Chapter 1: What is Economics?

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Chapter 1 What is Economics?

• Here we go! Get ready!
• Section 1 Scarcity and the Factors of Production

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What is Economics?

• What do you know about the subject of economics?

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Scarcity and Choice

• Primary idea We cant have everything we need
  and want!

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• 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???

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• 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??...

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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.

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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.

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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

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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.

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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

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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
• Artists creation of a painting
• Repair of a television

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Capital

• Capital any human-made resource used to produce
  other goods and services
• There are two kinds
• Physical
• and
• Human

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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

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Capital

• Human Capital
• Knowledge and skills a worker gains through
  education and experience

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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

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Scarce Resources

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

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Section 2

• Opportunity Cost

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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.

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Trade-Offs Who makes them?

• Individuals
• Businesses
• How to use land, labor, and capital resources
• Society
• Guns or butter?

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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?

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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

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Section 3

• Production
• Possibility
• Curves
• Its your first
• graph in Econ.
• Get excited.

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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 didnt just have all that stuff sitting
  around!)

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Now that you know some economic concepts

• you probably realize that we cant just suddenly
  make a bunch of military stuff without giving up
  something! (ahhemmtrade-offs)

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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)

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And thats what Production Possibilities in Econ
is all about

• Excited yet? Well, heres a definition for you
• Production Possibilities curve shows
  alternative ways to use an economys productive
  resources

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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

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

• Its supposed to show that every society has to
  choose what to produce.
• Guns represent military expenditures.
• Butter represents money spent on domestic
  (consumer) things.

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

• Were 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

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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?

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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?...

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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 its usually a good idea to be
  producing at one of the extremes or somewhere in
  between? Why?

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Drawing a Production Possibilities Curve

• Options of production for this country
• What is the best combination??
• Hmmmwell, that takes some analyzing!

Watermelons Shoes
0 15
8 14
14 12
18 9
20 5
21 0
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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

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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??

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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
• Its all about making decisions!

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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

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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

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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

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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 cant get there with
  current land, labor, and capital

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Growth

• Production possibilities curves represent only a
  countrys 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.

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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

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Growth

• When an economy grows, the entire curve shifts
  to the right
• Why???

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Growth

• A countrys production capacity can decrease, too
  
• When a country goes to war and loses land as a
  result
• If a countrys population ages, supply of labor
  and human capital decreases
• When this happens, the curve shifts to the left.

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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

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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
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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
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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

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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

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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.