©2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

©2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 11 The Economic Way of Thinking Survey of ECON Robert L. Sexton Chapter 2 © JOHNANGELILLO/UPI /LANDOV ©2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

22 Chapter 2 Sections – Choices, Costs, and Trade-Offs – Marginal Thinking – Specialization and Trade – The Production Possibilities of an Economy – Economic Systems

©2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 55 Choices If we had unlimited resources, and thus an ability to produce all of the goods and services anyone wanted, we would not have to choose among those wants.

©2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 66 We are all faced with the fact of scarcity, and as a consequence, we must make choices. Because none of us can afford to buy everything we want, each time we do decide to buy one good or service, we reduce our ability to buy other things we would also like to have. Choices

©2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 77 People must choose. The cost of a choice is the values that must be foregone. Opportunity Cost OPPORTUNITY COST the value of the best forgone alternative that was not chosen

©2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 88 “To choose is to lose.” “An opportunity cost is an opportunity lost.” To get more of anything that is desirable, you must accept less of something else that you also value. Opportunity Cost

©2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 99 When you buy something, you have to pay for the items you bought. This amount is called the money price. It is an opportunity cost, because you could have used that money to purchase other goods or services. Additional opportunity costs include the non-price costs incurred to acquire the items. Opportunity Cost: Money Price

©2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 10 The opportunity cost of going to college includes not only monetary costs, such as tuition and books, but also the opportunity cost of your time. Opportunity Cost: Example

©2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 11 A lunch may be free to you, but it is not free from society’s perspective. Some of society’s scarce resources that could have been used to produce something else of value will have been used in the preparation of the lunch. Does a Free Lunch Exist? © TERRANCE EMERSON/SHUTTERSTOCK “There's no such thing as a free lunch.”

©2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 15 Marginal Thinking Most choices involve how much of something to do rather than whether or not to do something. © DORON GILD/GETTY IMAGES The question is not whether you’ll have coffee today, but rather how much coffee you will have.

©2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 16 Marginal Thinking Economists emphasize marginal thinking because the focus is on additional, or marginal, choices. Marginal choices involve the effects of adding or subtracting from the current situation.

©2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 17 Watch out for the difference between average and marginal costs. Suppose an airline had 10 unoccupied seats on a flight from L.A. to New York and the average cost was $400 per seat ($100,000/250). If there are 10 people on standby who are each willing to pay $300, should the airline sell them the tickets? Marginal Thinking: Example © Laurence Dean/iStockphoto.com

©2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 18 Another good example of marginal thinking is an auction. Prices are bid up marginally as the auctioneer calls out one price after another. When a bidder views the new price (the marginal cost) to be greater than the value she places on the good (the marginal benefit), she withdraws from further bidding. Marginal Thinking: Example

©2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 19 RULE OF RATIONAL CHOICE individuals will pursue an activity if the expected marginal benefits are greater than the expected marginal costs or E(MB) > E(MC) Marginal Thinking: The Rule of Rational Choice

©2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 20 NET BENEFITS the difference between the expected marginal benefits and the expected marginal costs Marginal Thinking: Net Benefits

©2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 21 We can use the concept of marginal thinking to evaluate pollution levels. We have to weigh the expected marginal benefits of a cleaner environment against the expected marginal costs of a cleaner environment. Zero pollution levels would be far too costly in terms of what we would have to give up. Marginal Thinking: Pollution Example

©2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 22 Just as we can have optimal (or best) levels of pollution that are greater than zero, the same marginal thinking can be used to analyze crime and safety issues. The result will not be either no crime or perfectly safe products. Marginal Thinking: Safety Example

©2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 23 The issue is not safe versus unsafe products but how much safety we want. It is not risk versus no risk but rather how much risk we want. Additional safety comes at a higher cost. Marginal Thinking: Safety Example

©2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 27 People are specializing when they concentrate their energies on only one or a few activities. This allows them to make the best use of (and thus gain the most benefit from) their limited resources. Specialization

©2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 28 If a person, a region, or a country can produce a good or service at a lower opportunity cost than others, we say that they have a comparative advantage in the production of that good or service. They can gain by specializing in the production of the good in which they have a comparative advantage. Comparative Advantage

©2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 29 We all specialize to some extent and rely on others to produce most of the goods and services we want. The wages from that work can then be used to buy goods and services from others who specialize in the production of those goods and services. We All Specialize © LISA F. YOUNG/SHUTTERSTOCK

©2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 30 The primary advantages of specialization are that employees acquire greater skill from repetition. They avoid wasted time in shifting from one task to another. They do the types of work for which they are best suited. Advantages of Specialization

©2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 31 Trade, or voluntary trade, directly increases wealth by making both parties better off (or they wouldn’t trade). It is the prospect of wealth-increasing exchange that leads to productive specialization. Specialization and Trade

©2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 32 Trade increases wealth by allowing a person, a region, or a nation to specialize in those products that it produces at a lower opportunity cost and to trade for the products that others produce at a lower opportunity cost. For example, the United States is better at producing wheat, whereas Brazil is better at producing coffee. The U.S. and Brazil trade these goods with each other. Specialization and Trade

©2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 36 The Production Possibilities Curve The economic concepts of scarcity, choice, and trade-offs can be illustrated by the use of a production possibilities curve, which represents the potential total output combinations of any two goods for an economy. That is, it illustrates an economy’s potential for allocating its limited resources for producing various combinations of goods in a given time period.

©2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 37 Using an example involving food and shelter, we can see a concave (bowed) production possibilities curve. Each point represents the potential amounts of food and shelter that can be produced in a given time period, given the quantity and quality of resources available. The Production Possibilities Curve: Food and Shelter

©2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 38 Exhibit 2.1: Production Possibilities Curve: The Trade-Off between Food and Shelter

©2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 39 The economy cannot produce beyond the levels indicated by the production possibilities curve during a given time period because there are not enough resources to produce that output. However, it is possible to operate inside the production possibilities curve. Off the Production Possibilities Curve

©2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 40 If an economy is operating inside its production possibilities curve, it is not at full capacity, and is not using all its scarce resources efficiently. As a result, actual output is less than potential output. Off the Production Possibilities Curve

©2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 41 Most modern economies have resources that are idle at least some of the time. Unemployed resources create a serious problem. For example, an unemployed coal miner who is unable to find work at a “reasonable” wage, or those unemployed in depressed times when factories are already operating below capacity. Clearly, the resources of these individuals are not being used efficiently. Using Resources Efficiently

©2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 42 It is not just labor resources that should be most effectively used. All resources entering into production should be used effectively. However, social concern focuses on labor for several reasons. –Labor costs are the largest share of production costs. –Unemployed or underemployed laborers may have mouths to feed at home, while an unemployed machine does not. Using Resources Efficiently

©2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 43 Efficiency requires society to use its resources to the fullest extent—getting the most we can out of our scarce resources; that is, there are no wasted resources. Efficiency

©2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 44 If resources are being used efficiently— that is, at a point along a production possibilities curve—more of one good or service requires the sacrifice of another good or service as its cost. Efficiency

©2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 45 Efficiency does not tell us which point along the production possibilities curve is best. But it does tell us that points inside the curve cannot be best because some resources are wasted. Efficiency

©2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 46 The production possibilities curve is not a straight line. It is concave from below (that is, bowed outward from the origin), reflecting increasing opportunity costs of producing additional amounts of a good. The Law of Increasing Opportunity Cost

©2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 47 Exhibit 2.2: Increasing Opportunity Cost and the Production Possibilities Curve

©2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 48 The basic reason for increasing opportunity cost is that some resources and skills cannot be easily adapted from their current uses to alternative uses. The more you produce of one good, the more you are forced to employ inputs that are relatively more suitable for producing other goods. The Law of Increasing Opportunity Cost

©2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 49 Generating Economic Growth An economy can only grow with qualitative or quantitative changes in the factors of production–land, labor, capital, and entrepreneurship. Advancements in technology, improvements in labor productivity, or new natural resource finds could all lead to outward shifts of the production possibilities curve.

©2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 50 In terms of the production possibilities curve, an outward shift in the possible combinations of goods and services produced indicates economic growth. With growth comes the possibility to have more of both goods than were previously available. Generating Economic Growth

©2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 51 Exhibit 2.3: Economic Growth and Production Possibilities

©2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 52 It is important to remember that increases in a society’s output do not make scarcity disappear. Even when output has grown more rapidly than population, people still face trade-offs. At any point along the production possibilities curve, in order to get more of one thing, you must give up something else. Growth Does Not Eliminate Scarcity

©2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 53 To generate economic growth, a society must produce fewer consumer goods and more capital goods in the present. They must sacrifice some consumption of consumer goods in the present in order to experience growth in the future. Capital Goods and Consumer Goods

©2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 54 Investing in capital goods will increase the future production capacity of the economy. So an economy that invests more and consumes less now will be able to produce and consume more in the future. Capital Goods and Consumer Goods

©2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 55 Exhibit 2.4: Economic Growth and the Production Possibilities Curve

©2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 56 Technological advance does not have to impact all sectors of the economy equally. There is a technological advance in food production but not in housing production. The technological advance in agriculture causes the production possibilities curve to extend out further on the horizontal axis, which measures food production. The Production Possibilities Curve: Technological Change

©2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 57 Exhibit 2.5: The Effects of a Technological Change on the Production Possibilities Curve

©2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 58 How do we produce more housing when the technological advance occurred in agriculture? Technological advance in agriculture allows us to shift some of our resources out of agriculture into housing. The Production Possibilities Curve: Summary

©2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 63 1.What is to be produced? 2.How are these goods to be produced? 3.For whom are the goods produced? The Three Fundamental Economic Questions

©2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 64 In market-oriented economies, people “vote” on economic affairs with their dollars. Consumer sovereignty describes how individual consumers in market economies determine what is to be produced. Consumer Sovereignty © ISTOCKPHOTO.COM

©2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 65 COMMAND ECONOMIES economies in which the government uses central planning to coordinate most economic activities Economies are organized in different ways to answer the question of what is to be produced. Types of Economic Systems: Command Economies

©2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 66 MARKET ECONOMIES economies that allocate goods and services through the private decisions of consumers, input suppliers, and firms Types of Economic Systems: Market Economies

©2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 67 Most countries, including the United States, have mixed economies. Types of Economic Systems: Mixed Economies MIXED ECONOMIES economies in which government and the private sector determine the allocation of resources

©2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 68 Because of scarcity, all economies, regardless of political structure, must decide how to produce the goods and services that they want. For example, when digging a ditch, a contractor must decide between many workers using their hands, a few workers with shovels, or one person with a backhoe. How Will the Goods and Services be Produced?

©2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 69 A decision must be made as to which method is appropriate. The best method is the least-cost method. How Will the Goods and Services be Produced?

©2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 70 The best or “optimal” form of production will vary from one economy to the next. Each nation tends to use the production processes that conserve its relatively scarce (and thus relatively more expensive) resources and use more of its relatively abundant resources. What Is the Best Form of Production?

©2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 71 LABOR INTENSIVE production that uses a large amount of labor Methods of Production CAPITAL INTENSIVE production that uses a large amount of capital

©2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 72 In every society, some mechanism must exist to determine how goods and services are to be distributed among the population. Who gets what? Why do some people get to consume or use far more goods and services than others? Who Will Get the Goods and Services Produced?

©2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 73 In a market economy, with private ownership and control of the means of production, the amount of output one is able to obtain depends on one’s income, which in turn depends on the quantity and quality of the scarce resources that the individual controls. Who Will Get the Goods and Services Produced?

©2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 74 In the movie Castaway, Chuck Noland (played by Tom Hanks) must find answers to the what, how, and for whom questions. Noland uses his entrepreneurial talents to make the best use of his scarce resources. Who Will Get the Goods and Services Produced: Example

©2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

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©2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

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