The Economic Way of Thinking

1. The Economic Way of Thinking What is “economics”?

2. What is “economics”? • Economics is the study of how individuals and societies satisfy their unlimited wants with limited resources.

3. Chapter 1: The Economic Way of Thinking • KEY CONCEPT • Scarcity is the situation that exists because wants are unlimited and resources are limited. • WHY THE CONCEPT MATTERS • The concept of scarcity is an issue you confront in everyday life. Suppose you have $10 to cover the cost of lunches this weekend. How would you use the money to cover your wants? How would buying a Sundrop for $1.50 on Friday night and Saturday night affect your lunch choices?

4. Scarcity: The Basic Economic Problem What Is Scarcity? • KEY CONCEPTS • Wants — desires that can be met by consuming products “I want a Sundrop”. • Needs — things necessary for survival “I need food or I’ll pass out” • Scarcity — lack of resources available to meet all human wants • This does not refer to a temporary shortage. • Economics — study of how people use resources to satisfy wants • examines how individuals and societies choose to use resources • organizes, analyzes, interprets data about economic behaviors • develops theories and economic laws to explain the economy, and uses these to predict the future

5. What Is Scarcity? • Principle 1: People Have Wants • People make choices about all their needs and wants • Wants are unlimited, ever changing

6. What Is Scarcity? • Principle 2: Scarcity Affects Everyone • Scarcity affects which goods and services are provided • Goods — physical objects that can be bought • Services — work a person does for pay • Consumer — person who buys good or service for personal use • Producer — person who makes a good or provides a service

7. Scarcity Leads to Three Economic Questions • KEY CONCEPTS • Scarcity affects society and producers as well as individuals • Society must answer three basic economic questions: • What will be produced? • How will it be produced? • For whom will it be produced?

8. Scarcity Leads to Three Economic Questions • Question 1: What Will Be Produced? • Societies must decide on mix of goods to produce • depends in part on their natural resources • Some countries allow producers and consumers to decide • In other countries, governments decide • Who do you think should decide? • Must also decide how much to produce; choice depends on societies’ wants

9. Scarcity Leads to Three Economic Questions • Question 2: How Will It Be Produced? • Decisions on production methods involve using resources efficiently • decisions influenced by a society’s natural resources • Societies adopt different approaches • with unskilled labor force, might use labor-intensive methods • with skilled labor force, might use capital-intensive methods

10. Scarcity Leads to Three Economic Questions • Question 3: For Whom Will It Be Produced? • How goods and services are distributed involves two questions • how should each person’s share be determined? • how will goods and services be delivered to people?

11. The Factors of Production • KEY CONCEPTS • Factors of production — resources needed to produce goods and services • land, labor, capital, entrepreneurship • supply is limited

12. The Factors of Production • Factor 1: Land • Land means all natural resources on or under the ground • includes water, forests, wildlife, mineral deposits

13. The Factors of Production • Factor 2: Labor • Labor is all the human time, effort, talent used to make products • physical and mental effort used to make a good or provide a service

14. The Factors of Production • Factor 3: Capital • Capital is a producer’s physical resources • tools, machines, offices, stores, roads, vehicles • sometimes called physical capital or real capital • Is also money • Workers invest in human capital — knowledge and skills • workers with more human capital are more productive

15. The Factors of Production • Factor 4: Entrepreneurship • Entrepreneurship — vision, skill, ingenuity, willingness to take risks • Entrepreneurs anticipate consumer wants, satisfy these in new ways • develop new products, methods of production, marketing or distributing • risk time, energy, creativity, money to make a profit

16. Reviewing Key Concepts • Explain the relationship between the terms in each of these pairs: • wants and scarcity • consumer and producer • factors of production and entrepreneurship

17. Economic Choice Today: Opportunity Cost Making Choices • KEY CONCEPTS • Economic choices shaped by • Incentives — benefits that encourage people to act in certain ways • Utility — benefit or satisfaction gained from using a good or service • To make choices, people economize: • make decisions according to best combination of costs and benefits

18. Making Choices • Factor 1: Motivations for Choice • People motivated by incentives, expected utility, desire to economize • They weigh costs against benefits to make purposeful choices • motivated by self-interest: look for ways to maximize utility

19. Making Choices • Factor 2: No Free Lunch • All choices have a cost • choosing one thing means giving up another, or paying a cost • cost can take form of money, time, other thing of value

20. Trade-Offs and Opportunity Cost • KEY CONCEPTS • Trade-off is alternative people give up when they make a choice • usually means giving up some, not all, of a thing to get more of another

21. Trade-Offs and Opportunity Cost • Example 1: Making Trade-Offs • Shanti wants to earn college credit over summer • semester-long university course offers more credits • six-week high school course leaves time for vacation

22. Trade-Offs and Opportunity Cost • Example 2: Counting the Opportunity Cost • Opportunity cost is value of next-best alternative a person gives up • not the value of all possible alternatives • Dan chooses to work for six months so he can travel for six months • opportunity cost: six months of salary

23. Analyzing Choices • KEY CONCEPTS • Cost-benefit analysis — examination of costs, expected benefits of choices • one of most useful tools for evaluating relative worth of economic choices

24. Analyzing Choices • Example: Max’s Decision-Making Grid • Decision-making grid shows what one gets, gives up with each choice • Max’s grid shows all possible choices for his free hours each week • lists choices, benefits and opportunity cost of each choice • With time, costs and benefits change; also goals and circumstances • Changes influence decisions, make people alter original choices

25. Analyzing Choices • Example: Marginal Costs and Benefits • Marginal cost • additional cost of using one more unit of a good or service • Marginal benefit • additional benefit of using one more unit of a good or service

26. Reviewing Key Concepts • Explain the relationship between the terms in each of these pairs: • incentive and utility • trade-off and opportunity cost • marginal cost and marginal benefit

27. Analyzing Production Possibilities Graphing the Possibilities • KEY CONCEPTS • Economic models — simplified representations of economic forces • Production possibilities curve (PPC) is one model • maximum goods or services that can be produced from limited resources • also called production possibilities frontier

28. Graphing the Possibilities • KEY CONCEPTS • PPC based on assumptions that simplify economic interactions • resources are fixed • all resources are fully employed • only two things can be produced • technology is fixed

29. Graphing the Possibilities • Production Possibilities Curve • PPC runs between extremes of producing only one item or the other • Data is plotted on a graph; lines joining points is PPC • shows maximum number of one item relative to other item • PPC shows opportunity cost of each choice • more of one product means less of the other

30. What We Learn from PPCs • KEY CONCEPTS • Concepts revealed by PPC: • Efficiency — producing the maximum amount of goods and services possible • Underutilization — producing fewer goods and services than possible

31. What We Learn from PPCs • Example: Efficiency and Underutilization • Each point on PPC represents efficiency • points inside curve mean underutilization; outside curve cannot be met • Law of increasing opportunity costs • as production switches from one product to another, more resources needed to increase production of second product

32. What We Learn from PPCs • Example: Increasing Opportunity Costs • Increase in opportunity cost — each new unit costs more than last one • Reasons for increasing cost of making more of one product • need new resources, machines, factories • must retrain workers • Costs paid by making less and less of other product

33. Changing Production Possibilities • Example: A Shift in the PPC • A country’s supply of resources changes over time • Example: U.S. in 1800s grew, gained resources, workers, new technology • new resources mean new production possibilities beyond frontier • Increased production shown on PPC as shift of curve outward • Increase in total output called economic growth

34. Reviewing Key Concepts • Explain how each term is illustrated by the production possibilities curve: • underutilization • efficiency

35. The Economists Toolbox Working with Data • KEY CONCEPTS • Statistics — numerical data or information • show patterns of human behavior • Economic models help organize and interpret data

36. Working with Data • Using Economic Models • Economic models focus on a limited number of variables • thus based on assumptions and use simplification • expressed in words, graphs, equations

37. Working with Data • Using Charts and Tables • Economists look for statistical relationships, trends, connections • Charts and tables display data in rows and columns • can reveal patterns by showing numbers in relation to other numbers

38. Working with Data • Using Graphs • Graphs use two sets of variables: along horizontal, vertical axes • Line graphs useful for showing changes over time • in economics, line referred to as a curve, even if straight • Bar graphs good for showing comparisons • Pie graph (or pie chart, circle graph) shows numbers in relation to whole

39. Microeconomics and Macroeconomics • KEY CONCEPTS • Microeconomics — studies behavior of individual players in an economy • includes individuals, families, businesses • Macroeconomics — studies behavior of economy as a whole • topics include inflation, unemployment, aggregate demand and aggregate supply

40. Microeconomics and Macroeconomics • Microeconomics • Microeconomics examines specific, individual elements in an economy • prices, costs, profits, competition, consumer and producer behavior • Some Topics of Interest: business organization, labor markets, environmental issues

41. Microeconomics and Macroeconomics • Macroeconomics • Macroeconomics studies sectors — combination of all individual units • Includes consumer, business, public or government sectors • Macroeconomics studies national or global topics: • monetary system, business cycle, tax policies, international trade

42. Positive Economics and Normative Economics • KEY CONCEPTS • Positive economics describes and explains economic behavior as it is • uses verifiable facts; does not make judgments • Normative economics studies what economic behavior should be • makes value judgments to recommend future actions

43. Positive Economics and Normative Economics • Positive Economics • Positive economics uses scientific method • observe data, hypothesize, test, refine, continue testing • Statements tested against real-world data • proved (or strongly supported) or disproved (or strongly questioned)

44. Positive Economics and Normative Economics • Normative Economics • Normative economics studies facts, asks if course of action is good • Recommendations differ because values they are based on also differ

45. Adam Smith: Founder of Modern Economics • Seeing the Invisible • An Inquiry into the Nature and Causes of the Wealth of Nations, 1776 • challenged mercantilism; argued for free trade • Invisible hand guides free marketplace, benefits sellers and buyers • people pursue own economic self-interest • producers sell at prices that satisfy them and that consumers will pay

46. Reviewing Key Concepts • Explain the differences between the terms in each of these pairs: • statistics and economic model • macroeconomics and microeconomics • positive economics and normative economics

47. Case Study: The Real Cost of Expanding O’Hare Airport • Background • Chicago’s O’Hare Airport is one of the busiest airports in the United States. • Delays at O’Hare are commonplace. • Considerable debate over the best solution to improve efficiency. • What’s the Issue • What are the real costs involved in airport expansion? Study these sources to determine the costs tied to the expansion of O’Hare airport.

48. Case Study: The Real Cost of Expanding O’Hare Airport {continued} • Thinking Economically • Explain the real cost of expanding O’Hare Airport. Use information presented in the documents to support your answer. • Who are the most likely winners and losers as a result of the O’Hare expansion? Explain your answer. • How might supporters of expansion use a production possibilities model to strengthen their case?