What is Economics?
Chapter 18
Economic Choices
• Economics-the study
of how we make
decisions in a world
where resources are
limited
– Economics is
sometimes called the
science of decision
making
Scarcity
• As individuals, we have many needs
(things required for survival, such as food,
clothing and shelter)
• In addition, we also have an enormous
number of wants (things we would like to
have, such as entertainment, vacations,
and other things that make life more
comfortable)
Scarcity
• The fundamental economic problem is:
scarcity (not having enough resources to
produce all of the things we would like to
have)
WHAT to produce?
• One of the choices a
society has to face
is that of WHAT to
produce
• Ex.)We may have to
choose between
making goods for
defense or
producing services
for people who are
retired or too ill to
work
HOW to produce?
• A second choice that
society has to make is
that of HOW to produce
• Ex.)If we need more
crude oil, should we
allow drilling in an
Alaskan wildlife
sanctuary, or should we
restrict oil recovery to
more traditional areas?
For WHOM to produce?
• After goods and services are produced, a
society must determine how the goods
and services will be distributed among its
members
Using Economic Models
• To economists, the word “economy” means all the
activity in a nation that together affects the
production, distribution and use of goods and
services
• When studying a specific part of the economy
economists often formulate theories and gather
data
• The data that economists collect are called
economic models(simplified representations of
the real world that are used to explain how the
economy works, or to predict what would happen
if something in the economy should change)
Economic Models
Economic Models
• It is important to remember that models
are based on assumptions, or things
that we take for granted as true
– Ex.)You might assume that a restaurant is
out of your price range so you don’t try it,
but you could be wrong
• It is also important to keep I mind that
models can be revised
Micro and Macro Economics
• Economics is divided into two branches
– Microeconomics-the economic behavior and
decision making by individuals and small
businesses
– Macroeconomics-economic behavior and
decision making by government or whole
industries or societies
Making Economic Decisions
Trade-Offs
• The economic choices people
make involve exchanging one
good or service for another
– Ex.)You choose to buy a DVD
player, you are exchanging your
$$$ for the right to own the DVD
player rather than something
else that might cost the same
amount
• A trade-off is the alternative
you face if you decide to do
one thing rather than another
Opportunity Cost
• Opportunity cost-the
cost of the next best
use of your time or
money when you
choose to do one thing
rather than another
– Ex.)Money to go to
college (books, living,
etc.) vs. working a fulltime job
Measures of Cost
• Fixed costs-costs, or expenses, that are the
same no matter how many units of a good are
produced
• Variable costs-expenses that change with the
number of products produced
• Total costs-fixed costs added to variable costs
• Marginal costs-the extra, or additional cost
of producing one additional unit of output
Measures of Cost
• Marginal revenue-the change in total
revenue (the extra revenue) that results
from selling one more unit of output
• Marginal benefit-the additional or extra
benefit associated with an action
Cost-Benefit Analysis
• Once we define the
marginal costs and
benefits of a decision,
we can analyze the
decision
• Cost-benefit
analysis-economic
model that compares
the marginal costs
and marginal benefits
of a decision
Being an Economically Smart
Citizen
Understanding Your Role in the
Economy
• To be good economic citizens, we must be
informed. This means that we need to have
an understanding of what part we play and
how we affect the economy, and how the
economy affects us
• We have a market economy
– Market economy-an economic system in which
supply, demand and prices help people make
decisions and divide resources
Understanding Your Role in the
Economy
• A market economy
is sometimes
described as being
based on
capitalism (a
system in which
private citizens own
most, if not all, of the
means of
production)
Understanding Your Role in the
Economy
• A market economy
is also based on
free enterprise
• Free enterpriseeconomic system in
which individuals
and businesses are
allowed to compete
for profit with a
minimum of gov’t
interference
Understanding Your Role in the
Economy
• Keeping informed
• Understanding incentives
– Incentives-rewards that are offered to try
to persuade people to take certain
economic actions
• Understanding the Role of the
Government
Making Wise Choices
• The ultimate goal of being an economically
literate citizen is to be able to make wise
choices
• When you make consumer decisions based
on opportunity cost, you are engaging in
rational choice
– Rational choice-choosing the alternative that has
the greatest value from among comparable-quality
products
– When you make rational choices you purchase the
goods and services you believe can best satisfy
your wants for the lowest possible costs
The American Economy
Chapter 19
Economic Resources
Producing Goods and Services
• Goods-what is made (I.e. books, cars, etc.
things that we use to satisfy our wants and
needs)
• Services-work that is performed for
someone else
– Ex.) Waiting tables, cutting hair, concerts, etc.
Factors of Production
• There are four factors of production
(resources necessary to produce goods
and services)
– Natural resources
– Labor
– Capital
– Entrepreneurs
Factors of Production
• Natural resources-all
of the “gifts of nature”
that make production
possible
– Ex.)fertile fields,
abundant rainfall,
forests, mineral
deposits
Factors of Production
• Labor-physical and
mental efforts that
people contribute to
the production of
goods and services
– Ex.)carpenters,
bricklayers,
electricians
Factors of Production
• Capital-tools,
machinery, and
buildings used to
make other products
– Ex.)money, bulldozers,
trucks, hammers,
saws, drills, etc
Factors of Production
• Entrepreneurindividuals who start
new businesses,
introduce new
products and improve
management
techniques
Gross Domestic Product (GDP)
• People can measure their economic
success by the amount of their incomes
and their ability to provide for
themselves and their families
• The success of the overall economy is
measured in a similar way
• Gross Domestic Product (GDP)-total
value of all final goods and services
produced in one year
Gross Domestic Product (GDP)
• GDP is a monetary measure—
measured in $$$ (dollars)
• GDP is an important measure of
standard of living (the quality of life
based on the possession of necessities
and luxuries that make life easier)
• GDP is measured in QUANTITY
(numbers) NOT QUALITY
Economic Activity and
Productivity
The Circular Flow of Economic
Activity
There are several groups of decision makers in the economy.
The Consumer Sector
• Consumers earn their
incomes in factor
markets (the
markets where
productive resources
are bought and sold)
• Workers earn wages,
salaries and tips in
exchange for their
labor
The Business Sector
• When these
individuals receive
their incomes, they
spend it in product
markets (markets
where producers offer
goods and services
for sale)
The Government Sector
• The government
sector includes the 3
levels of gov’t
(federal/state/local)
• The gov’t provides
services and
receives revenues
from the goods and
services it sells
The Foreign Sector
• The foreign sector
represents all of the
countries in the
world—we buy
products from and sell
products to foreign
countries
• Accounts for less than
4% of the GDP
Productivity and Economic
Growth
• Productivity-a
measure of the amount
of how much you
produce in a given time
• Specialization-when
people, businesses,
regions, and even
countries concentrate
on goods or services
that they can produce
better than anyone else
– Ex.)tobacco,cotton
Productivity and Economic
Growth
• Division of laborbreaking down of a
job into separate,
smaller tasks, which
are performed by
different workers
– Improves productivity
Productivity and Economic
Growth
• Human capital-the
sum of the skills,
abilities, and
motivation of people
– Productivity tends to
increase when
businesses invest in
human capital
Productivity and Economic
Growth
• Economic
interdependence-we
rely on others and
others rely on us
– Katrina victims relied
on the rest of the
country to help after
the hurricane hit
Capitalism and Free
Enterprise
Features of Capitalism
• Capitalism-economic system in which
private citizens own and use the factors of
production in order to seek a profit
• Free enterprise-open and equal
competition
Features of Capitalism: Markets
• Markets are places
where goods and
services are sold
• Consumer
sovereignty-the role
of the consumer as
the ruler of the
market, determining
what products will be
produced
Features of Capitalism:
Economic Freedom
• Freedom to produce, buy or sell products
and services within the limits of the law
Features of Capitalism: Private
Property Rights
• Private property
rights-we have the
freedom to own and
use, or dispose of,
our own property as
we choose as long as
we do not interfere
with the right of others
Features of Capitalism:
Competition
• Competition-the struggle that goes on
between buyers and sellers to get the best
products at the lowest prices
Features of Capitalism: The
Profit Motive
• Profit-the amount of money left over after
all the costs of production have been paid
• Profit motive-the driving force that
encourages individuals and organizations
to improve their material well-being
Features of Capitalism:
Voluntary Exchange
• Voluntary exchange-the freedom to buy
or sell anything
Spread of Capitalism
• Two important concepts helped the spread
of capitalism:
– People work for economic gain
– Government should have limited role in the
economy
Adam Smith and Capitalism
• Adam Smith-Scottish
economist
• Wrote Wealth of
Nations in 1776
• Laissez-faire
economy-limited
government role in
economy
– “laissez-faire”-let it
alone or hands off