This section covers the following topics:

• Economic reasoning
• The Invisible Hand
• Trade and the production possibility curve
• Sectors of the economy
• Supply and demand

Section Summary

The free market coordinates people’s actions so that the right goods and produced in the right way for the right people.

Classical economics assumes that individuals are rational and self-interested, while modern economics takes a more nuanced (and realistic) view. The price of a good is regulated by the Invisible Hand, which equalizes supply and demand.

The production possibility curve shows all of the goods that can be created with given resources. It also demonstrates the concept of opportunity cost, or the benefit of the next-best alternative that you forgo when making a decision. By trading with each other, countries can exceed the production possibility curve and consume more goods. Countries have comparative advantages (which can be inherent or transferable) in the production of certain goods, meaning the opportunity cost of producing those goods is lower.

The economy has three main sectors: households, businesses and government. The government has the duty of facilitating sustainable economic growth by enforcing property rights, regulating the economy, preventing negative side-effects and correcting for externalities.

The demand curve is downward sloping, because the cheaper something is, the more you buy. As prices rise, people tend to substitute related goods. Changes in price cause a movement along the demand curve, while changes in average income or other factors shift the demand curve. Demand changes depending on whether the good is normal or inferior.

The supply curve is upward sloping, because the more you can sell a good for, the more you will produce to sell. As the price rises, the opportunity cost of not selling increases. Again, there is a difference between movement along the supply curve and a shift in supply.

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