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Understanding Economics 3rd edition by Mark Lovewell, Khoa Nguyen and Brennan Thompson
Chapter 1
The Economic Problem
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Learning Objectives
In this chapter, you will:
consider the economic problem that underlies the definition of economics
learn about the way economists specify economic choice
examine the production choices an entire economy faces, as demonstrated by the production possibilities model
analyze the three basic economic questions and how various economic systems answer them
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Economics Defined
Economics is the study of how to distribute scarce resources among competing ends.
Microeconomics focuses on individual consumers and businesses.
Macroeconomics takes a broad view of the economy.
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The Economic Problem
Economists deal with the economic problem.
Economic agents must continually make choices.
Their wants are unlimited.
They face a limited supply of economic resources (human, natural, capital)
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Economic Models
Economic models:
simplify economic reality
show how dependent variables are affected by independent variables
include inverse and/or direct relationships
incorporate a variety of assumptions such as ceteris paribus
are classified as part of either positive economics or normative economics
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Economic Choice
Economists assume that economic decision-makers maximize their own utility.
Decision-makers must keep in mind the opportunity cost of each alternative.
Opportunity cost is defined as the utility of the best forgone alternative.
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7. The Production Possibilities Model
The production possibilities model is based on three assumptions:
an economy makes only two products
resources and technology are fixed
all resources are employed to their fullest capacity
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8. The Production Possibilities Curve (a)
The production possibilities curve shows a range of possible output combinations for an economy.
It highlights the scarcity of resources.
It has a concave shape, which reflects the law of increasing opportunity costs.
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9. The Production Possibilities Curve (b) Figure 1.1, page 8
Production Possibilities Schedule
Hamburgers Computers point
on graph a
1000 b
unattainable f
900
Hamburgers
600 c a
900 1 b
600 2 c
0 3 d e
inefficient d
Computers
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10. The Law of Increasing Costs Figure 1.2, page 10
Production Possibilities Curve
Production Possibilities Schedule
Hamburgers Opportunity Computers point
Cost of on graph
Computers a
As the quantity
of computers
rises, so does their
opportunity cost.
1000 b
900 a
Hamburgers
600 c
100 b
300 c
600 d d
Computers
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11. Shifts in Production Possibilities Figure 1.2, page 10
Production Possibilities Curve
With more
computers, the
curve shifts out
in the next
period.
1000
Hamburgers
Computers
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12. The Basic Economic Questions
There are three basic questions any society must answer:
what to produce
how to produce
for whom to produce
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Economic Systems
There are three systems to choose from:
Traditional economies focus on non-economic concerns and have tight social constraints.
Market economies are consumer-centered and innovative but create inequality and instability.
Command economies equalize incomes but often have a lack of freedom.
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14. The Range of Economic Systems (a)
Most countries have mixed economies.
Modern mixed economies include both private and public sectors.
Traditional mixed economies combine traditional sectors with private and/or public sectors.
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Circular Flow Diagram
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16. The Range of Economic Systems (b) Figure 1.4, page 16
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Economic Goals
There are seven major economic goals:
economic efficiency
income equity
price stability
full employment
viable balance of payments
economic growth
environmental sustainability
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18. Complementary and Conflicting Economic Goals
Economic goals may be complementary.
An example is the relationship between full employment and economic growth.
Economic goals may be conflicting.
An example is the relationship between price stability and full employment.
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19. The Founder of Modern Economics
Adam Smith:
explained how the division of labour increases production
argued that self interest is transformed by the invisible hand of competition so that it creates significant economic benefits
stressed the principle of laissez faire, which means that governments should not intervene in economic activity
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Understanding Economics 3rd edition by Mark Lovewell, Khoa Nguyen and Brennan Thompson
Chapter 1
The End
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