Transcript lovewellch01

Understanding Economics
5th edition
by Mark Lovewell
Copyright © 2009 by McGraw-Hill
Ryerson Limited. All rights reserved.
Chapter 1
The Economic Problem
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Learning Objectives

After this chapter, you will be able to:
1.
2.
3.
4.
comprehend the economic problem – the problem of having
unlimited wants, but limited resources – that underlies the
definition of economics
explain how economists specify economic choice
summarize the production choices an entire economy faces, as
demonstrated by the production possibilities model
identify the three basic economic questions and how various
economic systems answer them
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How Economists Think

Economists assume that people customarily engage
in rational behaviour.
 People are assumed to make choices by logically weighing
the personal benefits and costs of available actions. They
then select the most attractive option.

Economists deal with the economic problem.
 Economic agents must continually make choices.
 Their wants are unlimited.
 They face a limited supply of economic resources.
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Economic Resources

Economic resources include:
 natural resources, or nature’s contribution to production
 capital resources, or the processed materials, equipment,
and buildings used in production
 human resources, which include both labour and
entrepreneurship
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Economic Models

Economic models:
 simplify economic reality
 show how dependent variables are affected by
independent variables
 include inverse and/or direct relationships
 incorporate a variety of assumptions such as ceteris
paribus
 are classified as part of either positive economics or
normative economics
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Economic Choice

Economists assume that economic decision-makers
maximize their own utility.
 Decision-makers must keep in mind the opportunity cost
of each alternative.
 Opportunity cost is defined as the utility of the best
forgone alternative.
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The Production Possibilities Model

The production possibilities model is based on three
assumptions:
 an economy makes only two products
 resources and technology are fixed
 all resources are employed to their fullest capacity
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The Production Possibilities
Curve (a)

The production possibilities curve shows a range of
possible output combinations for an economy.
 It highlights the scarcity of resources.
 It has a concave shape, which reflects the law of increasing
opportunity costs.
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The Production Possibilities
Curve (b)
Figure 1.1, page 9
Production Possibilities
Schedule
Production Possibilities Curve
a
1000
b
f
Hamburgers Computers
point
on graph
1000
0
a
900
1
b
600
2
c
0
3
d
Hamburgers
900
unattainable
c
600
e
inefficient
d
0
1
2
Computers
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3
The Law of Increasing Costs
Figure 1.2, page 11
Hamburgers
Opportunity Computers point
Cost of
on graph
Computers
1000
0
a
100
900
1
b
2
c
Production Possibilities Curve
a
1000
As the quantity
of computers
rises, so does their
opportunity cost.
b
900
Hamburgers
Production Possibilities Schedule
c
600
300
600
600
0
d
3
d
0
1
2
Computers
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3
Shifts in Production Possibilities
Figure 1.2, page 11
Production Possibilities Curve
With more
computers, the
curve shifts out
in the next
period.
Hamburgers
1000
0
3
Computers
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The Basic Economic Questions

There are three basic questions any society must
answer:
 what to produce
 how to produce
 for whom to produce
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Economic Systems

There are three systems to choose from:
 Traditional economies focus on non-economic concerns
and have tight social constraints.
 Market economies are consumer-centered and
innovative but create inequality and instability.
 Command economies equalize incomes but often have a
lack of freedom.
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The Range of Economic Systems
(a)

Most countries have mixed economies.
 Modern mixed economies include both private and
public sectors.
 Traditional mixed economies combine traditional
sectors with private and/or public sectors.
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The Range of Economic Systems
(b)
Figure 1.4, page 17
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Transition Economies


China and India exhibit the conflicts and
opportunities found in rapidly changing mixed
economies.
Both economies are examples of transition economies,
exhibiting high rates of economic growth and rising
average incomes.
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The Case of China




The contemporary economic transformation of China
began in the 1970s with growth-enhancing reforms in
its agricultural sector.
In the 1980s, this growth spread to other sectors,
thanks to reforms allowing state-owned producers to
keep some of their profits.
After 1990, private companies became common,
causing a further increase in annual growth.
By the late 2000s, this growth meant that China’s
economy was five times larger than in 1978.
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The Case of India



Reforms during the early 1990s freed private
businesses in key sectors of India’s economy.
High growth rates appeared first in services, before
being extended to manufacturing.
India’s annual rates of economic growth now average
about 8% – just a little less than the 10% rates found in
China’s economy.
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Economic Goals

There are seven major economic goals:
 economic efficiency
 income equity
 price stability
 full employment
 viable balance of payments
 economic growth
 environmental sustainability
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Climate Change



Concerns over climate change illustrate the
complexities in accomplishing economic goals.
The mainstream scientific prediction is that, if
unchecked, the increase in carbon emissions will cause
average global temperatures to rise by between 1.5%
and 6% by 2100.
So far, attempts to reduce emissions worldwide,
through the Kyoto Protocol, have achieved only
limited success.
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Complementary and Conflicting
Economic Goals

Economic goals may be complementary.
 An example is the relationship between full employment
and economic growth.

Economic goals may be conflicting.
 An example is the relationship between price stability
and full employment.
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The Founder of Modern
Economics

Adam Smith:
 explained how the division of labour increases
production
 argued that self interest is transformed by the invisible
hand of competition so that it creates significant
economic benefits
 stressed the principle of laissez faire, which means that
governments should not intervene in economic activity
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Economics as an Art (a)

While some economists view their subject as a science,
others view it as a discipline.


These economists stress the ways in which economic
models are like artistic sketches, with the added need to
include society’s political and cultural aspects.
When social surroundings change, economic models
may therefore need to change as well.
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Economics as an Art (b)

Building a good economic model is an art as well as a
science.


By identifying the principles of rational behaviour in
various walks of life, contemporary economists are
extending creative models into areas that could not
have been guessed a few decades ago.
Examples of these applications are analyzing falling
North American crime rates, the maximization of
student academic achievement, and the factors that
influence the longevity of marriages.
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The Past as Prologue (a)
(Online Learning Center)
 In pre-modern times, economic ideas were only dimly
present in ways of thinking.
 In the ancient world, economic activity was based on
the following principles:
 the widespread use of slavery
 an aversion to the use of markets and a patronizing view
of “trade”
 a lack of concern with technological innovation
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The Past as Prologue (b)
(Online Learning Center)
 During the Middle Ages in Europe, economic activity
was based on:
 the system of feudalism, with relations between
peasants and nobles tied, at least in theory, by a set of
mutual obligations
 religiously based rules, such as the idea of the ‘just price’
and condemnation of ‘usury’
 a gradually growing acceptance of markets
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The Past as Prologue (c)
(Online Learning Center)
 After 1500, capitalism arose in Europe based on the
following factors:
 the undermining of feudal relations due to plagues and
wars, and a new focus on money
 the rise of exploration and trade
 an influx of precious metals from the Americas
 the Protestant Reformation, with Martin Luther’s
emphasis on individual faith as the key to personal
salvation, and John Calvin’s notion of predestination,
with riches gradually being seen as a sign of God’s favour
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The Past as Prologue (d)
(Online Learning Centre)
 The economic ideas of early capitalism were related to
a viewpoint known as mercantilism. According to its
supporters:
 government regulations should attempt to keep gold
and silver within national borders, since a nation’s
wealth was thought to be best measured in terms of
treasure
 tariffs and other types of protection should be used to
ensure a surplus of trade
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The Past as Prologue (e)
(Online Learning Centre)
 Mercantilist thinking was on the wane by 1750, when
economists such as Adam Smith emphasized that
wealth was in the form of real resources, not treasure,
and that trade could be beneficial for both buyers and
sellers.
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Chapter 1
The End
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