Chapter 1: The Economic Way of Thinking

Sec. 1: Scarcity: The Basic Economic Problem

What is Scarcity?

Wants – Needs –

People always want more, no matter what they have wants are unlimited, but

resources to fill are limited

Scarcity – not a temporary

shortage, it is a problem facing individuals, businesses, govt., society

Science to study it is called economics

Economics – the study of how people choose to use scarce resources to satisfy their wants

Econ involves: Examining – Organizing, analyzing, and

interpreting data about those economic behaviors

Developing theories and economic laws that explain how the economy works and to predict what might happen in the future.

Principle 1: Choice is central to

the use of scarce resources.

Choices about needs – what kind of food

Choices about wants – these are unlimited & ever changing

Principle 2: Scarcity affects which

goods are made and services are provided Goods – physical objects

that can be purchased Services – work that one

person performs for another for payment

Consumer – Producer –

Scarcity Leads to 3 Questions

Question 1:

Society must decide the mix of goods and services it will produce what is produced depends on the natural resources

possessed but resources do not completely control what a country

produces some countries decide by allowing consumers and

producers to decide in other countries, the govt. decides what goods and

services will be produced This question also involves how much to produce

the country must review its wants at any time to decide this

Question 2:

This involves using scarce resources in the most efficient ways to satisfy wants this is also influenced by the natural

resources that a society possesses ex. - growing crops – different approaches large unskilled labor force – labor intensive

methods – few machines highly skilled labor force – capital intensive

– lots of machines

Question 3:

This involves how goods will be distributed

among people in society Questions –Need to determine how

much people should get how much they pay or equal share

Distribution networks –

The Factors of Production

 

-the economic resources needed to produce goods and services

Factor 1:

Includes all natural resources found on or under the ground that are used to produce goods and services

Factor 2:

is all the human time, effort, and talent that goes in to the making of products

Factor 3:

is all the resources made and used by people to produce and distribute goods and services ex. –

human capital – ex. – college, job

training

Factor 4:

Is the combination of vision, skills, ingenuity, and willingness to take risks that is needed to create and run new businesses most entrepreneurs are

innovators try to anticipate and meet

needs of consumers in new ways

new product, method of production, way of marketing or distributing

Are also risk takers – risk time, energy, creativity, money in hope for profit

Sec. 2: Economic Choice Today: Opportunity Cost

Making Choices

-What shapes the economic choices?-incentive – -utility – -“economize” – consider both incentive and

utility – -make decisions according to what you

believe is the best combination of costs and benefits

FACTOR 1:

Choices are shaped by incentive, expected utility, and the desire to economize

Costs vs. benefits – looking for best mix of costs and benefits

Making decisions – guided by self-interest – looking for ways to maximize utility 

FACTOR 2:

Every choice involves costs

Money, time, or something else of value

Trade-Offs and Opportunity Costs

Trade-offs –

EXAMPLE 1:

*choice – semester long course at university vs. 6 week course at high school

selects 6 week course, less credits, but gets summer vacation

EXAMPLE 2:

Opportunity cost – Alternative over

another *choice – work for year

vs. work for 6 months and travel for months

Selects work for 6 months and travel for 6 months – less income, but visits friends

Analyzing Choices

-cost-benefits analysis –

-useful tool for individuals, businesses and govt. when to evaluate relative worth of economic choices

Example: Max’s Decision-Making Grid

application of cost-benefit analysis is decision-making grid

shows what you get and what you give up when you make choices

costs and benefits change over time, as do goals and circumstances

changes influence decisions people make

Example: Marginal Costs and Benefits

marginal costs – marginal benefit – analysis is central to study of

economics helps explain the decisions consumers,

producers, and govt. make as they try to meet their unlimited wants with

limited resources

Sec. 3: Analyzing Production Possibilities

Graphing the Possibilities

Economic models –

Production Possibilities Curve(PPC) – a graph used to illustrate the impact of scarcity on an economy by showing the maximum number of goods or services that can be produced using limited resources

PPC assumptions

Resources are fixed – no way to increase the availability of land, labor, capital and entrepreneurship

All resources are fully employed – there is no waste of any of the factors of production

Only two things can be produced – assumption simplifies the situation and suits the graphic format – one variable on each axis

Technology is fixed – no technological breakthroughs to improve methods of production

-Curve represents border or frontier between what is and what is not possible to produce

also called a Production Possibilities Frontieruseful for bus. & govt., but can be used by individual

Production Possibilities Curve

Figure 1.3 – 5 production possibilities for loaves of bread and bran muffins

Figure 1.4 – graph plotted from data in table – line is the PPC points represent maximum of one product

relative to the other also shows opportunity cost of one

product compared to the other 

What We Learn From PPCs

No economy operates according to simplified assumptions of PPC but it spotlights concepts that work in

the real world of scarce resources Efficiency – Underutilization –

Example: Efficiency and Underutilization

Figure 1.5 – guns vs. butter – military vs. consumer production each point the on curve shows different

combination of each, and each represents efficiency

each point inside the curve is underutilization, and points outside the curve are impossible because resources are fixed

Law of Increasing Opportunity Costs

Example: Increasing Opportunity Costs

Figure 1.5 – switching from guns to butter or butter to guns each additional unit

costs more to make than the last, explains bow shape of curve

reason – making one is different from making the other – new machines, factories, and retrain Workers

Changing Production Possibilities

The PPC represents present PP if resources are fixed, but that usually changes over time additional

resources means new PP and the PPC moves outward 

Example: A Shift in the PPCin the 1700s the US occupied only a small area along the Atlantic 100 yrs. Later, it expanded

to the Pacific – meaning the addition of resources, in addition to the added immigrants means additional labor

this is shown on the PPC as a shift of the curve outward – this is called economic growth

Sec. 4: The Economist’s Toolbox

Working with Data

Economics is something that everyone knows and works with everyday

Economists study this to figure out why some nations are rich or poor and why consumers want one product while others want another product

Statistics –

Using Economic Models

Models are based on assumptions and are simplified because they are based on a limited number of variables models expressed in words, graphs or

equations explain why things are as they are, help

predict future economic activity

Using Charts and Tables

Look for trends, connections and other interesting relationships

Showing numbers in relation to other numbers can reveal patterns in

the data

Using Graphs

Graphs are used to ID trends in statistics

Line graph – useful for showing changes over time

Line graphs use 2 sets of numbers or variables – one on horizontal and one on vertical axis

The numbers of what is being used are plotted on the graph and connected to form a line upward slope – upward

trend downward slope –

downward trend straight line – same

slope curved line – varied

slope

Bar Graph – useful for comparisons vividly shows

changes in data Pie Graph –

slices drawn in proportion to the number they represent

Microeconomics & Macroeconomics

-Microeconomics – -Macroeconomics – is the study of the behavior of the economy as a whole and involves topics such as inflation, unemployment, aggregate demand, and aggregate supply

Microeconomics

Micro – examines specific, individuals elements

in the economy prices, costs, profits, competition,

behavior of consumers and producers areas of specialized concentration business organization, labor markets,

agricultural economics, econ of environmental issues

Macroeconomics

Macro – examines the big picture – economy as a whole

the effect of widespread unemployment on the whole nation

a general rise on prices studies the consumer sector (household sector),

business sector, and public or govt. sector Sector –

bring a national or global perspective to work study monetary system, up and down of business

cycles, impact of national tax policies on economy, international trade and effect on rich and poor nations

Positive Economics and Normative Economics

-Positive economics – way of describing and explaining economics as it is and not

how it should be, involves verifiable facts- Normative economics –

POSITIVE ECONOMICS

Uses scientific method –

Statements can be tested against real world data and either proved or disproved

NORMATIVE ECONOMICS

Based on value judgments goes beyond facts to

ask if actions are good, values differ, so then recommendations will

Adam Smith: Founder of Modern Economics

Born in Kirkcaldy, Scotland in 1723

Studied and taught literature, logic, and moral philosophy

1764 – traveled to France – the Enlightenment – result – looked at world in new way

-1776 – challenged idea of mercantilism – govt.

controlled trade with its colonies said free trade would be better said people behave in ways that satisfy

their economic self-interests an invisible hand guides the marketplace buyers and sellers benefit from each

transition becomes foundation of modern economics