Economics: The Core Issues
Chapter 1
McGraw-Hill/Irwin
Copyright © 2010 by the McGraw-Hill Companies, Inc. All rights reserved.
The Economy Is Us
• The economy is the aggregation of individual
production and consumption decisions
• Important link between individual choices and
collective outcomes
1-2
Macro Versus Micro
• Economics: The study of how best to allocate
scarce resources among competing uses
– Macroeconomics: The study of aggregate
economic behavior, of the economy as a whole
– Microeconomics: The study of individual
behavior in the economy, of the components of the
larger economy
1-3
Three Core Choices
• Three core choices confront every nation:
– 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
1-4
Scarcity: The Core Problem
• Scarcity: Lack of enough resources to satisfy
all desired uses of those resources
– Scarcity of resources limits the amount of
production that can be undertaken
– Requires choices to be made
1-5
Factors of Production
• Factors of Production: Resource inputs used
to produce goods and services
• Four Types:
–
–
–
–
Land
Labor
Capital
Entrepreneurship
1-6
Factors of Production
• Land: Includes all natural resources
– e.g. oil, water, iron ore, energy, etc.
• Labor: Quantity and quality of human
resources
– Includes physical presence of workers as well as
their skills and abilities
1-7
Factors of Production
• Capital: Final goods produced for use in
production of other goods and services
– Includes equipment and structures, such as:
• Factories
• Production machinery
• Fleet vehicles
1-8
Factors of Production
• Entrepreneurship: Assembling of resources
to produce new or improved products and
technologies
– It’s not just a matter of what resources you have
but also of how well you use them
1-9
Opportunity Costs
• Opportunity cost: The next most desired
goods and services foregone to obtain
something else
– What is given up to undertake a chosen activity
• Associated with every decision
– For example, if we choose to produce bread then
we cannot produce pizza crust with the same flour
1-10
Production Possibilities
• Production possibilities: The alternative
combinations of final goods and services that
could be produced in a given time period with
all available resources and technology
1-11
The Production Possibilities Curve
• Production possibilities curve (PPC):
Describes the various output combinations that
could be produced in a given time period with
available resources and technology
• Represents a menu of output choices an
economy confronts
1-12
The Production Possibilities Curve
• Illustrates Two Essential Principles:
– Scarce resources: Production is limited by
available resources and technology
– Opportunity costs: Can obtain additional
quantities of a good only by reducing production
of another
1-13
A Production Possibilities Curve
Truck Production
Total Truck Labor per Total Labor
Labor Output x Truck =
Required
OUTPUT OF TRUCKS
Point
5
A
B
4
C
3
A
B
C
D
E
F
10
10
10
10
10
10
2
2
2
2
2
2
10
8
6
4
2
0
Labor Not Potential
Increase in
Used for Output of
Tank Output
Trucks
Tanks
0
2
4
6
8
10
0
2
3
3.8
4.5
5
+2
+1
+ 0.8
+ 0.7
+ 0.5
D
2
E
1
0
5
4
3
2
1
0
Tank Production
1
2
3
4
F
5
OUTPUT OF TANKS
1-14
Increasing Opportunity Costs
• Resources do not transfer perfectly from the
production of one good to another
• Increased production of one good or service
can only be attained by sacrificing everincreasing quantities of others
1-15
Increasing Opportunity Costs
• The shape of the curve illustrates increasing
opportunity costs
• Lose some efficiency in the transfer
– Resources used for truck production are not ideally
suited for producing tanks
1-16
Law of Increasing Opportunity Costs
OUTPUT OF TRUCKS
A Step 1: give up one truck
5
B
4
Step 2: get two tanks
3
Step 3: give up another truck
C
Step 4: get one more tank
2
D
E
1
0
1
2
3
4
5
F
OUTPUT OF TANKS
1-17
Efficiency
• Efficiency: Maximum output of a good from
the resources used in production
• Every point on the production possibilities
curve is a point of efficiency
1-18
Points Inside the Curve
• A production possibilities curve shows
potential output
• Actual output can be less than potential due to
– Inefficiency: Resources not being used to
maximum potential
– Unemployment: Some resources are idle
1-19
A Point Inside the Curve
OUTPUT OF TRUCKS
5
A
4
B
3
Y
2
1
0
C
Some resources are
unemployed or used
inefficiently
1
2
3
4
5
OUTPUT OF TANKS
1-20
Points Outside the Curve
• Any point outside the production possibilities
curve is unattainable with available resources
and technology
1-21
A Point Outside the Curve
OUTPUT OF TRUCKS
5
A
X
Currently not attainable
B
4
C
3
2
1
0
1
2
3
4
5
OUTPUT OF TANKS
1-22
Economic Growth
• Economic growth: An increase in output due
to an expansion of production possibilities
– Production possibilities increase with more
resources or better technology
• The production possibilities curve shifts
outward
1-23
Economic Growth
OUTPUT OF TRUCKS
PP2
PP1
0
OUTPUT OF TANKS
1-24
The Mechanism of Choice
• An economy is largely defined by how it
answers the WHAT, HOW and FOR WHOM
questions
1-25
Continuing Debates
• The core of most debates is some variation of
the WHAT, HOW, or FOR WHOM questions
– Conservatives favor Adam Smith’s laissez-faire
approach
– Liberals think government intervention is likely to
improve market outcomes
1-26
A Mixed Economy
• Countries answer the questions differently
• Mixed economy: An economy that uses both
market signals and government directives to
allocate goods and resources
1-27
Theory Versus Reality
• 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
1-28