Macroeconomics
Unit 1
Economics: The Basic Issues
Top Five Concepts
©2007 by E.H. McKay III
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Concept 1
Factors of Production
Economists classify our economic resources into four
categories:
Land
Labor
Capital
Entrepreneurship
What is contained within each category?
Land
The category land refers to the ground
or land and what it contains.
It includes the water underground or
above ground and the air.
It includes the minerals and resources
in the ground like iron ore, crude oil,
and natural gas.
Labor
The category labor refers to
the quantity of workers
necessary to produce a good
or service.
Labor also refers to the
knowledge and ability of the
workers.
Capital
The category capital refers to the
goods that are used to produce a final
good or service.
For example, a computer memory chip
can be a capital good since it is used
to produce a final product – a personal
computer.
The machines used by a cereal
company to fill boxes of cereal are
also capital goods since the machine
helps produce a final good – the box of
cereal.
Entrepreneurship
The fourth category, entrepreneurship,
refers to the bringing together of all
resources to produce a good or service.
An entrepreneur is a person or group of
people who can bring all the necessary
resources together to produce a good or
service.
Frequently entrepreneurs have ideas and
visions of how to produce an item more
efficiently or differently than before.
Concept 2
Scarcity
Our society, whether we are talking about consumers,
business, or the government, is confronted with scarce
resources.
Scarcity refers to the problem of not enough resources to
satisfy all of the desired uses for those resources. Resources
that are scarce include money, time, knowledge, skills, land,
and many others.
The economic problem associated with scarcity is that choices
must be made about how resources are used.
Concept 3
Opportunity Costs
Since we are confronted with scarce resources, how do we
choose how many and what resources will be used to produce
a product or service?
The use of scarce resources to produce a particular product or
service implies that those resources cannot be used to produce
a different product or service.
For example a person who is employed by a company
producing computer chips cannot be employed by another
company at the same time producing video games.
Concept 3
Opportunity Costs
The “cost” of making computer chips would include the “cost” of
not making more video games. These costs are known as
opportunity costs.
Opportunity cost is simply what is given up in order to
produce or obtain something else. You are experiencing an
opportunity cost at this moment – what are you giving up in
order to view this presentation?
If resources were no longer scarce, then opportunity costs
would become irrelevant.
Concept 4
Production Possibilities
As economists examine opportunity costs, the relationship
between the opportunity costs of two different items can be
shown graphically using a production possibilities curve.
The production possibilities curve illustrates the tradeoff
between the resources necessary to produce two different
goods or services.
The curve itself is a curved downward sloping line.
The Production Possibilities Curve
Output Of Video Games
5
A
4
B
3
2
1
0
1
2
3
Output Of Breakfast Cereal
4
5
C
Concept 4
Production Possibilities
The previous graph illustrated the tradeoff between two
different goods based upon the factors of production that are
required to produce each item.
We could allocate all of our resources to produce video games,
but then we cannot produce cereal (Point A).
We could allocate all of our resources to produce cereal, but
then we cannot produce video games (Point C).
Concept 4
Production Possibilities
Usually society has expressed a preference for both goods and
the question of how resources are allocated is decided by the
demand for each of the products.
At Point B for example, three video games and three boxes of
cereal can be produced allocating scarce resources to the
production of both items.
Concept 4
Production Possibilities
Allocating resources from one industry to another is not usually
an efficient process.
Production possibilities curves tend to bend outward reflecting
increasing opportunity costs as resources from one industry are
allocated to another. Simply put, it may take more resources to
produce good A than good B.
Why do we experience increasing opportunity costs?
Concept 4
Production Possibilities
Increasing opportunity costs occur for several reasons:
• Moving labor from one industry to another may require
additional training. The amount of labor used to produce a
good or service may vary.
• The amount of land resources used to produce a good or
service can vary between industries.
• The amount of capital needed can also vary depending upon
the good or service produced.
Concept 5
The Market Mechanism
Who decides what is produced, how it will be produced, and
for whom?
Economists have developed many theories about how these
decisions are made.
Adam Smith, an economist from the 18th century, believed
that a process known as the invisible hand of the
marketplace answered these basic economic questions.
Concept 5
The Market Mechanism
Smith believed that the market decides what, how, and for
whom to produce. This is the invisible hand.
As consumers express their preferences for goods and
services by purchasing, producer continue to produce products
to meet the demand.
If consumers are no longer interested in a product, they will
discontinue purchasing it and producers respond by eliminating
the production of the item.
Concept 5
The Market Mechanism
If consumers become interested in new products or services,
producers allocate more resources (the four factors of
production) to produce those items.
A key factor in the relationship between the consumer and
producer is the price of the product.
If the price becomes too high, consumer demand falls. If the
price drops, consumer demand increases.
Concept 5
The Market Mechanism
Adam Smith believed that the relationship between the buyer
(the consumer) and the seller (the producer) should not be
altered or affected by the government.
The concept of “laissez-faire” is derived from Adam Smith’s
theory that the government should “leave it alone” in reference
to the market relationship between the buyer and seller.
Concept 5
The Market Mechanism
When the invisible hand or as it is called today the market
mechanism has failed to produce optimal outcomes, market
failure has occurred.
Market failure on a large scale can lead to higher
unemployment or a recession.
On a smaller scale market failure can occur when a company
produces a product that is unsafe to use or manufacture.
Summary
The major concepts from this unit are:
•
•
•
•
•
The four factors of production
Opportunity cost
Scarcity
Production possibilities
The Market Mechanism
Think about how they relate to you, a business, and the
government.