Transcript Economics: The Core Issues

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Economics: The Core Issues
Chapter 1
In This Chapter…
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


What is Economics about?
The Core Issues in Economics
Key (Basic) Concepts in Economics
Why Study Economics?
1. What is
Economics?
1. What is Economics?
Definition:
 Why are you here?
 Why am I here?
 Why should I teach you? Why should
you have to register for my class?
1. What is Economics?
Definition:
 Economics is the study of how best to
allocate scarce resources among competing
uses.
1. What is Economics?
 In general we have relentless quest
for more and better
 This relentless quest for more arises
from
 Necessity
 Increased income
 Development and growth
1. What is Economics?
 We have unlimited wants (desire)—It either
grows or changes, but….
 But the RESOURCES from which we produce
goods and services that satisfy our needs
(wants) are limited.
 Resources are Limited in Supply. That is,
Resources are Scarce!!!
1. What is Economics?
 Although resources are scarce, they have
alternative (multiple) uses
 To get the best out of the scarce resources we
have, we choose between the alternative uses
 Scarcity entails Choice, and choice involves
Making Decisions
1. What is Economics? Summary
 Economics is the study of how best to
allocate scarce resources among competing
uses…..
 Economics is the study of how the society
chooses to allocate its scarce resources
among alternative uses
 The study of resource allocation
 The science of choice
2. The Core Issues in
Economics
2. Three Core Issues of
Economics
 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.
2. Three Core Issues of
Economics
Fact!
All societies, Individuals,
Economies face these
Core Economic problems
(Decisions)
Why?
3. Key (Basic)
Concepts in
Economics
3. Basic Concepts
3.1. Scarcity (What is scarcity)?
 Scarcity is the lack of enough
resources to satisfy all desired uses of
those resources.
 That is, we can’t have everything we
want because relative to our wants,
Economic Resources are limited in
supply (availability).
 Thus it is the foundation of economics
3. Basic Concepts
3.2. What are Resources?
Are factors of production that are used
to produce goods and services with
which we satisfy our needs.
Inputs that are needed to produce
outputs
3. Basic Concepts
 Four Basic Factors of Production
3. Basic Concepts
 Land
 refers to all natural resources such as
crude oil, water, air, and minerals.
 Labor
 refers to the skills and abilities to
produce goods and services.
Factors of Production
 Capital
 Goods produced for use in the production
of other goods, e.g., equipment,
structures.
 Entrepreneurship:
 is the assembling of resources to
produce new or improved products and
technologies. (know how, managerial
capacity)
3. Basic Concepts
 3.3. What is the economy?
 The economy is an abstraction that
refers to the sum of all our individual
production and consumption
activities.
 The economy is us — the aggregation
of all of our supply and demand
decisions.
3. Basic Concepts
 So far….
 What Resources are (Factors of Production)
 What the Economy is ( an abstraction of us
and our actions)
 Scarcity of Resources (Limitation) and
Insatiable Wants (desires)
 Implication-1?
1. There is a limit to the output we
produce!
3. Basic Concepts
 Example:
 Colonization of the Moon and
Exploration of Mars


http://msnbc.msn.com/id/%204008805/
 or
http://cndyorks.gn.apc.org/yspace/articles/spaced_out_i
nvaders.htm
3. Basic Concepts
 No matter how an economy is organized
there is a limit to how fast it can grow.
 Recall:
 We can’t have everything we want because
relative to our wants, Economic Resources are
limited in supply (availability)….
 The most evident limit is the amount of
resources available for producing goods and
services.
3. Basic Concepts
 Scarcity — thus is the result of the
imbalance between our desires and
available resources
 Implication-2?
 —forces us to make economic choices.
 What, how and how much to produce?
 Choice between alternative uses
 ….Definition of economics?
3. Basic Concepts
 Studying how the society allocates its scarce
resources Requires…
1. The knowledge of alternative combination of
outputs that could be produced from the mix
of the available resource(s) and
 The Production Possibilities
2. The Costs of Making Choices… ….

Opportunity Cost
Basic Concepts
3.4. Opportunity Costs
 It is what is given up in order to get something
else. (The best alternative forgone)
 Opportunity cost is the most desired goods or
services that are forgone in order to obtain
something else.
 The cost of allocating scarce resources for
one use rather than the other use
3. Basic Concepts
3.5. Production Possibilities Curve
(Frontier)—PPC (PPF)
 A graphic representation of production
possibilities
 Production possibilities are the maximum
alternative combination of goods and services
that could be produced in a given period of
time with all the available resources and
technology.
The Production Possibilities
Curve (PPC)
Truck Production
Total Labor Truck Output x Labor per Truck =
Tank Production
Total Labor
Required
Labor Not Used Potential Output Increase in Tank
for Trucks
of Tanks per Day
Output
A 10
5
2
10
0
0
B 10
4
2
8
2
2.0
>
2.0
C 10
3
2
6
4
3.0
>
1.0
D 10
2
2
4
6
3.8
>
0.8
E 10
1
2
2
8
4.5
>
0.7
F 10
0
2
0
10
5.0
>
0.5
The Production Possibilities
Curve (PPC)
Truck Production
Total Labor Truck Output x Labor per Truck =
Tank Production
Total Labor
Required
Labor Not Used Potential Output Increase in Tank
for Trucks
of Tanks per Day
Output
A 10
5
2
10
0
0
B 10
4
2
8
2
2.0
>
2.0
C 10
3
2
6
4
3.0
>
1.0
D 10
2
2
4
6
3.8
>
0.8
E 10
1
2
2
8
4.5
>
0.7
F 10
0
2
0
10
5.0
>
0.5
The Production Possibilities
Curve
OUTPUT OF TRUCKS
5
A
B
4
C
3
D
2
E
1
0
1
2
3
OUTPUT OF TANKS
4
5
F
The Production Possibilities
Curve
 Each point on the production
possibilities curve depicts an alternative
mix of output.
 A(5 trucks, 0 Tanks)
 B(4 trucks, 2 Tanks)
.
.
 F(0 trucks, 5 Tanks)
 Production Possibilities Curve (PPC)
also Illustrates Several Essential
Principles and Core Issues
1. Scarce resources – there’s a limit to
the amount we can produce in a given
time period with available resources
and technology.
OUTPUT OF TRUCKS
5
A
X
Currently not attainable
B
4
C
3
2
1
0
1
2
3
OUTPUT OF TANKS
4
5
2. Opportunity Costs – we can obtain
additional quantities of any desired good
only by reducing the potential production of
another good.
Thus movement along the PPC represent
opportunity cost
How much we give up in the production
of one output to get more of the other
output)--tradeoffs
Opportunity Costs
OUTPUT OF TRUCKS
5
A
Step 1: give up one truck
B
4
3
2
Step 2: get two tanks
Step 3: give up another truck
C
Step 4: get one more tank
D
E
1
0
1
2
3
OUTPUT OF TANKS
4
5
F
 It shows the Law of Increasing Opportunity
Costs
 Increasing quantities of any good can be
obtained only by sacrificing everincreasing quantities of other goods…?
 Resources do not transfer perfectly from the
production of one good to another.
Increasing Opportunity Costs
OUTPUT OF TRUCKS
5
A
Step 1: give up one truck
B
4
3
2
Step 2: get two tanks
Step 3: give up another truck
C
Step 4: get one more tank
D
E
1
0
1
2
3
OUTPUT OF TANKS
4
5
F
Some Real Life Examples
 The Cost of North Korea’s Military
 North Korea’s inability to feed itself is
due in part to its large army.
 Resources used for the military aren’t
available for producing food.
The Cost of North Korea’s
Military
FOOD OUTPUT
A
G
P
Reduced food
output
C
O
N
Military buildup
H
MILITARY OUTPUT
D
B
The Military Share of Output
16.3
Percent of Output Allocated to Military
12.0
2.7
0.5
0.9
1.0
1.2
1.5
2.8
3.4
3.8
4.1
3.6. Efficiency and Inefficiency
PPC also shows whether outcomes (of
allocation decision) are Efficient or Inefficient.
 Efficiency means getting the maximum
output of a good from the resources used in
production.
 Every point on a production possibilities
curves is efficient.
 Inefficiency
 Recall that a production possibilities curves shows
potential output, not necessarily actual output.
 Thus if we are inefficient, actual output will be less
than the potential output.
 Any point inside the PPC represent inefficient
outcomes
 ?????
 Countries may end up inside their
production possibilities curve if all
available resources are not used.
 ……Unemployment
OUTPUT OF TRUCKS
5
A
4
B
3
Y
2
C
Unemployment
1
0
1
2
3
OUTPUT OF TANKS
4
5
3. Basic Concepts
3.7. Economic Growth
Economic growth is an increase in output
(real GDP) — an expansion of production
possibilities.
 PPC also shows Economic Growth or Decline
 A point outside the production possibilities
curve suggests that we could get more
goods than we are capable of producing!
Recall- Currently Unattainable
Levels
OUTPUT OF TRUCKS
5
A
X
Currently not attainable
B
4
C
3
2
1
0
1
2
3
OUTPUT OF TANKS
4
5
 with more resources or better
technology, production possibilities
curve may shift outward.
 Such a shift represents Economic
Growth
OUTPUT OF TRUCKS
Economic Growth
0
PP2
PP1
OUTPUT OF TANKS
 Back to the Core Issues in Economics
Basic Decisions
 Production possibilities define the
output choices confronting a nation
(the three core issues in economics):
 WHAT to produce
 HOW to produce
 FOR WHOM to produce
WHAT
 There are millions of points along a
production possibilities curve, and
each one represents a specific mix of
output.
 We can choose only one of these
points at any time.
HOW
 There are lots of different ways of
producing goods and services.
 Someone has to make a decision
about which production methods to
use.
FOR WHOM
 Who is going to get the output
produced?
 An economy is largely defined by how
it answers the WHAT, HOW and FOR
WHOM questions.
 Three type of economies
 Free Market Economy
 Centrally Planned (Command) Economy
 Mixed Economy
 Market Economy: is a system that is
based on market mechanism (the
use of market prices and sales to
signal desired outputs (or resource
allocations).
 I.e., the market decides the mix of
output in an economy.
 Laissez faire policy--the doctrine of
leave it alone — of nonintervention by
government in the market mechanism.
The Invisible Hand of a Market
Economy
 Centrally Planned (Command
Economy)
 Karl Marx argued that the government
not only had to intervene but had to
own all the means of production.
 Markets permit capitalists to enrich
themselves while the proletariat toil
long hours for subsistence wages.
 A Mixed Economy:
 ….is one that uses both market signals
and government directives to allocate
goods and resources.
 Most economies use a combination of
market signals and government
directives to select economic outcomes.
Failures
 Markets Fail
 Governments Fail too
Market Failure
 A market failure is an imperfection in the market
mechanism that prevents optimal outcomes.
 If the market signals don’t give the best possible
answers, we say that the market mechanism has
failed.
 Example:
 Environmental Pollution (Over Production of goods
with harmful effects (negative externalities),
Underproduction of goods with positive effects
(positive externalities)
Government Failure
 Government intervention (Regulation) may
move us closer to our economic goals. The
government may also fail.
 A government failure is government
intervention that fails to improve economic
outcomes.
 Example:

The cost of regulation may outweigh the
benefits
Why Study Economics?
Seeking Balance
 The challenge for society is to minimize
failures by selecting the appropriate
balance of market signals and
government directives.
 …and the basic purpose of studying
economics is thus to understand how
the economy functions.
 How an economy is organized, how it
behaves, and how successfully it achieves
it basic objectives.
Why Study Economics?
 How to best achieve a goal with the
available resources.
 Helps us make the right decisions
Macro Versus Micro
 Macroeconomics is the study of
aggregate economic behavior, of the
economy as a whole.
 Microeconomics is the study of
individual behavior in the economy, of
the components of the larger
economy.
 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 and analyze the behavior
of economics agents (individuals and
businesses)
 One such a model and the demand and supply