What is Economics?

Chapter 18

Economic Choices

• Economics-the study of how we make decisions in a world where resources are limited– Economics is

sometimes called the science of decision making

Scarcity

• As individuals, we have many needs (things required for survival, such as food, clothing and shelter)

• In addition, we also have an enormous number of wants (things we would like to have, such as entertainment, vacations, and other things that make life more comfortable)

Scarcity

• The fundamental economic problem is: scarcity (not having enough resources to produce all of the things we would like to have)

WHAT to produce?

• One of the choices a society has to face is that of WHAT to produce

• Ex.)We may have to choose between making goods for defense or producing services for people who are retired or too ill to work

HOW to produce?

• A second choice that society has to make is that of HOW to produce

• Ex.)If we need more crude oil, should we allow drilling in an Alaskan wildlife sanctuary, or should we restrict oil recovery to more traditional areas?

For WHOM to produce?

• After goods and services are produced, a society must determine how the goods and services will be distributed among its members

Using Economic Models • To economists, the word “economy” means all

the activity in a nation that together affects the production, distribution and use of goods and services

• When studying a specific part of the economy economists often formulate theories and gather data

• The data that economists collect are called economic models(simplified representations of the real world that are used to explain how the economy works, or to predict what would happen if something in the economy should change)

Economic Models

Economic Models

• It is important to remember that models are based on assumptions, or things that we take for granted as true– Ex.)You might assume that a restaurant is

out of your price range so you don’t try it, but you could be wrong

• It is also important to keep I mind that models can be revised

Micro and Macro Economics

• Economics is divided into two branches– Microeconomics-the economic behavior and

decision making by individuals and small businesses

– Macroeconomics-economic behavior and decision making by government or whole industries or societies

Making Economic Decisions

Trade-Offs

• The economic choices people make involve exchanging one good or service for another– Ex.)You choose to buy a DVD

player, you are exchanging your $$$ for the right to own the DVD player rather than something else that might cost the same amount

• A trade-off is the alternative you face if you decide to do one thing rather than another

Opportunity Cost

• Opportunity cost-the cost of the next best use of your time or money when you choose to do one thing rather than another– Ex.)Money to go to

college (books, living, etc.) vs. working a full-time job

Measures of Cost

• Fixed costs-costs, or expenses, that are the same no matter how many units of a good are produced

• Variable costs-expenses that change with the number of products produced

• Total costs-fixed costs added to variable costs

• Marginal costs-the extra, or additional cost of producing one additional unit of output

Measures of Cost

• Marginal revenue-the change in total revenue (the extra revenue) that results from selling one more unit of output

• Marginal benefit-the additional or extra benefit associated with an action

Cost-Benefit Analysis

• Once we define the marginal costs and benefits of a decision, we can analyze the decision

• Cost-benefit analysis-economic model that compares the marginal costs and marginal benefits of a decision

Being an Economically Smart Citizen

Understanding Your Role in the Economy

• To be good economic citizens, we must be informed. This means that we need to have an understanding of what part we play and how we affect the economy, and how the economy affects us

• We have a market economy– Market economy-an economic system in which

supply, demand and prices help people make decisions and divide resources

Understanding Your Role in the Economy

• A market economy is sometimes described as being based on capitalism (a system in which private citizens own most, if not all, of the means of production)

Understanding Your Role in the Economy

• A market economy is also based on free enterprise

• Free enterprise-economic system in which individuals and businesses are allowed to compete for profit with a minimum of gov’t interference

Understanding Your Role in the Economy

• Keeping informed

• Understanding incentives– Incentives-rewards that are offered to try

to persuade people to take certain economic actions

• Understanding the Role of the Government

Making Wise Choices

• The ultimate goal of being an economically literate citizen is to be able to make wise choices

• When you make consumer decisions based on opportunity cost, you are engaging in rational choice– Rational choice-choosing the alternative that has

the greatest value from among comparable-quality products

– When you make rational choices you purchase the goods and services you believe can best satisfy your wants for the lowest possible costs

The American Economy

Chapter 19

Economic Resources

Producing Goods and Services

• Goods-what is made (I.e. books, cars, etc. things that we use to satisfy our wants and needs)

• Services-work that is performed for someone else– Ex.) Waiting tables, cutting hair, concerts, etc.

Factors of Production

• There are four factors of production (resources necessary to produce goods and services)– Natural resources– Labor– Capital – Entrepreneurs

Factors of Production

• Natural resources-all of the “gifts of nature” that make production possible– Ex.)fertile fields,

abundant rainfall, forests, mineral deposits

Factors of Production

• Labor-physical and mental efforts that people contribute to the production of goods and services– Ex.)carpenters,

bricklayers, electricians

Factors of Production

• Capital-tools, machinery, and buildings used to make other products– Ex.)money, bulldozers,

trucks, hammers, saws, drills, etc

Factors of Production

• Entrepreneur-individuals who start new businesses, introduce new products and improve management techniques

Gross Domestic Product (GDP)

• People can measure their economic success by the amount of their incomes and their ability to provide for themselves and their families

• The success of the overall economy is measured in a similar way

• Gross Domestic Product (GDP)-total value of all final goods and services produced in one year

Gross Domestic Product (GDP)

• GDP is a monetary measure—measured in $$$ (dollars)

• GDP is an important measure of standard of living (the quality of life based on the possession of necessities and luxuries that make life easier)

• GDP is measured in QUANTITY (numbers) NOT QUALITY

Economic Activity and Productivity

The Circular Flow of Economic Activity

There are several groups of decision makers in the economy.

The Consumer Sector

• Consumers earn their incomes in factor markets (the markets where productive resources are bought and sold)

• Workers earn wages, salaries and tips in exchange for their labor

The Business Sector

• When these individuals receive their incomes, they spend it in product markets (markets where producers offer goods and services for sale)

The Government Sector

• The government sector includes the 3 levels of gov’t (federal/state/local)

• The gov’t provides services and receives revenues from the goods and services it sells

The Foreign Sector

• The foreign sector represents all of the countries in the world—we buy products from and sell products to foreign countries

• Accounts for less than 4% of the GDP

Productivity and Economic Growth

• Productivity-a measure of the amount of how much you produce in a given time

• Specialization-when people, businesses, regions, and even countries concentrate on goods or services that they can produce better than anyone else– Ex.)tobacco,cotton

Productivity and Economic Growth

• Division of labor-breaking down of a job into separate, smaller tasks, which are performed by different workers– Improves productivity

Productivity and Economic Growth

• Human capital-the sum of the skills, abilities, and motivation of people– Productivity tends to

increase when businesses invest in human capital

Productivity and Economic Growth

• Economic interdependence-we rely on others and others rely on us– Katrina victims relied

on the rest of the country to help after the hurricane hit

Capitalism and Free Enterprise

Features of Capitalism

• Capitalism-economic system in which private citizens own and use the factors of production in order to seek a profit

• Free enterprise-open and equal competition

Features of Capitalism: Markets

• Markets are places where goods and services are sold

• Consumer sovereignty-the role of the consumer as the ruler of the market, determining what products will be produced

Features of Capitalism: Economic Freedom

• Freedom to produce, buy or sell products and services within the limits of the law

Features of Capitalism: Private Property Rights

• Private property rights-we have the freedom to own and use, or dispose of, our own property as we choose as long as we do not interfere with the right of others

Features of Capitalism: Competition

• Competition-the struggle that goes on between buyers and sellers to get the best products at the lowest prices

Features of Capitalism: The Profit Motive

• Profit-the amount of money left over after all the costs of production have been paid

• Profit motive-the driving force that encourages individuals and organizations to improve their material well-being

Features of Capitalism: Voluntary Exchange

• Voluntary exchange-the freedom to buy or sell anything

Spread of Capitalism

• Two important concepts helped the spread of capitalism:– People work for economic gain– Government should have limited role in the

economy

Adam Smith and Capitalism

• Adam Smith-Scottish economist

• Wrote Wealth of Nations in 1776

• Laissez-faire economy-limited government role in economy– “laissez-faire”-let it

alone or hands off