Economics: The Core Issues Chapter 1 McGraw-Hill/Irwin ©2008 The McGraw-Hill Companies, All Rights Reserved Chapter 1 – Economics: The Core Issues 1. What is economics? 1. Scarcity. 2. The 4 Factors of Production. 3. The 3 core economic questions. 2. Opportunity Cost, & Production Possibilities (graphing). 3. Mechanisms of Choice. 4. What Economics is all about. 2 1 – What is economics? - Scarcity - Factors of Production - 3 Core Economic Questions 3 Economics What is economics? A social science. 4 Economics “Ceteris paribus:” “everything else being equal.” the assumption that nothing else is changing. 5 Economics What is economics? A social science. Scarcity is the fundamental concept/problem of economics. 6 Scarcity (Scarcity: the lack of enough resources to satisfy all desired uses of those resources.) LO1 7 Economics What is economics? A social science. Scarcity is the fundamental concept of economics. Our resources are limited. Our needs and wants are unlimmited. We can never meet all of our wants and needs from our limited resources. 8 Economics Economics: the study of the decisions that people and societies make in trying to: fulfill unlimited wants and needs… …from … limited resources. - Or, in your book’s words… 9 Economics Economics is the study of how best to allocate scarce resources among competing uses. Scarce Resources Unlimmited Wants 10 Three core issues must be resolved: All societies must answer 3 basic questions in the face of scarcity: WHAT to produce with our limited resources? HOW to produce those goods and services? FOR WHOM goods and services are produced? - that is, who will get what we make? LO2 11 The Economy Is Us The economy is: the sum of all our individual production and consumption activities. So… The economy is us: the economy is what we make and consume. 12 Factors of Production Factors of production: resource inputs used to produce goods and services: Land Labor Capital Entreprenuership 13 Factors of Production Land refers to all natural resources such as crude oil, water, air, forests, minerals, etc. Labor – not just quantity, but quality is also important. 14 Factors of Production Capital includes the final 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. 15 Entrepreneurship “…its not just a matter of what resources you have, but also of how well you use them…” 16 Limits to Output No matter how an economy is organized there is a limit to how fast it can grow. The most evident limit is the amount of resources available for producing goods and services. LO1 17 2 – Opportunity Cost, & Production Possibilities 19 Limits to Output Scarcity … (the imbalance between our desires and available resources) …forces us to make economic choices. LO1 20 Opportunity Costs Opportunity cost is the most desired goods or services that are forgone in order to obtain something else. It is what is given up in order to get something else. 21 Production Possibilities Production possibilities: the alternative combinations of final goods and services that could be produced considering: a given period of time, and using all available resources and technology. We must choose the actual combination we will produce at. 22 Production Possibilities Production possibilities CURVE: An economic model illustrating the concepts of: Scarcity, Opportunity cost (trade-offs), The central role of choice. (Economists use theories, or models, of economic behavior to predict, evaluate, and design economic policy.) 23 The Production Possibilities Curve OUTPUT OF TRUCKS 5 A B 4 C 3 D 2 E 1 0 1 2 3 4 5 F OUTPUT OF TANKS - Each point on the production possibilities curve depicts an alternative mix of output. 24 The Production Possibilities Curve OUTPUT OF TRUCKS 5 4 3 2 1 0 1 2 3 4 5 OUTPUT OF TANKS - Each point on the production possibilities curve depicts an alternative mix of output. 25 The Production Possibilities Curve OUTPUT OF TRUCKS 5 A B 4 C 3 D 2 E 1 0 1 2 3 4 5 F OUTPUT OF TANKS - Each point on the production possibilities curve depicts an alternative mix of output. 26 Efficiency Efficiency: getting the maximum output of a good from the resources used in production. TRUCKS Every point on a production possibilities curves is efficient. 5 4 3 2 1 0 A B C D E 1 2 TANKS 3 4 F 5 28 Inefficiency A production possibilities curve shows potential output, not necessarily actual output. If we are inefficient, actual output will be less than the potential output. 29 Inefficiency (Such inefficiencies plagued centrally planned economies.) 30 Unemployment OUTPUT OF TRUCKS 5 A 4 B 3 Y 2 C Unemployment 1 0 1 2 3 OUTPUT OF TANKS 4 5 32 Economic Growth A point outside the production possibilities curve is a combination of goods that we are currently incapable of producing. 33 Economic Growth OUTPUT OF TRUCKS 5 A X Currently not attainable B 4 C 3 2 1 0 1 2 3 OUTPUT OF TANKS 4 5 34 Economic Growth The production possibilities curve shifts outward (increases) with: more resources, or … better technology. This is Economic growth: an increase in output (real GDP) – an expansion of production possibilities. 35 OUTPUT OF TRUCKS Economic Growth 0 PP2 PP1 OUTPUT OF TANKS 36 Opportunity Costs OUTPUT OF TRUCKS 5 A B 4 Opportunity costs (“trade offs”) C 3 D 2 E 1 0 1 2 3 4 5 F OUTPUT OF TANKS - Increasing the output of one good requires sacrificing the output of other goods. 37 Law of Increasing Opportunity Costs Law of Increasing Opportunity Costs: Increasing quantities of one good can only be obtained by sacrificing everincreasing quantities of other goods. Reflected in the shape of the curve. 39 The Law of Increasing Opportunity Costs OUTPUT OF TRUCKS 5 A B 4 C 3 D 2 E 1 0 1 2 3 4 5 F OUTPUT OF TANKS - Each point on the production possibilities curve depicts an alternative mix of output. 40 Law of 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 4 5 F OUTPUT OF TANKS 41 The Classic Example… 42 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 43 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. 44 North Korea at night The Military Share of Output 45 3 – Mechanisms of Choice (Economic Systems) 46 The Mechanisms of Choice An economy is largely defined by how it answers the WHAT, HOW and FOR WHOM questions. The two major systems are: Market system, Command system. LO3 51 The Invisible Hand of a Market Economy The market mechanism is the use of market prices and sales to signal desired outputs (or resource allocations). LO3 52 The Invisible Hand of a Market Economy What to make: The market decides the mix of output in an economy through the forces of supply and demand. How to make: Competition for profits prompts producers to seek efficient methods. Who receives what is produced: LO3 Those who produce (market value) receive a commensurate share of the production. 53 The Invisible Hand of a Market Economy Laissez faire — the doctrine of nonintervention by government in the market. Adam Smith – The Wealth of Nations – 1776. Individuals pursuing their own interests also benefit society by seeking efficient production in pursuit of profits under competition. The “invisible hand” of the market. LO3 54 The Invisible Hand of a Market Economy Government intervention only interferes with and compromises the natural efficiency and productivity of the market. Adam Smith LO3 55 The Invisible Hand of a Market Economy LO3 57 Government Intervention and Command Economies 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 and exploit the proletariat who toil long hours for subsistence wages. LO3 58 Government Intervention and Command Economies John Maynard Keynes offered a less drastic solution. In Keynes’ view, government should play an active but not an allinclusive role in managing the economy. LO3 59 A Mixed Economy Mixed economy: uses both market signals and government directives to allocate goods and resources. Most economies are mixed economies. LO3 60 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 tend to think government intervention is likely to improve the answers. LO3 61 A Mixed Economy 64 Market Failure Reliance on market signals don’t always lead to optimal outcomes. Suboptimal results can include: Undesirable output mix. Unemployment. Pollution. Many more… This is known as market failure. 65 66 Government Failure Government intervention may move us closer to our economic goals or it may fail. Government failure: government intervention that worsens (or fails to improve) economic outcomes. 67 A Mixed Economy 68 Seeking Balance The challenge for society is to minimize failures by selecting the appropriate balance of market signals and government directives. 69 4 – What Economics is all about. 71 What Economics Is All About The basic purpose of studying economics is understanding how economies function: How an economy is organized, how it behaves, and how successfully it achieves it basic objectives. 72 End Versus Means Economists don’t formulate an economy’s objectives... …Politicians and the political process do. Economists focus on the means available for achieving given goals. 73 So…. Economists focus on factual analysis and explanation of the economy: Ex: what the monetary cost of a providing health care will be, who would bear the burden under a given plan. Politicians and the public debate and make values choices: Ex: If the costs (the trade-offs) are acceptable, and if the assignment of the burden is fair or reasonable. 74 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. 75 Theory Versus Reality Economists use theories, or models, of economic behavior to evaluate and design economic policy. In these theories, we typically ignore the possibility that many things can change at one time. Ceteris paribus is the assumption that nothing else is changing. 76 Imperfect Knowledge We may never find an absolute truth, because the inner workings of the economy change over time. 77 Economics: the Core Issues End of Chapter 1 McGraw-Hill/Irwin ©2008 The McGraw-Hill Companies, All Rights Reserved