1. Chapter 1: The Challenge of Economics McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All Rights Reserved.

2. 1-2 The Central Problem of Scarcity oOur materialistic wants and desires continue to grow: oNewest camera phone oLarger TV oBigger home oMore exotic vacation oWhy can’t we have everything we want? oOur wants exceed our resources. LO-1

3. 1-3 Economics and Opportunity Cost oEconomics: oThe study of how best to allocate scarce resources among competing uses. oOpportunity Cost: oThe most desired goods and services that are foregone in order to obtain something else. oThe next best alternative that you give up. LO-2

4. 1-4 Factors of Production oResource inputs used to produce goods and services. oThe four resources: oLand, labor, capital, and entrepreneurship. LO-2

5. 1-5 Scarcity oCentral problem of economics. oLack of available resources to satisfy all desired uses of those resources. LO-1

6. 1-6 Three Basic Economic Questions oWHAT to produce oHOW to produce oFOR WHOM to produce LO-3

7. 1-7 WHAT to Produce oOur wants exceed our resources. oWe have to decide what we want most. oWe have to sacrifice less desired activities and goods. LO-3

8. 1-8 Production Possibilities oHow much we could produce depends on how many resources are available: oLand – including natural resources oLabor – number and skills of workers oCapital – machinery, buildings, networks oEntrepreneurship – skill in creating products, services, and processes LO-3

9. 1-9 Production Possibilities oProduction possibilities – The alternative combinations of goods and services that could be produced in a given time period with all available resources and technology. LO-3

10. 1-10 The Choices Nations Make oA nation must choose what to do with its scarce resources during war or periods of military buildup. oProduce military goods (“guns”) or consumer goods (“butter”)? oEvery time we increase missile production, house construction must be reduced. LO-3

11. 1-11 Production Possibilities Curve LO-3

12. 1-12 Peace Dividend oSince the Korean War, the share of U.S. output allocated to the military has greatly decreased. oThe peace dividend is the increase in nonmilitary output due to a reduction in military spending. oMilitary spending has increased, however, since the 9/11 attacks. LO-3

13. 1-13 The Best Possible Mix The Best Possible Mix oThere is only one best possible (optimal) mix of output at any given time. oThe first economic goal of any society is to produce that optimal mix of output. LO-3

14. 1-14 Investment and Economic Growth oInvestment: oExpenditures on (production) of new plant and equipment (capital) in a given time period, plus changes in inventories. oEconomic growth: oAn increase in output (real GDP). oAn expansion of production possibilities outward. LO-3

15. 1-15 Investment and Economic Growth LO-3

16. 1-16 HOW to Produce oThe second economic goal for every society is to find an optimal method of producing goods and services. LO-3

17. 1-17 FOR WHOM to Produce oThe “for whom” question focuses on how an economy’s output is distributed across members of society. LO-3

18. 1-18 FOR WHOM to Produce oThe economic pie can be divided in several ways: oDistribution based on productive contributions. oDistribution based on need. oSome combination of productive contributions and need. LO-3

19. 1-19 Incentives oDistribution based on need rather than work effort may result in less work effort. oThere is less output to distribute. oThe size of the pie may get smaller. LO-3

20. 1-20 The Mechanisms of Choice & the Political Process oThere are conflicts and tradeoffs with every choice. oMany basic economic decisions are made through the political process. LO-4

21. 1-21 The Market Mechanism oThe use of market prices and sales to signal desired outputs (or resource allocations). oMarket sales and prices send a signal to producers about what mix of output consumers want. LO-4

22. 1-22 The Market Mechanism oLaissez faire is the doctrine of “leave it alone,” or nonintervention by government in the market mechanism. oThis concept is associated with Adam Smith. LO-4

23. 1-23 Central Planning oThe government decides what goods are produced, at what prices they are sold, and who gets them. oThis concept is associated with Karl Marx. LO-5

24. 1-24 Mixed Economies oEconomies that use both market and non- market signals to allocate goods and resources. oThis represents a combination of the other two systems. oMost nations today are mixed economies. LO-5

25. 1-25 Undesirable Choices and Market Failure oMarkets don’t always produce the “right” amount of output. oMarket Failure: oAn imperfection in the market mechanism that prevents optimal outcomes. LO-5

26. 1-26 The Wrong Mix of Output oThe market might produce too much of some products and too little of other products. oThe market might fail to make full use of the economy’s production possibilities. LO-5

27. 1-27 Too Much Pollution oMarkets might select the wrong choice of HOW to produce. oMay result in various forms of pollution. oExamples include air and water pollution. LO-5

28. 1-28 Externalities oCosts (or benefits) of a market activity borne by a third party. oThe difference between the social and private costs (or benefits) of a market activity. LO-5

29. 1-29 Too Much Poverty oMarkets might fail to distribute goods and services in the best possible way. oTaxes and income transfers may be used to reslice the economic pie. LO-5

30. 1-30 Government Failure oGovernment intervention that fails to improve economic outcomes. oGovernment will not necessarily offer better answers to the WHAT, HOW, and FOR WHOM questions. LO-5

31. 1-31 Government Failure oGovernment intervention might worsen the mix of output. oIt might even reduce the total amount of output through over-regulation. oThere is no guarantee that the visible hand of government will be any cleaner than the invisible hand of the marketplace. LO-5

32. 1-32 What Economics Is All About oA combination of market signals and government interventions forge better answers to the WHAT, HOW, and FOR WHOM questions. oThe first goal of economic theory is to help society find better answers to the three basic questions. LO-3

33. 1-33 What Economics Is All About oThe second goal of economic theory is to predict how changes in government policy or market institutions will affect economic outcomes. LO-4

34. 1-34 Macro versus Micro oMacroeconomics is the study of aggregate economic behavior, of the economy as a whole. oMicroeconomics is the study of individual behavior in the economy, of the components or pieces of the larger economy. LO-1

35. 1-35 Theory versus Reality oReality is too complex to describe and explain in one course. oEconomists focus on basic relationships and use these to predict economic events and formulate economic policies. LO-1

36. 1-36 Ceteris Paribus oThe assumption of nothing else changing. oIt is an important way of “thinking like an economist”. LO-1

37. 1-37 Politics versus Economics oEconomic theory can make significant contributions to policy formulation. oAll policy decisions are ultimately a mix of politics and economic theory. LO-1

38. 1-38 Modest Expectations oThe goals of this course are modest: oDevelop a reasonable perspective of economic behavior. oAcquire an understanding of basic principles. oYou should then have a better view of how the economy works. LO-1

39. 1-39 Appendix: Using Graphs oGraphs illustrate the relationship between two variables.

40. 1-40 Slopes oSlope shows the relationship between changes in study time and changes in grade-point average in the following example.

41. 1-41 A Change in Slope

42. 1-42 Shifts oWhen a curve shifts, the underlying relationship between the two variables has changed.

43. 1-43 Linear versus Nonlinear Curves oA linear curve has a constant slope and is represented by a straight line. oA nonlinear curve has a slope that changes.

44. 1-44 Causation oA graph is a summary of empirical observations. oIt says nothing about cause and effect.

45. End of Chapter 1 The Challenge of Economics 1-45