CHAPTER
1
Introduction:
What Is
Economics?
© 2001 Prentice Hall Business Publishing
Economics: Principles and Tools, 2/e
O’Sullivan & Sheffrin
1
What Is Economics?

Economics is the study of the choices
made by people who are faced with
scarcity.

Scarcity is a situation in which resources
are limited and can be used in different
ways.
2
© 2001 Prentice Hall Business Publishing
Economics: Principles and Tools, 2/e
O’Sullivan & Sheffrin
Summary Slide

Society’s Choices
3
© 2001 Prentice Hall Business Publishing
Economics: Principles and Tools, 2/e
O’Sullivan & Sheffrin
Society’s Choices

Having a limited amount of resources
means that we must sacrifice one thing
in order to obtain another.

The decisions of producers, consumers
and government determine how an
economic system answers three
fundamental questions:
4
© 2001 Prentice Hall Business Publishing
Economics: Principles and Tools, 2/e
O’Sullivan & Sheffrin
Society’s Choices

What goods and services do we
produce?

If we devote more resources to the
production of one good, we have
fewer resources for the production of
another.
5
© 2001 Prentice Hall Business Publishing
Economics: Principles and Tools, 2/e
O’Sullivan & Sheffrin
Society’s Choices

How do we produce these goods
and services?

How do we organize production and
what methods and techniques
should we use?
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© 2001 Prentice Hall Business Publishing
Economics: Principles and Tools, 2/e
O’Sullivan & Sheffrin
Society’s Choices

For whom do we produce the
output?

How should we distribute the output
produced among members of
society?
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© 2001 Prentice Hall Business Publishing
Economics: Principles and Tools, 2/e
O’Sullivan & Sheffrin
Factors of Production
Factors of production, or productive
inputs, are the resources we use to
produce goods and services:





Natural resources
Labor
Physical capital
Human capital
Entrepreneurship
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© 2001 Prentice Hall Business Publishing
Economics: Principles and Tools, 2/e
O’Sullivan & Sheffrin
Factors of Production

Natural resources:

The things created by acts of nature
such as land, water, mineral, oil and
gas deposits; renewable and
nonrenewable resources.
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© 2001 Prentice Hall Business Publishing
Economics: Principles and Tools, 2/e
O’Sullivan & Sheffrin
Factors of Production

Labor:

The human effort, physical and
mental, used by workers in the
production of goods and services.
10
© 2001 Prentice Hall Business Publishing
Economics: Principles and Tools, 2/e
O’Sullivan & Sheffrin
Factors of Production

Physical capital.

All the machines, buildings,
equipment, roads and other objects
made by human beings to produce
goods and services.
11
© 2001 Prentice Hall Business Publishing
Economics: Principles and Tools, 2/e
O’Sullivan & Sheffrin
Factors of Production

Human capital:

The knowledge and skills acquired
by a worker through education and
experience.
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© 2001 Prentice Hall Business Publishing
Economics: Principles and Tools, 2/e
O’Sullivan & Sheffrin
Factors of Production

Entrepreneurship:

The effort to coordinate the
production and sale of goods and
services. Entrepreneurs take risk
and commit time and money to a
business without any guarantee of
profit.
13
© 2001 Prentice Hall Business Publishing
Economics: Principles and Tools, 2/e
O’Sullivan & Sheffrin
The Production Possibilities
Frontier (PPF) Curve

The PPF curve is a graphical
illustration of fundamental economic
problems related to our ability to
produce goods and services.

The PPF curve shows the possible
combinations of goods and
services available to an economy,
when resources are fully and
efficiently employed.
14
© 2001 Prentice Hall Business Publishing
Economics: Principles and Tools, 2/e
O’Sullivan & Sheffrin
The Production Possibilities
Frontier (PPF) Curve

When the economy is
at point i, resources
are not fully
employed and/or they
are not used
efficiently.
15
© 2001 Prentice Hall Business Publishing
Economics: Principles and Tools, 2/e
O’Sullivan & Sheffrin
The Production Possibilities
Frontier (PPF) Curve

Point h is desirable
because it yields
more of both goods,
but not attainable
given the amount of
resources available.
16
© 2001 Prentice Hall Business Publishing
Economics: Principles and Tools, 2/e
O’Sullivan & Sheffrin
The Production Possibilities
Frontier (PPF) Curve

Point e is one of the
possible combinations
of goods produced
when resources are
fully and efficiently
employed.
17
© 2001 Prentice Hall Business Publishing
Economics: Principles and Tools, 2/e
O’Sullivan & Sheffrin
The Production Possibilities
Frontier (PPF) Curve


© 2001 Prentice Hall Business Publishing
Economics: Principles and Tools, 2/e
At point e in this
example, resources are
devoted to the
production of four
space missions and
380 thousand
computers.
To increase the number
of space missions by
one, 80 thousand
computers will have to
be sacrificed.
18
O’Sullivan & Sheffrin
The Production Possibilities
Frontier (PPF) Curve


© 2001 Prentice Hall Business Publishing
Economics: Principles and Tools, 2/e
To increase the
production of one good
without decreasing the
production of the other,
the PPF curve must
shift outward.
From point f, an
additional 150
thousand computers or
two more space
missions are now
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possible.
O’Sullivan & Sheffrin
The Production Possibilities
Frontier (PPF) Curve

Resources are not
perfectly adaptable.

The PPF curve has a
concave shape
because resources
are not perfectly
adaptable in
production. As we
increase the
production of one
good, we sacrifice
progressively more
of the other.
20
© 2001 Prentice Hall Business Publishing
Economics: Principles and Tools, 2/e
O’Sullivan & Sheffrin
Microeconomics
 Microeconomics
is the study of the
choices made by consumers, firms, and
government, and how these decisions
affect the market for a particular good.
 Microeconomics focuses on the
analysis of individual economic units.
21
© 2001 Prentice Hall Business Publishing
Economics: Principles and Tools, 2/e
O’Sullivan & Sheffrin
Microeconomics
Microeconomic analysis can be used to:
 Understand how markets work and predict
changes.
 Make personal or managerial decisions.
 Evaluate the merits of public policies.
22
© 2001 Prentice Hall Business Publishing
Economics: Principles and Tools, 2/e
O’Sullivan & Sheffrin
Microeconomics

Microeconomics gives you the tools to
analyze the impact of:

Environmental regulations, taxes, imports,
gender discrimination, labor unions,
competition, patterns of production and
consumption, and other decisions made
by individual economic units.
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© 2001 Prentice Hall Business Publishing
Economics: Principles and Tools, 2/e
O’Sullivan & Sheffrin
Macroeconomics
Macroeconomics is the study of the
nation’s economy as a whole.
Macroeconomic analysis can be used to:
 Understand how a national economy
works.
 Understand the grand debates over
economic policy.
 Make informed business decisions.
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© 2001 Prentice Hall Business Publishing
Economics: Principles and Tools, 2/e
O’Sullivan & Sheffrin
Macroeconomics

Macroeconomic analysis can be used to
understand important everyday
economic issues such as:

Unemployment, inflation, interest rates,
exchange rates, the standard of living, the
federal budget, consumption, and saving
patterns.
25
© 2001 Prentice Hall Business Publishing
Economics: Principles and Tools, 2/e
O’Sullivan & Sheffrin
The Economic Way of Thinking

Economists use simplifying assumptions to
eliminate irrelevant details and focus on what
really matters. Assumptions are an aid to the
analytical process.

Simplifying assumptions do not have to be
realistic. We use maps, for example, to get us
from point A to point B knowing that the map is
not an accurate description of the road ahead,
but only an abstraction of reality.
26
© 2001 Prentice Hall Business Publishing
Economics: Principles and Tools, 2/e
O’Sullivan & Sheffrin
The Economic Way of Thinking

The “ceteris paribus” assumption is
used to explore the relationship between
two variables.


A variable is a measure of something that
can take on different values.
“Ceteris paribus” is Latin for “all else the
same.” To study the relationship
between two variables, we assume that
other variables do not change.
27
© 2001 Prentice Hall Business Publishing
Economics: Principles and Tools, 2/e
O’Sullivan & Sheffrin
Using Graphs and Formulas

Suppose that a student receives a weekly
income which consists of a $20 weekly
allowance from her parents, and $4 per hour of
work from her job.

There is a linear relationship between hours
worked and the student’s weekly income which
can be described by the formula:
W = $20 + ($4 x hours worked)
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© 2001 Prentice Hall Business Publishing
Economics: Principles and Tools, 2/e
O’Sullivan & Sheffrin
Using Graphs and Formulas

The expression W = $20 + ($4 x hours worked)
can be illustrated as follows:
29
© 2001 Prentice Hall Business Publishing
Economics: Principles and Tools, 2/e
O’Sullivan & Sheffrin
Shifting the Curve


If the student’s
allowance or hourly
wage change, the
line’s intercept and
slope will change,
respectively.
For example, an
increase in her weekly
allowance to $35 per
week will shift the line
upward by $15 for each
previous number of
hours worked.
30
© 2001 Prentice Hall Business Publishing
Economics: Principles and Tools, 2/e
O’Sullivan & Sheffrin
Negative Relationship

Consider a consumer with a monthly budget of $150
who buys CDs at a price of $10 per CD.
Each 5-unit
increase in the
amount of CDs
decreases the
amount left
over for other
goods by $50
(negative
relationship).
-50
vertical difference
=
  10
slope =
5
horizontal difference
© 2001 Prentice Hall Business Publishing
Economics: Principles and Tools, 2/e
O’Sullivan & Sheffrin
31
Nonlinear Relationship

There is a positive,
nonlinear
relationship between
study time and grade
on the exam.



The second hour of study
increases the grade by four
points (from 6 to 10).
But the ninth hour of study
increases the grade by only
one point (from 24 to 25).
There are diminishing returns in study time. As study
time increases, the exam grade increases at a
32
decreasing rate.
© 2001 Prentice Hall Business Publishing
Economics: Principles and Tools, 2/e
O’Sullivan & Sheffrin