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Economics
Chapter 1
The Economic Way of Thinking
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Economics
Chapter 1
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?
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Economics
Chapter 1
Section-1
Scarcity: The Basic Economic Problem
What Is Scarcity?
KEY CONCEPTS
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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
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Economics
Chapter 1
What Is Scarcity?
Principle 1: People Have Wants
• People make choices about all their needs and wants
• Wants are unlimited, ever changing
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Economics
Chapter 1
What Is Scarcity?
Principle 2: Scarcity Affects Everyone
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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
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Economics
Chapter 1
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?
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Economics
Chapter 1
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
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Economics
Chapter 1
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
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Economics
Chapter 1
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?
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Economics
Chapter 1
The Factors of Production
KEY CONCEPTS
• Factors of production — resources needed to produce goods and services
— include land, labor, capital, entrepreneurship
— supply is limited
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Economics
Chapter 1
The Factors of Production
Factor 1: Land
• Land means all natural resources on or under the ground
— includes water, forests, wildlife, mineral deposits
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Economics
Chapter 1
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
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Economics
Chapter 1
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
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Economics
Chapter 1
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
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Economics
Chapter 1
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
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Economics
Chapter 1
Section-2
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
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Economics
Chapter 1
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
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Economics
Chapter 1
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
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Economics
Chapter 1
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
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Economics
Chapter 1
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
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Economics
Chapter 1
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
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Economics
Chapter 1
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
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Economics
Chapter 1
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
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Economics
Chapter 1
Analyzing Choices
Example: Marginal Costs and Benefits
• Marginal cost
— lists choices, benefits and opportunity cost of each choice
• Marginal benefit
— additional benefit of using one more unit of a good or service
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Economics
Chapter 1
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
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Economics
Chapter 1
Section-3
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
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Economics
Chapter 1
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
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Economics
Chapter 1
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
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Economics
Chapter 1
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
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Economics
Chapter 1
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
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Economics
Chapter 1
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
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Economics
Chapter 1
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
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Economics
Chapter 1
Reviewing Key Concepts
Explain how each term is illustrated by the production possibilities curve:
• underutilization
• efficiency
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Economics
Chapter 1
Section-4
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
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Economics
Chapter 1
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
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Economics
Chapter 1
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
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Economics
Chapter 1
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
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Economics
Chapter 1
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
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Economics
Chapter 1
Microeconomics and Macroeconomics
Microeconomics
• 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
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Economics
Chapter 1
Microeconomics and Macroeconomics
Microeconomics
• 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
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Economics
Chapter 1
Microeconomics and Macroeconomics
Microeconomics
• 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
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Economics
Chapter 1
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
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Economics
Chapter 1
Positive Economics and Normative Economics
Positive 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)
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Economics
Chapter 1
Positive Economics and Normative Economics
Normative Economics
• Normative economics studies facts, asks if course of action is good
• Recommendations differ because values they are based on also differ
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Economics
Chapter 1
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
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Economics
Chapter 1
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
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Economics
Chapter 1
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.
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Economics
Chapter 1
Case Study: The Real Cost of Expanding O’Hare Airport {continued}
Thinking Economically
1. Explain the real cost of expanding O’Hare Airport. Use information presented in the
documents to support your answer.
2. Who are the most likely winners and losers as a result of the O’Hare expansion? Explain
your answer.
3. How might supporters of expansion use a production possibilities model to strengthen their
case?
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Economics
Chapter 1
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