Chapter 1: What is Economics?

Here we go! Get ready!Section 1: Scarcity and the

Factors of Production

What is Economics?

What do you know about the subject of economics?

Scarcity and Choice

Primary idea: We can’t have everything we need and want!

Needs: necessary for survival Air, food, shelter

Wants: item we desire but do not NEED to survive

If we cannot have everything, how do we make decisions???

Economics is the study of how people seek to satisfy their needs and wants by making choices.

Why, oh why, must we make these difficult choices, you ask??...

Scarcity!

...because of the idea economists call scarcity

Scarcity means that we have limited quantities of resources to meet our unlimited wants.

Economics is about solving the problem of scarcity.

Goods and Services Goods – physical objects

Shoes and shirts Services – actions or activities that

one person performs for another Haircuts, dental checkups, tutoring

Although these goods and services are abundant in the U.S., they are still scarce because there is always a limit.

Scarcity Versus Shortages

Scarcity ≠ Shortage Shortage – when producers will not

or cannot offer goods or services at the current prices (more on this later) Temporary or long term

Scarcity – always exists b/c our needs and wants are always greater than our resources

Factors of Production

The resources that are used to make all goods and services are factors of production.

There are 3. They are land, labor, and capital.

Land

Land – all natural resources (found in nature) used to produce goods and services Fertile land for farming Products in or on the land

Coal, water, forests

Labor

Labor – the effort that a person devotes to a task for which that person is paid Medical aid provided by a doctor Tightening of a clamp by an assembly

line worker Artist’s creation of a painting Repair of a television

Capital

Capital – any human-made resource used to produce other goods and services

There are two kinds: Physical

and Human

Capital

Physical Capital Human made objects used to create

other goods and services Buildings and tools

Benefits of physical capital: Extra time More knowledge More productivity

Capital

Human Capital Knowledge and skills a worker gains

through education and experience

Who pulls these resources together?

Entrepreneurs – ambitious leaders who decide how to combine land, labor, and capital resources to create new goods and services Take risks to develop original ideas,

start businesses, create new industries, and fuel economic growth

Scarce Resources

No matter what good or service, the supplies of land, labor, and capital used to produce it are scarce.

Section 2

Opportunity Cost

Trade-Offs

Trade-offs – all the alternatives we give up whenever we choose one course of action over another

All individuals, businesses, and groups of people make decisions involving trade-offs.

Trade-Offs: Who makes them?

Individuals Businesses

How to use land, labor, and capital resources

Society Guns or butter?

Opportunity Cost

Opportunity cost – the most desirable alternative given up as the result of a decision What we trade for what we choose

Decision-making grids – weighing two alternatives What alternative offers the most

desirable benefits?

Thinking at the Margin

Economists always think “at the margin” when deciding how much more or less to do

It involves thinking about using ONE additional unit

Look at the opportunity costs and benefits of each additional unit

Section 3

Production Possibility Curves…It’s your first graph in Econ.Get excited.

Historical Example U.S. faced urgent

task when entering W.W. II… How could we

create the weapons and equipment needed to defeat Hitler?

(We didn’t just have all that stuff sitting around!)

Now that you know some economic concepts…

…you probably realize that we can’t just suddenly make a bunch of military stuff without giving up something! (ahhemm…trade-offs)

To create what we needed… …we had to switch

our production focus as a country from consumer goods (like food and clothing) to wartime goods (like guns, aircraft, and uniforms)

And that’s what Production Possibilities in Econ is all about

Excited yet? Well, here’s a definition for you:

Production Possibilities curve – shows alternative ways to use an economy’s productive resources

What does a Production Possibilities Curve look like, you ask?

Axes of the graph Show different kinds

of goods and services Farm goods vs.

factory goods Capital goods vs.

consumer goods “guns and butter”

Show any pair of specific goods or services

Hats vs. shoes

The classic example is “Guns v. Butter” What the heck does that mean?

It’s supposed to show that every society has to choose what to produce.

Guns represent military expenditures.

Butter represents money spent on domestic (consumer) things.

Now you get to learn how to draw a Production Possibilities Curve!

We’re going to use the creative example that your book provides on page 15. The authors have chosen to examine the production possibilities of: Shoes and watermelons

Label your axes Vertical axis: shoes Horizontal axis: watermelons

Drawing a Production Possibilities Curve

Determine points of possible production If this country devoted ALL resources

to making shoes (and produced NO watermelons), how many shoes could it produce?

If this country devoted ALL resources to making watermelons, how many watermelons could it produce?

Drawing a Production Possibilities Curve

So this country can produce: 15 million pairs of shoes

OR 21 million tons of watermelons

Do they have any other choices of production?...

Drawing a Production Possibilities Curve

Now determine points of production in between these two extremes A country can produce a number of

combinations of both goods Do you think it’s usually a good idea to

be producing at one of the extremes or somewhere in between? Why?

Drawing a Production Possibilities Curve Options of

production for this country

What is the best combination??

Hmmm…well, that takes some analyzing!

Watermelons

Shoes

0 15

8 14

14 12

18 9

20 5

21 0

Production Possibilities Frontier

Plot all of the points on the curve and connect them to draw a line (curve)

Production possibilities frontier – the line on a production possibilities graph that shows the maximum possible output (think of the word frontier – as far out as you can see)

any point on this line means a country is using all of its resources to produce a maximum combination of those two goods

Trade-Offs

Each point on the curve represents a trade-off

When we move along the curve, we are trading some of one product to make more of the other product

top of the curve: factories produce more shoes, but farms grow fewer watermelons

Moving down the curve: farms grow more watermelons, but factories make fewer shoes

Why??

Trade-Offs

…because of scarcity! Land, labor, and capital are scarce Using factors of production to

make one product leaves fewer resources to make something else

It’s all about making decisions!

Efficiency, Growth, and Cost

Why are production possibility curves important? Show how efficient an economy is Show whether an economy has

grown or shrunk Show the opportunity cost of a

decision to produce more of one good or service

Efficiency Efficiency – using

resources in such a way as to maximize the production or output of goods and services

Production possibilities frontier represents economy operating at full efficiency

Efficiency When economies are

inefficient, they are operating somewhere inside the frontier

This represents an underutilization of resources

Using fewer resources than the economy is capable of using

Efficiency Anywhere on the PPF:

the economy is operating at full efficiency

Somewhere inside the PPF: achievable but the economy is inefficient (not using their resources completely)

Outside the PPF: an economy can’t get there with current land, labor, and capital

Growth Production possibilities

curves represent only a country’s current possibilities. Right now, we cannot produce at X.

But things are always changing!

If quantity or quality of available land, labor, or capital changes, then the curve will move.

Growth If immigrants pour into a

country, then more labor becomes available The maximum amount of

goods the nation can produce increases

New inventions allow workers to produce more goods at lower costs

Growth When an

economy grows, the entire curve “shifts to the right” Why???

Growth

A country’s production capacity can decrease, too When a country goes to war and loses

land as a result If a country’s population ages, supply

of labor and human capital decreases When this happens, the curve

shifts to the left.

Cost

Cost does NOT EQUAL money in economics It is the alternative we give up when

we choose one option over another Cost always means opportunity cost

Production possibilities curves are used to see opportunity cost in a decision

Cost How many shoes

do we have to give up to go from producing no watermelons to 8 million watermelons?

Watermelons

Shoes

0 15

8 14

14 12

18 9

20 5

21 0

Cost How many shoes

do we have to give up to jump to the next level (producing 14 million watermelons – only 6 million more)?

Watermelons

Shoes

0 15

8 14

14 12

18 9

20 5

21 0

Law of increasing costs

Each time we grow watermelons, the sacrifice in terms of shoes increases

This is called the law of increasing costs – as production switches from one item to another, more and more resources are necessary to increase production of the second item. So the opportunity cost increases

Law of increasing costs Why?? Moving resources from factory to

farm production means farmers must use resources that are not as suitable for farming Ex: at first, use most fertile land to

be growing watermelons Over time, have to use poorer land

that can produce less

Shape of the curve

Law of increasing costs explains why production possibilities frontiers usually curve.

As we move along the curve, we trade off more and more to get less and less additional output.