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Chapter One

Chapter One. The Central Idea. Economics. Economics is the study of how people deal with scarcity Scarcity: Situation in which the quantity of resources is insufficient to meet all wants (not enough stuff for our wants) Leads to CHOICES: Must give up one thing in favor for another

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Chapter One

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  1. Chapter One The Central Idea

  2. Economics • Economics is the study of how people deal with scarcity • Scarcity: Situation in which the quantity of resources is insufficient to meet all wants (not enough stuff for our wants) • Leads to CHOICES: Must give up one thing in favor for another • Economic interaction is the exchanges of goods and services between people • These interactions can occur in a MARKET – an arrangement where economic exchanges between people take place

  3. Consumer Decisions • Opportunity Cost: Value of the next-best alternative that was not chosen • Gains from Trade: Improvements in income, production, or satisfaction owing to the exchange of goods or services • Important: Voluntary trade only happens if BOTH parties gain. • Does not change total amount of goods, just redistributes or reallocates

  4. Figure 1.1: Gains from Trade Through a Better Allocation of Goods

  5. Consumer Decisions • When acting alone, Emily and Johann can only produce 1 card each (2 total) • If they sell their services to each other, they can produce 10 total cards • They BOTH gain from trade

  6. Consumer Decisions • Specialization: People concentrating on what they are good at • Creates a DIVISION OF LABOR: workers concentrate on different tasks • Comparative Advantage: A situation where a person can produce a good for a lower opportunity cost than another person. • When people specialize where they have a comparative advantage, overall production is increased • International Trade: Exchange of goods or services between people in different countries

  7. Scarcity and Choice for the Economy as a Whole • Consumption vs. Investment • Opportunity cost of producing 200 movies instead of 100 movies is 2,000 computers • OC of making 300 movies instead of 200 movies is 4,000 computers • OC of making 400 movies instead of 300 is 5,000 computers • OC of making 500 movies instead of 400 is 13,000 computers

  8. Production Possibilities • Because OC continues to go up as we make more movies, it is called INCREASING opportunity cost

  9. Figure 1.2: The Production Possibilities Curve

  10. Production Possibilities Curve • Bows out because of increasing opportunity cost of producing movies – each move causes a more dramatic fall in graph • Points of line: EFFICIENT • Points under or to the left of line: INEFFICIENT • Points over or to the right of line: IMPOSSIBLE

  11. Figure 1.3: Shifts in the Production Possibilities Curve

  12. Shifts in the PP Curve • Shift out, up, right means increase in production, due to things like more workers or developing technology • Doesn’t need to be a uniform shift • Impossible points are not “forever” impossible

  13. Figure 1.4: Shifts in the Production Possibilities Curve Depend on Choices

  14. Market Economies and Price Systems • Market Economy: An economy where prices are freely determined and goods and services can be traded freely in markets • Examples: United States, Mexico, Australia • Command Economy (Centrally Planned Economy): An economy where the government determines prices and production • Examples: Soviet Union, China • Market Economies are more productive, so most of the world is trying to convert

  15. Key Elements of a Market Economy • Freely Determined Prices • Leads to inefficiencies. Example – feeding bread to cows in the Soviet Union • Property Rights and Incentives • Property rights give people control over their assets • Incentives are devices used to motivate people to take action, usually increasing productivity • Freedom to Trade both home and abroad

  16. Key Elements of a Market Economy, continued • A Role For Government • How much involvement should government have? Police? Education? Welfare? • Market Failure: Market is inefficient, potential for government involvement • Government Failure: Government made things worse • Role of Private Organizations • Organizations exist to reduce transaction costs (costs of buying and selling)

  17. The Price System • Signals • As demand increases, prices increase therefore “signaling” that there needs to be more workers, more production, etc. • Incentives • If more money is entering an industry, more firms will enter. In contrast, it will hurt competing industries. • Distribution • Workers in “hot” industries earn more, while competing industries’ employees will earn less.

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