Download The Economic Fundamentals

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

 Adam Smith- father of Economics – introduced a way of
thinking about economic ideas in his book “The Wealth of
Nations” 1776
 Economic Enigmas- puzzles or riddles that might be
explained through an economic analysis
What is Economics……
 Microeconomics- economic decision making by
individuals, households and businesses
 Macroeconomics- workings of the economy as a
whole
 Positive economics- statement that describes how
things are
 Normative Economics- statement of how things ought
to be
7 Principles Of Economics
Principle 1: Scarcity Forces Tradeoffs

Scarcity- there will never be enough of everything to
satisfy everyone completely

Tradeoff- choosing one thing over another
 “there is no such thing as a free lunch”- no-free-lunch- principle:
even that of accepting a free lunch involves tradeoffs.

Principle 2: Costs Versus Benefits

Costs- what you spend in time, money, and other sacrifices
 Benefits- what you gain from something in terms of money,
time, experience, or improvements
 Cost benefit analysis- listing of costs vs benefits to make a choice
7 Principles Of Economics
Principle 3: Thinking at the Margin
 Margin- border or outer edge of something “most decisions we
make each day involve choices about a little less or a little more
of something”
 Marginal Cost- what you give up to add one unit to an activity
 Marginal Benefit- what you gain by adding one more unit

Principle 4: Incentives Matter

Incentives- something that motivates a person to take a
particular course of action

Principle 5: Trade makes people better off
7 Principles Of Economics
Principle 6: Markets Coordinate Trade
 Market- an arrangement that brings buyers and
sellers together to do business with each other
 Invisible hand- Adam Smith’s theory that supply will
meet demand which is guided by an invisible hand
Principle 7: Future Consequences Count
 Law of Unintended Consequences- the actions of
people and governments always have effects that are
not expected or that are “unintended”
Scientific Method
 - Posing a question
 - researching the question
 - developing a hypothesis
 - conducting studies and collecting information
 - analyzing information
 -evaluating the hypothesis
Economic Graphs
Graph: Two dimensional
representation of a three
dimensional world
 Graph- visual
representation of the
relationship between two
given sets of data
 Variable- quantity that
can vary
 Curve- any line
representing data points
plotted on a graph
Economic Models
 Economic Model- Simplified representation of reality
that allows economists to focus on the effects of one
change at a time
 Rational Behavior model- tool for understanding
the mystery of human behavior
Why Is What We Want Scarce?
 We can’t get everything we want because there is a
limited amount of resources to fulfill our wants.
 All goods (physical objects) and services
(activities provided by others) are scarce because
the resources needed to produce them are scarce.
 Scarcity and shortage are not the same. A shortage is
a temporary condition that occurs when there is less
of a good or service available than people want at the
current price.
How Do We Satisfy Economic Wants?
 The productive resources that go into producing goods and
services are called factors of production. These inputs
make up the production equation:
land + labor + capital = goods and services
 Land resources are gifts of nature such as air, soil,
minerals, water, and plants.
 Labor resources include the physical and mental
activities that go into producing goods and services.
 Capital resources include the tools, machines,
buildings, and technologies that are used in the
production of goods and services.
 Entrepreneurs combine land, labor, and capital to
produce goods and services.
 They often supply vision, take risks, and provide the drive
needed to turn ideas into realities.
What Do We Give Up When We Make a Choice?
 People seek to maximize their utility (satisfaction or benefit)
when making decisions.
 This requires them to consider tradeoffs, or alternatives among
choices.
 Businesses and societies also face tradeoffs when making decisions.
 An opportunity cost of a decision is the value (in time,
money, etc.) of the next best alternative. In other words, it is
the cost of a decision.
 People tend to make decisions based on their marginal utility,
or the extra satisfaction they gain from one additional unit of a
good or service.
 Most goods and services have diminishing marginal utility
because as we get more of something, the pleasure we derive
from it tends to decrease.
How Can We Measure What We Gain and Lose When
Making Choices?
 A production possibilities
frontier (PPF) is a graph that
shows how an economy might
use its resources to produce two
goods.
 A PPF is used to calculate the
opportunity cost of moving
production from one point to
another.
 Every point on a PPF represents
an efficient use of resources. The
area under the curve represents
an attainable but inefficient use
of resources.
 Increases in productivity, a
measure of the output of a
system, can shift the PPF
outward.
Who Gets What? How Do Societies Decide?
 Every society must answer three fundamental
economic questions: what to produce, how, and for
whom?
 How societies answer these questions depends on their
economic goals: freedom, efficiency, equity, growth,
security, and stability.
 Societies differ in the degree of importance they attach
to each goal. Progress toward one goal can sometimes
be achieved only at the expense of another.
Who Decides What in Different Economic Systems?
 In answering the three economic questions, every
society develops an economic system.
 A traditional economy relies on custom and
tradition to dictate production and consumption.
The goals are economic security and stability.
 In a command economy, decisions about
production are made by a powerful ruler or central
authority. The goals are equity and security.
 In a market economy, individual producers and
consumers coordinate economic activity. The goals
are economic freedom and efficiency.
How do Mixed Economies Divide the
Decision Making?
 Nearly all countries have mixed economies, in
which both the government and individuals play
important roles in production and consumption.
 The government’s role varies but usually involves:
 protection (such as establishing institutions that enable
markets to operate)
 regulation (such as stepping in when markets operate in
a way that society finds unacceptable)
 public benefits (such as providing certain goods and
services that markets do not always provide or do not
provide enough of).
What are the Key Characteristics of the
U.S. Economic System
 In a free enterprise system, as in the United States,
individuals own the factors of production and make
decisions about how to use those factors within the
framework of the law.
 A free enterprise system has seven key characteristics:
economic freedom, competition, equal opportunity,
property rights, binding contracts, profit motive, and
limited government.
How Does Specialization Lead to Economic
Interdependence?
 Specialization is the development of skills or
knowledge in one aspect of a job or field of interest.
It leads to greater productivity and a higher standard
of living.
 Societies that specialize are more productive than
those that are self-sufficient.
 Specialization encourages trade. Trade is a voluntary
exchange that is usually facilitated with money.
 Trade creates economic interdependence, in which
people rely on others for most of the goods and
services they want.
How Do People and Nations Gain from
Specialization and Trade?
 An individual holds an absolute advantage when he
or she can produce a good or service using fewer
resources than someone else.
 An individual holds a comparative advantage when
he or she can produce a good or service at a lower
opportunity cost than someone else.
COMPARATIVE ADVANTAGE
CAMERAS
(units)
TV SETS
(units)
Japan
50
40
Australia
10
20
 Which country has the absolute


OPP. COST 1 CAMERA
1 TV SET
Japan
.8 units of a 1.25 units of
TV set
a camera
Australia
2 units of a
camera
.5 units of a
cameras


advantage in the production of
Cameras? TV Sets?
What is the opportunity Cost of
producing one camera for
Japan? For Australia?
What is the opportunity cost of
producing one TV Set for Japan?
For Australia?
For which good does Australia
have the Comparative
Advantage?
For which good does Japan have
the Comparative Advantage?
COMPARATIVE ADVANTAGE
CAMERAS
(units)
TV SETS
(units)
Japan
50
40
Australia
10
20
OPP. COST 1 CAMERA
1 TV SET
Japan
.8 units of a 1.25 units of
TV set
a camera
Australia
2 units of a
TV set
.5 units of a
camera
 Which country has the absolute advantage
in the production of Cameras? TV Sets?
 Japan for Both
 What is the opportunity Cost of producing
one camera for Japan? For Australia?
 Japan- .8 units of a TV Set
 Australia- 2 units of a TV Set
 What is the opportunity cost of producing
one TV Set for Japan? For Australia?
 Japan- 1.25 Units of a Camera
 Australia- .5 Units of a camera
 For which good does Australia have the
Comparative Advantage?
 TV Sets because they are giving up less
cameras
 For which good does Japan have the
Comparative Advantage?
 Cameras because they are giving up less
TV’s
Specialization
 Specialization and trade based on comparative advantage
benefits both trading partners—whether individuals,
societies, or nations. For example, Alexander Selkirk and
Pirate Jack can both produce turnips and clams. Even
though Pirate Jack holds an absolute advantage in the
production of both goods, he and Selkirk both benefit
when they specialize in producing the good for which they
hold a comparative advantage and trade for the other good.
 When the principle of comparative advantage guides who
produces what, society usually benefits.
 Some of the factors that give rise to comparative advantage
are climate, natural resources, education, wage levels, and
technology differences.
How Does Trade Make us Wealthier?
 Wealth is defined as our sense of well-being. It is not
just how much money we have, but how much we
value what we have.
 Trade makes us wealthier in three ways:
 • Trade moves goods to the people who value them
more.
 • Trade increases the quantity and variety of goods
available.
 • Trade lowers the cost of goods.