1. Economics: The Core Issues
Chapter 1

2. Economics
Economics is the study of how best to allocate scarce resources among competing uses.

3. Three core issues must be resolved:
WHAT to produce with our limited resources.
HOW to produce the goods and services we select.
FOR WHOM goods and services are produced; that is, who should get them.

4. The Economy Is Us
The economy is an abstraction that refers to the sum of all our individual production and consumption activities.
The economy is us — the aggregation of all of our supply and demand decisions.

5. Scarcity
Scarcity is the lack of enough resources to satisfy all desired uses of those resources.

6. Factors of Production
Factors of production are resource inputs used to produce goods and services.

7. Factors of Production
Land refers to all natural resources such as crude oil, water, air, and minerals.
Labor refers to the skills and abilities to produce goods and services.

8. Factors of Production
Capital includes the final goods produced for use in the production of other goods, e.g., equipment, structures.
Entrepreneurship is the assembling of resources to produce new or improved products and technologies.

9. Limits to Output
No matter how an economy is organized there is a limit to how fast it can grow.
The most evident limit is the amount of resources available for producing goods and services.

10. Limits to Output
Scarcity — the imbalance between our desires and available resources—forces us to make economic choices.

11. Opportunity Costs
Opportunity cost is the most desired goods or services that are forgone in order to obtain something else.
It is what is given up in order to get something else.

12. Production Possibilities
Production possibilities are the alternative combination of final goods and services that could be produced in a given period of time with all available resources and technology.

13. The Production Possibilities Curve
Each point on the production possibilities curve depicts an alternative mix of output.

14. The Production Possibilities Curve

15. The Production Possibilities CurveA B C D E F
OUTPUT OF TRUCKS 5 4 3 2 1
OUTPUT OF TANKS

16. Production Possibilities Illustrates Two Essential Principles
Scarce resources – there’s a limit to the amount we can produce in a given time period with available resources and technology.

17. Production Possibilities Illustrates Two Essential Principles
Opportunity costs – we can obtain additional quantities of any desired good only by reducing the potential production of another good.

18. Law of Increasing Opportunity Costs
Resources do not transfer perfectly from the production of one good to another.
Increasing quantities of any good can be obtained only by sacrificing ever-increasing quantities of other goods.

19. Law of Increasing Opportunity Costs
Step 1: give up one truck 5 B 4
Step 3: give up another truck
Step 2: get two tanks C 3
OUTPUT OF TRUCKS
Step 4: get one more tank D 2 E 1 F 1 2 3 4 5
OUTPUT OF TANKS

20. The Cost of North Korea’s Military
North Korea’s inability to feed itself is due in part to its large army.
Resources used for the military aren’t available for producing food.

21. The Cost of North Korea’s MilitaryP G
Reduced food output N C
FOOD OUTPUT
Military buildup O H D B
MILITARY OUTPUT

22. The Military Share of Output
0.5
0.9
1.0
1.2
2.7
2.8
3.4
3.8
4.1
12.0
16.3
Jamaica
Mexico
Japan
Canada
Germany
India
S. Korea
USA
Bosnia
China
Saudi Arabia
N. Korea
1.5
Percent of Output Allocated to Military

23. Efficiency
Efficiency means getting the maximum output of a good from the resources used in production.
Every point on a production possibilities curves is efficient.

24. Inefficiency
A production possibilities curves shows potential output, not necessarily actual output.
If we are inefficient, actual output will be less than the potential output.

25. Inefficiency
Countries may end up inside their production possibilities curve if resources are inefficiently combined.
Such inefficiencies plagued centrally planned economies.

26. Unemployment
Countries may end up inside their production possibilities curve if all available resources are not used.

27. Unemployment A 5 B 4 Y C 3 OUTPUT OF TRUCKS Unemployment 2 1 1 2 3 4 51 2 3 4 5
OUTPUT OF TANKS

28. Economic Growth
A point outside the production possibilities curve suggests that we could get more goods than we are capable of producing!
Economic growth is an increase in output (real GDP) — an expansion of production possibilities.

29. Economic Growth A X 5 Currently not attainable B 4 C 3
OUTPUT OF TRUCKS 2 1 1 2 3 4 5
OUTPUT OF TANKS

30. Economic Growth
Production possibilities increase with more resources or better technology.
The production possibilities curve shifts outward.

31. Economic Growth
PP2
PP1
OUTPUT OF TRUCKS
OUTPUT OF TANKS

32. Basic Decisions
Production possibilities define the output choices confronting a nation:
WHAT to produce
HOW to produce
FOR WHOM to produce

33. WHAT
There are millions of points along a production possibilities curve, and each one represents a specific mix of output.
We can choose only one of these points at any time.

34. HOW There are lots of different ways of producing goods and services.
Someone has to make a decision about which production methods to use.

35. FOR WHOM
Who is going to get the output produced?

36. The Mechanism of Choice
An economy is largely defined by how it answers the WHAT, HOW and FOR WHOM questions.

37. The Invisible Hand of a Market Economy
The market mechanism is the use of market prices and sales to signal desired outputs (or resource allocations).
The market decides the mix of output in an economy.

38. The Invisible Hand of a Market Economy
Laissez faire is the doctrine of leave it alone — of nonintervention by government in the market mechanism.

39. Government Intervention and Command Economies
Karl Marx argued that the government not only had to intervene but had to own all the means of production.
Markets permit capitalists to enrich themselves while the proletariat toil long hours for subsistence wages.

40. Government Intervention and Command Economies
John Maynard Keynes offered a less drastic solution.
In Keynes’ view, government should play an active but not an all-inclusive role in managing the economy.

41. Continuing Debates
The core of most debates is some variation of the WHAT, HOW, or FOR WHOM questions.
Conservatives favor Adam Smith’s laissez-faire approach.
Liberals tend to think government intervention is likely to improve the answers.

42. Continuing Debates
Countries answer the basic economics questions differently and their answers change over time.

43. A Mixed Economy
A mixed economy is one that uses both market signals and government directives to allocate goods and resources.
Most economies use a combination of market signals and government directives to select economic outcomes.

44. Market Failure
A market failure is an imperfection in the market mechanism that prevents optimal outcomes.
If the market signals don’t give the best possible answers, we say that the market mechanism has failed.

45. Government Failure
Government intervention may move us closer to our economic goals or it may fail.
A government failure is government intervention that fails to improve economic outcomes.

46. Seeking Balance
The challenge for society is to minimize failures by selecting the appropriate balance of market signals and government directives.

47. What Economics Is All About
The basic purpose of studying economics is understanding how economies function.
How an economy is organized, how it behaves, and how successfully it achieves it basic objectives.

48. End Versus Means Economists don’t formulate an economy’s objectives.
They focus on the means available for achieving given goals.

49. Macro Versus Micro
Macroeconomics is the study of aggregate economic behavior, of the economy as a whole.
Microeconomics is the study of individual behavior in the economy, of the components of the larger economy.

50. Theory Versus Reality
The economy is much too vast and complex to describe and explain in one course (or one lifetime).
Economists use theories, or models, of economic behavior to evaluate and design economic policy.

51. Theory Versus Reality
In these theories, we typically ignore the possibility that many things can change at one time.
Ceteris paribus is the assumption that nothing else is changing.

52. Politics
Political forces are a necessary ingredient in economic policy decisions.
Inevitably, political choices must be made.

53. Imperfect Knowledge
We may never find an absolute truth, because the inner workings of the economy change over time.

54. Economics: the Core Issues
End of Chapter 1