Chapter 1 The Economic Way of Thinking Mrs. Lehman South Broward High School Economics

Chapter 1: The Economic Way of Thinking KEY CONCEPT Scarcity is the situation that exists because wants are unlimited and resources are limited. WHY THE CONCEPT MATTERS The concept of scarcity is an issue you confront in everyday life. Suppose you have $20 to cover the cost of lunches for the week. How would you use the money to cover your wants Monday through Friday? How would buying a late afternoon snack for $1 on two of the days affect your lunch choices?

Scarcity: The Basic Economic Problem Section-1 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 2: Scarcity Affects Everyone Principle 1: People Have Wants People make choices about all their needs and wants Wants are unlimited, ever changing 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 KEY CONCEPTS Scarcity affects society and producers as well as individuals Society must answer three basic economic questions: — what will be produced? — how will it be produced? — for whom will it be produced?

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 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 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 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 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 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 Section-2 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 Factor 2: No 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

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 Example 1: Making Trade-Offs Shanti wants to earn college credit over summer — semester-long university course offers more credits — six-week high school course leaves time for vacation 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: six months of salary

Analyzing Choices KEY CONCEPTS Example: Max’s Decision-Making Grid Cost-benefit analysis — examination of costs, expected benefits of choices — one of most useful tools for evaluating relative worth of economic choices Example: Max’s Decision-Making Grid Decision-making grid shows what one gets, gives up with each choice Max’s grid shows all possible choices for his free hours each week — lists choices, benefits and opportunity cost of each choice With time, costs and benefits change; also goals and circumstances — Changes influence decisions, make people alter original choices Example: Marginal Costs and Benefits Marginal cost Marginal benefit — additional benefit of using one more unit of a good or service

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

Working with Data Using Charts and Tables Using Graphs Economists look for statistical relationships, trends, connections Charts and tables display data in rows and columns — can reveal patterns by showing numbers in relation to other numbers Using Graphs Graphs use two sets of variables: along horizontal, vertical axes Line graphs useful for showing changes over time — in economics, line referred to as a curve, even if straight Bar graphs good for showing comparisons Pie graph (or pie chart, circle graph) shows numbers in relation to whole Using Economic Models Economic models focus on a limited number of variables — thus based on assumptions and use simplification — expressed in words, graphs, equations

Microeconomics and Macroeconomics KEY CONCEPTS Microeconomics studies behavior of individual players in an economy includes individuals, families, businesses Macroeconomics studies behavior of economy as a whole topics include inflation, unemployment, aggregate demand and aggregate supply

Positive Economics and Normative Economics KEY CONCEPTS 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

Positive Economics and Normative Economics Positive economics uses scientific method observe data, hypothesize, test, refine, continue testing Statements tested against real-world data proved (or strongly supported) or disproved (or strongly questioned)

Positive Economics and Normative Economics Normative economics studies facts, asks if course of action is good Recommendations differ because values they are based on also differ

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

Analyzing Production Possibilities Section-3 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 KEY CONCEPTS 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

Graphing the Possibilities Production Possibilities Curve 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 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 Example: Increasing Opportunity Costs Increase in opportunity cost — each new unit costs more than last one 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 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

Vocabulary Wants desires that can be met by consuming products Needs Things necessary for survival Scarcity lack of resources available to meet all human wants Economics study of how people use resources to satisfy wants Good 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 Factors of Production include land, labor, capital, entrepreneurship Land means all natural resources on or under the ground

Vocabulary Labor All the human time, effort, talent used to make products Capital A producer’s physical resources Entrepreneurship vision, skill, ingenuity, willingness to take risks Incentives benefits that encourage people to act in certain ways Utility benefit or satisfaction gained from using a good or service Economize make decisions according to best combination of costs and benefits Trade-off alternative people give up when they make a choice Opportunity Cost value of next-best alternative a person gives up

Vocabulary Cost-Benefit Analysis examination of costs, expected benefits of choices Marginal Cost lists choices, benefits and opportunity cost of each choice Marginal Benefit additional benefit of using one more unit of a good or service Statistics Numerical data or information Microeconomics Studies behavior of individual players in an economy Macroeconomics studies behavior of economy as a whole Positive Economics describes and explains economic behavior as it is Normative Economics studies what economic behavior should be

simplified representations of economic forces Vocabulary Economic Models simplified representations of economic forces Production Possibilities Curve An economic model that shows a maximum goods or services that can be produced from limited resources Efficiency producing the maximum amount of goods and services possible Underutilization producing fewer goods and services than possible Law of Increasing Opportunity Cost as production switches from one product to another, more resources needed to increase production of second product