Guide to Reading

Economics is the study of how individuals and societies make choices about ways to use scarce resources to fulfill their needs and wants.

• economics

Main Idea

Key Terms

• needs • wants

• scarcity

• economic model

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Economic Choices• Economics is the study of how we make

decisions in a world where resources are limited.

• It is sometimes called the science of decision making.

• Needs are things we need for survival, such as food, clothing, and shelter.

• Wants are things we would like to have.

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(pages 406–408)(pages 406–408)

Economic Choices (cont.)

• The fundamental economic problem is scarcity–we do not have enough resources to produce all the things we would like to have.

• Because of scarcity, we must make choices among alternatives.

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(pages 406–408)(pages 406–408)

Economic Choices (cont.)

• Society must decide what to produce with its limited resources.

• For example, society may have to choose whether to produce goods for defense or services for poor people.

• Society must decide how to produce.

• For example, should we accept more pollution from factories in exchange for greater output of products?

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(pages 406–408)(pages 406–408)

Economic Choices (cont.)

• Society must decide for whom to produce.

• Who will receive the goods and services?

• In the United States, most goods and services are distributed through the price system.

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(pages 406–408)(pages 406–408)

Using Economic Models• The economy includes all the activity

in a nation that together affects the production, distribution, and use of goods and services.

(pages 408–409)(pages 408–409)

Using Economic Models (cont.)

• To study a part of the economy, economists use economic models.

• These are simplified representations of the real world, based on economic theories.

• Business and government often base decisions on solutions that emerge from testing economic models.

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(pages 408–409)(pages 408–409)

Using Economic Models (cont.)

• Models are based on assumptions.

• The quality of the model’s results can be no better than the assumptions on which it is based.

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(pages 408–409)(pages 408–409)

Using Economic Models (cont.)

• Economists use models to better understand the past or present and to predict the future.

• If predictions based on a model turn out to be wrong, economists revise the model.

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(pages 408–409)(pages 408–409)

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Why do economists use economic models?

Economists use models to study a specific part of the economy, such as rising unemployment. They use models to better understand the past or present and to predict the future. Businesses and governments make actual decisions based on the solutions that emerge from testing economic models.

Using Economic Models (cont.)

(pages 408–409)(pages 408–409)

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Guide to Reading

Trade-offs are present whenever choices are made.

• trade-off

Main Idea

Key Terms

• opportunity • cost

• marginal cost • marginal benefit

• cost-benefit analysis

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Trade-Offs• Economic decision making requires that

we take into account all the costs and all the benefits of an action.

• Economic choices involve trade-offs, or exchanging one thing for the use of another.

• For example, when you buy a product, you exchange money for the right to own that product rather than something else you could buy for the same price.

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(pages 410–413)(pages 410–413)

Trade-Offs (cont.)

• People, businesses, and societies make trade-offs every time they choose to use their resources in one way and not in another.

• More money for education may mean less money to spend on medical research or national defense.

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(pages 410–413)(pages 410–413)

Trade-Offs (cont.)

• Opportunity cost is what you cannot buy or do when you choose to do or buy one thing rather than another.

• It is the next best alternative that you had to give up for the choice you made.

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(pages 410–413)(pages 410–413)

Trade-Offs (cont.)

• Opportunity cost includes more than just money.

• It also includes the discomforts and inconveniences linked to the choice made.

• For example, the opportunity cost of cleaning the house includes not only the price of cleaning products, but also the time you spent cleaning instead of doing something else, like listening to music.

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(pages 410–413)(pages 410–413)

Trade-Offs (cont.)

• All businesses have fixed and variable costs.

• Fixed costs are expenses that are the same no matter how many units of a good are produced.

• Variable costs are expenses that change with the number of products produced.

• If a business produces more, variable costs like raw materials and wages will increase.

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(pages 410–413)(pages 410–413)

Trade-Offs (cont.)

• Fixed costs plus variable costs equal total costs.

• To find average total cost, divide total cost by the quantity produced.

• Marginal cost is the extra cost of producing one additional unit of output.

• If it costs an extra $50 to produce one more bicycle helmet, the marginal cost is $50.

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(pages 410–413)(pages 410–413)

Trade-Offs (cont.)

• Businesses measure total revenue and marginal revenue to decide what amount of output will produce the greatest profits.

• Total revenue equals the number of units sold times the average price per unit.

• Marginal revenue is the change in total revenue that results from selling one more unit of output.

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(pages 410–413)(pages 410–413)

Trade-Offs (cont.)

• We usually do something because we expect to achieve some benefit.

• Marginal benefit is the additional benefit associated with an action.

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(pages 410–413)(pages 410–413)

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Suppose you chose to study for a test. If you did not have a test the next day, you would have played basketball with friends. What is the opportunity cost of your decision? Explain.

Opportunity cost is the cost–in money, time, inconvenience, etc.–of the next best alternative given up for the choice made. Because playing basketball was the option you would have chosen next, it is the opportunity cost of the decision to study.

Trade-Offs (cont.)

(pages 410–413)(pages 410–413)

Cost-Benefit Analysis• Cost-benefit analysis is an economic

model used to compare marginal costs and marginal benefits of a decision.

• You should choose an action when the benefits are greater than the costs.

• If costs outweigh benefits, you should reject the option.

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(pages 413–414)(pages 413–414)

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Suppose you have done a cost-benefit analysis to decide how many lawns to mow to earn money during the summer. How can you tell from the graph how many lawns to mow?

You should mow only the number of lawns up to the point where marginal benefits equal marginal costs. For any additional lawns you mow after that point, the extra costs outweigh the extra benefits.

Cost-Benefit Analysis (cont.)

(pages 413–414)(pages 413–414)

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Guide to Reading

In a market economy, people and businesses act in their own best interests to answer the WHAT, HOW, and FOR WHOM questions.

• market economy

Main Idea

Key Terms

• capitalism • free enterprise

• incentive

• rational choice

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Understanding Your Role in the Economy• The United States has a market

economy.

• Most economic decisions are not made by the government, but by individuals looking out for their own and their families’ self-interests.

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(pages 416–418)(pages 416–418)

Understanding Your Role in the Economy (cont.)

• A market economy is participatory.

• The choices you make as a consumer affect the products that businesses make and the prices they receive for their products.

• Likewise, the products offered and their prices affect the choices you make.

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(pages 416–418)(pages 416–418)

Understanding Your Role in the Economy (cont.)

• A market economy is based on capitalism, a system in which citizens own most of the means of production.

• It is also based on free enterprise–businesses compete for profit with a minimum of government interference.

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(pages 416–418)(pages 416–418)

Understanding Your Role in the Economy (cont.)

• Keeping informed means reading news stories, listening to news reports, and gathering information about economic activities of businesses and government.

(pages 416–418)(pages 416–418)

Understanding Your Role in the Economy (cont.)

• Incentives are rewards offered to try to persuade people to take certain economic actions.

• Price is one incentive. • Others are bonuses for salespeople

and low credit rates for consumers.

• Knowing how incentives work will help you make wise choices.

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(pages 416–418)(pages 416–418)

Understanding Your Role in the Economy (cont.)

• One role of government in the economy is to help maintain competitive markets.

• Another role is to provide services, such as education and national defense, that the private sector does not provide.

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(pages 416–418)(pages 416–418)

Understanding Your Role in the Economy (cont.)

• Competition forces businesses to use society’s resources efficiently to produce goods and services people prefer and to produce quality products at low costs.

• Low production costs keep prices low for consumers.

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(pages 416–418)(pages 416–418)

Understanding Your Role in the Economy (cont.)

• Government can use incentives to encourage people and businesses to take certain actions.

• For example, offering scholarships encourages more people to get higher education.

• Government can also discourage certain actions.

• For example, tax laws can punish companies that cause pollution.

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(pages 416–418)(pages 416–418)

Making Wise Choices• Rational choice is choosing the alternative

that has the greatest value from among comparable-quality products.

• You make a rational choice when you buy the goods and services that you believe will best satisfy your wants for the lowest possible cost.

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(pages 418–419)(pages 418–419)

Making Wise Choices (cont.)

• Wise consumers will not all make the same choices.

• A rational choice is one that generates the greatest perceived value for any given expenditure.

• Wise decision making by individuals also benefits society by making the best use of scarce resources.

• Being fully informed is the best way to make the best economic as well as political decisions.

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(pages 418–419)(pages 418–419)

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How is good consumer decision making similar to good political decision making?

To make the best possible choices when you vote, you must be informed about candidates and issues. The same is true when you cast your dollar “votes” for goods and services. Being fully informed is the best way to make the best choices.

Making Wise Choices (cont.)

(pages 418–419)(pages 418–419)

Checking for Understanding (cont.)

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Identify What is an incentive? Provide an example of a government incentive.

Incentives are rewards to persuade people to take certain economic actions. An example of a government incentive is encouraging education by awarding scholarships and financial aid.

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Mathematics The area of economics that uses mathematical models to analyze, interpret, and predict economic behavior is known as econometrics.

There are several freedoms in free enterprise–the freedom to work where a person wants, the freedom to start one’s own business, the freedom to acquire property, the freedom to choose what goods to buy and sell, and even the freedom to fail. Sometimes people fail in their business efforts because other people have the freedom to spend their money as they choose.

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