Economics: The Core IssuesEconomics: The Core IssuesChapter 1
Copyright © 2010 by the McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin
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The Economy Is Us
• The economy is the aggregation of individual production and consumption decisions
• Important link between individual choices and collective outcomes
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Macro Versus Micro
• Economics: The study of how best to allocate scarce resources among competing uses– Macroeconomics: The study of aggregate
economic behavior, of the economy as a whole– Microeconomics: The study of individual
behavior in the economy, of the components of the larger economy
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Three Core Choices
• Three core choices confront every nation:– 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
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Scarcity: The Core Problem
• Scarcity: Lack of enough resources to satisfy all desired uses of those resources– Scarcity of resources limits the amount of
production that can be undertaken– Requires choices to be made
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Factors of Production• Factors of Production: Resource inputs used
to produce goods and services• Four Types:
– Land– Labor– Capital– Entrepreneurship
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Factors of Production
• Land: Includes all natural resources– e.g. oil, water, iron ore, energy, etc.
• Labor: Quantity and quality of human resources– Includes physical presence of workers as well as
their skills and abilities
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Factors of Production
• Capital: Final goods produced for use in production of other goods and services– Includes equipment and structures, such as:
• Factories• Production machinery• Fleet vehicles
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Factors of Production
• Entrepreneurship: Assembling of resources to produce new or improved products and technologies– It’s not just a matter of what resources you have
but also of how well you use them
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Opportunity Costs
• Opportunity cost: The next most desired goods and services foregone to obtain something else– What is given up to undertake a chosen activity
• Associated with every decision– For example, if we choose to produce bread then
we cannot produce pizza crust with the same flour
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Production Possibilities
• Production possibilities: The alternative combinations of final goods and services that could be produced in a given time period with all available resources and technology
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The Production Possibilities Curve
• Production possibilities curve (PPC): Describes the various output combinations that could be produced in a given time period with available resources and technology
• Represents a menu of output choices an economy confronts
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The Production Possibilities Curve
• Illustrates Two Essential Principles:– Scarce resources: Production is limited by
available resources and technology– Opportunity costs: Can obtain additional
quantities of a good only by reducing production of another
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A Production Possibilities Curve
A
B
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D
E
F
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0 1 2 3 4 5OUTPUT OF TANKS
PointTotal Labor
Truck Output x
Labor per Truck =
Total Labor Required
Labor Not Used for Trucks
Potential Output of
Tanks
Increase in Tank Output
A 10 5 2 10 0 0B 10 4 2 8 2 2 + 2C 10 3 2 6 4 3 + 1D 10 2 2 4 6 3.8 + 0.8E 10 1 2 2 8 4.5 + 0.7F 10 0 2 0 10 5 + 0.5
Truck Production Tank Production
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Increasing Opportunity Costs
• Resources do not transfer perfectly from the production of one good to another
• Increased production of one good or service can only be attained by sacrificing ever-increasing quantities of others
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• The shape of the curve illustrates increasing opportunity costs
• Lose some efficiency in the transfer– Resources used for truck production are not ideally
suited for producing tanks
Increasing Opportunity Costs
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Step 1: give up one truck
Step 2: get two tanksStep 3: give up another truck
Step 4: get one more tank
A
B
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0 1 2 3 4 5OUTPUT OF TANKS
Law of Increasing Opportunity Costs
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Efficiency
• Efficiency: Maximum output of a good from the resources used in production
• Every point on the production possibilities curve is a point of efficiency
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Points Inside the Curve
• A production possibilities curve shows potential output
• Actual output can be less than potential due to – Inefficiency: Resources not being used to
maximum potential– Unemployment: Some resources are idle
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OUTPUT OF TANKS
A
B
CY
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Some resources are unemployed or used
inefficiently
A Point Inside the Curve
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Points Outside the Curve
• Any point outside the production possibilities curve is unattainable with available resources and technology
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A Point Outside the Curve
OUTPUT OF TANKS
A
B
C
X5
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Currently not attainable
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Economic Growth
• Economic growth: An increase in output due to an expansion of production possibilities– Production possibilities increase with more
resources or better technology
• The production possibilities curve shifts outward
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Economic Growth
0
PP1
PP2
OUTPUT OF TANKS
OU
TP
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The Mechanism of Choice
• An economy is largely defined by how it answers the WHAT, HOW and FOR WHOM questions
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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 think government intervention is likely to
improve market outcomes
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A Mixed Economy
• Countries answer the questions differently• Mixed economy: An economy that uses both
market signals and government directives to allocate goods and resources
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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