What is Economics?

Chapter 1

Section 1Scarcity and Factors of Production

Book: Scarcity

What is Economics?

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

• For example: – You must choose how

to spend your time– Businesses must

choose how many people to hire

Micro v. Macro

• the branch of economics that examines the choices of individuals concerning one product, one firm, or one industry.

• the branch of economics that examines the behavior of the whole economy at once.

Microeconomics Macroeconomics

The fundamental economic problem facing all societies is

Scarcity.

• occurs when there are limited quantities of resources to meet unlimited needs or desires

• occur when producers will not or cannot offer goods or services at current prices

Scarcity

ShortagesVs

Scarcity

Choices

Three Basic Questions

WHAT to Produce?

HOW to Produce?

FOR WHOM to Produce?

Should they produce military goods or food?

Should they use equipment and few people or use more people and less equipment?

How are the things produced allocated?

Economists call the resources that are used to make all goods

and services, the factors of production.

The Factors of Production

• All the processes involved in making wealth and bringing it from its place of origin to the ultimate consumer.– Land– Labor – Capital

Land

• All natural resources that are used to produce goods and services.

Labor

• Any effort a person devotes to a task for which that person is paid.

Capital

• Any human-made resource that is used to create other goods and services.– Physical Capital – (a.k.a capital goods) all the

human-made goods that are used to produce other goods and services; tools and buildings

– Human Capital – the skills and knowledge gained by a worker through education and experience

Entrepreneurs

• Ambitious leaders who combines land, labor, and capital to create and market new goods and services.

Production

• When all factors of production (land, labor, capital and entrepreneurship) are present, production, or the process of creating goods and services, can take place.

The Circular Flow

Economists say that all goods and services are scarce because the land, labor, and capital used

to create them are scarce.

The Doorbell Rang• http://www.youtube

.com/watch?v=ESHLF92_rBw&feature=fvwrel&safety_mode=true&persist_safety_mode=1&safe=active

Answer the Questions in your Note Packet Labeled “The Doorbell Rang” based on the reading of this children’s book.

Section 2Opportunity Cost

Book: Opportunity Cost

Trade-offs

• Trade-offs are all the alternatives that we give up whenever we choose one course of action over others.

Trade-offs

Individuals and Trade-offs

Businesses and Trade-offs

Society and Trade-offs

If you choose to spend more time at work, you give up watching a movie or going to a baseball game.

A farmer who decides to plant broccoli cannot use the same land at the same time to grow cauliflower.

“guns or butter” A country who decides to produce more military goods (“guns”), has fewer resources to devote to consumer goods (“butter”) and vice versa.

Trade-offs

• Which alternative would you choose?

– Sleep late or wake early for a ski trip?– Sleep late or wake early to eat breakfast?– Sleep late or wake early to study for a test?

Opportunity Cost

• The most desirable alternative given up as a result of a decision is known as opportunity cost.

Now, in English please…

• In life, every choice we make comes at a cost since we forgo other possible alternatives in the process; this cost — whether it’s money, time, education, health, et cetera — is known as an opportunity cost.

• An opportunity cost is the value or benefit of the next best alternative.

Opportunity Cost: Example

Trade-Offs

(a) What is Calvin doing when his father asks him to do a chore?

(b) What other activity might Calvin have been planning to engage in?

Trade-Offs

(a) What are Calvin’s trade-offs for choosing to do the chore?

(b) What will Calvin get if he does the chore?

Trade-Offs

How do the trade-offs for choosing to do the chore change after Calvin demands $25.00 for it?

Activity: Monthly Budget

• Let’s See the Trade Offs I have made this year – i.e. my BUDGET

• http://www.washingtonpost.com/wp-srv/business/personalfinance/gradbudgetcalculator.htm

• You create one and justify your trade-offs.

At times, a decision’s opportunity cost may be unclear or

complicated. Using a decision-making grid can help you

determine whether you are willing to accept the opportunity cost of a choice you are about to make.

Decision-Making Grid

Karen’s problem: sleep late or get up early to study for a test.

In addition to opportunity costs, when economists look at

decisions, they point out that many decisions involve adding

one unit or subtracting one unit. When deciding how much more

or less to do, you are thinking at the margin.

Thinking at the Margin

• Deciding whether to do or use one additional unit of some resource, whether that resource be a dollar, a minute, etc…

Now back to Karen…

• When deciding whether or not to study, Karen used the “all-or-nothing” approach.

• In reality, Karen could have decided from several options or, in other words, she could have made a decision at the margin.

Thinking at the Margin

If Karen…

Thinking at the Margin

Now, consider this…

Is it worth it to spend 3 hours of studying if your grade is going to increase only slightly?

Thinking at the Margin

What should Karen do?

At 3 hours, the cost outweighs the benefit. This is thinking at the margin!

Thinking at the Margin

• Comparing opportunity costs and benefits at the margin could help someone decide– How much money to spend on a car– How many hours to work – How much time to spend watching TV– How many extra workers to hire– If a government program should include more

of a particular benefit

Thinking at the Margin can also be called cost/benefit analysis! What will you sacrifice? What

will you gain?

Section 3: Production Possibility Curves

In continuing the discussion on opportunity costs and trade-offs,

we are now going to describe tools that economists use to

analyze these concepts.

Production Possibilities Curve

• A production possibilities graph shows alternative ways that an economy can use its resources.

• The axes of the graph can be used to show categories of goods and services, such as farm goods and factory goods.

• The axes can also be used to show any pair of specific goods or services, such as watermelon and shoes.

Production Possibilities Curve

Notice, our country can produce a maximum of 15m pairs of shoes OR 21m tons of watermelons.

If the citizens of our country wanted to produce BOTH

watermelons and shoes, there are several different ways we can

use our resources.

Production Possibilities Frontier

By plotting six different combinations of watermelon and shoes, we created a production

possibilities frontier.

Production Possibilities Frontier

• The production possibilities frontier is the line that shows the maximum possible output for that economy.

Production Possibilities Frontier

• Each point represents a trade-off. To produce more shoes you produce less watermelons.

• WHY? Scarcity! Using the factors of production to make one product means that fewer resources are left to make something else.

Production possibilities graphs can tell us important information. They can show how efficient an

economy is, whether an economy has grown or shrunk, and the

opportunity cost of a decision to produce more of one good or

service.

Efficiency

• Efficiency means using resources in such a way as to maximize the production of goods and services. An economy producing output levels on the production possibilities frontier is operating efficiently.

Add definition to

sheet

Underutilization

• Underutilization means using fewer resources than an economy is capable of using.

• This can happen if workers were laid-off and farms or factories produced fewer goods.

Sh

oe

s (

mil

lio

ns

of

pa

irs

)

25

20

15

10

5

0 252015105

Watermelons (millions of tons)

Production Possibilities Graph

g (5,8)

A point of underutilization

c (14,12)

d (18,9)

e (20,5)

f (21,0)

a (0,15)b (8,14)

S

Growth

• If more resources become available, or if technology improves, an economy can increase its level of output and grow. When this happens, the entire production possibilities curve “shifts to the right.”

Sh

oe

s (

mil

lio

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of

pa

irs

)

25

20

15

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0 252015105

Watermelons (millions of tons)

Production Possibilities Graph

T

Future productionPossibilities frontier

c (14,12)

d (18,9)

e (20,5)

f (21,0)

a (0,15)b (8,14)

S

Lack of Growth

• Just as a country’s production capacity can increase so to can it decrease.

• When a country’s production capacity decreases, the curve shifts to the left.

• A decrease can result from a country going to war and losing territory (land), an aging population (labor), and/or a lack of education (human capital).

Opportunity Cost

Watermelons (millions of tons)

Shoes(millions of pairs)

Sh

oe

s (

mil

lio

ns

of

pa

irs

)

25

20

15

10

5

0 252015105

Production Possibilities Graph

Watermelons (millions of tons)

14

18

20

21

12

9

5

0

0 15

8 14

c (14,12)

d (18,9)

A production possibilities graph shows the cost of producing more of one item. To move from point c to point d on this

graph has a cost of 3 million pairs of shoes.

Increasing Costs

• A switch from shoes to watermelons comes at an increasing cost. Each time we grow more watermelons, the sacrifice in terms of shoes increases.

• Note that at the bottom it costs an additional 5m pairs of shoes to increase watermelon production by ONLY 1m tons.

Law of Increasing Cost

• Law that states that as we shift factors of production from making one good or service to another (shoes to watermelon), the cost of producing the second item (watermelon) increases.

Add definition to

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Why does the cost increase?

The final piece of the equation…

• A country’s production possibilities depends on BOTH its technological level and the resources it has.

Activity: Production Possibility Curves

• Complete the activity and turn it in at the end of class for credit.