1. The Economic Way of Thinking

2. Chapter 1: The Economic Way of Thinking
KEY CONCEPT
Scarcity is the situation that exists because wants are unlimited and resources are limited.
WHY THE CONCEPT MATTERS
The concept of scarcity is an issue you confront in everyday life. Suppose you have $20 to cover the cost of lunches for the week. How would you use the money to cover your wants Monday through Friday? How would buying a late afternoon snack for $1 on two of the days affect your lunch choices?

3. Scarcity: The Basic Economic Problem
What Is Scarcity?
KEY CONCEPTS
Wants — desires that can be met by consuming products
Needs — things necessary for survival
Scarcity — lack of resources available to meet all human wants
not a temporary shortage
Economics — study of how people use resources to satisfy wants
examines how individuals and societies choose to use resources
organizes, analyzes, interprets data about economic behaviors
develops theories, economic laws to explain economy, predict future

4. What Is Scarcity? Principle 1: People Have Wants
People make choices about all their needs and wants
Wants are unlimited, ever changing

5. What Is Scarcity? Principle 2: Scarcity Affects Everyone
Scarcity affects which goods and services are provided
Goods — physical objects that can be bought
Services — work one person does for another for pay
Consumer — person who buys good or service for personal use
Producer — person who makes a good or provides a service

6. Scarcity Leads to Three Economic Questions
KEY CONCEPTS
Scarcity affects society and producers as well as individuals
Society must answer three basic economic questions:
what will be produced?
how will it be produced?
for whom will it be produced?

7. Scarcity Leads to Three Economic Questions
Question 1: What Will Be Produced?
Societies must decide on mix of goods to produce
depends in part on their natural resources
Some countries allow producers and consumers to decide
In other countries, governments decide
Must also decide how much to produce; choice depends on societies’ wants

8. Scarcity Leads to Three Economic Questions
Question 2: How Will It Be Produced?
Decisions on production methods involve using resources efficiently
decisions influenced by a society’s natural resources
Societies adopt different approaches
with unskilled labor force, might use labor-intensive methods
with skilled labor force, might use capital-intensive methods

9. Scarcity Leads to Three Economic Questions
Question 3: For Whom Will It Be Produced?
How goods and services are distributed involves two questions
how should each person’s share be determined?
how will goods and services be delivered to people?

10. The Factors of Production
KEY CONCEPTS
Factors of production — resources needed to produce goods and services
include land, labor, capital, entrepreneurship
supply is limited

11. The Factors of Production
Factor 1: Land
Land means all natural resources on or under the ground
includes water, forests, wildlife, mineral deposits

12. The Factors of Production
Factor 2: Labor
Labor is all the human time, effort, talent used to make products
physical and mental effort used to make a good or provide a service

13. The Factors of Production
Factor 3: Capital
Capital is a producer’s physical resources
includes tools, machines, offices, stores, roads, vehicles
sometimes called physical capital or real capital
Workers invest in human capital — knowledge and skills
workers with more human capital are more productive

14. The Factors of Production
Factor 4: Entrepreneurship
Entrepreneurship — vision, skill, ingenuity, willingness to take risks
Entrepreneurs anticipate consumer wants, satisfy these in new ways
develop new products, methods of production, marketing or distributing
risk time, energy, creativity, money to make a profit

15. Reviewing Key Concepts
Explain the relationship between the terms in each of these pairs:
wants and scarcity
consumer and producer
factors of production and entrepreneurship

16. Economic Choice Today: Opportunity Cost
Making Choices
KEY CONCEPTS
Economic choices shaped by
Incentives — benefits that encourage people to act in certain ways
Utility — benefit or satisfaction gained from using a good or service
To make choices, people economize:
make decisions according to best combination of costs and benefits

17. Making Choices Factor 1: Motivations for Choice
People motivated by incentives, expected utility, desire to economize
They weigh costs against benefits to make purposeful choices
motivated by self-interest: look for ways to maximize utility

18. Making Choices Factor 2: No Free Lunch All choices have a cost
choosing one thing means giving up another, or paying a cost
cost can take form of money, time, other thing of value

19. Trade-Offs and Opportunity Cost
KEY CONCEPTS
Trade-off is alternative people give up when they make a choice
usually means giving up some, not all, of a thing to get more of another

20. Trade-Offs and Opportunity Cost
Example 1: Making Trade-Offs
Shanti wants to earn college credit over summer
semester-long university course offers more credits
six-week high school course leaves time for vacation

21. Trade-Offs and Opportunity Cost
Example 2: Counting the Opportunity Cost
Opportunity cost is value of next-best alternative a person gives up
not the value of all possible alternatives
Dan chooses to work for six months so he can travel for six months
opportunity cost: six months of salary

22. Analyzing Choices KEY CONCEPTS
Cost-benefit analysis — examination of costs, expected benefits of choices
one of most useful tools for evaluating relative worth of economic choices

23. Analyzing Choices Example: Max’s Decision-Making Grid
Decision-making grid shows what one gets, gives up with each choice
Max’s grid shows all possible choices for his free hours each week
lists choices, benefits and opportunity cost of each choice
With time, costs and benefits change; also goals and circumstances
Changes influence decisions, make people alter original choices

24. Analyzing Choices Example: Marginal Costs and Benefits Marginal cost
additional cost of using one more unit of a good or service
Marginal benefit
additional benefit of using one more unit of a good or service

25. Reviewing Key Concepts
Explain the relationship between the terms in each of these pairs:
incentive and utility
trade-off and opportunity cost
marginal cost and marginal benefit

26. Graphing the Possibilities
Analyzing Production Possibilities
Graphing the Possibilities
KEY CONCEPTS
Economic models — simplified representations of economic forces
Production possibilities curve (PPC) is one model
maximum goods or services that can be produced from limited resources
also called production possibilities frontier

27. Graphing the Possibilities
KEY CONCEPTS
PPC based on assumptions that simplify economic interactions
resources are fixed
all resources are fully employed
only two things can be produced
technology is fixed

28. Graphing the Possibilities
Production Possibilities Curve
PPC runs between extremes of producing only one item or the other
Data is plotted on a graph; lines joining points is PPC
shows maximum number of one item relative to other item
PPC shows opportunity cost of each choice
more of one product means less of the other

29. What We Learn from PPCs KEY CONCEPTS Concepts revealed by PPC:
Efficiency — producing the maximum amount of goods and services possible
Underutilization — producing fewer goods and services than possible

30. What We Learn from PPCs Example: Efficiency and Underutilization
Each point on PPC represents efficiency
points inside curve mean underutilization; outside curve cannot be met
Law of increasing opportunity costs
as production switches from one product to another, more resources needed to increase production of second product

31. What We Learn from PPCs Example: Increasing Opportunity Costs
Increase in opportunity cost — each new unit costs more than last one
Reasons for increasing cost of making more of one product
need new resources, machines, factories
must retrain workers
Costs paid by making less and less of other product

32. Changing Production Possibilities
Example: A Shift in the PPC
A country’s supply of resources changes over time
Example: U.S. in 1800s grew, gained resources, workers, new technology
new resources mean new production possibilities beyond frontier
Increased production shown on PPC as shift of curve outward
Increase in total output called economic growth

33. Reviewing Key Concepts
Explain how each term is illustrated by the production possibilities curve:
underutilization
efficiency

34. The Economists Toolbox
Working with Data
KEY CONCEPTS
Statistics — numerical data or information
show patterns of human behavior
Economic models help organize and interpret data

35. Working with Data Using Economic Models
Economic models focus on a limited number of variables
thus based on assumptions and use simplification
expressed in words, graphs, equations

36. Working with Data Using Charts and Tables
Economists look for statistical relationships, trends, connections
Charts and tables display data in rows and columns
can reveal patterns by showing numbers in relation to other numbers

37. Working with Data Using Graphs
Graphs use two sets of variables: along horizontal, vertical axes
Line graphs useful for showing changes over time
in economics, line referred to as a curve, even if straight
Bar graphs good for showing comparisons
Pie graph (or pie chart, circle graph) shows numbers in relation to whole

38. Microeconomics and Macroeconomics
KEY CONCEPTS
Microeconomics — studies behavior of individual players in an economy
includes individuals, families, businesses
Macroeconomics — studies behavior of economy as a whole
topics include inflation, unemployment, aggregate demand and aggregate supply

39. Microeconomics and Macroeconomics
Microeconomics examines specific, individual elements in an economy
prices, costs, profits, competition, consumer and producer behavior
Some Topics of Interest: business organization, labor markets, environmental issues

40. Microeconomics and Macroeconomics
Macroeconomics studies sectors — combination of all individual units
Includes consumer, business, public or government sectors
Macroeconomics studies national or global topics:
monetary system, business cycle, tax policies, international trade

41. Positive Economics and Normative Economics
KEY CONCEPTS
Positive economics describes and explains economic behavior as it is
uses verifiable facts; does not make judgments
Normative economics studies what economic behavior should be
makes value judgments to recommend future actions

42. Positive Economics and Normative Economics
Positive economics uses scientific method
observe data, hypothesize, test, refine, continue testing
Statements tested against real-world data
proved (or strongly supported) or disproved (or strongly questioned)

43. Positive Economics and Normative Economics
Normative economics studies facts, asks if course of action is good
Recommendations differ because values they are based on also differ

44. Adam Smith: Founder of Modern Economics
Seeing the Invisible
An Inquiry into the Nature and Causes of the Wealth of Nations, 1776
challenged mercantilism; argued for free trade
Invisible hand guides free marketplace, benefits sellers and buyers
people pursue own economic self-interest
producers sell at prices that satisfy them and that consumers will pay

45. Reviewing Key Concepts
Explain the differences between the terms in each of these pairs:
statistics and economic model
macroeconomics and microeconomics
positive economics and normative economics

46. Case Study: The Real Cost of Expanding O’Hare Airport
Background
Chicago’s O’Hare Airport is one of the busiest airports in the United States.
Delays at O’Hare are commonplace.
Considerable debate over the best solution to improve efficiency.
What’s the Issue
What are the real costs involved in airport expansion? Study these sources to determine the costs tied to the expansion of O’Hare airport.

47. Case Study: The Real Cost of Expanding O’Hare Airport {continued}
Thinking Economically
Explain the real cost of expanding O’Hare Airport. Use information presented in the documents to support your answer.
Who are the most likely winners and losers as a result of the O’Hare expansion? Explain your answer.
How might supporters of expansion use a production possibilities model to strengthen their case?