THE ECONOMIC

WAY OF THINKINGCHAPTER 1

SCARCITY: THE BASIC ECONOMIC PROBLEMSECTION 1

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

THE 2 PRINCIPLES

• PEOPLE HAVE WANTS

• SCARCITY AFFECTS EVERYONE

SCARCITY LEADS TO 3 ECONOMIC QUESTIONS

• WHAT WILL BE PRODUCED?

• HOW WILL IT BE PRODUCED?

• FOR WHOM WILL IT BE PRODUCED?

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?

HOW WILL IT BE PRODUCED?

• WHAT IS THE MOST EFFICIENT WAY?

• NATURAL RESOURCES INFLUENCE

• INCLUDING HOW WE USE PEOPLE

• LABOR INTENSIVE FARMING OR MACHINERY

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?

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.

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

ECONOMIC CHOICE TODAY: OPPORTUNITY COSTSECTION 2

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.

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

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

COST-BENEFIT ANALYSIS

• IS AN APPROACH THAT WEIGHS THE BENEFITS OF AN ACTION AGAINST ITS COSTS

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

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

ANALYZING PRODUCTION POSSIBILITIESSECTION 3

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.

PRODUCTION POSSIBILITIES CURVE (PPC)ASSUMPTIONS

• RESOURCES ARE FIXED

• ALL RESOURCES ARE FULLY EMPLOYED

• ONLY TWO THINGS CAN BE PRODUCED

• TECHNOLOGY IS FIXED

PPCBread muffins

12 0

10 35

7 63

4 84

0 100

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

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

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

SOME EXAMPLES

• OPPORTUNITY COST

• GUNS VS BUTTER

• INCREASE IN OPPORTUNITY COST – EACH ADDITIONAL UNIT COSTS MORE THAN THE LAST.

• SHIFT IN THE PPC

More resources or increased productivity shifts the PPC outward, or to the right, from PPC 1 to PPC2.

butter

gunsPPC1 PPC2

THE ECONOMIST’S TOOLBOXSECTION 4

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

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

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

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)

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