Economics Economics is the study of how people choose to allocate scarce resources to produce goods and services and how they choose to distribute those goods and services now and in the future.

Economics Microeconomics is the branch of economics concerned with the behavior of individual consumers and firms and with the determination of individual prices. Macroeconomics is the branch of economics concerned with the study of aggregate economic activities such as economic growth, inflation, and unemployment.

Scarcity and Choice The study of economics arises because resources are scarce. –Resources are said to be scarce because they are finite, while human wants are infinite. Resources ultimately run out; wants never do. Resources are: –Labor, capital, and land.

Economic Resources Labor –Human work. Labor is paid a wage. Capital –Physical capital such as buildings, machinery, equipment. Capital is paid interest. Land –Natural resources. Land is paid rent.

Economics and the Scientific Method Economics uses models or theories to understand and explain economic behavior. Theories have four components: –An hypothesis. –One or more assumptions. –A model. –Predictions and/or explanations.

Production Possibilities Model Hypothesis: The Law of Increasing Cost –If all resources are fully and efficiently employed, the existence of scarce resources means that increasing the production of one good requires increasing sacrifices in the production of another good.

Production Possibilities Model Assumptions: –Only two goods are produced. Consumer goods and non-consumer goods. –All resources are fully and efficiently employed. –Resources transfer freely but not perfectly between producing the two goods. –There is no growth.

Production Possibilities Model Model: –The production possibilities model shows the effect on production caused by the economic problem of scarcity. –The economic principle illustrated by the model is the concept of opportunity cost. Opportunity cost is defined as the value of the best alternative foregone.

Production Possibilities Model CG NCG Consumer goods, CG, are measured on the vertical axis Non-consumer goods, NCG, are measured on the horizontal axis. 0

Production Possibilities Model CG NCG A Z M At point A, only CG is produced. At point Z, only NCG is produced. At point M, both CG and NCG are produced. 0

Production Possibilities Model The Production Possibilities Frontier –The production possibilities frontier shows the maximum amount of goods and services that can be produced by an economy during a given period of time with available resources and technology. –We find the PPF by connecting all the points between A and Z.

Production Possibilities Frontier The PPF slopes down because when resources are fully employed, we must give up some CG to get more NCG and we must give up some NCG to get more CG. NCG CG A M Z 0

Production Possibilities Frontier NCG CG A Z As we move from point A to Z, we give up equal amounts of CG and get increasingly smaller amounts of NCG. B C D E F G H J K M N 0

Production Possibilities Model As we move from point A to point Z, we produce more NCG and less CG. –In order to do this, resources must move from CG to NCG. –But, while resources move they do not do so perfectly. At some point a given sacrifice of CG results in smaller and smaller increases in NCG. This is why the PPF is bowed-out.

Production Possibilities Model Conclusion: –The Law of Increasing Cost If all resources are fully and efficiently employed, the existence of scarce resources means that increasing the production of one good requires increasing sacrifices in the production of another good.

Production Possibilities Frontier NCG CG A Z U What does point U represent? What are the economic implications associated with a point such as U? 0

Production Possibilities Frontier NCG CG A Z U What does point U represent? If we are at point U, resources are unemployed. A move from U to the PPF increases production. Unemployment decreases everyone’s welfare. 0

Production Possibilities Frontier NCG CG A Z What does point G represent? What are the economic implications associated with a point such as G? G 0

Production Possibilities Frontier NCG CG G To get to point G, the PPF must shift out to the right. At point G, we have more of both goods. Growth increases everyone’s welfare. 0

Three Economic Decisions NCG CG What to produce? How to produce? For whom to produce? 0

How Does Society Answer the Three Questions? Markets –Demand and supply Government –Regulation –Government incentives and disincentives –Voting Tradition

What to Produce Our model permits us to choose to produce consumer goods and non-consumer goods. –We may produce lots of CG with small amounts of NCG, lots of NCG with small amounts of CG, or more or less equal amounts of both. Our choice will determine our standard of living now and in the future. Why?

How to Produce We may choose to produce in an efficient manner or an inefficient manner. –If we choose policies that permit full and efficient use of our resources, we will produce on the PPF. –If we choose policies that do not permit full and efficient use of our resources, we will produce inside the PPF. Our choice will determine our standard of living now and in the future. Why?

For Whom to Produce For whom to produce is a decision about income distribution. –If we rely on the market to make this decision, those who best produce the goods and services most wanted by the public will be better compensated than others and will have more goods and services. When this income distribution is perceives as being unfair, government may intervene and redistributes income to the less favored.