Economics
• Economics is the study of how people
choose to allocate scarce resources to
produce goods and services and how they
choose to distribute those goods and
services now and in the future.
Economics
• Microeconomics is the branch of economics
concerned with the behavior of individual
consumers and firms and with the
determination of individual prices.
• Macroeconomics is the branch of
economics concerned with the study of
aggregate economic activities such as
economic growth, inflation, and
unemployment.
Scarcity and Choice
• The study of economics arises because
resources are scarce.
– Resources are said to be scarce because they are
finite, while human wants are infinite.
• Resources ultimately run out; wants never do.
• Resources are:
– Labor, capital, and land.
Economic Resources
• Labor
– Human work. Labor is paid a wage.
• Capital
– Physical capital such as buildings, machinery,
equipment. Capital is paid interest.
• Land
– Natural resources. Land is paid rent.
Economics and the Scientific
Method
• Economics uses models or theories to
understand and explain economic behavior.
• Theories have four components:
–
–
–
–
An hypothesis.
One or more assumptions.
A model.
Predictions and/or explanations.
Production Possibilities Model
• Hypothesis: The Law of Increasing Cost
– If all resources are fully and efficiently
employed, the existence of scarce resources
means that increasing the production of one
good requires increasing sacrifices in the
production of another good.
Production Possibilities Model
• Assumptions:
– Only two goods are produced.
• Consumer goods and non-consumer goods.
– All resources are fully and efficiently
employed.
– Resources transfer freely but not perfectly
between producing the two goods.
– There is no growth.
Production Possibilities Model
• Model:
– The production possibilities model shows the
effect on production caused by the economic
problem of scarcity.
– The economic principle illustrated by the model
is the concept of opportunity cost.
• Opportunity cost is defined as the value of the best
alternative foregone.
Production Possibilities Model
CG
Consumer goods, CG, are
measured on the vertical axis
Non-consumer goods, NCG, are
measured on the horizontal axis.
0
NCG
Production Possibilities Model
CG
A
At point A, only CG is produced.
M
At point Z, only NCG is produced.
At point M, both CG and NCG
are produced.
0
Z
NCG
Production Possibilities Model
• The Production Possibilities Frontier
– The production possibilities frontier shows the
maximum amount of goods and services that
can be produced by an economy during a given
period of time with available resources and
technology.
– We find the PPF by connecting all the points
between A and Z.
Production Possibilities Frontier
CG
A
M
The PPF slopes down because
when resources are fully
employed, we must give up some
CG to get more NCG and we
must give up some NCG to get
more CG.
Z
0
NCG
Production Possibilities Frontier
CG
A
B
As we move from point A to
Z, we give up equal amounts
of CG and get increasingly
smaller amounts of NCG.
C
D
E
G
F
J
H
K M
N
0
Z
NCG
Production Possibilities Model
• As we move from point A to point Z, we
produce more NCG and less CG.
– In order to do this, resources must move from
CG to NCG.
– But, while resources move they do not do so
perfectly.
• At some point a given sacrifice of CG results in
smaller and smaller increases in NCG.
• This is why the PPF is bowed-out.
Production Possibilities Model
• Conclusion:
– The Law of Increasing Cost
• If all resources are fully and efficiently
employed, the existence of scarce resources
means that increasing the production of one
good requires increasing sacrifices in the
production of another good.
Production Possibilities Frontier
CG
A
What does point U represent?
What are the economic implications
associated with a point such as U?
U
0
Z
NCG
Production Possibilities Frontier
CG
A
What does point U represent?
If we are at point U, resources are
unemployed. A move from U to the
PPF increases production.
U
Unemployment decreases
everyone’s welfare.
Z
0
NCG
Production Possibilities Frontier
CG
A
G
What does point G represent?
What are the economic implications
associated with a point such as G?
Z
0
NCG
Production Possibilities Frontier
To get to point G, the PPF must
shift out to the right.
CG
G
At point G, we have more of
both goods.
Growth increases everyone’s
welfare.
0
NCG
Three Economic Decisions
CG
What to produce?
How to produce?
For whom to produce?
0
NCG
How Does Society Answer the
Three Questions?
• Markets
– Demand and supply
• Government
– Regulation
– Government incentives and disincentives
– Voting
• Tradition
What to Produce
• Our model permits us to choose to produce
consumer goods and non-consumer goods.
– We may produce lots of CG with small amounts
of NCG, lots of NCG with small amounts of
CG, or more or less equal amounts of both.
• Our choice will determine our standard of
living now and in the future. Why?
How to Produce
• We may choose to produce in an efficient
manner or an inefficient manner.
– If we choose policies that permit full and
efficient use of our resources, we will produce
on the PPF.
– If we choose policies that do not permit full and
efficient use of our resources, we will produce
inside the PPF.
• Our choice will determine our standard of
living now and in the future. Why?
For Whom to Produce
• For whom to produce is a decision about
income distribution.
– If we rely on the market to make this decision,
those who best produce the goods and services
most wanted by the public will be better
compensated than others and will have more
goods and services.
• When this income distribution is perceives as being
unfair, government may intervene and redistributes
income to the less favored.