CHAPTER 1

What is Economics?

CHAPTER 1SECTION 1

The Basic Problems of Economics

Need vs. Want

People often use the words “need” and “want” interchangeably.

Needs are things that are required for basic survival. Food Clothing Shelter

Wants are anything not needed for basic survival.

Need vs. Want

Needs are limited. There are a finite amount of things we need.

Wants are unlimited. We can want anything for any reason.

Economics: the study of how individuals, families, businesses, and societies use limited resources to fulfill their unlimited wants.

Choices

Spending decisions involve choices. Each available choice competes with

other available choices. Businesses, like individuals, must make

daily decisions about what to produce, when to produce it, and when to stop producing.

Societies face choices about how to utilize their resources in the production of goods and services.

The Problem of Scarcity

We have to make choices because all resources are limited. Trees in a large forest may appear to be unlimited

but there is a finite number of trees.

People compete for these limited resources.

Scarcity exists because people cannot satisfy their every want.

Unlike scarcity, shortages are temporary.

The Problem of Scarcity

Even if everyone in the world were rich, scarcity would continue to exist. There is always a limited amount of resources and

people will always compete for those resources. Time is also subject to scarcity- no one has

unlimited time.

Scarcity: the condition of not being able to have all of the goods and services one wants, because wants exceed what can be made from all available resources at any given time.

Factors of Production

Factors of Production: resources of land, labor, capital, and entrepreneurship used to produce goods and services.

Some economists have begun to list technology as a factor of production as well.

Factors of Production

Land: natural resources, surface land, and water. Land also includes-

Fish Animals Forests Mineral Deposits Other “gifts of nature”

Factors of Production

Labor: human effort directed toward producing goods and services.

Goods: tangible objects that can satisfy people’s wants or needs.

Services: actions that can satisfy people’s wants or needs.

Factors of Production

Capital: previously manufactured goods used to make other goods and services Capital goods are all the items used to

produce capital For example- The machines, buildings, and tools

used to assemble and automobile would be classified as capital goods.

Capital is designed to increase productivity. Productivity: the amount of output (goods and

services) that results from a given level of inputs (land, labor, capital, entrepreneurship).

Factors of Production

Entrepreneurship: ability of risk-taking individuals to develop new products and start new businesses in order to make profits.

Entrepreneurs must also incur the costs of a failed business.

About 30% of new business enterprises fail.

Factors of Production

Technology: advance in knowledge leading to new and improved goods and services and better ways of producing them.

Some economists list technology as a factor of production.

Previously, technology included any use of land, labor, and capital that produced goods and services more efficiently.

CHAPTER 1 SECTION 2

Trade-Offs

Trade-offs

Individuals, families, businesses, and societies are forced to make trade-offs every time they use their resources in one way and not another.

Trade-off: sacrificing one good or service to purchase or another

The Cost of Trade-offs

Trade-offs involve opportunity cost, or the loss of one alternative when you choose another.

Opportunity Cost: value of the next best alternative given up for the alternative that was chosen

Considering the opportunity cost can help people make decisions.

Production Possibilities Curve

Production Possibilities Curve: graph showing the maximum combinations of goods and services that can be produced from a fixed amount of resources in a given period of time

This curve can help people and businesses determine how much of each item to produce, thus revealing the trade-offs and opportunity cost involved in each decision.

Guns vs Bread/Butter

CHAPTER 1 SECTION 3

What Do Economists Do?

Schools of Economics

Economics is divided into two parts, microeconomics and macroeconomics

Microeconomics: the branch of economic theory that deals with behavior and decision making by small units such as businesses and firms

Macroeconomics: the branch of economic theory dealing with the economy as a whole and decision making by large units such as governments

Economic Models

Economic Model: a theory or simplified representation that helps explain and predict economic behavior

When studying a specific part of the economy, economists often formulate theories and gather data.

What Models Show

Models show how people behave economically.

When using a model, assume that some factors remain constant.

Models do not show every little part of an economy, rather a model will show only the basic factors needed to analyze the problem at hand.

Testing a Model

Models are useful if they help us analyze the way the real world works.

The economist can test his theory in the same way that scientists test their hypotheses.

Testing a model allows economists to see if the model represents reality under certain conditions.

Applying Models to Real Life

Much of the work of economists involves predicting how people will react in a particular situation.

However, models are not always accurate due to the inability to predict human behavior.

Economists cannot take into account all of the factors that may influence people’s behavior.

Schools of Economic Thought

Economists are influenced by personal opinions, beliefs, and the government under which they live.

These influences lead to differing economic theories and different schools of thought can have an impact on laws and government policies.

Schools of Economic Thought

Judgments about economic policies depend on a person’s values.

Values: beliefs or characteristics that a person or group considers important

The science of economics is not used to judge whether a certain policy is good or bad, rather economists only inform us as to likely short-term and long-term outcomes of policies.