What is Economics? Chapter 1

Important Definitions Economics – the study of how individuals & nations make choices about how to use scarce resources to fulfill their needs & unlimited wants Economics (1) describes, (2) analyzes, (3) explains, & (4) predicts economic activity.

Important Definitions Scarcity– state in which people do not and cannot have enough income, time, or other resources to satisfy all their desires Resource – anything that can be used to produce goods & services

Important Definitions Scarcity is the basic problem of economics. It ALWAYS exists, because all resources are limited, but our wants are unlimited. People are constantly forced to make choices.

Important Definitions Wants vs. Needs Needs – things required for survival Wants – everything we desire that is not a need

NEED OR WANT? MP3 player Television McDonald’s Extra Value Meal Car Apartment / House Education Family

THREE BASIC QUESTIONS What to produce? How to produce? Because resources are scarce, economic systems have to answer three basic economic questions: What to produce? (What items are most essential for our citizens?) How to produce? (What resources should we use to produce our goods?) For whom to produce? (i.e., Should we produce goods for children or the elderly? For the wealthy or the poor?)

FOUR Types of Resources Land – natural resources Labor – the work people do (human resource)

FOUR Types of Resources Capital – the property people use to make other goods & services

FOUR Types of Resources Entrepreneurship – the ability of individuals to start new businesses, to introduce new products & techniques, and to improve management techniques

Productive Resources Land, labor, capital, & entrepreneurship together are called the productive resources.

Productive Resources Productive resources are used to produce goods & services. [The production of all goods requires the use of all of the productive resources.] Goods – useful, tangible items that satisfy needs/wants Consumer goods – goods intended for final use by consumers (people who use goods)

Two types of goods Durable goods – any good that lasts three years or more Nondurable goods – an item that lasts less than three years when used on a regular basis

Goods / Services Service – an activity performed for a fee

(Everything has a cost!) Choices have a COST! TINSTAAFL – “There is no such thing as a free lunch.” (Everything has a cost!)

Choices have a COST! Trade-off –giving up one thing to do or use another (Ex: being in class today; going to college)

Choices have a COST! opportunity cost – the value of the next best alternative that had to be given up for the alternative that was chosen (Ex.: time in class, spending summer money)

How do people / businesses decide what to do / produce? Cost-benefit analysis – a means of comparing the cost of the action to the benefits received (“weighing pros & cons”)

How do people / businesses decide what to do / produce? Production possibilities curves – graphical representations that show all the combinations of goods & services that can be produced from a fixed amount of resources in a given period of time (AKA: “guns vs. butter” analogy)

Economics Economists are people who study the economy. economy – all the activity in a nation that together affects the production, distribution, & use of goods & services

The Basic Decision-Making Units A firm is an organization that transforms resources (inputs) into products (outputs). Firms are the primary producing units in a market economy. An entrepreneur is a person who organizes, manages, and assumes the risks of a firm, taking a new idea or a new product and turning it into a successful business. Households are the consuming units in an economy.

The Free Market Economy In a free market economy, households and business firms use markets to exchange money and products. monetary flow physical flow Circular Flow Diagram of a Market Economy Households Firms Households pay firms Households pay firms for goods and services. or goods and services. Product market Firms supply households with goods and services. Households supply firms with land, labor, and capital. Firms pay households for land, labor, and capital. Factor market

Input Markets and Output Markets Output, or product, markets are the markets in which goods and services are exchanged. Input markets are the markets in which resources—labor, capital, and land—used to produce products, are exchanged. Payments flow in the opposite direction as the physical flow of resources, goods, and services (counterclockwise).

Input Markets Input markets include: The labor market, in which households supply work for wages to firms that demand labor. The capital market, in which households supply their savings, for interest or for claims to future profits, to firms that demand funds to buy capital goods. The land market, in which households supply land or other real property in exchange for rent.