chapter
one
Economics:
Foundations and Models
After studying this
chapter, you should be
able to:
1
“Many U.S., Japanese, and
European firms have been
moving the production of
goods and services to
other countries.”
LEARNING OBJECTIVES
CHAPTER 1: Economics:
Foundations and Models
What Happens When U.S. Firms
Move to China?
2
3
4
5
Discuss these three important
economic ideas: People are
rational. People respond to
incentives. Optimal decisions
are made at the margin.
Discuss how an economy
answers these questions:
What goods and services will
be produced? How will the
goods and services be
produced? Who will receive
the goods and services?
Understand the role of
models in economic analysis.
Distinguish between
microeconomics and
macroeconomics.
Become familiar with
important economic terms.
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CHAPTER 1: Economics:
Foundations and Models
Economics: Foundations and Models
In this book, we use economics to answer
questions such as the following:
• “How are the prices of goods and services
determined?”
• “How does pollution affect the economy, and
how should government policy deal with these
effects?”
• “Why do firms engage in international trade,
and how do government policies affect
international trade?”
• “Why does government control the prices of
some goods and services, and what are the
effects of those controls?”
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CHAPTER 1: Economics:
Foundations and Models
Economics: Foundations and Models
Scarcity The situation where unlimited wants
exceed the limited resources available to fulfill
those wants.
Economics The study of the choices people
make to attain their goals, given their scarce
resources.
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1 LEARNING OBJECTIVE
CHAPTER 1: Economics:
Foundations and Models
Building a Foundation: Economics and Individual Decisions
Market An arrangement or institution that brings
together buyers and sellers of a good or service.
Three important ideas:
 People are rational
 People respond to economic incentives
 Optimal decisions are made at the margin
Marginal analysis Analysis that involves
comparing marginal benefits and marginal costs.
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CHAPTER 1: Economics:
Foundations and Models
Scarcity
Human
Wants
Scarce
Resources
Economic
System
Allocation of
Resources
WHAT?
HOW?
Distribution
FOR WHOM?
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2 LEARNING OBJECTIVE
CHAPTER 1: Economics:
Foundations and Models
The Economic Problem That Every Society Must Solve
Trade-off The idea that because of scarcity,
producing more of one good or service means
producing less of another good or service.
Three fundamental questions:
 What goods and services will be produced?
 How will the goods and services be produced?
 Who will receive the goods and services
produced?
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CHAPTER 1: Economics:
Foundations and Models
The Economic Problem That Every Society Must Solve
Centrally Planned Economies versus Market
Economies
Centrally planned economy An economy in
which the government decides how economic
resources will be allocated.
Market economy An economy in which the
decisions of households and firms interacting in
markets allocate economic resources.
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CHAPTER 1: Economics:
Foundations and Models
The Modern “Mixed” Economy
Mixed economy An economy in which
most economic decisions result from the
interaction of buyers and sellers in
markets, but where the government plays a
significant role in the allocation of
resources.
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CHAPTER 1: Economics:
Foundations and Models
The Modern “Mixed” Economy
Efficiency and Equity
Productive efficiency Occurs when a good or service is
produced at the lowest possible cost.
Allocative efficiency A state of the economy in which
production reflects consumer preferences; in particular,
every good or service is produced up to the point where the
last unit provides a marginal benefit to consumers equal to
the marginal cost of producing it.
Voluntary exchange The situation that occurs in markets
when both the buyer and seller of a product are made better
off by the transaction.
Equity The fair distribution of economic benefits.
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Economic Models
CHAPTER 1: Economics:
Foundations and Models
Normative and Positive Analysis
Positive analysis Analysis concerned with
what is.
Normative analysis Analysis concerned with
what ought to be.
Don’t Confuse Positive Analysis with Normative Analysis
1-1
When Economists Disagree: A Debate Over Outsourcing
Does outsourcing by U.S. firms
raise or lower incomes in the
United States?
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4 LEARNING OBJECTIVE
CHAPTER 1: Economics:
Foundations and Models
Microeconomics and Macroeconomics
Microeconomics The study of how
households and businesses make choices,
how they interact in markets, and how the
government attempts to influence their
choices.
Macroeconomics The study of the
economy as a whole, including topics such as
inflation, unemployment, and economic
growth.
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5 LEARNING OBJECTIVE
CHAPTER 1: Economics:
Foundations and Models
A Preview of Important Economic Terms

Entrepreneur

Opportunity cost

Innovation

Profit

Technology

Household

Firm, company, or business


Goods
Factors of production or
economic resources

Services

Capital

Revenue

Human capital
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CHAPTER 1: Economics:
Foundations and Models
Allocative efficiency
Centrally planned economy
Economic model
Economic variable
Economics
Equity
Macroeconomics
Marginal analysis
Market
Market economy
Microeconomics
Mixed economy
Normative analysis
Positive analysis
Productive efficiency
Scarcity
Trade-off
Voluntary exchange
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CHAPTER 1: Economics:
Foundations and Models
Theme of this course
Society is assumed to include:
Capitalism
Liberal Democracy
What is the role of the business firm in
such a society?
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CHAPTER 1: Economics:
Foundations and Models
Capitalism
Means of production privately owned
Profit motive
Free markets determine
Production decisions
Distribution decisions
Pricing
Minimal government interference or regulation
(Laissez-faire philosophy)
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CHAPTER 1: Economics:
Foundations and Models
Liberal Democracy
Elections (Representative democracy)
Subject to constraints
Constitution and rule of law
Liberal Rights
Property Rights
Due process
Speech
Assembly (and petition)
Religion
Privacy ???
Equality ???
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CHAPTER 1: Economics:
Foundations and Models
Liberal Democracy
Preconditions for liberal democracy
Broad and flourishing civil society
Strong middle class
Equitable distribution of income and wealth
Market economy
Liberal democracy supported by
Free and fair elections
Pluralism
Federalism
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CHAPTER 1: Economics:
Foundations and Models
Theme of this course
Society is assumed to include:
Capitalism
Liberal Democracy
What is the role of the business firm in
such a society?
Is the assumption of capitalism and
liberal democracy reasonable?
In the United States
In other countries?
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