Chapter 1: Economic Issues and Concepts Copyright © 2014 Pearson Canada Inc.

Chapter Outline/Learning Objectives Section Learning Objectives After studying this chapter, you will be able to 1.1What is Economics? 1.explain the importance of scarcity, choice, and opportunity cost, and how all three concepts are illustrated by the production possibilities boundary. 1.2The Complexity of Modern Economies 2.view the market economy as self-organizing in the sense that order emerges from a large number of decentralized decisions. 3.explain how specialization gives rise to the need for trade, and that trade is greatly facilitated by money. 4.identify the economy's decision makers and see how their actions create a circular flow of income and expenditure. 1.3Is There an Alternative to the Market Economy? 5.see that all actual economies are mixed economies, having elements of free markets, tradition, and government intervention. Copyright © 2014 Pearson Canada Inc. 2 Chapter 1, Slide

Economic issues that are of pressing concern: Productivity Growth Population Aging Climate Change Global Financial Stability Rising Government Debt Globalization Many of the challenges we face in Canada and around the world are primarily economic. 3 Copyright © 2014 Pearson Canada Inc. Chapter 1, Slide

1.1What is Economics? Economics is the study of the use of scarce resources to satisfy unlimited human wants. Resources A society's resources are usually divided into land, labour, and capital. Economists refer to resources as factors of production. Outputs are goods (tangibles) or services (intangibles). Copyright © 2014 Pearson Canada Inc. 4 Chapter 1, Slide

Scarcity and Choice Resources can produce only a fraction of the goods and services desired by people. Scarcity implies the need for choice. Every choice has an associated cost—opportunity cost. Opportunity cost is defined as the benefit given up by not using resources in the best alternative way. Copyright © 2014 Pearson Canada Inc. 5 Chapter 1, Slide

Fig. 1-1 Choosing Between Pizza and Beer Consider the choice David must make when he has only has $16 to spend. He wishes to spend it all on pizza and beer. A beer costs $4 and each slice of pizza costs $2. Copyright © 2014 Pearson Canada Inc. 6 Chapter 1, Slide Combination A is unattainable.

Fig. 1-1 Choosing Between Pizza and Beer All points that lie on or inside the line would be attainable combinations. The negatively sloped line provides a boundary between attainable and unattainable combinations. The opportunity cost of getting 1 extra slice of pizza is half of a beer that must be given up. 7 Copyright © 2014 Pearson Canada Inc. Chapter 1, Slide Attainable combinations Give up 2 slices of pizza Get 1 extra beer Unattainable combinations A

The PPB illustrates: scarcity choice opportunity cost Fig. 1-2 A Production Possibilities Boundary (PPB) Copyright © 2014 Pearson Canada Inc. 8 Chapter 1, Slide Points e and f show scarcity; they are unattainable with current resources. The negative slope illustrates opportunity cost. Points a, b, c, d show choice. They are all attainable, but which one will be chosen?

9 APPLYING ECONOMIC CONCEPTS 1-1 The Opportunity Cost of Your University Degree Copyright © 2014 Pearson Canada Inc. Chapter 1, Slide MyEconLab Economists use graphs to illustrate theories and to show data. For a quick refresher about how to use graphs, look for A Brief Introduction to Graphing in the Additional Topics section of this book's MyEconLab.

Four Key Economic Problems 1.What Is Produced and How? Resource allocation determines the quantities of various goods that are produced. In terms of our previous illustration, what combination of civilian and military goods will be chosen? Will the economy be inside the production possibilities boundary—inefficiently used resources? Copyright © 2014 Pearson Canada Inc. 10 Chapter 1, Slide

What is produced? In USA, NFL is the highest revenue generating sports in What about England? What about Canada?

2.What Is Consumed and By Whom? What determines how economies distribute total output? Why do some people get a lot while others get only a little? Will the economy consume exactly what it produces? Microeconomics is the study of the allocation of resources as it is affected by the workings of the price system. Four Key Economic Problems Copyright © 2014 Pearson Canada Inc. 12 Chapter 1, Slide

Average hourly wage at McDonalds: $10 / Hour Highest paid NHL player: $16.5 m for last season

3.Why Are Resources Sometimes Idle? An economy is operating inside its production possibilities boundary if some resources are idle. Under what circumstances are workers seeking jobs unable to find them? Should governments worry about idle resources? Is there anything governments can do about it? Four Key Economic Problems Copyright © 2014 Pearson Canada Inc. 14 Chapter 1, Slide

Growth in productive capacity is shown by an outward shift of the PPB. Point d was initially unattainable. But after sufficient growth, it becomes attainable. Four Key Economic Problems 4. Is Productive Capacity Growing? Macroeconomics is the study of determination of economic aggregates. Copyright © 2014 Pearson Canada Inc. 15 Chapter 1, Slide Fig. 1-3The Effect of Economic Growth on the PPB

16 Copyright © 2014 Pearson Canada Inc. Chapter 1, Slide The design and effectiveness of government policy is relevant to discussing all four problems. It can alter the allocation of the economy's resources to make society as a whole better off. It can be used to improve the distribution of consumption across individuals. It is also part of the discussion of why economic resources are sometimes idle (e.g., unemployment). It can affect the overall output and income. Economics and Government Policy

1.2The Complexity of Modern Economies The Nature of Market Economies Self-Organizing Who or what provides the goods and services individuals desire? Early economists noticed that the interaction of self-interested people creates a spontaneous social order—the economy is self-organizing. Self-interest, not benevolence, is the foundation of economic order. Copyright © 2014 Pearson Canada Inc. 17 Chapter 1, Slide

Efficiency Loosely speaking, efficiency refers to organizing available resources to produce the goods and services that people most value, when they most want them, and by using the fewest possible resources to do so. Adam Smith (1723–1790) In The Wealth of Nations, Smith was the first to develop this insight fully: "It is not from the benevolence of the butcher, the brewer, or the baker, that we expect our dinner, but from their regard to their own interest. We address ourselves, not to their humanity but to their self-love, and never talk to them of our own necessities but of their advantages." Copyright © 2014 Pearson Canada Inc. 18 Chapter 1, Slide

The Nature of Market Economies Incentives and Self-Interest Self-interest guides individuals. Individuals respond to incentives. Prices and quantities are set in (relatively) free markets in which individuals trade voluntarily. Institutions, created by the state, protect private property and enforce contractual obligations. 19 Copyright © 2014 Pearson Canada Inc. Chapter 1, Slide

The Decision Makers and Their Choices Three broad groups of decision makers: Consumers Producers Government In order to achieve their objectives, maximizing consumers and producers make marginal decisions.  they decide whether they will be made better off by buying or selling a little less of any given product. Copyright © 2014 Pearson Canada Inc. 20 Chapter 1, Slide

Fig. 1-4 The Circular Flow of Income and Expenditure Copyright © 2014 Pearson Canada Inc. 21 Chapter 1, Slide

The Flow of Income and Expenditure Individuals own factors of production. They sell the services of these factors to producers in factor markets and receive payment in return. These are the (factor) incomes of individuals. Producers transform factor services into goods and services, which they then sell to individuals in goods markets, receiving payment in return. These are the incomes of producers. Copyright © 2014 Pearson Canada Inc. 22 Chapter 1, Slide

Production and Trade Production usually displays two characteristics noted long ago by Adam Smith: specialization and division of labour. Specialization is the allocation of different jobs to different people. It is more efficient than self-sufficiency because: Individual abilities differ—comparative advantage. Focusing on one activity leads to improvements— learning by doing. Division of labour extends the idea of specialization for the production of a single good or service. Copyright © 2014 Pearson Canada Inc. 23 Chapter 1, Slide

Money and Trade Specialization must be accompanied by trade. Money eliminates the cumbersome system of barter by separating the transactions involved in the exchange of products, thereby facilitating specialization and trade. Production and Trade Copyright © 2014 Pearson Canada Inc. 24 Chapter 1, Slide

Production and Trade Globalization Underlying modern globalization is the rapid reduction of transportation and communication costs in the last half of the 20th century. Today, no country can take an isolationist economic stance and hope to take part in the global economy. In this course we will discuss the extent to which the process of globalization changes markets and changes the way government policy can influence economic outcomes. Copyright © 2014 Pearson Canada Inc. 25 Chapter 1, Slide

1.3Is There an Alternative to the Market Economy? Types of Economic Systems There are three pure types of economic systems: Traditional Command Free-Market In practice, every economy is a mixed economy, in the sense that it combines significant elements of all three systems. Copyright © 2014 Pearson Canada Inc. 26 Chapter 1, Slide

The Great Debate A century after Adam Smith, Karl Marx (1818–1883) argued that free-market economies could not be relied upon to generate a "just" distribution of output. He argued the benefits of a centrally planned system. Beginning with the Soviet Union in the 1920s, many countries inspired by Marx adopted socialist/communist systems. By the last few decades of the 20th century, most of these countries were unable to provide their citizens the rising living standards that existed in the more free-market economies. In the last two decades of the 20th century, most governments replaced their systems of central planning with much freer markets. Copyright © 2014 Pearson Canada Inc. 27 Chapter 1, Slide

The failure of the centrally planned economies does not demonstrate the superiority of completely free-market economies. Instead, it shows the superiority of mixed economies, with large elements of free markets. LESSONS FROM HISTORY 1-1 The Failure of Central Planning Copyright © 2014 Pearson Canada Inc. 28 Chapter 1, Slide MyEconLab The debate between government involvement and free markets figures prominently in the discussion of progress in today's developing countries. For a detailed discussion of Challenges Facing the Developing Countries, see the Additional Topics section of this book's MyEconLab.

Government in the Modern Mixed Economy Key government-provided institutions in market economies are private property and freedom of contract. Governments also intervene to: correct market failures provide public goods offset the effects of externalities Markets often work well, but sometimes government policy can improve the outcome for society as a whole. Copyright © 2014 Pearson Canada Inc. 29 Chapter 1, Slide