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Lecture notes Prepared by Anton Ljutic CHAPTER ONE The Economic Problem © 2004 McGraw–Hill Ryerson Limited This Chapter Will Enable You to (I): • Realize that scarcity, choice and cost are at the heart of economics • Explain the three fundamental questions that all societies must address • Understand the four major types of economies • Discuss whether economics is an art or a science • Understand the circular flow of income diagram © 2004 McGraw–Hill Ryerson Limited This Chapter Will Enable You to (II): • Use the production possibilities model to illustrate opportunity cost, efficiency, and unemployment • Define economics and understand why it is controversial but of great relevance • List the economic goals of society and understand why they are often difficult to achieve © 2004 McGraw–Hill Ryerson Limited Scarcity, Choice and Opportunity Cost (I) • Scarcity – Society must allocate limited productive resources among competing uses • Choice – The decision to produce one thing means that some other thing will not be produced • Opportunity cost – The value of the next-best alternative that is given up as a result of making a particular choice • Consumer goods and services – Products used by consumers to satisfy their wants. © 2004 McGraw–Hill Ryerson Limited Scarcity, Choice and Opportunity Cost (II) which involves forces Scarcity Choice Opportunity cost © 2004 McGraw–Hill Ryerson Limited Benefits of voluntary trade • • • • • • Athens Sparta Athens Sparta Athens Sparta 20 bread 10 bread 10 bread 5 bread 20 bread 20 plows or or and and and and © 2004 McGraw–Hill Ryerson Limited 10 plows 20 plows 5 plows 10 plows no plows no bread Three Fundamental Questions of Economics • What to produce? • How? • For whom? © 2004 McGraw–Hill Ryerson Limited Types of Economies (I) • Cooperation – Determines what work needs to be done, how it is to be done, and who is to obtain what share of the produce • Custom – Determines who performs which task and implies that traditional technology is superior to new ways of doing things © 2004 McGraw–Hill Ryerson Limited Types of Economies (II) • Command – Most of the important economic questions are answered by the orders of those in power • Market – Competition plays an important role • Mixed – Contains elements of command and competition © 2004 McGraw–Hill Ryerson Limited Factors of Production (I) • The productive resources that are available to an economy, categorized as land, labour, capital and enterprise. – Land • Any natural resource that can be used to produce goods and services. – Labour • Human physical and mental effort that can be used to produce goods and services. © 2004 McGraw–Hill Ryerson Limited Factors of Production (II) – Capital. • All human-made resources that can be used to produce goods and services. – Enterprise. • The human resource that innovates and takes risk. © 2004 McGraw–Hill Ryerson Limited Incomes of Factors of Production (I) • Wages – Payment and income for the use of labour • Interest – Payment and income for the use of capital • Rent – Payment and income for the use of land • Profit – Goes to the owners of the firm © 2004 McGraw–Hill Ryerson Limited Incomes of Factors of Production (II) Factor Factor payment • • • • • • • • Land Labour Capital Enterprise © 2004 McGraw–Hill Ryerson Limited Rent Wages Interest Profits Economics: Science or Art? • • • • • • Positive statements Normative statements Hypotheses - theories Scientific method Economics deals in generalities Economics uses models © 2004 McGraw–Hill Ryerson Limited Positive Versus Normative Statements • Positive Statements – Assertions about the world that can be tested by using empirical data • Normative Statements – Are based on a value system of beliefs and cannot be tested by using empirical data © 2004 McGraw–Hill Ryerson Limited Model Example One: Circular Flow Consumption spending $ Goods and services Business sector Household sector Factors of production $ Factor incomes: rent, wages, interest, profit Figure 1.1 © 2004 McGraw–Hill Ryerson Limited Model Example Two: Production Possibilities The model: • is a graphical representation of the various combinations of maximum output that can be produced • assumes efficiency, full employment and the use of the best technology • illustrates scarcity, choice and opportunity cost © 2004 McGraw–Hill Ryerson Limited The Production Possibilities Table Table 1.1 CARS WHEAT Choices % res.use Output %res. use Output A 0 0 100 20 B 20 10 80 19 C 40 18 60 17 D 60 24 40 13 E 80 28 20 8 F 100 30 0 0 © 2004 McGraw–Hill Ryerson Limited The Production Possibilities Curve (I) Wheat a Unattainable b x c Figure 1.2 Attainable d e © 2004 McGraw–Hill Ryerson Limited Cars The Production Possibilities Curve (II) • Scarcity Is represented by points outside the curve • Choice – Is represented by points on the curve (efficient) and points inside the curve (inefficient) • Opportunity Cost – Is represented by the downward slope of the curve. © 2004 McGraw–Hill Ryerson Limited The Law of Increasing Opportunity Costs • Factors of production are not of same quality. • As production of any item increases, the per unit cost of producing additional units of that item will increase. • As the production of cars increase, the per unit cost of cars increase, giving the production possibilities curve its bowed-out shape. © 2004 McGraw–Hill Ryerson Limited Constant Cost Prod. Possibilities Curve Figure 1.4 Shirts/day 5 4 3 2 1 0 0 1 2 3 © 2004 McGraw–Hill Ryerson Limited 4 5 Moccasins /day Prod. Possibilities and Technological Change Improved technology in the production of cars. Wheat Cars © 2004 McGraw–Hill Ryerson Limited Different Growth Rates Faster growth Figure 1.6 Original curve Slower growth © 2004 McGraw–Hill Ryerson Limited Consumer goods A Definition of Economics • The study of… • …the ways that humans organize themselves… • …to make the necessary choices… • …about how scarce resources are to be used to produce goods and services… • …necessary to satisfy human wants and needs © 2004 McGraw–Hill Ryerson Limited Economics: Fields of Study • Macroeconomics – The study of how the major components of an economy interact. Includes topics of unemployment, inflation, interest rate policy and government spending and taxation • Microeconomics – The study of the outcomes of decisions by people and firms through a focus on demand and supply, the costs of production, and market structures © 2004 McGraw–Hill Ryerson Limited Macroeconomic Goals • • • • • • • Improved standard of living Economic growth Full employment Stable prices Viable balance of international trade Equitable distribution of income Manageable government debt and deficit © 2004 McGraw–Hill Ryerson Limited Chapter Summary: What to Study and Remember (I) • Scarcity, choice and cost are at the heart of economics • There are three fundamental questions that all societies must address • There are four major types of economies • Resolve whether economics is an art or a science • The circular flow of income diagram © 2004 McGraw–Hill Ryerson Limited Chapter Summary: What to Study and Remember (II): • Use the production possibilities model to illustrate opportunity cost, efficiency, and unemployment • Define economics and understand why it is controversial but of great relevance • List the economic goals of society and understand why they are often difficult to achieve © 2004 McGraw–Hill Ryerson Limited