T HE E CONOMIC W AY OF T HINKING Chapter 1

KEY CONCEPTS Economics study of how people use resources to satisfy wants how individuals/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

S CARCITY : T HE B ASIC E CONOMIC P ROBLEM Scarcity is the economic problem of having seemingly unlimited human needs and wants, in a world of limited resources. Why does it exist? It exists because wants are unlimited and resources are limited

B ASIC E CONOMIC P RINCIPLES P RINCIPLE 1: P EOPLE H AVE W ANTS 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 People make choices about all their needs and wants Wants are unlimited, ever changing

B ASIC E CONOMIC P RINCIPLES P RINCIPLE 2: S CARCITY A FFECTS E VERYONE 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

T HREE B ASIC E CONOMIC Q UESTIONS Every society must answer three basic economic questions because of scarcity. Societies answer these questions differently, leading to a variety of economic systems.

T HREE B ASIC E CONOMICS Q UESTIONS Question 1: What Will Be Produced? Societies must decide on mix of goods to produce depends 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

T HREE B ASIC E CONOMICS Q UESTIONS Question 2: How Will It Be Produced? Production decisions involve using resources efficiently Influenced natural resources Societies adopt different approaches labor-intensive methods versus capital-intensive methods depends on availability

T HREE B ASIC E CONOMICS Q UESTIONS Question 3: For Whom Will It Be Produced? How goods and services are distributed involves two questions how should each persons share be determined? how will goods and services be delivered to people?

T HE F ACTORS OF P RODUCTION Factors of production resources needed to produce goods and services 1. land 2. labor 3. Capital 4. entrepreneurship supply is limited

T HE F ACTORS OF P RODUCTION Factor 1: Land Land means all natural resources on or under the ground includes water, forests, wildlife, mineral deposits

T HE F ACTORS OF P RODUCTION 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

T HE F ACTORS OF P RODUCTION Factor 3: Capital Capital is a producers 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

T HE F ACTORS OF P RODUCTION 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

Two factors affect economic decisions: 1. Incentives benefits that encourage people to act in certain ways 2. Utility benefit or satisfaction gained from using a good or service Choices vary between individuals based on what is best for him / her Making Economic Choices

M AKING E CONOMIC C HOICES 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

M AKING E CONOMIC C HOICES 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

T RADE -O FFS AND O PPORTUNITY C OST 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

T RADE -O FFS AND O PPORTUNITY C OST Example of a Trade Off Jessica wants to earn college credit over summer semester-long university course offers more credits six-week high school course leaves time for vacation

T RADE -O FFS AND O PPORTUNITY C OST Opportunity cost is value of next-best alternative a person gives up not the value of all possible alternativ es Example of Opportunity Cost Dan chooses to work for six months so he can travel for six months opportunity cost = six months of salary

V IDEO C LIP : O PPORTUNITY C OST

O PPORTUNITY C OST A CTIVITY In a group of 2 -3 consider this scenario: You have won $1,000. Create a chart with these columns: What will you buy? What will you gain from each choice? What do you give up with each choice? (Whats the opportunity cost?)

A NALYZING E CONOMIC C HOICES Cost-benefit analysis: examines the costs and expected benefits of choices one of most useful tools for evaluating relative worth of economic choices

A NALYZING E CONOMIC C HOICES 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

A NALYZING P RODUCTION P OSSIBILITIES KEY CONCEPTS Production possibilities curve (PPC) is one model (graph) PPC shows the maximum goods or services that can be produced from limited resources also called production possibilities frontier PPC PPC based on assumptions: resources are fixed all resources are fully employed only two things can be produced technology is fixed

G RAPHING THE P OSSIBILITIES 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

W HAT W E L EARN FROM PPC S Efficiency producing the maximum amount of goods and services possible Underutilization producing fewer goods and services than possible

W HY IS THE PPC A C URVE ? Law of increasing opportunity costs as production switches from one product to another, more resources needed to increase production of second product 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

L ET S L OOK AT S OME E XAMPLES PPC Practice

C HANGING P RODUCTION P OSSIBILITIES A countrys 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

PPFT HE C URVE What Does Guns And Butter Curve Mean? In a theoretical economy with only two goods, a choice must be made between how much of each good to produce. As an economy produces more guns (military spending) it must reduce its production of butter (food), and vice versa.

M ICROECONOMICS AND M ACROECONOMICS 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

M ICROECONOMICS AND M ACROECONOMICS 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

E XAMPLES OF M ACRO AND M ICRO Which is it? 1. National Unemployment Figures Rise 2. World Trade Organization Meets 3. Shipbuilder Wins Navy Contract 4. Cab Drivers on Strike! 5. Gasoline Prices Jump 25 Cents