Chapter 1: The Economic Way of Thinking
Sec. 1: Scarcity: The Basic Economic Problem
What is Scarcity?
Wants – Needs –
People always want more, no matter what they have wants are unlimited, but
resources to fill are limited
Scarcity – not a temporary
shortage, it is a problem facing individuals, businesses, govt., society
Science to study it is called economics
Economics – the study of how people choose to use scarce resources to satisfy their wants
Econ involves: Examining – Organizing, analyzing, and
interpreting data about those economic behaviors
Developing theories and economic laws that explain how the economy works and to predict what might happen in the future.
Principle 1: Choice is central to
the use of scarce resources.
Choices about needs – what kind of food
Choices about wants – these are unlimited & ever changing
Principle 2: Scarcity affects which
goods are made and services are provided Goods – physical objects
that can be purchased Services – work that one
person performs for another for payment
Consumer – Producer –
Scarcity Leads to 3 Questions
Question 1:
Society must decide the mix of goods and services it will produce what is produced depends on the natural resources
possessed but resources do not completely control what a country
produces some countries decide by allowing consumers and
producers to decide in other countries, the govt. decides what goods and
services will be produced This question also involves how much to produce
the country must review its wants at any time to decide this
Question 2:
This involves using scarce resources in the most efficient ways to satisfy wants this is also influenced by the natural
resources that a society possesses ex. - growing crops – different approaches large unskilled labor force – labor intensive
methods – few machines highly skilled labor force – capital intensive –
lots of machines
Question 3:
This involves how goods will be distributed
among people in society Questions –Need to determine how
much people should get how much they pay or equal share
Distribution networks –
The Factors of Production
-the economic resources needed to produce goods and services
Factor 1:
Includes all natural resources found on or under the ground that are used to produce goods and services
Factor 2:
is all the human time, effort, and talent that goes in to the making of products
Factor 3:
is all the resources made and used by people to produce and distribute goods and services ex. –
human capital – ex. – college, job
training
Factor 4: Is the combination of vision,
skills, ingenuity, and willingness to take risks that is needed to create and run new businesses most entrepreneurs are
innovators try to anticipate and meet
needs of consumers in new ways
new product, method of production, way of marketing or distributing
Are also risk takers – risk time, energy, creativity, money in hope for profit
Sec. 2: Economic Choice Today: Opportunity Cost
Making Choices
-What shapes the economic choices?-incentive – -utility – -“economize” – consider both incentive and
utility – -make decisions according to what you
believe is the best combination of costs and benefits
FACTOR 1:
Choices are shaped by incentive, expected utility, and the desire to economize
Costs vs. benefits – looking for best mix of costs and benefits
Making decisions – guided by self-interest – looking for ways to maximize utility
FACTOR 2:
Every choice involves costs
Money, time, or something else of value
Trade-Offs and Opportunity Costs
Trade-offs –
EXAMPLE 1:
*choice – semester long course at university vs. 6 week course at high school
selects 6 week course, less credits, but gets summer vacation
EXAMPLE 2: Opportunity cost – Alternative over another *choice – work for year
vs. work for 6 months and travel for months
Selects work for 6 months and travel for 6 months – less income, but visits friends
Analyzing Choices
-cost-benefits analysis –
-useful tool for individuals, businesses and govt. when to evaluate relative worth of economic choices
Example: Max’s Decision-Making Grid
application of cost-benefit analysis is decision-making grid
shows what you get and what you give up when you make choices
costs and benefits change over time, as do goals and circumstances
changes influence decisions people make
Example: Marginal Costs and Benefits
marginal costs – marginal benefit – analysis is central to study of
economics helps explain the decisions consumers,
producers, and govt. make as they try to meet their unlimited wants with
limited resources
Sec. 3: Analyzing Production Possibilities
Graphing the Possibilities
Economic models –
Production Possibilities Curve(PPC) – a graph used to illustrate the impact of scarcity on an economy by showing the maximum number of goods or services that can be produced using limited resources
PPC assumptions
Resources are fixed – no way to increase the availability of land, labor, capital and entrepreneurship
All resources are fully employed – there is no waste of any of the factors of production
Only two things can be produced – assumption simplifies the situation and suits the graphic format – one variable on each axis
Technology is fixed – no technological breakthroughs to improve methods of production
-Curve represents border or frontier between what is and what is not possible to produce
also called a Production Possibilities Frontieruseful for bus. & govt., but can be used by individual
Production Possibilities Curve
Figure 1.3 – 5 production possibilities for loaves of bread and bran muffins
Figure 1.4 – graph plotted from data in table – line is the PPC points represent maximum of one product
relative to the other also shows opportunity cost of one product
compared to the other
What We Learn From PPCs
No economy operates according to simplified assumptions of PPC but it spotlights concepts that work in
the real world of scarce resources Efficiency – Underutilization –
Example: Efficiency and Underutilization
Figure 1.5 – guns vs. butter – military vs. consumer production each point the on curve shows different
combination of each, and each represents efficiency
each point inside the curve is underutilization, and points outside the curve are impossible because resources are fixed
Law of Increasing Opportunity Costs
Example: Increasing Opportunity Costs
Figure 1.5 – switching from guns to butter or butter to guns each additional unit
costs more to make than the last, explains bow shape of curve
reason – making one is different from making the other – new machines, factories, and retrain Workers
Changing Production Possibilities
The PPC represents present PP if resources are fixed, but that usually changes over time additional
resources means new PP and the PPC moves outward
Example: A Shift in the PPCin the 1700s the US occupied only a small area along the Atlantic 100 yrs. Later, it expanded
to the Pacific – meaning the addition of resources, in addition to the added immigrants means additional labor
this is shown on the PPC as a shift of the curve outward – this is called economic growth
Sec. 4: The Economist’s Toolbox
Working with Data
Economics is something that everyone knows and works with everyday
Economists study this to figure out why some nations are rich or poor and why consumers want one product while others want another product
Statistics –
Using Economic Models
Models are based on assumptions and are simplified because they are based on a limited number of variables models expressed in words, graphs or
equations explain why things are as they are, help
predict future economic activity
Using Charts and Tables
Look for trends, connections and other interesting relationships
Showing numbers in relation to other numbers can reveal patterns in
the data
Using Graphs
Graphs are used to ID trends in statistics
Line graph – useful for showing changes over time
Line graphs use 2 sets of numbers or variables – one on horizontal and one on vertical axis
The numbers of what is being used are plotted on the graph and connected to form a line upward slope – upward
trend downward slope –
downward trend straight line – same
slope curved line – varied
slope
Bar Graph – useful for comparisons vividly shows
changes in data Pie Graph –
slices drawn in proportion to the number they represent
Microeconomics & Macroeconomics
-Microeconomics – -Macroeconomics – is the study of the behavior of the economy as a whole and involves topics such as inflation, unemployment, aggregate demand, and aggregate supply
Microeconomics
Micro – examines specific, individuals elements
in the economy prices, costs, profits, competition,
behavior of consumers and producers areas of specialized concentration business organization, labor markets,
agricultural economics, econ of environmental issues
Macroeconomics
Macro – examines the big picture – economy as a whole
the effect of widespread unemployment on the whole nation
a general rise on prices studies the consumer sector (household sector),
business sector, and public or govt. sector Sector –
bring a national or global perspective to work study monetary system, up and down of business
cycles, impact of national tax policies on economy, international trade and effect on rich and poor nations
Positive Economics and Normative Economics
-Positive economics – way of describing and explaining economics as it is and not
how it should be, involves verifiable facts- Normative economics –
POSITIVE ECONOMICS
Uses scientific method –
Statements can be tested against real world data and either proved or disproved
NORMATIVE ECONOMICS
Based on value judgments goes beyond facts to
ask if actions are good, values differ, so then recommendations will
Adam Smith: Founder of Modern Economics
Born in Kirkcaldy, Scotland in 1723
Studied and taught literature, logic, and moral philosophy
1764 – traveled to France – the Enlightenment – result – looked at world in new way
-1776 – challenged idea of mercantilism – govt.
controlled trade with its colonies said free trade would be better said people behave in ways that satisfy their
economic self-interests an invisible hand guides the marketplace buyers and sellers benefit from each
transition becomes foundation of modern economics