The Economic Way of Thinking

Scarcity: The Basic Economic Problem What Is Scarcity? KEY CONCEPTS Wants — desires that can be met by consuming products Needs — things necessary for survival Scarcity — lack of resources available to meet all human wants not a temporary shortage Economics — study of how people use resources to satisfy wants examines how individuals and societies choose to use resources organizes, analyzes, interprets data about economic behaviors develops theories, economic laws to explain economy, predict future

What Is Scarcity? Principle 1: People Have Wants People make choices about all their needs and wants Wants are unlimited, ever changing

What Is Scarcity? Principle 2: Scarcity Affects Everyone Scarcity affects which goods and services are provided Goods — physical objects that can be bought Services — work one person does for another for pay Consumer — person who buys good or service for personal use Producer — person who makes a good or provides a service

Scarcity Leads to Three Economic Questions Question 1: What Will Be Produced? Societies must decide on mix of goods to produce depends in part on their natural resources Some countries allow producers and consumers to decide In other countries, governments decide Must also decide how much to produce; choice depends on societies’ wants

Scarcity Leads to Three Economic Questions Question 2: How Will It Be Produced? Decisions on production methods involve using resources efficiently decisions influenced by a society’s natural resources Societies adopt different approaches with unskilled labor force, might use labor-intensive methods with skilled labor force, might use capital-intensive methods

Scarcity Leads to Three Economic Questions Question 3: For Whom Will It Be Produced? How goods and services are distributed involves two questions how should each person’s share be determined? how will goods and services be delivered to people?

The Factors of Production KEY CONCEPTS Factors of production — resources needed to produce goods and services include land, labor, capital, entrepreneurship supply is limited

The Factors of Production Factor 1: Land Land means all natural resources on or under the ground includes water, forests, wildlife, mineral deposits

The Factors of Production Factor 2: Labor Labor is all the human time, effort, talent used to make products physical and mental effort used to make a good or provide a service

The Factors of Production Factor 3: Capital Capital is a producer’s physical resources includes tools, machines, offices, stores, roads, vehicles sometimes called physical capital or real capital Workers invest in human capital — knowledge and skills workers with more human capital are more productive

The Factors of Production Factor 4: Entrepreneurship Entrepreneurship — vision, skill, ingenuity, willingness to take risks Entrepreneurs anticipate consumer wants, satisfy these in new ways develop new products, methods of production, marketing or distributing risk time, energy, creativity, money to make a profit

Economic Choice Today: Opportunity Cost Making Choices KEY CONCEPTS Economic choices shaped by Incentives — benefits that encourage people to act in certain ways Utility — benefit or satisfaction gained from using a good or service To make choices, people economize: make decisions according to best combination of costs and benefits

Making Choices Factor 1: Motivations for Choice People motivated by incentives, expected utility, desire to economize They weigh costs against benefits to make purposeful choices motivated by self-interest: look for ways to maximize utility

Making Choices Factor 2: No Free Lunch “There is no such thing as a free lunch!” All choices have a cost choosing one thing means giving up another, or paying a cost cost can take form of money, time, other thing of value Even if something is free to you, is it really free?

Trade-Offs and Opportunity Cost KEY CONCEPTS Trade-off is alternative people give up when they make a choice usually means giving up some, not all, of a thing to get more of another

Trade-Offs and Opportunity Cost Example 2: Counting the Opportunity Cost Opportunity cost is value of next-best alternative a person gives up not the value of all possible alternatives Dan chooses to work for six months so he can travel for six months opportunity cost – 6 months of salary LeBron James, Cam Newton

Analyzing Choices KEY CONCEPTS Cost-benefit analysis — examination of costs, expected benefits of choices one of most useful tools for evaluating relative worth of economic choices

Analyzing Choices Example: Marginal Costs and Benefits Marginal cost additional cost of using one more unit of a good or service Marginal benefit additional benefit of using one more unit of a good or service When making a decision, we weigh the marginal costs and marginal benefits Rational decisions = when marginal benefits = or are > marginal costs

Graphing the Possibilities Analyzing Production Possibilities Graphing the Possibilities KEY CONCEPTS Economic models — simplified representations of economic forces Production possibilities curve (PPC) is one model maximum goods or services that can be produced from limited resources also called production possibilities frontier

Graphing the Possibilities Production Possibilities Curve PPC based on assumptions that simplify economic interactions resources are fixed all resources are fully employed only two things can be produced Technology is fixed PPC runs between extremes of producing only one item or the other Data is plotted on a graph; lines joining points is PPC shows maximum number of one item relative to other item PPC shows opportunity cost of each choice more of one product means less of the other

What We Learn from PPCs KEY CONCEPTS Concepts revealed by PPC: Efficiency — producing the maximum amount of goods and services possible Underutilization — producing fewer goods and services than possible

What We Learn from PPCs Example: Efficiency and Underutilization Each point on PPC represents efficiency points inside curve mean underutilization; outside curve cannot be met Law of increasing opportunity costs as production switches from one product to another, more resources needed to increase production of second product Reasons for increasing cost of making more of one product need new resources, machines, factories must retrain workers Costs paid by making less and less of other product

Changing Production Possibilities Example: A Shift in the PPC A country’s supply of resources changes over time Example: U.S. in 1800s grew, gained resources, workers, new technology new resources mean new production possibilities beyond frontier Increased production shown on PPC as shift of curve outward Increase in total output called economic growth

The Economists Toolbox Working with Data Statistics — numerical data or information show patterns of human behavior Economic models help organize and interpret data

Microeconomics and Macroeconomics Microeconomics — studies behavior of individual players in an economy includes individuals, families, businesses Microeconomics examines specific, individual elements in an economy prices, costs, profits, competition, consumer and producer behavior Some Topics of Interest: business organization, labor markets, environmental issues

Microeconomics and Macroeconomics Macroeconomics — studies behavior of economy as a whole topics include inflation, unemployment, aggregate demand and aggregate supply Macroeconomics studies sectors — combination of all individual units Includes consumer, business, public or government sectors Macroeconomics studies national or global topics: monetary system, business cycle, tax policies, international trade

Positive Economics and Normative Economics Positive economics describes and explains economic behavior as it is uses verifiable facts; does not make judgments Normative economics studies what economic behavior should be makes value judgments to recommend future actions

Adam Smith: Founder of Modern Economics Seeing the Invisible An Inquiry into the Nature and Causes of the Wealth of Nations, 1776 challenged mercantilism; argued for free trade Invisible hand guides free marketplace, benefits sellers and buyers people pursue own economic self-interest producers sell at prices that satisfy them and that consumers will pay