The Economic Perspective Chapter 1

Economic Problem The problem is that, although your wants, or desires, are virtually unlimited, the resources available to satisfy these wants are scarce.The problem is that, although your wants, or desires, are virtually unlimited, the resources available to satisfy these wants are scarce.

Scarcity All resources are scarce

Scarcity Means limited goods and servicesMeans limited goods and services Restricts options and demands choicesRestricts options and demands choices Price > ZEROPrice > ZERO

Rational Self-Interest Means that individuals try to maximize the expected benefit achieved with a given cost or to minimize the expected cost of achieving a given benefitMeans that individuals try to maximize the expected benefit achieved with a given cost or to minimize the expected cost of achieving a given benefit

Making decisions at the margin Margin: the cutoff point; decision making at the margin refers to deciding on one more or one less of somethingMargin: the cutoff point; decision making at the margin refers to deciding on one more or one less of something Weighing and balancing of alternativesWeighing and balancing of alternatives –Marginal benefit –Marginal cost –Benefits > Costs

Scientific Method ElementsElements –Observation of real-world behavior and outcomes –Formulation of hypothesis –Testing of this explanation by comparing the outcomes of specific events to predict outcome –The acceptance, rejection, or modification of the hypothesis –The continued testing of the hypothesis against the facts.

Microeconomics Analyzes the individual components of the economy, such as the choices made by people, firms, and industries.Analyzes the individual components of the economy, such as the choices made by people, firms, and industries. Markets – make possible the voluntary exchange of resources, goods and services; can take physical, electronic, and other forms.Markets – make possible the voluntary exchange of resources, goods and services; can take physical, electronic, and other forms. Market prices – serve as signals that guide the allocation of resourcesMarket prices – serve as signals that guide the allocation of resources

Macroeconomics Analyzes economic aggregates such as aggregate employment, output, growth, and inflationAnalyzes economic aggregates such as aggregate employment, output, growth, and inflation Most important is GDPMost important is GDP –Gross domestic product

Normative Economics A statement that represents an opinion, which cannot be proved or disproved What ought to be Ethical value judgments

Positive Economics A statement that can be proved or disproved by reference to factsA statement that can be proved or disproved by reference to facts What isWhat is Scientific portionScientific portion

Society’s Economizing Problem The need to make choices because economic wants exceed economic meansThe need to make choices because economic wants exceed economic means

Scarce resources Society has limited economic resourcesSociety has limited economic resources

Resources The inputs, or factors of production, used to produce the goods and services that people want resourcesThe inputs, or factors of production, used to produce the goods and services that people want resources Also called factors of productionAlso called factors of production

Land Includes all the natural resources used in the production processIncludes all the natural resources used in the production process

Labor The physical and mental effort used to produce goods and servicesThe physical and mental effort used to produce goods and services

Labor - mental Mental effort –Consists of the knowledge and skill people acquire to enhance their productivity

Capital The buildings, equipment, and human skill used to produce goods and servicesThe buildings, equipment, and human skill used to produce goods and services –Physical capital –Human capital

Capital Physical capital –Consists of factories, machines, tools, buildings, airports, highways, and other human creation

Entrepreneurial Ability Managerial and organizational skills needed to start a firm, combined with the willingness to take risksManagerial and organizational skills needed to start a firm, combined with the willingness to take risks

Functions of Entrepreneur Entrepreneur takes the initiative in combining the resources of land, labor, and capitalEntrepreneur takes the initiative in combining the resources of land, labor, and capital The entrepreneur makes the strategic business decisions that set the course of an enterpriseThe entrepreneur makes the strategic business decisions that set the course of an enterprise Innovator Risk bearer

Entrepreneurs PickPick Anita Roddick William H. Gates

Payments to Resources WagesWages –Payment to resource owners for their labor InterestInterest –Payment to resource owners for the use of their capital RentRent –Payment to resource owners for the use of their natural resources. ProfitsProfits –The reward for entrepreneurial ability.

Production Possibilities Frontier AssumptionsAssumptions –Output is limited to two products: consumer goods and capital goods –Resources are FIXED in both quantity and quality during that period –Technology does not change –Full employment

Production Possibilities Frontier A curve showing alternative combinations of goods that can be produced when available resources are used fully and efficiently.A curve showing alternative combinations of goods that can be produced when available resources are used fully and efficiently. ProductABCDE Consumer01234 Capital109740

Production Possibilities Frontier Capital Goods Consumer goods 0 Production possibilities curve A B C Inefficient D. Unattainable Points on line are efficient

Production Possibilities Frontier Efficient pointsEfficient points –Any point found on the production possibilities frontier such as A and B Inefficient pointsInefficient points –Inside the curve UnattainableUnattainable –Outside the curve

Economic growth An increase in the economy’s ability to produce goods and servicesAn increase in the economy’s ability to produce goods and services An outward shift of the production possibilities frontierAn outward shift of the production possibilities frontier Caused byCaused by –Changes in resource availability –Increases in capital stock –Technological change

Economic Growth Caused by –Increases in capital stock –Technological change

Economic Growth Capital Goods Consumer goods 0 Production possibilities curve Shift in PPF

Economic Analysis Fallacy of compositionFallacy of composition –What is true at the micro level is also true at the macro level What is true for the individual is true for the wholeWhat is true for the individual is true for the whole Fallacy of that association is causationFallacy of that association is causation –The incorrect idea that if two variables are associated in time, one must necessarily cause the other

Economic Analysis Secondary EffectsSecondary Effects –Unintended consequences of economic actions that may develop slowly over time as people react to events.