Download Economics Chapter 1

What is Economics?
Chapter 1
SECTION
1
What Is Economics?


Economics is the study of how people
make choices to satisfy their wants
For example:
• You must choose how to spend your time
• Businesses must choose how many people to
hire
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2
Scarcity and Shortages

Scarcity occurs when
there are limited
quantities of
resources to meet
unlimited needs or
desires

Shortages occur
when producers will
not or cannot offer
goods or services at
current prices
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The Factors of Production



Land All natural resources that are
used to produce goods and services.
Labor Any effort a person devotes to a
task for which that person is paid.
Capital Any human-made resource that
is used to create other goods and
services.
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The Factors of Popcorn
Production
Land
Labor
Capital
Popping Corn
The human effort needed
to pop the corn
Corn-Popping
Device
Vegetable Oil
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Trade-offs and Opportunity Cost


Trade-offs are all the alternatives that we
give up whenever we choose one course
of action over others.
The most desirable alternative given up
as a result of a decision is known as
opportunity cost.
All individuals and groups of people make decisions
that involve trade-offs.
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The Decision-Making Grid

Economists encourage us to consider
Karen’s Decision-making
Grid
Alternatives
the benefits and costs of our decisions.
Sleep late
Wake up early to study
Benefits
• Enjoy more sleep
• Have more energy during the day
• Better grade on test
• Teacher and parental approval
• Personal satisfaction
Decision
• Sleep late
• Wake up early to study for test
Opportunity cost
• Extra study time
• Extra sleep time
Benefits forgone
• Better grade on test
• Teacher and parental approval
• Personal satisfaction
• Enjoy more sleep
• Have more energy during the day
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Thinking at the Margin

When you decide how much more or less to do, you
are thinking at the margin.
Options
Benefit
Opportunity Cost
1st hour of extra
study time
Grade of C on
test
1 hour of
sleep
2nd hour of extra
study time
Grade of B on
test
2 hours of
sleep
3rd hour of extra
study time
Grade of B+ on
test
3 hours of
sleep
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Production Possibilities

A production possibilities graph shows alternative ways that an
economy can use its resources.
The production possibilities frontier is the line that shows the
maximum possible output for that economy.
Production Possibilities Graph
25
Watermelons
Shoes
(millions of tons) (millions of pairs)
0
15
8
14
14
12
18
9
20
5
21
0
Shoes (millions of pairs)

20
15
a (0,15)
b (8,14)
c (14,12)
10
d (18,9)
5
0
A production
possibilities frontier
e (20,5)
f (21,0)
5
10
15
20
25
Watermelons (millions of tons)
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Efficiency
Production Possibilities Graph


Efficiency means
using resources in
such a way as to
maximize the
production of goods
and services.
An economy
producing output
levels on the
production
possibilities frontier is
operating efficiently.
Shoes (millions of pairs)
25
20
S
15
a (0,15)
b (8,14)
c (14,12)
10
g (5,8)
5
d (18,9)
e (20,5)
A point of
underutilization
0
5
10
f (21,0)
15
20
Watermelons (millions of tons)
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10
25
Growth
Production Possibilities Graph
25

Growth If more
resources become
available, or if
technology improves,
an economy can
increase its level of
output and grow.
When this happens,
the entire production
possibilities curve
“shifts to the right.”
Future production
Possibilities frontier
T
Shoes (millions of pairs)

20
S
15
a (0,15)
b (8,14)
c (14,12)
10
d (18,9)
5
e (20,5)
f (21,0)
0
5
10
15
20
Watermelons (millions of tons)
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25
Cost A production possibilities graph shows
the cost of producing more of one item. To
move from point c to point d on this graph has
a cost of 3 million pairs of shoes.

Cost
Production Possibilities Graph
25
0
15
8
14
14
12
18
9
20
5
21
0
Shoes (millions of pairs)
Watermelons
Shoes
(millions of tons) (millions of pairs)
20
15
c (14,12)
10
d (18,9)
5
0
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5
10
15
20
25
Watermelons (millions of tons)
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Economic Systems
Chapter 2
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The Three Economic Questions

Every society must answer three
questions:
• What goods and services should be
•
•
produced?
How should these goods and services be
produced?
Who consumes these goods and services?
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Economic Goals

Societies answer
the three
economic
questions based
on their values.
Economic Goals
Economic efficiency
Making the most of resources
Economic freedom
Freedom from government
intervention in the production and
distribution of goods and services
Economic
security and
predictability
Assurance that goods and services
will be available, payments will be
made on time, and a safety net will
protect individuals in times of
economic disaster
Economic equity
Fair distribution of wealth
Economic growth
and innovation
Innovation leads to economic
growth, and economic growth leads
to a higher standard of living.
Other goals
Societies pursue additional goals,
such as environmental protection.
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Four Economic Systems
An economic system is the method used by a society to
produce and distribute goods and services.
Traditional economies rely on
habit, custom, or ritual to decide
what to produce, how to produce
it, and to whom to distribute it.
In a market economy economic
decisions are made by
individuals and are based on
exchange, or trade.
In a centrally planned economy
the central government makes all
decisions about the production
and consumption of goods and
services.
Mixed economies are systems
that combine tradition and the
free market with limited
government intervention.
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Why Do Markets Exist?
Markets exist because none of us produces
all the goods and services we require to satisfy
our needs and wants.
A market is an arrangement that
allows buyers and sellers to
exchange goods and services.
Specialization is the concentration
of the productive efforts of
individuals and firms on a limited
number of activities.
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The Free Market Economy

In a free market
economy,
households and
business firms use
markets to exchange
money and
products.
Households own the
factors of production
and consume goods
and services.
Circular Flow Diagram of a Market Economy
Households pay
firms for goods
and services.
Product market
monetary flow
physical flow
Firms supply
households with
goods and services.
Households
Firms
Households supply
firms with land, labor,
and capital.
physical flow
monetary flow
Factor market
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Firms pay
households for land,
labor, and capital.
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The Market’s Self-Regulating
Nature



In every transaction, the buyer and seller consider only
their self-interest, or their own personal gain. Self-interest
is the motivating force in the free market.
Producers in a free market struggle for the dollars of
consumers. This is known as competition, and is the
regulating force of the free market.
The interaction of buyers and sellers, motivated by selfinterest and regulated by competition, all happens without
a central plan. This phenomenon is called “the invisible
hand of the marketplace.”
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Advantages of the Free Market
Economic Efficiency
 As a self-regulating
system, a free market
economy is efficient.
Economic Freedom
 Free market economies
have the highest degree
of economic freedom of
any economic system.
Economic Growth
 Because competition
encourages innovation,
free markets encourage
growth.
Additional Goals
 Free markets offer a
wider variety of goods
and services than any
other economic system.
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Organization of Centrally
Planned Economies
In a centrally planned economy, the government
owns both land and capital. The government
decides what to produce, how much to produce,
and how much to charge.
Socialism is a social and political
philosophy based on the belief that
democratic means should be used
to distribute wealth evenly
throughout a society.
Communism is a political system
characterized by a centrally planned
economy with all economic and
political power resting in the hands
of the government.
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The Former Soviet Union

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
Soviet Agriculture
•
In the Soviet Union, the government created large
state-owned farms and collectives for most of the
country’s agricultural production.
Soviet Industry
•
Soviet planners favored heavy-industry production
(such as steel and machinery), over the production of
consumer goods.
Soviet Consumers
•
Consumer goods in the Soviet Union were scarce and
usually of poor quality.
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Problems of a Centrally Planned
Economy
Centrally planned economies face problems
of poor-quality goods, shortages, and
diminishing production.
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The Rise of Mixed Economies
Market economies, with all their advantages,
have certain drawbacks.
Limits of Laissez Faire
Laissez faire is the doctrine that
government generally should not
interfere in the marketplace.
Governments create laws
protecting property rights and
enforcing contracts. They also
encourage innovation through
patent laws.
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Government’s Role in a Mixed
Economy
Circular Flow Diagram of a Mixed Economy
Product market
monetary flow
In a mixed economy,
 The government
purchases land,
labor, and capital
from households in
the factor market,
and
 Purchases goods
and services in the
product market.
physical flow
Households
expenditures
Government
expenditures
physical flow
monetary flow
Factor market
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Firms
Comparing Mixed Economies

An economic system that permits the conduct of
business with minimal government intervention is
called free enterprise. The degree of government
involvement in the economy varies among nations.
Continuum of Mixed Economies
Centrally planned
Free market
Iran
North Korea
Cuba
South Africa
China
Russia
France
Botswana
Greece
United Kingdom
Canada
Peru
Hong Kong
Singapore
United States
Source: 1999 Index of Economic Freedom, Bryan T. Johnson, Kim R. Holmes, and Melanie Kirkpatrick
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American Free Enterprise
Chapter 3
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The Basic Principles of Free
Enterprise
Several key characteristics make up the basic
principles of free enterprise.
1. Profit Motive
5. Free contract
The drive for the improvement of
material well-being.
The right to decide what
agreements in which you
want to take part.
2. Open opportunity
The ability for anyone to
compete in the marketplace.
6. Voluntary exchange
The right to decide what
and when you want to buy
and sell a product.
3. Legal equality
Equal rights to all.
4. Private property rights
7. Competition
The rivalry among sellers
to attract consumers.
The right to control your
possessions as you wish.
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The Consumer’s Role
A fundamental purpose of the free enterprise
system is to give consumers the freedom to
make their own economic choices.
Through their economic
dealings with producers,
consumers make their desires
known. When buying products,
they indicate to producers what
to produce and how much to
make.
Consumers can also make their
desires known by joining interest
groups, which are private
organizations that try to persuade
public officials to vote according
to the interests of the groups’
members.
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The Government’s Role
Americans expect the government to protect them from
potential problems that arise from the production of
various products or the products themselves.
Public Disclosure Laws
Laws that require companies to provide consumers with
important information about their products, such as fuel
efficiency of automobiles, side-effects of medication.
Public Interest
Both state and federal governments’ involvement in concerns
of the public as a whole, such as environmental protection,
sanitary food production.
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Tracking Business Cycles



Macroeconomics is the study of the behavior
and decision making of entire economies.
A business cycle is a period of a
macroeconomic expansion followed by a
period of contraction.
One measure of a nation’s macroeconomy is
gross domestic product (GDP). GDP is the
total value of all final goods and services
produced in a particular economy.
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Promoting Economic Strength
Policymakers pursue three main outcomes as they seek
to stabilize the economy.
Employment
One aim of federal economic policy is to provide jobs for everyone who is able
to work.
Growth
 For each generation of Americans to do better than previous ones, the economy
must grow to provide additional goods and services.
Stability
 Stability gives consumers, producers, and investors confidence in the economy
and in our financial institutions, promoting economic freedom and growth.

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Encouraging Innovation
The government encourages the development
of new technologies in several ways.
Technology is the process used to produce a
good or service.
• Federal agencies fund many
research and development
projects. Also, new
technology often evolves out
of government research.
• A patent gives the inventor
of a new product the
exclusive right to produce
and sell it for 20 years.
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Public Goods

A public good is a shared good or service for
which it would be impractical to make
consumers pay individually and to exclude
nonpayers.
•
•
Public goods are funded by the public sector, the part
of the economy that involves transactions of the
government.
A free rider is someone who would not choose to pay
for a certain good or service, but who would get the
benefits of it anyway if it is provided as a public good.
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Market Failures
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
Would the free market ensure that roads
are built everywhere they are needed?
It’s doubtful. Neither could individuals
afford to pay for a freeway.
A market failure is a situation in which the market, on its
own, does not distribute resources efficiently.
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Externalities

An externality is an economic side effect of
a good or service that generates benefits or
costs to someone other than the person
deciding how much to produce or consume.
•
The building of a new dam and creation of a lake generates:
•
•
Positive Externalities
• A possible source of hydroelectric power
• Swimming
• Boating
• Fishing
• Lakefront views
Negative Externalities
• Loss of wildlife habitat due to flooding
• Disruption of fish migration along the river
• Overcrowding due to tourism
• Noise from racing boats and other watercraft
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The Poverty Problem
The poverty threshold is an income level below that
which is needed to support families or households.


The poverty threshold is determined by the
federal government and is adjusted
periodically.
Welfare is a general term that refers to
government aid to the poor.
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Redistribution Programs
Cash transfers are direct payments of money
to eligible people.
Temporary Assistance for Needy Families (TANF)
This program allows individual states to decide how to best use
federally provided funds.
Social Security
Social Security provides direct cash transfers of retirement income
to the nation’s elderly and living expenses to the disabled.
Stability
Unemployment compensation provides money to eligible workers
who have lost their jobs.
Workers’ Compensation
Workers’ compensation provides a cash transfer of state funds to
employees injured while on the job.
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Other Redistribution Programs

Besides cash transfers, other redistribution
programs include:
In-kind benefits
• In-kind benefits are goods and services provided by the
government for free or at greatly reduced prices.
Medical benefits
• Health insurance is provided by the government for the
elderly and disabled (Medicare) and for poor people who
are unemployed or are not covered by their employer’s
insurance (Medicaid).
Education benefits
• Federal, state, and local governments all provide
educational opportunities for the poor.
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