Chapter 01 - The Central Concepts of Economics
CHAPTER
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The Central Concepts of Economics
CHAPTER OUTLINE
I. Why Study Economics
a. Scarcity and Efficiency
i. Economic Efficiency
b. Microeconomics and Macroeconomics
c. The Logic of Economics
i. Scientific Approach
ii. Fallacies
1. Post hoc
2. Failure to hold other things constant
3. Fallacy of composition
iii. Positive vs. Normative Economics
II. The Three Problems of Economic Organization
a. Fundamental Questions of Economic Organization
i. What commodities are produced?
ii. How are goods produced?
iii. For whom are goods produced?
b. Market, Command, and Mixed Economies
III. Society’s Technological Possibilities
a. Inputs and Outputs
i. Land
ii. Labor
iii. Capital
b. The Production-Possibility Frontier
i. Applying the PPF to Society’s Choices
ii. Opportunity Costs
iii. Efficiency
1. Productive efficiency
2. Waste from Business Cycle and Environmental Degradation
IV. Summary
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Chapter 01 - The Central Concepts of Economics
CHAPTER OVERVIEW AND TEACHING TIPS
This beginning chapter is one of motivation and overview. A series of examples are used to define economics,
and particular attention is paid to the concepts of scarcity and efficiency. Many of the issues that are presented here
are expanded upon, at chapter-length, later in the text. It may not be a bad idea to point this out to students, so they
do not feel swamped by all these new concepts and problems. To beginning students, economics is a new way of
looking at, and thinking about, the world around them. For many, it may take some getting used to. In the second
part of the chapter, the three main problems of economic organization (what, how, and for whom) are discussed.
Students take society so much for granted that they often fail to notice that it is answering these questions all the
time. This section also provides a convenient framework for talking about the different types of economies (market,
command, and mixed).
In the last section of the chapter, there is a discussion of the production-possibility frontier that every society
faces. Here, the inevitable fact of scarcity is hammered home. In its attempt to find answers for the problems of
economic organization, society is faced with a series of economic tradeoffs: public goods vs. private goods, luxuries
vs. necessities, consumer goods vs. capital investment. The production-possibility frontier can be used to illustrate
many important economic processes. The key concept that is presented here is opportunity cost. Opportunity costs
provide a convenient way of measuring costs without having to introduce money into the economy. It is also
important to point out that only the “next best” alternative be considered — not all other alternatives. This is also an
ideal opportunity to introduce the topic of economic growth. Within the discussion of PPF, the last section of the
chapter also provides an important pedagogical tool—a careful introduction to the use of graphs and diagrams in
economics.
LEARNING OBJECTIVES
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Recognize that while there are numerous specific examples of economic problems and decisions, they are
all illustrations of the basic definition of economics: Economics is the study of how societies use scarce resources to
produce valuable commodities and distribute those commodities among various peoples
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Understand the what, the how, and the for whom of economic decision making.
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Define the three primary inputs in the production of outputs: land, labor, and capital.
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Distinguish between microeconomics and macroeconomics.
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Distinguish between positive and normative economics.
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Understand the concept of productive efficiency and how it relates to both the use of inputs and the basic
definition of economics.
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Use the production-possibility frontier to illustrate the choices that societies face.
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Introduce the concept of opportunity cost. Provide examples both from the individual’s perspective and
from society’s point of view.
SUGGESTED ANSWERS TO QUESTIONS IN THE TEXT
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Positive economic statements are nonjudgmental statements of “fact”. Data can be gathered to support or
refute them. The collection and analysis of data must indeed be done impartially and without bias (i.e., with a cool
head). Ideally, our students will not only learn the principles of economic analysis, but seek to apply those principles
in the world around them.
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Stigler’s statement is mostly normative—who determines the criteria for what is efficient, or what is
progressive? While they both address the universal economic problem of scarcity from different points of view, both
Stigler and Marshall argue for the need of objective reasoning. Occasionally, what is best for the individual may not
be best for the whole. Someone needs to be looking at the big picture.
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Definitions.
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Answers will vary. While at the BLS website, students should click on “ATUS Tables” and then select
Table A-1.
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The maximum number of haircuts possible is 1000/.5 = 2000. No shirts can be made with 2000 haircuts, so
(0, 2000) is on the frontier. To make one shirt always requires the release of 5 hours of time; i.e., the sacrifice of
5/.5 = 10 haircuts; the slope of the frontier is thus -10. So, graph H = 2000 - 10S.
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Plot the following points: A = (0 butter, 15 guns); B = (2, 14); C = (4, 12); D = (6, 9); E = (8, 5); F = (10,
0). Connect the points. Notice that the butter intercept doubles, while the guns intercept is unchanged.
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Depletion causes the frontier to contract gradually. Invention and technological change could slow the rate
of that contraction, or perhaps even reverse the trend.
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Chapter 01 - The Central Concepts of Economics
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Inefficient study time would generate points beneath Diligent’s PPF. As study inputs are increased, the
PPF will shift out to the northeast.
DISCUSSION QUESTIONS
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Why do scholars study economics? Why do political leaders and policymakers talk to economists? Why
should the general citizen worry about economics? Why are you taking this course?
In choosing among various economic alternatives involving ethical ends, what role should the economist’s
opinion play? Can all of one’s ethical judgments be eliminated from economic analysis?
How can everyday acquaintance with economics be both a help and a hindrance in economic analysis?
What are some of the economic topics with which most people have emotional ties?
Is there some issue in economics that you and your father or mother would argue about? Can you think
why the difference of opinion arises?
Why is it impossible to eliminate subjectivity completely in the study of economics? Is this a severe
criticism of the scientific method as applied to economics? Discuss.
How do changing economic conditions affect the working person? The student? The scientist? The
President of the United States? The candidate for federal office?
Common sense may prove to be nonsense “on close examination.” Do you agree? On whose definition of
common sense should we rely?
“A socialist nation and a capitalist nation do not differ in the fundamental economic problems that they
face; they differ in the ways they go about solving those problems.” Do you agree? Why or why not? Do
they also differ in what they consider to be desirable solutions?
Do you think society could organize 200 million people on the principles of the kibbutz or cooperative?
Why or why not?
“The need of U.S. manufacturers to spend large sums on advertising to stimulate artificial wants indicates
that economic scarcity will soon lose its relevance.” Is this true, and if not true now, is it likely to become
so?
If a nation goes from full employment to mass unemployment, how would the three economic problems be
affected?
“A production-possibility frontier is only an array of technically feasible outputs. This does not mean that
a society will actually be operating on its production-possibility frontier.” Indicate where a society would
be relative to its production-possibility frontier in the event of (a) a depression, (b) a war.
How would an important new invention affect the production-possibility frontier of a society? Can the
society in which the invention takes place have more of only that one good?
What are some of the things you have to know to draw up a production-possibility frontier for any two
goods? What would you do if the economy produced more than two goods?
Assume Econoland produces haircuts and shirts with inputs of labor. Econoland has 3000 units of labor
available. A haircut requires 1/3 hour of labor, while a shirt requires 2 hours of labor. Construct
Econoland’s production-possibility frontier.
Would the production-possibility frontier look different in a command economy? Explain.
The how, what, and for whom are solved differently in different systems. Consider each of the following
and explain how the three big questions of economic organization are solved: within your family, within
your college or university, in the food industry, and in the army.
From January 1983 through the fall of 1988, the American economy grew rapidly as unemployment fell
and capital equipment was utilized more intensively. Draw two PPFs, one for 1983 and one for 1988, and
put in two points to illustrate where the economy might have been in both those years.
ESSAY QUESTIONS
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“Economists are useful for analyzing the objective effects of alternative policies.” Discuss.
Economists say that business people maximize profits, but business people claim that they do not do so
consciously. Does this mean that economists cannot analyze business behavior in terms of profit
maximization?
To what degree can any science be objective? Any social science?
How would you define economics? Explain your definition and the relationship of economics to other
scholarly disciplines.
Describe and discuss the triad of economic problems every society must somehow solve. Give examples of
how various societies attempt to meet their problems.
What is the economic law of scarcity? Define and contrast scarce and free goods.
State precisely what the for whom problem is. Describe at least three different ways of solving the problem
in a society. Can the problem be eliminated?
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Chapter 01 - The Central Concepts of Economics
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“Substitution is the law of life in a full-employment economy.” Explain. Illustrate diagrammatically. Does
it make any difference if there is less than full employment?
Use the production-possibility frontier to demonstrate the choices open to a society between current
consumption and capital formation. What can you say about a society that is on the frontier compared with
one that is not? Explain in full.
Demonstrate graphically how the PPF shifts outward in the case where all inputs are doubled, and in the
case where one of the inputs is held constant. Explain the differences between the two cases.
Suppose food needs both labor and land, and clothing needs land only. What shape will the productionpossibility frontier have? Explain.
Land is superabundant. One food unit requires 2 units of labor, and each clothing unit requires 3 units of
labor. Given 12 total labor units, what is society’s production-possibility frontier? How does the law of
scarcity apply here?
Explain how you would measure the cost of shifting some quantity of a given input from the production of
one good into the production of another. Relate your answer to the concept of a PPF.
Discuss how opportunity costs are used to measure movement along a production possibilities frontier.
Discuss the relationships between scarcity, opportunity cost, and the production possibility frontier.
Assume that you have two countries that have identical PPF in year 1. Assume also that country A spends
more on current consumption than country B. Using graphs show the PPF for the two countries at some
future date.
Under what conditions, if any, would it be desirable for a country to be inside its PPF?
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