Chapter 1: The Nature and Methods of Economic Definition of Economics The social science concerned with the efficient use of limited or scarce resources to achieve maximum satisfaction of human needs. Human wants are unlimited, but the means to satisfy the wants are limited.

Got stuff? Who made it? How was it made? How did you get it?

I. The Economic Problem the basic economic problem is scarcity: -- wants are unlimited, but resources are limited so with scarcity, we must make choices, and with choices, come costs

2.Products are sometimes classified as luxuries or necessities, but the division is subjective. 3.Services satisfy wants as well as goods. 4.Businesses and governments also have wants. 5. Over time, wants change and multiply.

B. the second fundamental fact: Scarce resources: 1.Economic resources are limited relative to wants. 2.Economic resources are sometimes called factors of production (inputs) and include four categories:

Scarcity and choice Resources can only be used for one purpose at a time. Scarcity requires that choices be made. we have to decide (make a choice) what we will have and what we will forgo The cost of any good, service, or activity is the value of what must be given up to obtain it (opportunity cost).

Cost is the opportunity cost -- what you give up when you make a choice -- “there’s no such thing as a free lunch”

Cost of going to college -- what you can buy with tuition & fees -- what you could earn by working -- what you could do with the free time

you are willing to give up -- tuition -- wages -- leisure time to go to college -- b/c you expect higher income or more rewarding career

economics is the study of choices of how to allocate scarce resources choices made by -- consumers -- businesses -- governments

What are resources? use resources to produce goods and services factors of production -- land -- labor -- capital -- entrepreneurship

Land all natural resources -- land -- minerals -- water -- wildlife

Labor size of labor force (quantity) skills of labor force (quality) -- human capital the value of time

Capital physical capital -- goods used to make other goods -- factories -- machines -- infrastructure

NOT financial capital -- stocks, bonds, bank loans financial capital facilitates building of physical capital

entrepreneurship human resource ideas -- doing things better -- e-commerce -- new products

RESOURCE PAYMENTS Rent or Rental Income Interest Income WAGES PROFIT & LOSS PROPERTY RESOURCES LAND CAPITAL HUMAN RESOURCES LABOR ENTREPRENEUR

Three Questions to answer: 1. What to produce? 2. How to produce the stuff in #1? 3. For whom to produce? (who gets the stuff in #1?)

Example: A Bentley 1. What to produce? Bentley Motors designs a luxury car with buyers in mind Bentley Motors decides how much to produce give the price and their costs Buyers decide how many to buy, based on price, their income, tastes, etc.

Bentley Motors designs factory, uses machinery, & trains workers to minimize cost BUT retain a certain quality government restricts this decision: Pollution laws safety laws labor laws 2. How to produce?

Those who are willing and able to pay K.D 50,000 for one. (this is why I don’t have it) 3. Who gets the Bentley ?

Who answers #1-3? pure capitalism when buyers and sellers interact to answer these questions markets unrestricted private property prices coordinate #1-3

the U.S. is a mixed market economy, since government plays a role enforces property rights regulates markets taxes to provide goods & services

command system the government answers questions 1-3 former U.S.S.R., N. Korea reduced incentives for efficiency coordination failures

Why Study Economics? Economics for citizenship 1. Most political problems have an economic aspect, whether it is balancing the budget, fighting over the tax structure (Kuwait is planning to introduce income tax), welfare reform, international trade, or concern for the environment. 2.Both the voters and the elected officials can fulfill their role more effectively if they have an understanding of economic principles.

Why Study Economics? Professional and personal applications Economics helps people to make sense of every day activity they observe around them Economic principles enable business managers to make more intelligent decisions.

Economics can help individuals make better buying decisions, better employment choices, and better financial investments. Economics is to examine problems and decisions from a social rather than personal point of view.

Policy economics applies economic facts and principles to help resolve specific problems and to achieve certain economic goals. Steps in formulating economic policy: 1. State goals. 2. Recognize various options that can be used to achieve goals. 3. Evaluate the options on the basis of specific criteria important to decision-makers.

Macroeconomics and Microeconomics Macroeconomics examines the economy as a whole. It includes measures of total output, total employment, total income, aggregate expenditures, and the general price level. Microeconomics looks at specific economic units. It is concerned with the individual industry, firm or household and the price of specific products and resources.

Specialization How do we get the most out of our resources? We specialize in what we do best and trade that for what we need

I teach. I get paid for it. I use the money to buy food oil changes clothes

If I grew my own food made my own clothes fixed my own car I would not consume as much Specialization produces gains! I can consume more than what I could make on my own

Who specializes in what? Comparative advantage if you produce a good at a lower opportunity cost then you should specialize in it

Example: married couple Husband: surgeon $250,000 /year Wife: 5th grade teacher $50,000 /year who should run the household? Who has lower opportunity cost? The wife.

with specialization, division of labor different people specialize in different things people become very good at their task efficiency gains -- get more out of same resources

specialization is everywhere doctors neurosurgeon, obstetrics, pediatrics,… lawyers divorce, real estate, patent law, personal injury...

The bottom line: Scarcity & opportunity cost are unavoidable. BUT efficiency & specialization make the most of scarce resources

Employment and Efficiency Economics is a science of efficiency in the use of scarce resources. Efficiency requires full employment of available resources and full production. 1.Full employment means all available resources should be employed. 2.Full production means that employed resources are providing maximum satisfaction of our economic wants. Underemployment occurs if this is not so.

PIZZA01234 (in hundred thousands) ROBOTS (in thousands) in table form PRODUCTION POSSIBILITIES 39

PIZZA01234 (in hundred thousands) ROBOTS (in thousands) in table form graphical form Robots (thousands) Pizzas (hundred thousands) PRODUCTION POSSIBILITIES 40

PIZZA01234 (in hundred thousands) ROBOTS (in thousands) in table form graphical form Robots (thousands) Pizzas (hundred thousands) PRODUCTION POSSIBILITIES 41

PIZZA01234 (in hundred thousands) ROBOTS (in thousands) in table form graphical form Robots (thousands) Pizzas (hundred thousands) PRODUCTION POSSIBILITIES 42

PIZZA01234 (in hundred thousands) ROBOTS (in thousands) in table form graphical form Robots (thousands) Pizzas (hundred thousands) PRODUCTION POSSIBILITIES 43

PIZZA01234 (in hundred thousands) ROBOTS (in thousands) in table form graphical form Robots (thousands) Pizzas (hundred thousands) PRODUCTION POSSIBILITIES 44

PIZZA01234 (in hundred thousands) ROBOTS (in thousands) in table form graphical form Robots (thousands) Pizzas (hundred thousands) PRODUCTION POSSIBILITIES 45

At any point in time, a full-employment, full- production economy must sacrifice some of product X to obtain more of product Y. PRODUCTION POSSIBILITIES Limited Resources means a limited output... 46

Choices will be necessary because resources and technology are fixed. A production possibilities table illustrates some of the possible choices. A production possibilities curve is a graphical representation of choices. 1.Points on the curve represent maximum possible combinations of robots and pizza given resources and technology. 2.Points inside the curve represent underemployment or unemployment. 3.Points outside the curve are unattainable at present. 47

Optimal or best product-mix: 1.It will be some point on the curve. 2.The exact point depends on society; this is a normative decision. 48

Q Q Robots (thousands) Pizzas (hundred thousands) A B C D E W Attainable but Inefficient Unattainable Attainable & Efficient PRODUCTION POSSIBILITIES 49

Q Q Robots (thousands) Pizzas (hundred thousands) A B C D E W Attainable but Inefficient Unattainable Attainable & Efficient PRODUCTION POSSIBILITIES Notes... The amount of other products that must be forgone or sacrificed to obtain 1 unit of a specific product is called the opportunity cost of that good. LAW OF INCREASING OPPORTUNITY COSTS 50

Q Q Robots (thousands) Pizzas (hundred thousands) A B C D E W Attainable but Inefficient Unattainable Attainable & Efficient PRODUCTION POSSIBILITIES Notes... LAW OF INCREASING OPPORTUNITY COSTS A graph of the production possibilities curve will be CONCAVE - bowed out from the origin. Economic resources are not completely adapt- able to other uses. 51

E. Law of increasing opportunity costs: 1.The amount of other products that must be foregone to obtain more of any given product is called the opportunity cost. 2.Opportunity costs are measured in real terms rather than money (market prices are not part of the production possibilities model). 3.The more of a product produced the greater is its (marginal) opportunity cost. 4.The slope of the production possibilities curve becomes steeper, demonstrating increasing opportunity cost. This makes the curve appear bowed out, concave from the origin. 52

Economic Rationale: a.Economic resources are not completely adaptable to alternative uses. b.To get increasing amounts of pizza, resources that are not particularly well suited for that purpose must be used. Workers that are accustomed to producing robots on an assembly line may not do well as kitchen help. How does society decide its optimal point on the production possibilities curve? 53

Unemployment, Growth, and the Future Unemployment and productive inefficiency occur when the economy is producing less than full production or inside the curve (point U in the following figure). In a growing economy, the production possibilities curve shifts outward: 1.when resource supplies expand in quantity or quality. 2.when technological advances are occurring. 54

Q Q Robots (thousands) Pizzas (hundred thousands) U Unemployment & Underemployment Shown by Point U More of either or both is possible PRODUCTION POSSIBILITIES 55

Q Q Robots (thousands) Pizzas (hundred thousands) U Unemployment & Underemployment Shown by Point U More of either or both is possible PRODUCTION POSSIBILITIES Notes... Economic Growth The ability to produce a larger total output - a rightward shift of the production possibilities curve caused by... 56

Q Q Robots (thousands) Pizzas (hundred thousands) U Unemployment & Underemployment Shown by Point U More of either or both is possible PRODUCTION POSSIBILITIES Notes... Economic Growth 1 – Increase in resource supplies 2 – Better resource quality 3 – Technological advances 57

Economic Growth Q Q Robots (thousands) Pizzas (hundred thousands) A’ B’ C’ D’ E’ PRODUCTION POSSIBILITIES 58

Present choices and future possibilities: Using resources to produce consumer goods and services represents a choice for present over future consumption. Using resources to invest in technological advances, education, and capital goods represents a choice for future over present goods. The decision as to how to allocate resources in the present will create more or less economic growth in the future. (See for example Global Perspective 2-1 where various countries are compared with respect to their economic growth rates relative to the share of GDP devoted to investment.) D.A Qualification: International Trade 1.A nation can avoid the output limits of its domestic Production Possibilities through international specialization and trade. 2.Specialization and trade have the same effect as having more and better resources of improved technology. 59

Two Examples of Economic Growth ALTA - FAVORS PRESENT GOODS Goods for the Present Goods for the Future CURRENT CURVE FUTURE CURVE CONSUMPTION PRODUCTION POSSIBILITIES Alta 60

Two Examples of Economic Growth ALTA - FAVORS PRESENT GOODS ZORN - FAVORS FUTURE GOODS Goods for the Present Goods for the Future CURRENT CURVE FUTURE CURVE CONSUMPTION Goods for the Present Goods for the Future FUTURE CURVE CONSUMPTION CURRENT CURVE PRODUCTION POSSIBILITIES Alta Zorn 61

Economic systems Economic systems differ in two important ways: Who owns the factors of production and the method used to coordinate economic activity. A.The market system: 1.There is private ownership of resources. 2.Markets and prices coordinate and direct economic activity. 3.Each participant acts in his or her own self-interest. 4.In pure capitalism the government plays a very limited role. 62

Economic systems B. Command economy, socialism or communism: 1.There is public (state) ownership of resources. 2.Economic activity is coordinated by central planning. C. Mixed economy 63