Transcript Chapter 1: The Economic Way of Thinking

Chapter 1: The Nature and
Methods of Economic
Definition of Economics
The social science concerned with the
efficient use of limited or scarce resources
to achieve maximum satisfaction of human
needs.
Human wants are unlimited, but the means
to satisfy the wants are limited.
Got stuff?
• Who made it?
• How was it made?
• How did you get it?
I. The Economic Problem
• the basic economic problem is
•
•
scarcity:
-- wants are unlimited, but resources
are limited
so with scarcity, we must make
choices,
and with choices, come costs
2.
Products are sometimes classified as luxuries or necessities, but
the division is subjective.
3.
4.
5.
Services satisfy wants as well as goods.
Businesses and governments also have wants.
Over time, wants change and multiply.
B. the second fundamental fact: Scarce resources:
1.
2.
Economic resources are limited relative to wants.
Economic resources are sometimes called factors of
production (inputs) and include four categories:
Scarcity and choice
• Resources can only be used for one purpose
at a time.
• Scarcity requires that choices be made. we
have to decide (make a choice) what we will
have and what we will forgo
• The cost of any good, service, or activity is the
value of what must be given up to obtain it
(opportunity cost).
• Cost is the opportunity cost
-- what you give up when you make a
choice
-- “there’s no such thing
as a free lunch”
Cost of going to college
-- what you can buy with tuition & fees
-- what you could earn by working
-- what you could do with the free time
• you are willing to give up
-- tuition
-- wages
-- leisure time
to go to college
-- b/c you expect higher income or
more rewarding career
economics is the study of choices
• of how to allocate scarce resources
• choices made by
-- consumers
-- businesses
-- governments
What are resources?
• use resources to produce goods and
•
services
factors of production
-- land
-- labor
-- capital
-- entrepreneurship
Land
• all natural resources
-- land
-- minerals
-- water
-- wildlife
Labor
• size of labor force (quantity)
• skills of labor force (quality)
-- human capital
• the value of time
Capital
• physical capital
-- goods used to make other goods
-- factories
-- machines
-- infrastructure
• NOT financial capital
-- stocks, bonds, bank loans
• financial capital facilitates
building of physical capital
entrepreneurship
• human resource
• ideas
-- doing things better
-- e-commerce
-- new products
RESOURCE PAYMENTS
PROPERTY RESOURCES
LAND
Rent or Rental Income
CAPITAL
Interest Income
HUMAN RESOURCES
LABOR
ENTREPRENEUR
WAGES
PROFIT & LOSS
Three Questions to answer:
1. What to produce?
2. How to produce the stuff in #1?
3. For whom to produce?
(who gets the stuff in #1?)
Example: A Bentley
1. What to produce?
• Bentley Motors designs a luxury car with
buyers in mind
• Bentley Motors decides how much to
•
produce give the price and their costs
Buyers decide how many to buy, based on
price, their income, tastes, etc.
2. How to produce?
• Bentley Motors designs factory, uses
machinery, & trains workers to minimize
cost BUT retain a certain quality
• government restricts this decision:
• Pollution laws
• safety laws
• labor laws
3. Who gets the Bentley?
• Those who are willing and able to
pay K.D 50,000 for one.
(this is why I don’t have it)
Who answers #1-3?
•
pure capitalism
• when buyers and sellers interact to
answer these questions
• markets unrestricted
• private property
• prices coordinate #1-3
•
the U.S. is a mixed market economy,
since government plays a role
• enforces property rights
• regulates markets
• taxes to provide goods & services
•
command system
• the government answers questions 1-3
• former U.S.S.R., N. Korea
• reduced incentives for efficiency
• coordination failures
Why Study Economics?
Economics for citizenship
1.
Most political problems have an economic aspect,
whether it is balancing the budget, fighting over the
tax structure (Kuwait is planning to introduce
income tax), welfare reform, international trade, or
concern for the environment.
2.
Both the voters and the elected officials can fulfill
their role more effectively if they have an
understanding of economic principles.
Why Study Economics?
Professional and personal applications
•
•
Economics helps people to make sense of every day
activity they observe around them
Economic principles enable business managers to
make more intelligent decisions.
• Economics can help individuals make
better buying decisions, better
employment choices, and better
financial investments.
• Economics is to examine problems
and decisions from a social rather
than personal point of view.
Policy economics
applies economic facts and principles to help resolve
specific problems and to achieve certain economic
goals.
•
1.
2.
3.
Steps in formulating economic policy:
State goals.
Recognize various options that can be used to
achieve goals.
Evaluate the options on the basis of specific criteria
important to decision-makers.
Macroeconomics and Microeconomics
Macroeconomics examines the economy as a whole. It
includes measures of total output, total employment,
total income, aggregate expenditures, and the general
price level.
Microeconomics looks at specific economic units.
•
It is concerned with the individual industry, firm or
household and the price of specific products and
resources.
Specialization
• How do we get the most out of our
•
resources?
We specialize in what we do best
and trade that for what we need
• I teach.
• I get paid for it.
• I use the money to buy
• food
• oil changes
• clothes
• If I
• grew my own food
• made my own clothes
• fixed my own car
• I would not consume as much
• Specialization produces gains!
• I can consume more
than what I could make
on my own
Who specializes in what?
• Comparative advantage
• if you produce a good at a lower
opportunity cost
then you should specialize in it
Example: married couple
• Husband:
surgeon
• $250,000 /year
• Wife:
5th grade teacher
• $50,000 /year
• who should run the household?
• Who has lower opportunity cost?
The wife.
with specialization,
• division of labor
• different people specialize in different
things
• people become very good at their task
• efficiency gains
-- get more out of same resources
specialization is everywhere
• doctors
• neurosurgeon, obstetrics, pediatrics,…
• lawyers
• divorce, real estate, patent law,
personal injury...
The bottom line:
• Scarcity & opportunity cost are
unavoidable.
BUT
• efficiency & specialization
make the most of scarce resources
Employment and Efficiency
Economics is a science of efficiency in the use of scarce
resources. Efficiency requires full employment of available
resources and full production.
1.
Full employment means all available resources should be
employed.
2.
Full production means that employed resources are providing
maximum satisfaction of our economic wants.
Underemployment occurs if this is not so.
PRODUCTION POSSIBILITIES
in table form
PIZZA
0
1
2
3
4
9
7
4
0
(in hundred thousands)
ROBOTS
(in thousands)
39
10
PRODUCTION POSSIBILITIES
in table form
PIZZA
0
1
2
3
4
9
7
4
0
(in hundred thousands)
ROBOTS
10
(in thousands)
40
(thousands)
Robots
graphical form
Pizzas (hundred thousands)
PRODUCTION POSSIBILITIES
in table form
PIZZA
0
1
2
3
4
9
7
4
0
(in hundred thousands)
ROBOTS
10
(in thousands)
41
(thousands)
Robots
graphical form
Pizzas (hundred thousands)
PRODUCTION POSSIBILITIES
in table form
PIZZA
0
1
2
3
4
9
7
4
0
(in hundred thousands)
ROBOTS
10
(in thousands)
42
(thousands)
Robots
graphical form
Pizzas (hundred thousands)
PRODUCTION POSSIBILITIES
in table form
PIZZA
0
1
2
3
4
9
7
4
0
(in hundred thousands)
ROBOTS
10
(in thousands)
43
(thousands)
Robots
graphical form
Pizzas (hundred thousands)
PRODUCTION POSSIBILITIES
in table form
PIZZA
0
1
2
3
4
9
7
4
0
(in hundred thousands)
ROBOTS
10
(in thousands)
44
(thousands)
Robots
graphical form
Pizzas (hundred thousands)
PRODUCTION POSSIBILITIES
in table form
PIZZA
0
1
2
3
4
9
7
4
0
(in hundred thousands)
ROBOTS
10
(in thousands)
45
(thousands)
Robots
graphical form
Pizzas (hundred thousands)
PRODUCTION POSSIBILITIES
Limited Resources means
a limited output...
At any point in time,
a full-employment, fullproduction economy must
sacrifice some of product X to
obtain more of product Y.
46
Choices will be necessary because resources and technology are
fixed. A production possibilities table illustrates some of the
possible choices.
A production possibilities curve is a graphical representation of
choices.
1. Points on the curve represent maximum possible combinations of
robots and pizza given resources and technology.
2. Points inside the curve represent underemployment or
unemployment.
3. Points outside the curve are unattainable at present.
47
Optimal or best product-mix:
1. It will be some point on the curve.
2. The exact point depends on society;
this is a normative decision.
48
PRODUCTION POSSIBILITIES
Robots (thousands)
Q 14
13
12
11
10
9
8
7
6
5
4
3
2
1
Unattainable
A
C
W
Attainable
& Efficient
D
Attainable
but
Inefficient
E
1
49
B
2
3
4
5
6
7
Pizzas (hundred thousands)
8
Q
PRODUCTION POSSIBILITIES
Robots (thousands)
Q 14
13
12
11
10
9
8
7
6
5
4
3
2
1
Notes...
Unattainable
LAW OF INCREASING
A OPPORTUNITY
COSTS
B
The amount
of other
C
W
products that must be
forgone or D
sacrificed to
Attainable
obtain 1 unit of a specific
product is called the & Efficient
Attainable
opportunity
cost of that
but
good.
Inefficient
E
1
50
2
3
4
5
6
7
Pizzas (hundred thousands)
8
Q
PRODUCTION POSSIBILITIES
Robots (thousands)
Q 14
51
13
12
11
10
9
8
7
6
5
4
3
2
1
Notes...
Unattainable
LAW OF INCREASING
A OPPORTUNITY
COSTS
B
A graph of the production
C
possibilities curve W
will be
CONCAVE - bowed out from
D
Attainable
the origin.
&
Attainable
Economic resources are
but
not completely adaptInefficient
able
to other uses.
Efficient
1
7
E
2
3
4
5
6
Pizzas (hundred thousands)
8
Q
E. Law of increasing opportunity costs:
1. The amount of other products that
must be foregone to obtain more of any
given product is called the opportunity
cost.
2. Opportunity costs are measured in
real terms rather than money (market
prices are not part of the production
possibilities model).
3. The more of a product produced the
greater is its (marginal) opportunity cost.
52
Economic Rationale:
a. Economic resources are not
completely adaptable to alternative uses.
53
b. To get increasing amounts of pizza,
resources that are not particularly well
suited for that purpose must be used.
Workers that are accustomed to
producing robots on an assembly line
Unemployment, Growth, and the
Future
Unemployment and productive
inefficiency occur when the economy is
producing less than full production or
inside the curve (point U in the following
figure).
54
In a growing economy, the production
possibilities curve shifts outward:
PRODUCTION POSSIBILITIES
Robots (thousands)
Q 14
Unemployment &
Underemployment
Shown by Point U
13
12
11
10
9
8
7
6
5
4
3
2
1
U
1
55
More of either or
both is possible
2
3
4
5
6
7
Pizzas (hundred thousands)
8
Q
PRODUCTION POSSIBILITIES
Robots (thousands)
Q 14
13
12
11
10
9
8
7
6
5
4
3
2
1
Notes... Unemployment &
Underemployment
Economic
Growth
Shown by Point U
The ability to produce
a larger total output a rightward shift of
the production
Morecaused
of either or
possibilities curve
U
both is possible
by...
1
56
2
3
4
5
6
7
Pizzas (hundred thousands)
8
Q
PRODUCTION POSSIBILITIES
Robots (thousands)
Q 14
13
12
11
10
9
8
7
6
5
4
3
2
1
Unemployment &
Notes...Underemployment
Economic
Growth
Shown by
Point U
1 – Increase in resource
supplies
2 – Better resource
quality More of either or
U
both is possible
3 – Technological
advances
1
57
2
3
4
5
6
7
Pizzas (hundred thousands)
8
Q
PRODUCTION POSSIBILITIES
Robots (thousands)
Q 14
A’
13
12
11
10
9
8
7
6
5
4
3
2
1
C’
D’
E’
1
58
Economic Growth
B’
2
3
4
5
6
7
Pizzas (hundred thousands)
8
Q
Present choices and future possibilities:
Using resources to produce consumer goods and services
represents a choice for present over future consumption. Using
resources to invest in technological advances, education, and
capital goods represents a choice for future over present goods.
The decision as to how to allocate resources in the present will
create more or less economic growth in the future.
(See for example Global Perspective 2-1 where various countries
are compared with respect to their economic growth rates relative
to the share of GDP devoted to investment.)
D.
A Qualification: International Trade
1. A nation can avoid the output limits of its domestic Production
Possibilities through international specialization and trade.
2. Specialization and trade have the same effect as having more and
better resources of improved technology.
59
PRODUCTION POSSIBILITIES
Two Examples of Economic Growth
Goods for the Future
ALTA - FAVORS
PRESENT GOODS
CURRENT
CURVE
FUTURE
CURVE
CONSUMPTION
Goods for the Present
60
Alta
PRODUCTION POSSIBILITIES
Two Examples of Economic Growth
CURRENT
CURVE
FUTURE
CURVE
CONSUMPTION
Goods for the Present
61
Alta
ZORN - FAVORS
FUTURE GOODS
Goods for the Future
Goods for the Future
ALTA - FAVORS
PRESENT GOODS
CONSUMPTION
FUTURE
CURVE
CURRENT
CURVE
Goods for the Present
Zorn
Economic systems
Economic systems differ in two important ways: Who owns
the factors of production and the method used to coordinate
economic activity.
A. The market system:
1.
2.
3.
4.
62
There is private ownership of resources.
Markets and prices coordinate and direct economic activity.
Each participant acts in his or her own self-interest.
In pure capitalism the government plays a very limited role.
Economic systems
B. Command economy, socialism or communism:
1. There is public (state) ownership of resources.
2. Economic activity is coordinated by central planning.
C. Mixed economy
63
Specialization
• How do we get the most out of our
•
resources?
We specialize in what we do best
and trade that for what we need
• I teach.
• I get paid for it.
• I use the money to buy
• food
• oil changes
• clothes
• If I
• grew my own food
• made my own clothes
• fixed my own car
• I would not consume as much
• Specialization produces gains!
• I can consume more
than what I could make
on my own
Who specializes in what?
• Comparative advantage
• if you produce a good at a lower
opportunity cost
then you should specialize in it
Example: married couple
• Husband:
surgeon
• $250,000 /year
• Wife:
5th grade teacher
• $50,000 /year
• who should run the household?
• Who has lower opportunity cost?
The wife.
with specialization,
• division of labor
• different people specialize in different
things
• people become very good at their task
• efficiency gains
-- get more out of same resources
specialization is everywhere
• doctors
• neurosurgeon, obstetrics, pediatrics,…
• lawyers
• divorce, real estate, patent law,
personal injury...
The bottom line:
• Scarcity & opportunity cost are
unavoidable.
BUT
• efficiency & specialization
make the most of scarce resources
Employment and Efficiency
Economics is a science of efficiency in the use of scarce
resources. Efficiency requires full employment of available
resources and full production.
1.
Full employment means all available resources should be
employed.
2.
Full production means that employed resources are providing
maximum satisfaction of our economic wants.
Underemployment occurs if this is not so.
PRODUCTION POSSIBILITIES
in table form
PIZZA
0
1
2
3
4
9
7
4
0
(in hundred thousands)
ROBOTS
(in thousands)
73
10
PRODUCTION POSSIBILITIES
in table form
PIZZA
0
1
2
3
4
9
7
4
0
(in hundred thousands)
ROBOTS
10
(in thousands)
74
(thousands)
Robots
graphical form
Pizzas (hundred thousands)
PRODUCTION POSSIBILITIES
in table form
PIZZA
0
1
2
3
4
9
7
4
0
(in hundred thousands)
ROBOTS
10
(in thousands)
75
(thousands)
Robots
graphical form
Pizzas (hundred thousands)
PRODUCTION POSSIBILITIES
in table form
PIZZA
0
1
2
3
4
9
7
4
0
(in hundred thousands)
ROBOTS
10
(in thousands)
76
(thousands)
Robots
graphical form
Pizzas (hundred thousands)
PRODUCTION POSSIBILITIES
in table form
PIZZA
0
1
2
3
4
9
7
4
0
(in hundred thousands)
ROBOTS
10
(in thousands)
77
(thousands)
Robots
graphical form
Pizzas (hundred thousands)
PRODUCTION POSSIBILITIES
in table form
PIZZA
0
1
2
3
4
9
7
4
0
(in hundred thousands)
ROBOTS
10
(in thousands)
78
(thousands)
Robots
graphical form
Pizzas (hundred thousands)
PRODUCTION POSSIBILITIES
in table form
PIZZA
0
1
2
3
4
9
7
4
0
(in hundred thousands)
ROBOTS
10
(in thousands)
79
(thousands)
Robots
graphical form
Pizzas (hundred thousands)
PRODUCTION POSSIBILITIES
Limited Resources means
a limited output...
At any point in time,
a full-employment, fullproduction economy must
sacrifice some of product X to
obtain more of product Y.
80
Choices will be necessary because resources and technology are
fixed. A production possibilities table illustrates some of the
possible choices.
A production possibilities curve is a graphical representation of
choices.
1. Points on the curve represent maximum possible combinations of
robots and pizza given resources and technology.
2. Points inside the curve represent underemployment or
unemployment.
3. Points outside the curve are unattainable at present.
81
Optimal or best product-mix:
1. It will be some point on the curve.
2. The exact point depends on society;
this is a normative decision.
82
PRODUCTION POSSIBILITIES
Robots (thousands)
Q 14
13
12
11
10
9
8
7
6
5
4
3
2
1
Unattainable
A
C
W
Attainable
& Efficient
D
Attainable
but
Inefficient
E
1
83
B
2
3
4
5
6
7
Pizzas (hundred thousands)
8
Q
PRODUCTION POSSIBILITIES
Robots (thousands)
Q 14
13
12
11
10
9
8
7
6
5
4
3
2
1
Notes...
Unattainable
LAW OF INCREASING
A OPPORTUNITY
COSTS
B
The amount
of other
C
W
products that must be
forgone or D
sacrificed to
Attainable
obtain 1 unit of a specific
product is called the & Efficient
Attainable
opportunity
cost of that
but
good.
Inefficient
E
1
84
2
3
4
5
6
7
Pizzas (hundred thousands)
8
Q
PRODUCTION POSSIBILITIES
Robots (thousands)
Q 14
85
13
12
11
10
9
8
7
6
5
4
3
2
1
Notes...
Unattainable
LAW OF INCREASING
A OPPORTUNITY
COSTS
B
A graph of the production
C
possibilities curve W
will be
CONCAVE - bowed out from
D
Attainable
the origin.
&
Attainable
Economic resources are
but
not completely adaptInefficient
able
to other uses.
Efficient
1
7
E
2
3
4
5
6
Pizzas (hundred thousands)
8
Q
E. Law of increasing opportunity costs:
1. The amount of other products that
must be foregone to obtain more of any
given product is called the opportunity
cost.
2. Opportunity costs are measured in
real terms rather than money (market
prices are not part of the production
possibilities model).
3. The more of a product produced the
greater is its (marginal) opportunity cost.
86
2
C HAPTE R
The Market
System and
the Circular
Flow
SCARCE RESOURCES
ECONOMIC RESOURCES
PROPERTY RESOURCES
1. LAND
2. CAPITAL
HUMAN RESOURCES
3. LABOR
4. ENTREPRENEURIAL ABILITY
Resource payments: correspond to resource
categories
PROPERTY RESOURCES
RENTAL
LAND
INCOME
INTEREST
CAPITAL
INCOME
HUMAN RESOURCES
LABOR
ENTREPRENEUR
WAGES
PROFIT &
LOSS
Macroeconomics Starts Here
Economic Systems
•
Definition: A particular set of
institutional arrangements and a
coordinating mechanism to respond
to the economizing problem.
• Economic systems differ as to:
1) who owns the factors of production
2) the method used to motivate,
coordinate, and direct economic
activity.
The Command System
• The government owns most property
•
resources and economic decision
making occur through a central
economic plan.
The central planning board
determines production goals for
each firm and resources to be
allocated.
The Market System
• There is private ownership of
•
•
•
resources.
Markets and prices coordinate and
direct economic activity.
Each participant acts in its own selfinterest.
In pure capitalism the government
plays a very limited role.
Characteristics of the Market
System
• Private Property.
• Freedom of firms to choose.
• Self interest.
• Competition.
• Markets and prices.
• Technology and capital goods.
• Specialization.
• Use of money.
• Active, but limited government.
The Circular Flow Model
• There are two groups of decision makers
in the private economy: households
(resource owners) and businesses
(resource users)
• The market system (resource markets
and product markets) coordinates these
decisions.
What happens in the resource markets?
a. Households sell resources directly or
indirectly (through ownership of corporations)
to businesses.
b. Businesses buy resources in order to
produce goods and services.
c. Interaction of these sellers and buyers
determines the price of each resource,
which in turn provides income for the owner
of that resource.
d. Flow of payments from businesses for the
resources constitutes business costs and
What happens in the product markets?
a. Households are on the buying side of these
markets, purchasing goods and services.
b. Businesses are on the selling side of these
markets, offering products for sale.
c. Interaction of these buyers and sellers
determines the price of each product.
d. Flow of consumer expenditures constitutes
sales receipts for businesses.
CIRCULAR FLOW MODEL
RESOURCE
MARKET
BUSINESSES
HOUSEHOLDS
PRODUCT
MARKET
CIRCULAR FLOW MODEL
RESOURCE
MARKET
RESOURCES
INPUTS
BUSINESSES
HOUSEHOLDS
PRODUCT
MARKET
CIRCULAR FLOW MODEL
$ COSTS
$ INCOMES
RESOURCE
MARKET
RESOURCES
INPUTS
BUSINESSES
HOUSEHOLDS
GOODS &
SERVICES
GOODS &
SERVICES
PRODUCT
MARKET
CIRCULAR FLOW MODEL
$ COSTS
$ INCOMES
RESOURCE
MARKET
RESOURCES
INPUTS
BUSINESSES
HOUSEHOLDS
GOODS &
SERVICES
GOODS &
SERVICES
PRODUCT
MARKET
CIRCULAR FLOW MODEL
$ COSTS
$ INCOMES
RESOURCE
MARKET
RESOURCES
INPUTS
BUSINESSES
HOUSEHOLDS
GOODS &
SERVICES
GOODS &
SERVICES
PRODUCT
MARKET
$ REVENUE
$ CONSUMPTION
CIRCULAR FLOW MODEL
$ COSTS
$ INCOMES
RESOURCE
MARKET
RESOURCES
INPUTS
BUSINESSES
HOUSEHOLDS
GOODS &
SERVICES
GOODS &
SERVICES
PRODUCT
MARKET
$ REVENUE
$ CONSUMPTION
More Realistic Circular Flow
Macroeconomic Policies