Econ 102 The Canadian Economy Chapter 1 The Economic Problem Copyright © 2002 by McGraw-Hill Ryerson Limited. All rights reserved.

Copyright © 2002 by McGraw-Hill Ryerson Limited. All rights reserved. Chapter Objectives In this chapter, you will: consider the economic problem that underlies the definition of economics; learn about the way economists specify economic choice; examine the production choices an entire economy faces, as demonstrated by the production possibilities model; analyze the three basic economic questions and how various economic systems answer them. Copyright © 2002 by McGraw-Hill Ryerson Limited. All rights reserved.

Outline of Topics 1.1 What Economists Do 1.2 Economic Choice 1.3 The Production Possibilities Model 1.4 Economic Systems

1.1 What Economists Do The Economic Problem Economists deal with the economic problem. Economic agents must continually make choices. Their wants are unlimited. They face a limited supply of economic resources. Economic resources including natural, capital, and human resources ( see Definitions on page 3)

1.1 What Economists Do Economics Defined Economics is the study of how to distribute scarce resources among competing ends. Microeconomics focuses on individual consumers and businesses. Macroeconomics takes a broad view of the economy. Copyright © 2002 by McGraw-Hill Ryerson Limited. All rights reserved.

1.1 What Economists Do Economic Models simplify economic reality show how dependent variables are affected by independent variables include inverse and/or direct relationships incorporate a variety of assumptions such as ceteris paribus are classified as part of either positive economics or normative economics (See Definitions on page 5 & 6) Copyright © 2002 by McGraw-Hill Ryerson Limited. All rights reserved.

1.2 Economic Choice Utility Maximization Economists assume that economic decision-makers maximize their own utility. Utility: the satisfaction gained from any action Decision-makers must keep in mind the opportunity cost of each alternative. Opportunity cost: the utility that could have been gained by choosing an action’s best alternative. Copyright © 2002 by McGraw-Hill Ryerson Limited. All rights reserved.

1.3 The Production Possibilities Model The production possibilities model is based on three assumptions: an economy makes only two products resources and technology are fixed all resources are employed to their fullest capacity Copyright © 2002 by McGraw-Hill Ryerson Limited. All rights reserved.

Copyright © 2002 by McGraw-Hill Ryerson Limited. All rights reserved. 1.3 The Production Possibilities Model The Production Possibilities Curve (a) The production possibilities curve shows a range of possible output combinations for an economy. It highlights the scarcity of resources. It has a concave shape, which reflects the law of increasing opportunity costs. Copyright © 2002 by McGraw-Hill Ryerson Limited. All rights reserved.

The Production Possibilities Curve (b) Figure 1.1, page 8 Production Possibilities Schedule Hamburgers Computers point on graph a 1000 b unattainable f 900 Hamburgers 600 c 1000 0 a 900 1 b 600 2 c 0 3 d e inefficient d 0 1 2 3 Computers Copyright © 2002 by McGraw-Hill Ryerson Limited. All rights reserved.

The Law of Increasing Opportunity Costs Figure 1.2, page 10 Production Possibilities Curve Production Possibilities Schedule Hamburgers Opportunity Computers point Cost of on graph Computers a As the quantity of computers rises, so does their opportunity cost. 1000 b 900 1000 0 a Hamburgers 600 c 100 900 1 b 300 600 2 c 600 0 3 d d 0 1 2 3 Computers Copyright © 2002 by McGraw-Hill Ryerson Limited. All rights reserved.

Economic Growth: Outward Shifts in Production Possibilities Production Possibilities Curve With more computers, the curve shifts out in the next period. 1000 Hamburgers 0 3 Computers Copyright © 2002 by McGraw-Hill Ryerson Limited. All rights reserved.

Copyright © 2002 by McGraw-Hill Ryerson Limited. All rights reserved. 1.4 Economic Systems Economic Systems: the organization of an economy, which represents a country’s distinct set of social customs, political institutions, and economic practices The Basic Economic Questions: There are three basic questions any society must answer: what to produce how to produce for whom to produce Copyright © 2002 by McGraw-Hill Ryerson Limited. All rights reserved.

1.4 Economic Systems There are three systems to choose from: Traditional Economy: an economic system in which economic decisions are made on the basis of custom. Traditional economies focus on non-economic concerns and have tight social constraints.

Copyright © 2002 by McGraw-Hill Ryerson Limited. All rights reserved. 1.4 Economic Systems Market Economy: an economic system based on private ownership and the use of markets in economic decision-making Market economies are consumer-centered and innovative but create inequality and instability. Benefits: Consumer sovereignty: the decision of what to produce is ultimately guided by the needs and wants of household in their role as consumers Innovation Copyright © 2002 by McGraw-Hill Ryerson Limited. All rights reserved.

1.4 Economic Systems Drawbacks: Inequities of income distribution Possible market problems: eg, pollution Possible Instability of total output Command Economy: an economic system based on public ownership and central planning. Benefits: Distribute income equally Economic growth

1.4 Economic Systems Drawbacks: Planning difficulties Inefficiencies A lack of freedom.

1.4 Economic Systems Mixed Economy Most countries fall between the extremes of traditional, market, and command economies. Modern mixed economies: an economic system that combines aspects of a market economy and a command economy; production decisions are made both in private markets and by government Traditional mixed economies: economic systems in which a traditional sectors co-exists with modern sectors Copyright © 2002 by McGraw-Hill Ryerson Limited. All rights reserved.

The Range of Economic Systems Figure 1.4, page 16 Copyright © 2002 by McGraw-Hill Ryerson Limited. All rights reserved.

1.4 Economic System Economic Goals There are seven major economic goals: economic efficiency income equity price stability full employment viable balance of payments economic growth environmental sustainability Copyright © 2002 by McGraw-Hill Ryerson Limited. All rights reserved.

1.4 Economic System Complementary and Conflicting Economic Goals Economic goals may be complementary. An example is the relationship between full employment and economic growth. Economic goals may be conflicting. An example is the relationship between price stability and full employment. Copyright © 2002 by McGraw-Hill Ryerson Limited. All rights reserved.

The Founder of Modern Economics Adam Smith: explained how the division of labour increases production argued that self interest is transformed by the invisible hand of competition so that it creates significant economic benefits stressed the principle of laissez faire, which means that governments should not intervene in economic activity Copyright © 2002 by McGraw-Hill Ryerson Limited. All rights reserved.