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ECONOMICS
CHAPTER 1
What is Economics?
WHAT IS ECONOMICS?

Economics-the study of how
people seek to satisfy their
needs and wants by making
choices.

Need-

Want-

Goods

services
SCARCITY AND SHORTAGES?

Scarcity-
FACTORS OF PRODUCTION

Land-

Labor-

Capital 
Physical

human
OPPORTUNITY COST
AND TRADE-OFFS
Tradeoffs
Opportunity
cost
THE DECISION-MAKING GRID
Karen’s Decision-making Grid
Alternatives
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
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
PRODUCTION POSSIBILITIES
A production possibilities graph shows alternative ways that an economy can use
its resources.
Production Possibilities Graph
Watermelons
(millions of tons)
25
Shoes
(millions of pairs)
20
0
15
8
14
14
12
18
9
20
5
21
0
Shoes (millions of pairs)

15
a (0,15)
b (8,14)
10
c (14,12)
5
d (18,9)
A production
possibilities frontier
0
5
10
15
e (20,5)
f (21,0)
20
Watermelons (millions of tons)
25
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.
25
20
Shoes (millions of pairs)

S
15
a (0,15)
b (8,14)
10
c (14,12)
g (5,8)
d (18,9)
5
A point of
underutilization
e (20,5)
f (21,0)
0
5
10
15
20
Watermelons (millions of tons)
25
GROWTH
Production Possibilities Graph
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.”
25
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)
25
COST
Cost: Switching production from one product to
another involves a loss of production for one item.
Production Possibilities Graph
Watermelons
(millions of
tons)
0
Shoes
(millions of
pairs)
15
8
14
14
12
18
9
20
5
21
0
25
Shoes (millions of pairs)

20
15
c (14,12)
10
d (18,9)
5
0
5
10
15
20
25
Watermelons (millions of tons)
CHAPTER 2
Answering the three economic questions
THE THREE ECONOMIC QUESTIONS

Every society must answer three questions:
1. What goods and services should be produced?
2. How should these goods and services be produced?
3. Who consumes these goods and services?
ECONOMIC GOALS

Economic Efficiency –

Economic Freedom –

Economic security –

Economic Equity –

Econ Growth –
An economic system is the method used by a society to produce
and distribute goods and services.
Traditional economies
Market economy
Centrally planned economy
Mixed economies
WHY DO MARKETS EXIST?
A market
Specialization
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.
Invisible hand
interest
competition
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
Households supply
firms with land, labor,
and capital.
Firms
Firms pay
households for land,
labor, and capital.
Self
physical flow
monetary flow
Factor market
THE INVISIBLE HAND OF THE FREE
MARKET


Comes from the great philosopher Adam Smith
(18th century)
Made up of two components
Self
Interest
Competition
ADVANTAGES OF THE FREE MARKET
Efficiency
Growth
Freedom
Variety
CENTRALLY PLANNED ECONOMIES
Socialism =
Communism=
THE FORMER SOVIET UNION

Soviet Agriculture


Soviet Industry


Large farms called collectives
Focus on military goods and heavy industry
Soviet Consumers

Few available products but very cheap prices
PROBLEMS OF A CENTRALLY PLANNED
ECONOMY
Centrally planned economies face problems of
poor-quality goods, shortages, and diminishing
production.
GOVERNMENT’S ROLE IN A MIXED ECONOMY
Circular Flow Diagram of a Mixed Economy
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
Product market
monetary flow
physical flow
Households
expenditures
Government
market.
physical flow
monetary flow
Factor market
expenditures
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
Source: 1999 Index of Economic Freedom, Bryan T. Johnson, Kim R. Holmes, and Melanie Kirkpatrick
Hong Kong
Singapore
United States
CHAPTER 2 OPEN NOTE QUIZ
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
List and describe the goals achieved/advantages of free
markets.
Describe centrally planned economies.
What are the three questions that each society must
answer?
How does socialism differ from communism?
What type of economy does the U.S. have? Why?
What two factors help to keep free markets regulated?
What is the invisible hand?
What is laissez faire?
Why are most countries mixed economies?
What is the primary role of government in the United
States economy?
CHAPTER 2 REVIEW








3 economic questions
Centrally planned economies
Free market economies
Traditional economies
Advantages of mixed economies
Advantages of free market
economies
What happened to the major
centrally planned economies
(China, Soviet Union
Continuum of Mixed economies


(especially Canada, U.S. China)
Economic Goals




Efficiency
Growth
Freedom
Additional goals (varies)
Invisible hand
 Self interest
 Competition
 Why are most
countries mixed
 Adam Smith

CHAPTER 3
American Free Enterprise
FREE ENTERPRISE

Free Enterprise -
BASIC PRINCIPLES OF FREE ENTERPRISE

Profit motive-

Open opportunity-
ECONOMIC RIGHTS

Legal Equality-

Private property-

Free contracts-

Voluntary exchange-

Competition-
WHAT SHOULD GOVERNMENT DO?
Protect Consumers


Public Disclosure lawsProtecting Health and Safety-
PROVIDING A SAFETY NET






The Poverty ProblemPoverty threshold- level of income below what is needed to
support families or households. In 2000 a single parent under 65
was $11,869 and a four person family was $17,463.
Government Role-
Yet as a society that prefers limited government activity in the
economy, poverty poses tough questions:
A. What can government do to combat poverty?
B. What should government do?