What is Economics?
Section 1
How Economic Systems Work
 People decide how to produce goods and services by thinking about factors such as the
environment, pollution, and cost. For example, if people need more oil, should companies be
allowed to drill for oil in a wildlife park?
 Companies must also decide on important issues such as how much pollution to produce. A
company may want to make less pollution, but it may cost more money to decrease the amount
of pollution.
 Societies also must decide who will receive the goods and services they produce. Most goods
and services in the United States are given out through a price system.
 There are many different ways goods and services may be given out. For example, some
economies may give out goods by majority rule, by sharing equally, or on a first-come-firstserved basis.
Making Economic Decisions
Trade-Offs
 To make a good economic decision, people must understand all the costs and benefits of a
choice. Economic choices are about trading one good or service for another.
 All choices involve trade-offs, or the result of making one choice instead of another. Trade-offs
do not apply only to money.
 Individuals, businesses, and governments make trade-offs each time they make one economic
choice instead of another.
 Another part of an economic choice is opportunity cost, or the next best use of your time or
money when you make one that you lost, or give up, when you make a trade-off. For example, if
you choose to clean your room, one part of the opportunity cost is the price of cleaning
products.
 However, the opportunity cost also includes the time it takes to clean your room because you
could have spent that time in a different way. If cleaning your room takes one hour, then that is
one hour that you lose to talk on the phone with friends.
 There are different ways to measure the costs and benefits of economic decisions. Before a
business decides to make a product, it must consider the costs.
 One type of cost is fixed. These costs are the same no matter how many items are produced.
Fixed costs include such items as mortgage payments and property taxes.
 Another type of cost is variable. These costs change depending on how many items are
produced. Variable costs include items such as wages and materials.
 If a business wants to make more of a product, then it needs to buy more materials. The total
cost of making a product is fixed costs plus the variable costs.
 Some businesses look at average total costs. You can find the average total cost by dividing the
total cost by the number of products made.
Economic Choices
 Economics is the study of how people make choices when resources are limited. Economics is
also the study of how things are made, sold, bought, and used.
 People make choices on the basis of their needs and wants. Because people cannot have
everything, they must make decisions between their needs and wants, based on the amount of
money they have to spend.
 The study of economics is divided into two branches: microeconomics and macroeconomics.

In microeconomics, researchers study how small groups, such as individuals and businesses,
make decisions. In macroeconomics, researchers study how the whole economy works. They
also study how large groups such as governments, industries, and societies make decisions.
 These two branches of economics are economic models, or theories that try to explain why
people spend the way they do.
 Each country has its own economic system, or way of making products. The economic system in
the United States is called free enterprise capitalism.
The Problem of Scarcity
 Resources are things used in making goods and providing services. Countries with many
resources can meet the needs and wants of people better than countries with few resources.
 Scarcity, or limits on resources, occurs when people do not have enough resources to make
what they want. Scarcity affects choices about what to make, how much of it to make, and how
to make it, and who will get it.
 Because of scarcity, people must make choices among products to decide how they can best
spend their limited resources. For example, a person might compare prices of cars to figure out
which car is best for his or her wants and needs. A person may decide that he or she has the
money to pay for a large car, or he or she may think that buying a small car is a better decision.
 Societies must decide what goods and services to produce, how to produce them, and for whom
they will produce them. They may have to choose whether to use their resources to make more
weapons for defense or to provide better health care services for people who are sick.
 One other type of cost is marginal.
 Marginal cost is the added cost of making one more item. For example, if the total cost of
making 30 bicycle helmets is $1,500, and the total cost of making 31 helmets is $1,550, then the
marginal cost is $50.
 Businesses try to make profits. There are two ways to measure revenue, or profit. Total revenue
is the number of items sold multiplied by the average price per item.
 If you make 50 products and they each cash $2, then the total revenue is 50 x 2, or $100. When
businesses think about changing the number of products they make, they also think about how
their revenue will change.
 Marginal revenue is the extra revenue that results from selling one more item. Businesses are
also interested in marginal benefit, which is the extra benefit received when one more item is
produced.
 People often make economic decisions through a cost-benefit analysis. This type of analysis
compares marginal costs with marginal benefits.
 A good decision is based on choosing the option in which the benefits are greater than the costs.
People can use graphs to make a cost-benefit analysis.
 A cost-benefit analysis can help people decide how much to produce by showing how many
products will the most benefit with the least cost. A cost-benefit analysis also can help people
answer other basic economic questions.