THE ECONOMIC WAY OF THINKINGChapter 1

KEY CONCEPTSEconomics — study of how people use resources to

satisfy wantshow individuals/societies choose to use resourcesorganizes, analyzes, interprets data about economic behaviors

develops theories, economic laws to explain economy, predict future

Scarcity: The Basic Economic Problem

SCARCITY: THE BASIC ECONOMIC PROBLEM

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

BASIC ECONOMIC PRINCIPLESPRINCIPLE 1: PEOPLE HAVE WANTS

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

BASIC ECONOMIC PRINCIPLESPRINCIPLE 2: SCARCITY AFFECTS EVERYONE

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

THREE BASIC ECONOMIC QUESTIONS

Every society must answer three basic economic questions because of scarcity.

Societies answer these questions differently, leading to a variety of economic systems.

THREE BASIC ECONOMICS QUESTIONS

Question 1: What Will Be Produced?

Societies must decide on mix of goods to producedepends on their natural resources

Some countries allow producers and consumers to decide

In other countries, governments decideMust also decide how much to produce;

choice depends on societies’ wants

THREE BASIC ECONOMICS QUESTIONS

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

THREE BASIC ECONOMICS QUESTIONS

Question 3: For Whom Will It Be

Produced?

How goods and services are distributed involves two questions how should each person’s

share be determined? how will goods and services

be delivered to people?

THE FACTORS OF PRODUCTIONFactors of production resources needed to

produce goods and services

1. land 2. labor 3. Capital4. entrepreneurship supply is limited

THE FACTORS OF PRODUCTION

Factor 1: Land Land means all natural resources on or under the groundincludes water, forests, wildlife, mineral deposits

THE FACTORS OF PRODUCTION

Factor 2: Labor Labor is all the human time, effort, talent used to make productsphysical and mental effort used to make a good or provide a service

THE FACTORS OF PRODUCTION

Factor 3: Capital Capital is a producer’s physical

resources includes tools, machines, offices, stores, roads, vehicles

sometimes called physical capital or real capital

Workers invest in human capital — knowledge and skillsworkers with more human capital are more productive

THE FACTORS OF PRODUCTION

Factor 4: Entrepreneurship Entrepreneurship — vision, skill,

ingenuity, willingness to take risksEntrepreneurs anticipate consumer

wants, satisfy these in new waysdevelop 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 ways2. 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

MAKING ECONOMIC CHOICES

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

MAKING ECONOMIC CHOICES

Factor 2: No Free Lunch

All choices have a costchoosing one

thing means giving up another, or paying a cost

cost can take form of money, time, other thing of value

TRADE-OFFS AND OPPORTUNITY COST

Trade-off is alternative

people give up when they make a choiceusually means giving up some, not all, of a thing to get more of another

TRADE-OFFS AND OPPORTUNITY COST

Example of a Trade OffJessica wants to earn college credit

over summersemester-long university course offers more credits

six-week high school course leaves time for vacation

TRADE-OFFS AND OPPORTUNITY COST

Opportunity cost is value of next-best alternative a person gives up

not the value of all possible alternatives

Example of Opportunity CostDan chooses to work for six months so he

can travel for six monthsopportunity cost = six months of salary

VIDEO CLIP: OPPORTUNITY COST

OPPORTUNITY COST ACTIVITY

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? (What’s the opportunity cost?)

ANALYZING ECONOMIC CHOICES

Cost-benefit analysis: examines the costs and expected

benefits of choicesone of most useful tools for evaluating relative worth of economic choices

ANALYZING ECONOMIC CHOICES

Marginal Costs and Benefits

Marginal cost additional cost of using one more unit of a good or service

Marginal benefitadditional benefit of using one more unit of a good or service

ANALYZING PRODUCTION POSSIBILITIES

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

GRAPHING THE POSSIBILITIES 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

WHAT WE LEARN FROM PPCS

Efficiency — producing the maximum amount of goods and services possible

Underutilization — producing fewer goods and services than possible

WHY IS THE PPC A CURVE?

Law of increasing opportunity costsas 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 productneed new resources, machines, factoriesmust retrain workers

Costs paid by making less and less of other product

LET’S LOOK AT SOME EXAMPLES

PPC Practice

CHANGING PRODUCTION POSSIBILITIES

A country’s supply of resources changes over timeExample: U.S. in 1800s grew, gained

resources, workers, new technologynew resources mean new production

possibilities beyond frontier Increased production shown on PPC as shift

of curve outward Increase in total output called economic

growth

PPF—THE CURVE

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. 

MICROECONOMICS AND MACROECONOMICS

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

MICROECONOMICS AND MACROECONOMICS

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

EXAMPLES OF MACRO AND MICRO

Which is it?1. National Unemployment Figures

Rise2. World Trade Organization Meets3. Shipbuilder Wins Navy Contract4. Cab Drivers on Strike!5. Gasoline Prices Jump 25 Cents