroeconomics: the economy as a whole. Growth, unemployment, inflation, the aggregate.

📊 Micro and Macro Side by Side

	Microeconomics	Macroeconomics
Looks at	Agents and markets	The whole economy
Examples	The price of bread, wages in a sector	GDP, inflation, unemployment
Typical question	How much does this firm produce?	Is the country growing this year?

📖 Source: OpenStax Micro 3e, §1.2 “Microeconomics and Macroeconomics”.

In this course we start with micro (Block 1) and move up to macro (Block 2). 🧗

🧭 Positive or Normative?

Two ways of stating something in economics:

📏 Positive: describes what is, and can be tested. “Raising VAT reduces sales.”

⚖️ Normative: says what ought to be, and involves value judgments. “VAT should be cut.”

A good economist always keeps the two apart. 🧠

📖 Source: OpenStax Micro 3e, §2.3 “Confronting Objections to the Economic Approach”, which sets positive against normative statements.

📝 Review · Part 1

Let us consolidate before moving on. Two multiple choice questions and one exercise. ✍️

❓ Multiple Choice 1

Scarcity exists because:

A. Governments manage resources badly.

B. Wants exceed available resources.

C. There is not enough money in the economy.

D. There is too much specialization.

✅ B. Scarcity is wants exceeding resources. It would exist even in a society without money.

❓ Multiple Choice 2

The division of labor raises output through all of the following except:

A. Specializing in tasks where you have an advantage.

B. Gains from practice and speed.

C. Economies of scale.

D. A reduction in people’s wants.

✅ D. The division of labor does not change wants, it raises output.

🧮 Development Exercise

A hospital has 30 doctors. It can have each of them do everything (diagnose, operate, follow up), or split them into specialized teams.

a) Name the three channels through which specialization would raise output.
b) Specialization also has a cost here. Name one, and say what it depends on.
c) Is “this hospital should specialize” a positive or a normative statement?

✅ Solution

a) Advantage (each doctor works where they are relatively best), practice (repetition raises speed and quality) and economies of scale (theaters and equipment used intensively rather than sitting idle).

b) Coordination. Patients must be handed over between teams, and information is lost at every handover. The cost grows with the number of handovers, so specialization only pays if the hospital is large enough: Smith’s extent of the market, again.

c) Normative: it says what ought to happen. The positive version is testable: “specialized teams treat more patients per doctor per day.” 🧠

Part 2 · Choice in a World of Scarcity

💶 How Much Would You Pay for a 10 Euro Note?

A €10 note is for sale. What is the most you would hand over for it? 🤔

€11? No. You would be down €1 the moment you paid. ❌

€9.99? Yes, and you would be one cent better off. ✅

Willingness to pay, or reservation price: the most you would pay, the point where buying and not buying feel the same. Here it is exactly €10.

💰 Benefit, Cost and Surplus

Every choice has a benefit \(B\), what it is worth to you, and a cost \(C\), what you hand over.

\[S = B - C\]

Surplus: what the choice leaves you with once you have paid for it.

Buy the note at €9.99 and \(S = 0.01\). Pay €11 and \(S = -1\). Act only while \(S > 0\). 🎯

⚖️ Now Two Options, and Only One Choice

Scarcity, again: taking one means giving up the other.

Option 1 leaves you \(B_1 - C_1\). Option 2 leaves you \(B_2 - C_2\).

Being rational means one thing here: take the option with the larger surplus.

So you take option 1 exactly when \[B_1 - C_1 > B_2 - C_2\]

🔑 That Inequality Is the Opportunity Cost

Move \(C_1\) across, and change nothing else:

\[B_1 - C_1 > B_2 - C_2 \qquad \Longleftrightarrow \qquad B_1 > \underbrace{C_1 + (B_2 - C_2)}_{\text{opportunity cost of option 1}}\]

Read the right hand side. What option 1 truly costs is what you pay for it, plus the surplus you gave up by not taking the best alternative.

Opportunity cost: your own cost, plus the surplus of the best alternative you turned down.

So the whole rule is benefit > opportunity cost, and it holds for exactly one option: the best one. 🎯

📖 Source: OpenStax Micro 3e, §2.1, “The Concept of Opportunity Cost”. Mind the word: some texts keep it for the given-up surplus alone. Here it is the full economic cost, what you pay plus what you forgo.

🧮 Check It on Numbers

Your summer: a paid internship, or a summer school costing €1,200.

Option	Benefit	Cost	Surplus
Internship	2,000	0	2,000
Summer school	3,000	1,200	1,800

Internship: opportunity cost \(= 0 + 1800 = 1800\), and \(2000 > 1800\). Rational. ✅

Summer school: opportunity cost \(= 1200 + 2000 = 3200\), and \(3000 < 3200\). Not rational. ❌

Note the summer school has the larger benefit and still loses. Only the best option passes its own test. 🔑

💶 A Concrete Choice

You have €20 a week to spend on coffees (€2 each) and cakes (€1 each).

If you spend it all on coffee: 10 coffees, zero cakes.

If you spend it all on cakes: 20 cakes, zero coffees.

And in between?

Every combination that costs exactly €20. 👇

📖 Source: OpenStax Micro 3e, §2.1, “How Individuals Make Choices Based on Their Budget Constraint”. Same figure there, built for Alphonso: burgers and bus tickets.

📉 The Budget Constraint

The line is the budget constraint: every combination costing exactly 20 euros. The shaded area is the budget set, everything you can afford.

🔀 Opportunity Cost, Read Off the Figure

Same rule, now on the budget line. You are at “coffee only” and you want 1 cake.

The cake costs €1, and €1 is half a coffee.

The alternative you gave up is not abstract: it is the coffee you do not drink. So the cost of a cake is half a coffee. ☕

Which is what the slope of the budget line has been telling you all along. 📐

⚖️ Everything Has an Opportunity Cost

There is no free lunch. 🍽️

An hour of studying is an hour you are neither working nor resting.

A thousand euros in a deposit account is a thousand euros not invested elsewhere.

Thinking in terms of opportunity cost is half of thinking like an economist.

➕ Marginal Thinking

Big decisions are rarely “all or nothing”. They are “a bit more or a bit less”.

You do not decide “study or do not study”. You decide whether one more hour is worth it.

You compare the marginal benefit of that hour with its marginal cost.

The golden rule: keep doing something as long as the marginal benefit is greater than the marginal cost. 🧠

📖 Source: OpenStax Micro 3e, §2.1, “Marginal Decision-Making and Diminishing Marginal Utility”, which is where the book explains why choices are made at the margin rather than all or nothing.

🧮 This Is a First Order Condition

Let \(B(q)\) be the total benefit of doing \(q\) and \(C(q)\) the total cost. The problem is

\[\max_{q} \; B(q) - C(q)\]

Differentiating and setting to zero: \(B'(q) = C'(q)\).

That is, MB = MC. The “golden rule” of economics is the first order condition you already know. 🎯

📉 The Optimum Is Where the Margins Cross

MB falls, MC rises, and they cross at q* = 4 hours. No more, no less.

🎯 Incentives Matter

People respond to incentives: when the marginal cost or benefit changes, behavior changes.

The price of gasoline goes up: people drive less and buy more efficient cars.

Half of economic analysis is asking: “how does the margin change?” 🧠

🧨 Beware of Sunk Costs

You have already spent €8 on a cinema ticket. Halfway through, you realize you hate the film.

Stay or leave?

The €8 is not coming back, whatever you do.

Sunk cost: a cost already incurred and unrecoverable.

The rational decision: ignore the sunk cost, look only at the future. If you hate the film, leave. 🎬

📖 Source: OpenStax Micro 3e, §2.1, “Sunk Costs”. The book tells it as Selena, who pays 8 dollars for a film and knows after 30 minutes that it is terrible.

📝 Review · Part 2

Two multiple choice questions and one exercise. ✍️

❓ Multiple Choice 3

You may take option 1 or option 2, never both, and option 1 is the rational choice. The opportunity cost of option 1 is:

A. The cost \(C_1\) you actually pay for it.

B. The benefit \(B_2\) of the option you turned down.

C. The surplus \(B_2 - C_2\) you gave up, and nothing more.

D. \(C_1 + (B_2 - C_2)\): what you pay, plus the surplus you gave up.

✅ D. Rationality is \(B_1 - C_1 > B_2 - C_2\), which is \(B_1 > C_1 + (B_2 - C_2)\). Option C is only the implicit half; the money you hand over is a cost too.

❓ Multiple Choice 4

The sunk cost of a decision:

A. Should weigh heavily in the decision.

B. Is irrelevant to the rational decision.

C. Is the same thing as opportunity cost.

D. Grows over time.

✅ B. It is no longer recoverable, so it cannot change a choice about the future. Only benefits and costs still ahead of you count.

🧮 Numerical Exercise

Studying \(q\) hours brings a total benefit \(B(q) = 90q - 7.5q^{2}\) and carries a total cost \(C(q) = 30q + 7.5q^{2}\) (euros, \(q\) in hours).

a) Derive the marginal benefit and the marginal cost.
b) Find the optimal number of hours \(q^{*}\).
c) What net benefit does the student get at \(q^{*}\)?

✅ Solution

a) Differentiate the totals: \[MB(q) = B'(q) = 90 - 15q, \qquad MC(q) = C'(q) = 30 + 15q\]

b) Set \(MB = MC\): \(90 - 15q = 30 + 15q \Rightarrow 60 = 30q \Rightarrow q^{*} = 2\) hours, where \(MB = MC = 60\) euros per hour.

c) \(B(2) - C(2) = (180 - 30) - (60 + 30) = 150 - 90 = 60\) euros. It really is a maximum: \(B'' - C'' = -15 - 15 < 0\). ✅

Part 3 · Scarcity at the Country Level

🌍 From the Person to the Economy

The same ideas (scarcity and opportunity cost) apply to a whole country.

A country has limited resources (workers, machines, land) and has to choose what to produce.

Let us look at that with a simple, powerful tool. 👇

📐 The Production Possibilities Frontier

Imagine an economy that produces only bread 🍞 and software 💻.

🔎 Reading the Frontier

🔵 On the curve (A): all resources are used. This is efficient.

🔴 Inside the curve (B): waste, idle resources. This is inefficient.

🟢 Outside the curve (C): desirable, but unattainable with today’s resources and technology.

Keep the two words apart: inside is a waste, outside is a limit. Only one of them is a mistake. 🎯

📖 Source: OpenStax Micro 3e, §2.2 “The Production Possibilities Frontier and Social Choices”, which draws the same frontier for a society choosing between healthcare and education.

📈 Why the Frontier Is Curved

To produce more software, we move along the curve and give up bread.

At first it is cheap: we shift into software the workers who are least suited to baking.

Then it gets expensive: only good bakers are left. The opportunity cost rises.

That is why the frontier is curved, and not a straight line. 📐

📖 Source: OpenStax Micro 3e, §2.2, where the curvature is tied to the law of diminishing returns.

🚀 Growth Means Pushing the Frontier Out

How do we get to point C, unattainable today?

With more resources (more workers, more machines) or better technology.

Economic growth shifts the frontier outward. That is the subject of Block 2. 🌱

🤝 The Other Way Out: Trade

Growth is slow. There is a second route to a point beyond the frontier, and it works immediately.

Remember the pin factory. Specialization raised output, but only because the specialist could trade for everything else they needed.

A country is a pin factory writ large. So: what happens if two countries specialize and trade? 🌍

📐 Two Countries, Two Frontiers

Portugal and Denmark each produce wine 🍷 and cloth 🧵. Straight-line frontiers, to keep the arithmetic clean:

Country	All wine	All cloth	Opportunity cost of 1 wine
Portugal	100	50	0.5 cloth
Denmark	40	80	2 cloth

Portugal gives up less cloth for each unit of wine. Portugal has the comparative advantage in wine, Denmark in cloth.

Note what this is: an opportunity cost comparison. Part 2, applied to countries. 🔁

📖 Source: OpenStax Micro 3e, §2.2, “The PPF and Comparative Advantage”, told with the US and Brazil, wheat and sugar cane. Wine and cloth are Ricardo’s own pair, in On the Principles of Political Economy and Taxation (1817), ch. 7.

🚀 Consuming Outside Your Own Frontier

Portugal produces only wine and trades at 1 cloth per wine, a rate between the two opportunity costs. It consumes where its own frontier could never reach. 🎯

🔑 Why This Is the Big Idea

The frontier bounds what a country can produce. Trade breaks the link between what it produces and what it consumes.

The whole chain of today’s session, in one line: scarcity → opportunity cost → comparative advantage → specialization → trade → consumption beyond the frontier. ⛓️

It is the pin factory argument, one level up. We make it formal in session 13. 🔁

📝 Review · Part 3

Consolidate before we close. Two multiple choice questions and one exercise. ✍️

❓ Multiple Choice 5

A point inside the Production Possibilities Frontier represents:

A. An efficient combination.

B. An unattainable combination.

C. A combination with wasted resources.

D. Economic growth.

✅ C. Inside the frontier there are idle resources: inefficient production.

❓ Multiple Choice 6

A country consuming a bundle that lies outside its own production possibilities frontier:

A. Is producing inefficiently.

B. Has necessarily had economic growth this year.

C. Is impossible under any circumstances.

D. Is specializing and trading with another country.

✅ D. Growth moves the frontier itself, and takes time. Trade leaves the frontier where it is and separates production from consumption, which is why the bundle can sit outside it.

🧮 Numerical Exercise

With 30 euros you can buy books (10 euros each) or concert tickets (15 euros each).

a) How many books at most?
b) How many concerts at most?
c) What is the opportunity cost of 1 concert, measured in books?
d) Write the budget constraint and give its slope.

✅ Solution

a) \(30 / 10 = 3\) books.

b) \(30 / 15 = 2\) concerts.

c) One concert costs 15 euros, which buys 1.5 books. Opportunity cost: 1.5 books. 🎵

d) With \(B\) books and \(C\) concerts, \(10B + 15C = 30\), so \(B = 3 - 1.5\,C\). The slope is \(-1.5\): the slope of the budget line is the opportunity cost, carrying a minus sign. ✅

Wrap-Up

🎯 What to Take From This Session

⚖️ Everything starts with scarcity: limited resources, unlimited wants.

🧩 The division of labor and exchange are society’s answer to scarcity.

💶 Every choice has an opportunity cost. Rational decisions are marginal (MB = MC, a first order condition) and ignore sunk costs.

📐 The Production Possibilities Frontier shows scarcity, efficiency and growth in a single figure.

🤝 Comparative advantage turns opportunity cost into a reason to specialize, and trade lets a country consume beyond its own frontier.

👋 Next Session

Consumer Choice.

Today we chose by comparing surplus. Next we write that choice down properly: preferences, a budget, and the constrained maximization that produces demand. 🎯

See you next week. 🙌