The Economic PerspectiveThe Economic Perspective

Chapter 1Chapter 1

Economic ProblemEconomic Problem

• The problem is that, although your The problem is that, although your wants, or desires, are virtually wants, or desires, are virtually unlimited, the resources available unlimited, the resources available to satisfy these wants are scarce.to satisfy these wants are scarce.

ScarcityScarcity

All resources are scarce

ScarcityScarcity

• Means limited goods and servicesMeans limited goods and services• Restricts options and demands Restricts options and demands

choiceschoices• Price > ZEROPrice > ZERO

Rational Self-InterestRational Self-Interest

• Means that individuals try to Means that individuals try to maximize the expected benefit maximize the expected benefit achieved with a given cost or to achieved with a given cost or to minimize the expected cost of minimize the expected cost of achieving a given benefitachieving a given benefit

Making decisions at the Making decisions at the marginmargin

• Margin: the cutoff point; decision making Margin: the cutoff point; decision making at the margin refers to deciding on one at the margin refers to deciding on one more or one less of somethingmore or one less of something

• Weighing and balancing of alternativesWeighing and balancing of alternatives– Marginal benefitMarginal benefit– Marginal costMarginal cost– Benefits > CostsBenefits > Costs

Scientific MethodScientific Method

• ElementsElements– Observation of real-world behavior and Observation of real-world behavior and

outcomesoutcomes– Formulation of hypothesisFormulation of hypothesis– Testing of this explanation by comparing the Testing of this explanation by comparing the

outcomes of specific events to predict outcomes of specific events to predict outcomeoutcome

– The acceptance, rejection, or modification of The acceptance, rejection, or modification of the hypothesisthe hypothesis

– The continued testing of the hypothesis The continued testing of the hypothesis against the facts. against the facts.

MicroeconomicsMicroeconomics

• Analyzes the individual components of Analyzes the individual components of the economy, such as the choices made the economy, such as the choices made by people, firms, and industries.by people, firms, and industries.

• Markets – make possible the voluntary Markets – make possible the voluntary exchange of resources, goods and exchange of resources, goods and services; can take physical, electronic, services; can take physical, electronic, and other forms.and other forms.

• Market prices – serve as signals that Market prices – serve as signals that guide the allocation of resourcesguide the allocation of resources

MacroeconomicsMacroeconomics

• Analyzes economic aggregates Analyzes economic aggregates such as aggregate employment, such as aggregate employment, output, growth, and inflationoutput, growth, and inflation

• Most important is GDPMost important is GDP– Gross domestic productGross domestic product

Normative EconomicsNormative Economics

• A statement that A statement that represents an represents an opinion, which opinion, which cannot be proved cannot be proved or disprovedor disproved

• What ought to beWhat ought to be• Ethical value Ethical value

judgmentsjudgments

Positive EconomicsPositive Economics

• A statement that A statement that can be proved or can be proved or disproved by disproved by reference to factsreference to facts

• What is What is • Scientific portionScientific portion

Society’s Economizing Society’s Economizing ProblemProblem

• The need to make choices because The need to make choices because economic wants exceed economic economic wants exceed economic meansmeans

Scarce resourcesScarce resources

• Society has limited economic Society has limited economic resourcesresources

ResourcesResources

• The inputs, or factors of production, The inputs, or factors of production, used to produce the goods and used to produce the goods and services that people want services that people want resourcesresources

• Also called factors of productionAlso called factors of production

LandLand

• Includes all the Includes all the natural resources natural resources used in the used in the production production processprocess

LaborLabor

• The physical and The physical and mental effort used mental effort used to produce goods to produce goods and servicesand services

Labor - mentalLabor - mental

• Mental effortMental effort– Consists of the Consists of the

knowledge and knowledge and skill people skill people acquire to acquire to enhance their enhance their productivityproductivity

CapitalCapital

• The buildings, equipment, and The buildings, equipment, and human skill used to produce goods human skill used to produce goods and servicesand services– Physical capitalPhysical capital– Human capitalHuman capital

CapitalCapital

• Physical capitalPhysical capital– Consists of Consists of

factories, factories, machines, tools, machines, tools, buildings, airports, buildings, airports, highways, and highways, and other human other human creationcreation

Entrepreneurial AbilityEntrepreneurial Ability

• Managerial and organizational skills Managerial and organizational skills needed to start a firm, combined needed to start a firm, combined with the willingness to take riskswith the willingness to take risks

Functions of EntrepreneurFunctions of Entrepreneur

• Entrepreneur takes Entrepreneur takes the initiative in the initiative in combining the combining the resources of land, resources of land, labor, and capitallabor, and capital

• The entrepreneur The entrepreneur makes the strategic makes the strategic business decisions business decisions that set the course of that set the course of an enterprisean enterprise

• InnovatorInnovator• Risk bearerRisk bearer

EntrepreneursEntrepreneurs

• Pick Pick

Anita RoddickWilliam H. Gates

Payments to ResourcesPayments to Resources

• WagesWages– Payment to resource owners for their laborPayment to resource owners for their labor

• InterestInterest– Payment to resource owners for the use of Payment to resource owners for the use of

their capitaltheir capital• RentRent

– Payment to resource owners for the use of Payment to resource owners for the use of their natural resources.their natural resources.

• ProfitsProfits– The reward for entrepreneurial ability.The reward for entrepreneurial ability.

Production Possibilities Production Possibilities FrontierFrontier

• AssumptionsAssumptions– Output is limited to two products: Output is limited to two products:

consumer goods and capital goodsconsumer goods and capital goods– Resources are Resources are FIXED FIXED in both quantity in both quantity

and quality during that periodand quality during that period– Technology Technology does not changedoes not change– Full employmentFull employment

Production Possibilities Production Possibilities FrontierFrontier

• A curve showing alternative A curve showing alternative combinations of goods that can be combinations of goods that can be produced when available resources are produced when available resources are used fully and efficiently.used fully and efficiently.

ProductProduct AA BB CC DD EE

ConsumerConsumer 00 11 22 33 44

CapitalCapital 1010 99 77 44 00

Production Possibilities Production Possibilities FrontierFrontier

Capital Goods

Consumer goods

0

Production possibilities curve

A

BCInefficient

D.Unattainable

Points on line are efficient

Production Possibilities Production Possibilities FrontierFrontier

• Efficient pointsEfficient points– Any point found on the production Any point found on the production

possibilities frontier such as A and Bpossibilities frontier such as A and B

• Inefficient pointsInefficient points– Inside the curveInside the curve

• UnattainableUnattainable– Outside the curveOutside the curve

Economic growthEconomic growth

• An increase in the economy’s ability An increase in the economy’s ability to produce goods and servicesto produce goods and services

• An outward shift of the production An outward shift of the production possibilities frontierpossibilities frontier

• Caused byCaused by– Changes in resource availabilityChanges in resource availability– Increases in capital stockIncreases in capital stock– Technological changeTechnological change

Economic GrowthEconomic Growth

Caused byCaused by– Increases in capital stockIncreases in capital stock– Technological changeTechnological change

Economic GrowthEconomic Growth

Capital Goods

Consumer goods

0

Production possibilities curveShift

in PPF

Economic AnalysisEconomic Analysis

• Fallacy of compositionFallacy of composition– What is true at the micro level is also true at What is true at the micro level is also true at

the macro levelthe macro level• What is true for the individual is true for the wholeWhat is true for the individual is true for the whole

• Fallacy of that association is causationFallacy of that association is causation– The incorrect idea that if two variables are The incorrect idea that if two variables are

associated in time, one must necessarily associated in time, one must necessarily cause the othercause the other

Economic AnalysisEconomic Analysis

• Secondary EffectsSecondary Effects– Unintended consequences of Unintended consequences of

economic actions that may develop economic actions that may develop slowly over time as people react to slowly over time as people react to events.events.