The Economic Way of Thinking - Bethel Social...

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THE ECONOMIC WAY OF THINKING

CHAPTER 1: THE ECONOMIC WAY OF THINKING

• KEY CONCEPT

• Scarcity is the situation that exists because wants are unlimited and resources are limited.

• WHY THE CONCEPT MATTERS

• The concept of scarcity is an issue you confront in everyday life. Suppose you have $20 to cover the cost of lunches for the week. How would you use the money to cover your wants Monday through Friday? How would buying a late afternoon snack for $1 on two of the days affect your lunch choices?

WHAT IS SCARCITY?• KEY CONCEPTS

• Wants — desires that can be met by consuming products

• Needs — things necessary for survival

• Scarcity — lack of resources available to meet all human wants

• not a temporary shortage

• Economics — study of how people use resources to satisfy wants

• examines how individuals and societies choose to use resources

• organizes, analyzes, interprets data about economic behaviors

• develops theories, economic laws to explain economy, predict future

Scarcity: The Basic Economic

Problem

WHAT IS SCARCITY?

• Principle 1: People Have Wants

• People make choices about all their needs and wants

• Wants are unlimited, ever changing

WHAT IS SCARCITY?

• Principle 2: Scarcity Affects Everyone

• Scarcity affects which goods and services are provided

• Goods — physical objects that can be bought

• Services — work one person does for another for pay

• Consumer — person who buys good or service for personal use

• Producer — person who makes a good or provides a service

SCARCITY LEADS TO THREE ECONOMIC QUESTIONS

• KEY CONCEPTS

• Scarcity affects society and producers as well as individuals

• Society must answer three basic economic questions:

• what will be produced?

• how will it be produced?

• for whom will it be produced?

• Question 1: What Will Be Produced?

• Societies must decide on mix of goods to produce

• depends in part on their natural resources

• Some countries allow producers and consumers to decide

• In other countries, governments decide

• Must also decide how much to produce; choice depends on societies’ wants

• Question 2: How Will It Be Produced?

• Decisions on production methods involve using resources efficiently

• decisions influenced by a society’s natural resources

• Societies adopt different approaches

• with unskilled labor force, might use labor-intensive methods

• with skilled labor force, might use capital-intensive methods

• Question 3: For Whom Will It Be Produced?

• How goods and services are distributed involves two questions

• how should each person’s share be determined?

• how will goods and services be delivered to people?

THE FACTORS OF PRODUCTION

• KEY CONCEPTS

• Factors of production — resources needed to produce goods and services

• include land, labor, capital, entrepreneurship

• supply is limited

• Factor 1: Land

• Land means all natural resources on or under the ground

• includes water, forests, wildlife, mineral deposits

• Factor 2: Labor

• Labor is all the human time, effort, talent used to make products

• physical and mental effort used to make a good or provide a service

• Factor 3: Capital

• Capital is a producer’s physical resources

• includes tools, machines, offices, stores, roads, vehicles

• sometimes called physical capital or real capital

• Workers invest in human capital — knowledge and skills

• workers with more human capital are more productive

• Factor 4: Entrepreneurship

• Entrepreneurship — vision, skill, ingenuity, willingness to take risks

• Entrepreneurs anticipate consumer wants, satisfy these in new ways

• develop new products, methods of production, marketing or distributing

• risk time, energy, creativity, money to make a profit

REVIEWING KEY CONCEPTS

• Explain the relationship between the terms in each of these pairs:

• wants and scarcity

• consumer and producer

• factors of production and entrepreneurship

MAKING CHOICES• KEY CONCEPTS

• Economic choices shaped by

• Incentives — benefits that encourage people to act in certain ways

• Utility — benefit or satisfaction gained from using a good or service

• To make choices, people economize:

• make decisions according to best combination of costs and benefits

Economic Choice Today:

Opportunity Cost

MAKING CHOICES

• Factor 1: Motivations for Choice

• People motivated by incentives, expected utility, desire to economize

• They weigh costs against benefits to make purposeful choices

• motivated by self-interest: look for ways to maximize utility

MAKING CHOICES

• Factor 2: No Free Lunch

• All choices have a cost

• choosing one thing means giving up another, or paying a cost

• cost can take form of money, time, other thing of value

TRADE-OFFS AND OPPORTUNITY COST

• KEY CONCEPTS

• Trade-off is alternative people give up when they make a choice

• usually means giving up some, not all, of a thing to get more of another

• Example 1: Making Trade-Offs

• Shanti wants to earn college credit over summer

• semester-long university course offers more credits

• six-week high school course leaves time for vacation

• Example 2: Counting the Opportunity Cost

• Opportunity cost is value of next-best alternative a person gives up

• not the value of all possible alternatives

• Dan chooses to work for six months so he can travel for six months

• opportunity cost: six months of salary

ANALYZING CHOICES

• KEY CONCEPTS

• Cost-benefit analysis — examination of costs, expected benefits of choices

• one of most useful tools for evaluating relative worth of economic choices

ANALYZING CHOICES

• Example: Max’s Decision-Making Grid

• Decision-making grid shows what one gets, gives up with each choice

• Max’s grid shows all possible choices for his free hours each week

• lists choices, benefits and opportunity cost of each choice

• With time, costs and benefits change; also goals and circumstances

• Changes influence decisions, make people alter original choices

ANALYZING CHOICES

• Example: Marginal Costs and Benefits

• Marginal cost

• additional cost of using one more unit of a good or service

• Marginal benefit

• additional benefit of using one more unit of a good or service

• Explain the relationship between the terms in each of these pairs:

• incentive and utility

• trade-off and opportunity cost

• marginal cost and marginal benefit

GRAPHING THE POSSIBILITIES• KEY CONCEPTS

• Economic models — simplified representations of economic forces

• Production possibilities curve (PPC) is one model

• maximum goods or services that can be produced from limited resources

• also called production possibilities frontier

Analyzing Production Possibilities

GRAPHING THE POSSIBILITIES

• KEY CONCEPTS

• PPC based on assumptions that simplify economic interactions

• resources are fixed

• all resources are fully employed

• only two things can be produced

• technology is fixed

GRAPHING THE POSSIBILITIES

• Production Possibilities Curve

• PPC runs between extremes of producing only one item or the other

• Data is plotted on a graph; lines joining points is PPC

• shows maximum number of one item relative to other item

• PPC shows opportunity cost of each choice

• more of one product means less of the other

WHAT WE LEARN FROM PPCS

• KEY CONCEPTS

• Concepts revealed by PPC:

• Efficiency — producing the maximum amount of goods and services possible

• Underutilization — producing fewer goods and services than possible

• Example: Efficiency and Underutilization

• Each point on PPC represents efficiency

• points inside curve mean underutilization; outside curve cannot be met

• Law of increasing opportunity costs

• as production switches from one product to another, more resources needed to increase production of second product

• Example: Increasing Opportunity Costs

• Increase in opportunity cost — each new unit costs more than last one

• Reasons for increasing cost of making more of one product

• need new resources, machines, factories

• must retrain workers

• Costs paid by making less and less of other product

CHANGING PRODUCTION POSSIBILITIES

• Example: A Shift in the PPC

• A country’s supply of resources changes over time

• Example: U.S. in 1800s grew, gained resources, workers, new technology

• new resources mean new production possibilities beyond frontier

• Increased production shown on PPC as shift of curve outward

• Increase in total output called economic growth

• Explain how each term is illustrated by the production possibilities curve:

• underutilization

• efficiency

WORKING WITH DATA• KEY CONCEPTS

• Statistics — numerical data or information

• show patterns of human behavior

• Economic models help organize and interpret data

The Economists Toolbox

WORKING WITH DATA

• Using Economic Models

• Economic models focus on a limited number of variables

• thus based on assumptions and use simplification

• expressed in words, graphs, equations

WORKING WITH DATA

• Using Charts and Tables

• Economists look for statistical relationships, trends, connections

• Charts and tables display data in rows and columns

• can reveal patterns by showing numbers in relation to other numbers

WORKING WITH DATA

• Using Graphs

• Graphs use two sets of variables: along horizontal, vertical axes

• Line graphs useful for showing changes over time

• in economics, line referred to as a curve, even if straight

• Bar graphs good for showing comparisons

• Pie graph (or pie chart, circle graph) shows numbers in relation to whole

MICROECONOMICS AND MACROECONOMICS

• KEY CONCEPTS

• Microeconomics — studies behavior of individual players in an economy

• includes individuals, families, businesses

• Macroeconomics — studies behavior of economy as a whole

• topics include inflation, unemployment, aggregate demand and aggregate supply

• Microeconomics

• Microeconomics examines specific, individual elements in an economy

• prices, costs, profits, competition, consumer and producer behavior

• Some Topics of Interest: business organization, labor markets, environmental issues

• Macroeconomics

• Macroeconomics studies sectors — combination of all individual units

• Includes consumer, business, public or government sectors

• Macroeconomics studies national or global topics:

• monetary system, business cycle, tax policies, international trade

POSITIVE ECONOMICS AND NORMATIVE ECONOMICS

• KEY CONCEPTS

• Positive economics describes and explains economic behavior as it is

• uses verifiable facts; does not make judgments

• Normative economics studies what economic behavior should be

• makes value judgments to recommend future actions

• Positive Economics

• Positive economics uses scientific method

• observe data, hypothesize, test, refine, continue testing

• Statements tested against real-world data

• proved (or strongly supported) or disproved (or strongly questioned)

• Normative Economics

• Normative economics studies facts, asks if course of action is good

• Recommendations differ because values they are based on also differ

ADAM SMITH: FOUNDER OF MODERN ECONOMICS

• Seeing the Invisible

• An Inquiry into the Nature and Causes of the Wealth of Nations, 1776

• challenged mercantilism; argued for free trade

• Invisible hand guides free marketplace, benefits sellers and buyers

• people pursue own economic self-interest

• producers sell at prices that satisfy them and that consumers will pay

• Explain the differences between the terms in each of these pairs:

• statistics and economic model

• macroeconomics and microeconomics

• positive economics and normative economics

CASE STUDY: THE REAL COST OF EXPANDING O’HARE

AIRPORT• Background

• Chicago’s O’Hare Airport is one of the busiest airports in the United States.

• Delays at O’Hare are commonplace.

• Considerable debate over the best solution to improve efficiency.

• What’s the Issue

• What are the real costs involved in airport expansion? Study these sources to determine the costs tied to the expansion of O’Hare airport.

CASE STUDY: THE REAL COST OF EXPANDING O’HARE AIRPORT

{CONTINUED}

• Thinking Economically

1.Explain the real cost of expanding O’Hare Airport. Use information presented in the documents to support your answer.

2.Who are the most likely winners and losers as a result of the O’Hare expansion? Explain your answer.

3.How might supporters of expansion use a production possibilities model to strengthen their case?

The Economic Way of Thinking - Bethel Social...

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