Chapter 1: What is Economics?

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!

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?

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

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.

Chapter 1: What is Economics?