Introduction: What Is Economics? 1 C H A P T E R 1 © 2001 Prentice Hall Business PublishingEconomics: Principles and Tools, 2/eO’Sullivan & Sheffrin

2 What Is Economics?  Economics is the study of the choices made by people who are faced with scarcity.  Scarcity is a situation in which resources are limited and can be used in different ways.

© 2001 Prentice Hall Business PublishingEconomics: Principles and Tools, 2/eO’Sullivan & Sheffrin 3 Summary Slide  Society’s Choices

© 2001 Prentice Hall Business PublishingEconomics: Principles and Tools, 2/eO’Sullivan & Sheffrin 4 Society’s Choices  Having a limited amount of resources means that we must sacrifice one thing in order to obtain another.  The decisions of producers, consumers and government determine how an economic system answers three fundamental questions:

© 2001 Prentice Hall Business PublishingEconomics: Principles and Tools, 2/eO’Sullivan & Sheffrin 5 Society’s Choices  What goods and services do we produce? If we devote more resources to the production of one good, we have fewer resources for the production of another.

© 2001 Prentice Hall Business PublishingEconomics: Principles and Tools, 2/eO’Sullivan & Sheffrin 6 Society’s Choices  How do we produce these goods and services? How do we organize production and what methods and techniques should we use?

© 2001 Prentice Hall Business PublishingEconomics: Principles and Tools, 2/eO’Sullivan & Sheffrin 7 Society’s Choices  For whom do we produce the output? How should we distribute the output produced among members of society?

© 2001 Prentice Hall Business PublishingEconomics: Principles and Tools, 2/eO’Sullivan & Sheffrin 8 Factors of Production  Natural resources  Labor  Physical capital  Human capital  Entrepreneurship Factors of production, or productive inputs, are the resources we use to produce goods and services:

© 2001 Prentice Hall Business PublishingEconomics: Principles and Tools, 2/eO’Sullivan & Sheffrin 9 Factors of Production  Natural resources: The things created by acts of nature such as land, water, mineral, oil and gas deposits; renewable and nonrenewable resources.

© 2001 Prentice Hall Business PublishingEconomics: Principles and Tools, 2/eO’Sullivan & Sheffrin 10 Factors of Production  Labor: The human effort, physical and mental, used by workers in the production of goods and services.

© 2001 Prentice Hall Business PublishingEconomics: Principles and Tools, 2/eO’Sullivan & Sheffrin 11 Factors of Production  Physical capital. All the machines, buildings, equipment, roads and other objects made by human beings to produce goods and services.

© 2001 Prentice Hall Business PublishingEconomics: Principles and Tools, 2/eO’Sullivan & Sheffrin 12 Factors of Production  Human capital: The knowledge and skills acquired by a worker through education and experience.

© 2001 Prentice Hall Business PublishingEconomics: Principles and Tools, 2/eO’Sullivan & Sheffrin 13 Factors of Production  Entrepreneurship: The effort to coordinate the production and sale of goods and services. Entrepreneurs take risk and commit time and money to a business without any guarantee of profit.

© 2001 Prentice Hall Business PublishingEconomics: Principles and Tools, 2/eO’Sullivan & Sheffrin 14 The Production Possibilities Frontier (PPF) Curve  The PPF curve shows the possible combinations of goods and services available to an economy, when resources are fully and efficiently employed.  The PPF curve is a graphical illustration of fundamental economic problems related to our ability to produce goods and services.

© 2001 Prentice Hall Business PublishingEconomics: Principles and Tools, 2/eO’Sullivan & Sheffrin 15 The Production Possibilities Frontier (PPF) Curve  When the economy is at point i, resources are not fully employed and/or they are not used efficiently.

© 2001 Prentice Hall Business PublishingEconomics: Principles and Tools, 2/eO’Sullivan & Sheffrin 16 The Production Possibilities Frontier (PPF) Curve  Point h is desirable because it yields more of both goods, but not attainable given the amount of resources available.

© 2001 Prentice Hall Business PublishingEconomics: Principles and Tools, 2/eO’Sullivan & Sheffrin 17 The Production Possibilities Frontier (PPF) Curve  Point e is one of the possible combinations of goods produced when resources are fully and efficiently employed.

© 2001 Prentice Hall Business PublishingEconomics: Principles and Tools, 2/eO’Sullivan & Sheffrin 18 The Production Possibilities Frontier (PPF) Curve  At point e in this example, resources are devoted to the production of four space missions and 380 thousand computers.  To increase the number of space missions by one, 80 thousand computers will have to be sacrificed.

© 2001 Prentice Hall Business PublishingEconomics: Principles and Tools, 2/eO’Sullivan & Sheffrin 19 The Production Possibilities Frontier (PPF) Curve  To increase the production of one good without decreasing the production of the other, the PPF curve must shift outward.  From point f, an additional 150 thousand computers or two more space missions are now possible.

© 2001 Prentice Hall Business PublishingEconomics: Principles and Tools, 2/eO’Sullivan & Sheffrin 20 The Production Possibilities Frontier (PPF) Curve  Resources are not perfectly adaptable. The PPF curve has a concave shape because resources are not perfectly adaptable in production. As we increase the production of one good, we sacrifice progressively more of the other.

© 2001 Prentice Hall Business PublishingEconomics: Principles and Tools, 2/eO’Sullivan & Sheffrin 21 Microeconomics  Microeconomics focuses on the analysis of individual economic units.  Microeconomics is the study of the choices made by consumers, firms, and government, and how these decisions affect the market for a particular good.

© 2001 Prentice Hall Business PublishingEconomics: Principles and Tools, 2/eO’Sullivan & Sheffrin 22 Microeconomics  Understand how markets work and predict changes.  Make personal or managerial decisions.  Evaluate the merits of public policies. Microeconomic analysis can be used to:

© 2001 Prentice Hall Business PublishingEconomics: Principles and Tools, 2/eO’Sullivan & Sheffrin 23 Microeconomics  Microeconomics gives you the tools to analyze the impact of: Environmental regulations, taxes, imports, gender discrimination, labor unions, competition, patterns of production and consumption, and other decisions made by individual economic units.

© 2001 Prentice Hall Business PublishingEconomics: Principles and Tools, 2/eO’Sullivan & Sheffrin 24 Macroeconomics Macroeconomic analysis can be used to:  Understand how a national economy works.  Understand the grand debates over economic policy.  Make informed business decisions. Macroeconomics is the study of the nation’s economy as a whole.

© 2001 Prentice Hall Business PublishingEconomics: Principles and Tools, 2/eO’Sullivan & Sheffrin 25 Macroeconomics  Macroeconomic analysis can be used to understand important everyday economic issues such as: Unemployment, inflation, interest rates, exchange rates, the standard of living, the federal budget, consumption, and saving patterns.

© 2001 Prentice Hall Business PublishingEconomics: Principles and Tools, 2/eO’Sullivan & Sheffrin 26 The Economic Way of Thinking  Simplifying assumptions do not have to be realistic. We use maps, for example, to get us from point A to point B knowing that the map is not an accurate description of the road ahead, but only an abstraction of reality.  Economists use simplifying assumptions to eliminate irrelevant details and focus on what really matters. Assumptions are an aid to the analytical process.

© 2001 Prentice Hall Business PublishingEconomics: Principles and Tools, 2/eO’Sullivan & Sheffrin 27 The Economic Way of Thinking  “Ceteris paribus” is Latin for “all else the same.” To study the relationship between two variables, we assume that other variables do not change.  The “ceteris paribus” assumption is used to explore the relationship between two variables. A variable is a measure of something that can take on different values.

© 2001 Prentice Hall Business PublishingEconomics: Principles and Tools, 2/eO’Sullivan & Sheffrin 28 Using Graphs and Formulas  Suppose that a student receives a weekly income which consists of a $20 weekly allowance from her parents, and $4 per hour of work from her job.  There is a linear relationship between hours worked and the student’s weekly income which can be described by the formula: W = $20 + ($4 x hours worked)

© 2001 Prentice Hall Business PublishingEconomics: Principles and Tools, 2/eO’Sullivan & Sheffrin 29 Using Graphs and Formulas  The expression W = $20 + ($4 x hours worked) can be illustrated as follows:

© 2001 Prentice Hall Business PublishingEconomics: Principles and Tools, 2/eO’Sullivan & Sheffrin 30 Shifting the Curve  If the student’s allowance or hourly wage change, the line’s intercept and slope will change, respectively.  For example, an increase in her weekly allowance to $35 per week will shift the line upward by $15 for each previous number of hours worked.

© 2001 Prentice Hall Business PublishingEconomics: Principles and Tools, 2/eO’Sullivan & Sheffrin 31 Negative Relationship  Consider a consumer with a monthly budget of $150 who buys CDs at a price of $10 per CD. Each 5-unit increase in the amount of CDs decreases the amount left over for other goods by $50 (negative relationship).

© 2001 Prentice Hall Business PublishingEconomics: Principles and Tools, 2/eO’Sullivan & Sheffrin 32 Nonlinear Relationship  There is a positive, nonlinear relationship between study time and grade on the exam.  The second hour of study increases the grade by four points (from 6 to 10).  But the ninth hour of study increases the grade by only one point (from 24 to 25).  There are diminishing returns in study time. As study time increases, the exam grade increases at a decreasing rate.