What is Economics? Chapter 18

The Fundamental Economic Problem Section 1

What is Economics?

What is Economics? Economics is the study of how we make decisions in a world where resources are scarce and how things are made, bought, sold, and used. It is sometimes called the science of decision making.

Scarcity Needs are things we need for survival, such as food, clothing, and shelter. Wants are things we would like to have. The fundamental economic problem is scarcity–we do not have enough resources to produce all the things we would like to have. Because of scarcity, we must make choices among alternatives.

Scarcity and Choice

Economics Microeconomics= The study of the behavior and decision making of small units such as individuals and businesses. Economists looks at the small picture (Micro) Macroeconomics= Deals with the economy as a whole and decision making by large units such as governments or whole industries or societies. looks at the big picture (Macro)

Using Economic Models To study a part of the economy, economists use economic models. These are simplified representations of the real world that are used to explain how the economy works. Business and government often base decisions on solutions that emerge from testing economic models.

Using Economic Models Models are based on assumptions. The quality of the model’s results can be no better than the assumptions on which it is based. Economists use models to better understand the past or present and to predict the future. If predictions based on a model turn out to be wrong, economists revise the model.

Economic System A countries way of producing the things its people want and need. Free enterprise capitalism= businesses are allowed to compete for profit with a minim of government interference.

Resources Resources= the things used in making goods and providing services. They include tools, natural resources, and human resources. A country with many resources is capable of satisfying its peoples wants and needs better than a country with few resources.

What to produce? Society must decide what to produce with its limited resources. For example, society may have to choose whether to build a school or make improvements on our roads

How to produce? Society must decide how to produce. For example, should we accept more pollution from factories in exchange for greater output of products? Drilling for oil in Alaska

Whom to produce? Society must decide for whom to produce. Who will receive the goods and services? Who will benefit from a new school? In the United States, most goods and services are distributed through the price system.

Economic Choices in Business and Government

__ 1. the study of how individuals and nations make choices about ways to use scarce resources to fulfill their needs and wants __ 2. not having enough resources to produce all of the things we would like to have __ 3. simplified representation of the real world that economists develop to describe how the economy behaves and is expected to perform in the future __ 4. requirements for survival, such as food, clothing, and shelter __ 5. things we would like to have, such as entertainment, vacations, and items that make life comfortable

Making Economic Decision Chapter 18

Trade-Offs Economic decision making requires that we take into account all the costs and all the benefits of an action. Economic choices involve trade-offs, or exchanging one thing for the use of another. For example, taking more time to study for a test means less time to talk on the telephone with friends, and talking on the phone for a long time means less time studying for the test.

Trade-Offs People, businesses, and societies make trade-offs every time they choose to use their resources in one way and not in another. More money for education may mean less money to spend on medical research or national defense.

Opportunity Costs (pg. 412) Opportunity cost is what you cannot buy or do when you choose to do or buy one thing rather than another. It is the next best alternative that you had to give up for the choice you made.

Opportunity Costs Opportunity cost includes more than just money. It also includes the discomforts and inconveniences linked to the choice made. For example, the opportunity cost of cleaning the house includes not only the price of cleaning products, but also the time you spent cleaning instead of doing something else, like listening to music.

Measure of Costs: Fixed and Variable Costs All businesses have fixed and variable costs. Fixed costs are expenses that are the same no matter how many units of a good are produced. Variable costs are expenses that change with the number of products produced. If a business produces more, variable costs like raw materials and wages will increase.

Total Costs Fixed costs plus variable costs equal total costs (total costs for the month). To find average total cost, divide total cost by the quantity produced.

Marginal Costs Marginal cost is the extra cost of producing one additional unit of output. If it costs an extra $50 to produce one more bicycle helmet, the marginal cost is $50.

Marginal Revenue Businesses measure total revenue and marginal revenue to decide what amount of output will produce the greatest profits. Total revenue equals the number of units sold times the average price per unit. Marginal revenue is the change in total revenue that results from selling one more unit of output.

Marginal Benefit We usually do something because we expect to achieve some benefit. Marginal benefit is the additional benefit associated with an action. Would I benefit from _________???????

Cost-Benefit Analysis Cost-benefit analysis is an economic model used to compare marginal costs and marginal benefits of a decision. You should choose an action when the benefits are greater than the costs. If costs outweigh benefits, you should reject the option.

Cost-Benefit Analysis Suppose you are a farmer trying to decide how many acres to plant. The graph on page 508 of your textbook shows a cost-benefit analysis for this decision. You will plant the most productive land first. The extra benefits decline as you plant less productive land. The graph shows that after 15 acres, the extra costs outweigh the extra benefits of planting more acres.

Cost-Benefit Analysis The result of this analysis tells you to plant no more than 15 acres. You could do a similar analysis to determine what to produce. For example, you could compare the results of planting crops other than wheat. The crop that produces the greatest marginal benefit is the one you should plant.

Cost Benefit Analysis You could use this method to decide for whom to produce. You could compare the costs and benefits of selling your wheat nearby or 100 miles away. You would choose to distribute your product wherever the marginal benefit was greatest.

__ 2. economic model that compares the marginal costs and marginal benefits of a decision __ 3. the cost of the next best alternative use of time and money when choosing to do one thing rather than another __ 4. the additional or extra benefit associated with an action __ 5. the alternative you face if you decide to do one thing rather than another

Being an Economically Smart Citizen Section 3

Understanding Your Role in the Economy The United States has a market economy. Most economic decisions are not made by the government, but by individuals looking out for their own and their families’ self-interests.

Understanding Your Role in the Economy A market economy is participatory The choices you make as a consumer affect the products that businesses make and the prices they receive for their products. Likewise, the products offered and their prices affect the choices you make.

What kind of Economy does the United State Have? A market economy is based on capitalism, a system in which citizens own most of the means of production. It is also based on free enterprise– businesses compete for profit with a minimum of government interference.

Keeping Informed Keeping informed means reading news stories, listening to news reports, and gathering information about economic activities of businesses and government.

Understanding Incentives Incentives are rewards offered to try to persuade people to take certain economic actions. Price is one incentive. Others are bonuses for salespeople and low credit rates for consumers. Knowing how incentives work will help you make wise choices.

Understanding the Role of Government One role of government in the economy is to help maintain competitive markets. Another role is to provide services, such as education and national defense, that the private sector does not provide. Competition forces businesses to use society’s resources efficiently to produce goods and services people prefer and to produce quality products at low costs. Low production costs keep prices low for consumers.

Reward and Punish Consumer Behavior Government can use incentives to encourage people and businesses to take certain actions. For example, offering scholarships encourages more people to get higher education. Government can also discourage certain actions. For example, high sales tax on tobacco can discourage people from buying it.

Making Wise Decisions Rational choice is choosing the alternative that has the greatest value from among comparable-quality products. You make a rational choice when you buy the goods and services that you believe will best satisfy your wants for the lowest possible cost. Wise consumers will not all make the same choices.

Making Wise Decisions A rational choice is one that generates the greatest perceived value for any given expenditure. Wise decision making by individuals also benefits society by making the best use of scarce resources. Being fully informed is the best way to make the best economic as well as political decisions.

__ 1. choosing the alternative that has the greatest value from among comparable-quality products __ 2. system in which individuals own the factors of production and make economic decisions through free interaction __ 3. a system in which private citizens own most, if not all, of the means of production and decide how to use them within legislated limits

__ 4. reward offered to try to persuade people to take certain economic actions __ 5. economic system in which individuals and businesses are allowed to compete for profit with a minimum of government interference