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