Economics: The Core Issues Chapter 1 McGraw-Hill/Irwin Copyright © 2010 by the McGraw-Hill Companies, Inc. All rights reserved.

The Economy Is Us The economy is the aggregation of individual production and consumption decisions Important link between individual choices and collective outcomes

Macro Versus Micro Economics: The study of how best to allocate scarce resources among competing uses Macroeconomics: The study of aggregate economic behavior, of the economy as a whole Microeconomics: The study of individual behavior in the economy, of the components of the larger economy

Three Core Choices Three core choices confront every nation: WHAT to produce with our limited resources HOW to produce the goods and services we select FOR WHOM goods and services are produced; that is, who should get them

Scarcity: The Core Problem Scarcity: Lack of enough resources to satisfy all desired uses of those resources Scarcity of resources limits the amount of production that can be undertaken Requires choices to be made

Factors of Production Factors of Production: Resource inputs used to produce goods and services Four Types: Land Labor Capital Entrepreneurship

Factors of Production Land: Includes all natural resources e.g. oil, water, iron ore, energy, etc. Labor: Quantity and quality of human resources Includes physical presence of workers as well as their skills and abilities

Factors of Production Capital: Final goods produced for use in production of other goods and services Includes equipment and structures, such as: Factories Production machinery Fleet vehicles

Factors of Production Entrepreneurship: Assembling of resources to produce new or improved products and technologies It’s not just a matter of what resources you have but also of how well you use them

Opportunity Costs Opportunity cost: The next most desired goods and services foregone to obtain something else What is given up to undertake a chosen activity Associated with every decision For example, if we choose to produce bread then we cannot produce pizza crust with the same flour

Production Possibilities Production possibilities: The alternative combinations of final goods and services that could be produced in a given time period with all available resources and technology

The Production Possibilities Curve Production possibilities curve (PPC): Describes the various output combinations that could be produced in a given time period with available resources and technology Represents a menu of output choices an economy confronts

The Production Possibilities Curve Illustrates Two Essential Principles: Scarce resources: Production is limited by available resources and technology Opportunity costs: Can obtain additional quantities of a good only by reducing production of another

A Production Possibilities Curve F OUTPUT OF TRUCKS 5 4 3 2 1 OUTPUT OF TANKS

Increasing Opportunity Costs Resources do not transfer perfectly from the production of one good to another Increased production of one good or service can only be attained by sacrificing ever-increasing quantities of others

Increasing Opportunity Costs The shape of the curve illustrates increasing opportunity costs Lose some efficiency in the transfer Resources used for truck production are not ideally suited for producing tanks

Law of Increasing Opportunity Costs Step 1: give up one truck 5 B 4 Step 3: give up another truck Step 2: get two tanks C 3 OUTPUT OF TRUCKS Step 4: get one more tank D 2 E 1 F 1 2 3 4 5 OUTPUT OF TANKS

Efficiency Efficiency: Maximum output of a good from the resources used in production Every point on the production possibilities curve is a point of efficiency

Points Inside the Curve A production possibilities curve shows potential output Actual output can be less than potential due to Inefficiency: Resources not being used to maximum potential Unemployment: Some resources are idle

A Point Inside the Curve 5 B 4 Y C 3 OUTPUT OF TRUCKS Some resources are unemployed or used inefficiently 2 1 1 2 3 4 5 OUTPUT OF TANKS

Points Outside the Curve Any point outside the production possibilities curve is unattainable with available resources and technology

A Point Outside the Curve X Currently not attainable 5 B 4 C 3 OUTPUT OF TRUCKS 2 1 1 2 3 4 5 OUTPUT OF TANKS

Economic Growth Economic growth: An increase in output due to an expansion of production possibilities Production possibilities increase with more resources or better technology The production possibilities curve shifts outward

Economic Growth PP2 PP1 OUTPUT OF TRUCKS OUTPUT OF TANKS

The Mechanism of Choice An economy is largely defined by how it answers the WHAT, HOW and FOR WHOM questions

Continuing Debates The core of most debates is some variation of the WHAT, HOW, or FOR WHOM questions Conservatives favor Adam Smith’s laissez-faire approach Liberals think government intervention is likely to improve market outcomes

A Mixed Economy Countries answer the questions differently Mixed economy: An economy that uses both market signals and government directives to allocate goods and resources

Theory Versus Reality The economy is much too vast and complex to describe and explain in one course (or one lifetime) Economists use theories, or models, of economic behavior to evaluate and design economic policy