The Economic Way of Thinking

Chapter 1: The Economic Way of Thinking Scarcity is the situation that exists because wants are unlimited and resources are limited.

Scarcity: The Basic Economic Problem What Is Scarcity? 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 Shortage – a situation when suppliers decide to cut production of a good

People Have Wants People make choices about all their needs and wants Wants are unlimited, ever changing

Scarcity Affects Everyone Scarcity affects which goods & 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 3 economic questions every society must answer: 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: how should each person’s share be determined? how will goods & services be delivered to people?

The Factors of Production Factors of production — resources needed to produce goods and services include land, labor, capital, entrepreneurship supply of these factors 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

Practice With a partner, decide on a good or service you would like to produce (of course it’s appropriate for class and legal). Tell me in your notes: 1. the good or service 2. each of the 4 factors of production -tell me the land you need to produce -tell me the labor you need to produce etc. We will share out when everyone is finished.

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

Economic Choice Today: Opportunity Cost Making Choices 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

There’s No Such Thing as a 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 Trade-off is alternative people give up when they make a choice Your most desired Trade-off is your OPPORTUNITY COST

Analyzing Choices 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 (text pg. 15) 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

Marginal Costs and Benefits 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

Reviewing Key Concepts 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 Analyzing Production Possibilities Graphing the Possibilities 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

Production Possibilities Curve 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

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 Each point on PPC represents efficiency (producing the maximum amount of goods and services possible); points inside curve mean underutilization (producing fewer goods and services than possible); outside curve cannot be met (unattainable)

Increasing Opportunity Costs Law of increasing opportunity costs as production switches from one product to another, more resources are needed to increase production of second product anotherwords, 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

Shifting the Production Possibilities 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

Reviewing Key Concepts Explain how each term is illustrated by the production possibilities curve: underutilization efficiency

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 Explain the real cost of expanding O’Hare Airport. Use information presented in the documents to support your answer. Who are the most likely winners and losers as a result of the O’Hare expansion? Explain your answer. How might supporters of expansion use a production possibilities model to strengthen their case?