Econ 102 The Canadian Economy
Chapter 1
The Economic Problem
Copyright © 2002 by McGraw-Hill Ryerson Limited. All rights reserved.
1
Chapter Objectives

In this chapter, you will:
 consider the economic problem that underlies
the definition of economics;
 learn about the way economists specify
economic choice;
 examine the production choices an entire
economy faces, as demonstrated by the
production possibilities model;
 analyze the three basic economic questions
and how various economic systems answer
them.
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Outline of Topics
1.1 What Economists Do
 1.2 Economic Choice
 1.3 The Production Possibilities Model
 1.4 Economic Systems

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1.1 What Economists Do
The Economic Problem


Economists deal with the economic problem.
 Economic agents must continually make
choices.
 Their wants are unlimited.
 They face a limited supply of economic
resources.
Economic resources
including natural, capital, and human
resources ( see Definitions on page 3)
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1.1 What Economists Do
Economics Defined

Economics is the study of how to
distribute scarce resources among
competing ends.
 Microeconomics focuses on individual
consumers and businesses.
 Macroeconomics takes a broad view of
the economy.
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1.1 What Economists Do
Economic Models

Economic models:
 simplify economic reality
 show how dependent variables are affected by
independent variables
 include inverse and/or direct relationships
 incorporate a variety of assumptions such as ceteris
paribus
 are classified as part of either positive economics
or normative economics
 (See Definitions on page 5 & 6)
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1.2 Economic Choice
Utility Maximization

Economists assume that economic decisionmakers maximize their own utility.
 Utility: the satisfaction gained from any
action
 Decision-makers must keep in mind the
opportunity cost of each alternative.
 Opportunity cost: the utility that could
have been gained by choosing an action’s
best alternative.
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1.3 The Production Possibilities
Model

The production possibilities model is based on
three assumptions:
 an economy makes only two products
 resources and technology are fixed
 all resources are employed to their fullest
capacity
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1.3 The Production Possibilities Model
The Production Possibilities Curve (a)

The production possibilities curve shows a
range of possible output combinations for an
economy.
 It highlights the scarcity of resources.
 It has a concave shape, which reflects the
law of increasing opportunity costs.
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The Production Possibilities Curve (b)
Figure 1.1, page 8
Production Possibilities
Schedule
Production Possibilities Curve
a
1000
b
f
Hamburgers Computers
point
on graph
1000
0
a
900
1
b
600
2
c
0
3
d
Hamburgers
900
unattainable
c
600
e
inefficient
d
0
1
2
3
Computers
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The Law of Increasing Opportunity Costs
Figure 1.2, page 10
Hamburgers
Opportunity Computers point
Cost of
on graph
Computers
1000
0
a
100
900
1
b
2
c
Production Possibilities Curve
a
1000
As the quantity
of computers
rises, so does their
opportunity cost.
b
900
Hamburgers
Production Possibilities Schedule
c
600
300
600
600
0
d
3
d
0
1
2
3
Computers
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Economic Growth:
Outward Shifts in Production Possibilities
Production Possibilities Curve
With more
computers, the
curve shifts out
in the next
period.
Hamburgers
1000
0
3
Computers
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1.4 Economic Systems

Economic Systems: the organization of an
economy, which represents a country’s distinct
set of social customs, political institutions, and
economic practices
The Basic Economic Questions: There are three basic
questions any society must answer:
 what to produce
 how to produce
 for whom to produce
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1.4 Economic Systems
There are three systems to choose from:
 Traditional Economy: an economic system in
which economic decisions are made on the basis
of custom.
 Traditional economies focus on non-economic
concerns and have tight social constraints.

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1.4 Economic Systems



Market Economy: an economic system based on private
ownership and the use of markets in economic decisionmaking
Market economies are consumer-centered and innovative
but create inequality and instability.
Benefits:
 Consumer sovereignty: the decision of what to
produce is ultimately guided by the needs and
wants of household in their role as consumers
 Innovation
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1.4 Economic Systems

Drawbacks:
 Inequities of income distribution
 Possible market problems: eg, pollution
 Possible Instability of total output

Command Economy: an economic system based on
public ownership and central planning.
 Benefits:
 Distribute income equally
 Economic growth
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1.4 Economic Systems

Drawbacks:
 Planning difficulties
 Inefficiencies
 A lack of freedom.
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1.4 Economic Systems
Mixed Economy



Most countries fall between the extremes of
traditional, market, and command economies.
Modern mixed economies: an economic system
that combines aspects of a market economy
and a command economy; production decisions
are made both in private markets and by
government
Traditional mixed economies: economic
systems in which a traditional sectors co-exists
with modern sectors
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The Range of Economic Systems
Figure 1.4, page 16
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1.4 Economic System
Economic Goals

There are seven major economic goals:







economic efficiency
income equity
price stability
full employment
viable balance of payments
economic growth
environmental sustainability
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1.4 Economic System
Complementary and Conflicting Economic
Goals


Economic goals may be complementary.
 An example is the relationship between full
employment and economic growth.
Economic goals may be conflicting.
 An example is the relationship between
price stability and full employment.
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The Founder of Modern Economics

Adam Smith:
 explained how the division of labour
increases production
 argued that self interest is transformed by
the invisible hand of competition so that it
creates significant economic benefits
 stressed the principle of laissez faire, which
means that governments should not
intervene in economic activity
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