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THE ECONOMIC
WAY OF THINKINGCHAPTER 1
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SCARCITY: THE BASIC ECONOMIC PROBLEMSECTION 1
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WHAT IS SCARCITY?• WANTS – ARE DESIRES THAT CAN BE SATISFIED BY CONSUMING A GOOD OR A
SERVICE
• NEEDS – ARE THINGS THAT ARE NECESSARY FOR SURVIVAL
• SCARCITY – EXISTS WHEN THERE ARE NOT ENOUGH RESOURCES TO SATISFY HUMAN WANTS. SCARCITY IS NOT A TEMPORARY SHORTAGE OF SOME DESIRED THING.
• ECONOMICS IS THE STUDY OF HOW INDIVIDUALS AND SOCIETIES SATISFY THEIR UNLIMITED WANTS WITH LIMITED RESOURCES
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THE 2 PRINCIPLES
• PEOPLE HAVE WANTS
• SCARCITY AFFECTS EVERYONE
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SCARCITY LEADS TO 3 ECONOMIC QUESTIONS
• WHAT WILL BE PRODUCED?
• HOW WILL IT BE PRODUCED?
• FOR WHOM WILL IT BE PRODUCED?
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WHAT WILL BE PRODUCED?
• SOCIETY MUST DECIDE THE MIX OF GOODS AND SERVICES IT WILL PRODUCE.
• FOOD, TELEVISIONS, AUTOMOBILES, COMPUTERS?
• WHAT NATURAL RESOURCES DO WE HAVE?
• WHAT DO CONSUMERS WANT? DO WE CARE WHAT THEY WANT?
• HOW MUCH DO WE PRODUCE?
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HOW WILL IT BE PRODUCED?
• WHAT IS THE MOST EFFICIENT WAY?
• NATURAL RESOURCES INFLUENCE
• INCLUDING HOW WE USE PEOPLE
• LABOR INTENSIVE FARMING OR MACHINERY
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FOR WHOM WILL IT BE PRODUCED?
• HOW MUCH SHOULD PEOPLE GET?
• EQUAL SHARES? PAY?
• HOW SHOULD THEIR SHARE BE DELIVERED TO THEM?
• TRUCKS, CARS, BOATS, HIGHWAYS, TRAINS, AIRPLANES, MULE, MAGIC?
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FACTORS OF PRODUCTION• LAND – REFERS TO ALL NATURAL RESOURCES USED TO PRODUCE GOODS
AND SERVICES
• LABOR – IS ALL OF THE HUMAN EFFORT USED TO PRODUCE GOODS AND SERVICES. IT IS NOT JUST PHYSICAL WORK. (DOCTORS, LAWYERS, ETC)
• CAPITAL IS ALL OF THE RESOURCES MADE AND USED BY PEOPLE TO PRODUCE GOODS AND SERVICES
• ENTREPRENEURSHIP – INVOLVES THE VISION, SKILLS, AND RISK-TAKING NEEDED TO CREATE AND RUN BUSINESS.
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HUMAN CAPITAL
• WORKERS INVEST IN HUMAN CAPITAL (THE KNOWLEDGE AND SKILLS GAINED THOUGH EXPERIENCE)
• COLLEGE DEGREE
• JOB TRAINING
• SKILLS
• WHEN WORKERS POSSESS MORE HUMAN CAPITAL, THEY ARE MORE PRODUCTIVE
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ECONOMIC CHOICE TODAY: OPPORTUNITY COSTSECTION 2
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KEY CONCEPTS
• INCENTIVE ARE METHODS USED TO ENCOURAGE PEOPLE TO TAKE CERTAIN ACTIONS.
• UTILITY IS THE BENEFIT OR SATISFACTION RECEIVED FROM USING A GOOD OR SERVICE
• ECONOMIZE MEANS TO MAKE DECISIONS ACCORDING TO THE BEST COMBINATION OF COSTS AND BENEFITS.
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MAKING CHOICES• FACTOR 1: MOTIVATIONS FOR CHOICE
• CHOICE POWERS ECONOMY
• WHAT POWERS CHOICE?
• INCENTIVES
• EXPECTED UTILITY
• DESIRE TO ECONOMIZE
• GUIDED BY SELF-INTEREST
• NOT THAT YOU BEHAVE SELFISHLY!
• MAXIMIZE UTILITY
• FACTOR 2: NO FREE LUNCH
• “THERE IS NO SUCH THING AS A FREE LUNCH.”
• EVERY CHOICE INVOLVES COSTS.
• MONEY
• TIME
• OR SOMETHING ELSE
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TRADE-OFFS AND OPPORTUNITY COST• EXAMPLE 1 – MAKING TRADE OFFS
• TRADE-OFF IS THE ALTERNATIVE PEOPLE GIVE UP WHEN THEY MAKE A CHOICE
• PIZZA OR WINGS
• MOVIE OR STUDYING
• JOB OR HANGING OUT WITH FRIENDS
• EXAMPLE 2 – COUNTING THE OPPORTUNITY COST
• OPPORTUNITY COST IS THE VALUE OF SOMETHING THAT IS GIVEN UP TO GET SOMETHING ELSE THAT IS WANTED.
• IT IS THE VALUE OF THE NEXT BEST ALTERNATIVE
• JOBS OR HANGING OUT WITH FRIENDS
• MONEY OR FUN
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COST-BENEFIT ANALYSIS
• IS AN APPROACH THAT WEIGHS THE BENEFITS OF AN ACTION AGAINST ITS COSTS
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Choice Benefit Opportunity Cost
One hour of study D in Economics Class One hour with friends
Two hours of study C in Economics Class Two hours with friends
Three hours of study B in Economic Class Three hours with friends
Four hours of study B+ in Economic Class Four hours with friends
Five Hours of study A- in Economic Class Five hours with friends
Six hours of study A in Government Class
Six hours with friends
Seven hours of study A in Government Class
Seven hours with Friends
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MARGINAL COSTS AND BENEFITS
• MARGINAL COST IS THE ADDITIONAL COST OF USING ONE MORE UNIT OF A PRODUCT
• MARGINAL BENEFIT IS THE ADDITIONAL SATISFACTION FROM USING ONE MORE UNIT OF A PRODUCT
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ANALYZING PRODUCTION POSSIBILITIESSECTION 3
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KEY CONCEPTS
• ECONOMIC MODEL IS A SIMPLIFIED REPRESENTATION OF ECONOMIC FORCES
• PRODUCTION POSSIBILITIES CURVE IS A GRAPH USED BY ECONOMISTS TO SHOW THE IMPACT OF SCARCITY ON AN ECONOMY.
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PRODUCTION POSSIBILITIES CURVE (PPC)ASSUMPTIONS
• RESOURCES ARE FIXED
• ALL RESOURCES ARE FULLY EMPLOYED
• ONLY TWO THINGS CAN BE PRODUCED
• TECHNOLOGY IS FIXED
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PPCBread muffins
12 0
10 35
7 63
4 84
0 100
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ab
c
A = Here you are using all the ingredients to make only bread
B= combination
C= Here you are using all the ingredients to make muffins
muffins
bread
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WHAT WE LEARN FROM PPCS
• EFFICIENCY INVOLVES PRODUCING THE MAXIMUM AMOUNT OF GOODS AND SERVICES POSSIBLE
• UNDERUTILIZATION MEANS PRODUCING FEWER GOODS AND SERVICES THAN POSSIBLE
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a
b
c
A = Any point on the curve represents efficiency
B= inside the curve is underutilization
C= outside the curve is a production impossibility.
butter
guns
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SOME EXAMPLES
• OPPORTUNITY COST
• GUNS VS BUTTER
• INCREASE IN OPPORTUNITY COST – EACH ADDITIONAL UNIT COSTS MORE THAN THE LAST.
• SHIFT IN THE PPC
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More resources or increased productivity shifts the PPC outward, or to the right, from PPC 1 to PPC2.
butter
gunsPPC1 PPC2
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THE ECONOMIST’S TOOLBOXSECTION 4
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WORKING WITH DATA• KEY CONCEPTS
• STATISTICS ARE INFORMATION IN NUMERICAL FORM
• USING ECONOMIC MODELS
• BASED ON ASSUMPTIONS AND ARE SIMPLIFIED BECAUSE THY FOCUS ON A LIMITED NUMBER OF VARIABLES. IN SOME CASES, MODELS CAN HELP ECONOMISTS TO PREDICT FUTURE ECONOMIC ACTIVITY. THE PPC IS AN EXAMPLE.
• USING CHARTS AND TABLES
• USING GRAPHS
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MICROECONOMICS• MICROECONOMICS IS THE STUDY OF INDIVIDUALS, FAMILIES, AND BUSINESSES IN AN
ECONOMY.
• SMALL
• UNITS OF STUDY
• CONSUMER MARKETS, BUSINESS MARKETS, LABOR MARKETS
• TOPICS OF INTEREST
• MARKETS, PRICES, COSTS, PROFITS, COMPETITION, GOVERNMENT REGULATION
• CONSUMER BEHAVIOR
• BUSINESS BEHAVIOR
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MACROECONOMICS• MACROECONOMICS IS THE STUDY OF THE ECONOMY AS A WHOLE AND IS CONCERNED WITH
LARGE-SCALE ECONOMIC ACTIVITY.
• BIG
• UNITS OF STUDY
• ECONOMIC GROWTH, ECONOMIC STABILITY, INTERNATIONAL TRADE
• TOPICS OF INTEREST
• MONEY, BANKING, FINANCE
• GOVERNMENT TAXING AND SPENDING POLICIES
• EMPLOYMENT AND UNEMPLOYMENT
• INFLATION
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POSITIVE AND NORMATIVE ECONOMICS
• POSITIVE ECONOMICS STUDIES ECONOMIC BEHAVIOR AS IT IS
• NORMATIVE ECONOMICS INVOLVES JUDGMENTS OF WHAT ECONOMIC BEHAVIOR OUGHT TO BE
• IT GOES BEYOND THE FACTS TO ASK IF ACTIONS ARE GOOD.
• LOTTERY PROCEEDS FOR SCHOOLS (TICKETS ARE PURCHASED BY LOWER INCOMES)
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ADAM SMITH: FOUNDER OF MODERN ECONOMICS• WEALTH OF NATIONS
• 1776
• ARGUED FOR FREE TRADE (NOT MERCANTILISM)
• PEOPLE BEHAVE IN WAYS TO SATISFY ECONOMIC SELF-INTERESTS
• “INVISIBLE HAND”
• GUIDES THE MARKET
• PRODUCE TOO MUCH? CUT PRODUCTION
• PRODUCE TOO LITTLE? MAKE MORE
• WANT IT IN GREEN? MAKE GREEN
• THE INVISIBLE HAND GUIDES THE MARKET INTO BALANCE