Chapter 1 the economic way of thinking
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Chapter 1: The Economic Way of Thinking. Sec. 1: Scarcity: The Basic Economic Problem. What is Scarcity?. Wants – Needs – . People always want more, no matter what they have wants are unlimited, but resources to fill are limited Scarcity –

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Chapter 1: The Economic Way of Thinking

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Chapter 1: The Economic Way of Thinking


Sec. 1: Scarcity: The Basic Economic Problem


What is Scarcity?

  • Wants –

  • Needs –

  • People always want more, no matter what they have

    • wants are unlimited, but resources to fill are limited

  • Scarcity –

    • not a temporary shortage, it is a problem facing individuals, businesses, govt., society

  • Science to study it is called economics


Economics – the study of how people choose to use scarce resources to satisfy their wants

  • Econ involves:

  • Examining –

  • Organizing, analyzing, and interpreting data about those economic behaviors

  • Developing theories and economic laws that explain how the economy works and to predict what might happen in the future.


  • Principle 1:

    • Choice is central to the use of scarce resources.

    • Choices about needs – what kind of food

    • Choices about wants – these are unlimited & ever changing

  • Principle 2:

  • Scarcity affects which goods are made and services are provided

    • Goods – physical objects that can be purchased

    • Services – work that one person performs for another for payment

    • Consumer –

    • Producer –


Scarcity Leads to 3 Questions


Question 1:

  • Society must decide the mix of goods and services it will produce

    • what is produced depends on the natural resources possessed

    • but resources do not completely control what a country produces

  • some countries decide by allowing consumers and producers to decide

    • in other countries, the govt. decides what goods and services will be produced

  • This question also involves how much to produce

    • the country must review its wants at any time to decide this


Question 2:

  • This involves using scarce resources in the most efficient ways to satisfy wants

    • this is also influenced by the natural resources that a society possesses

    • ex. - growing crops – different approaches

    • large unskilled labor force – labor intensive methods – few machines

    • highly skilled labor force – capital intensive – lots of machines


Question 3:

  • This involves how goods will be distributed

    among people in society

  • Questions –Need to determine how much people should get how much they pay or equal share

  • Distribution networks –


-the economic resources needed to produce goods and services

The Factors of Production


Factor 1:

  • Includes all natural resources found on or under the ground that are used to produce goods and services


Factor 2:

  • is all the human time, effort, and talent that goes in to the making of products


Factor 3:

  • is all the resources made and used by people to produce and distribute goods and services

    • ex. –

  • human capital –

    • ex. – college, job training


Factor 4:

  • Is the combination of vision, skills, ingenuity, and willingness to take risks that is needed to create and run new businesses

    • most entrepreneurs are innovators

    • try to anticipate and meet needs of consumers in new ways

    • new product, method of production, way of marketing or distributing

  • Are also risk takers – risk time, energy, creativity, money in hope for profit


Sec. 2: Economic Choice Today: Opportunity Cost


Making Choices

-What shapes the economic choices?

-incentive –

-utility –

-“economize” – consider both incentive and utility –

-make decisions according to what you believe is the best combination of costs and benefits


Factor 1:

Factor 2:

Every choice involves costs

Money, time, or something else of value

  • Choices are shaped by incentive, expected utility, and the desire to economize

  • Costs vs. benefits – looking for best mix of costs and benefits

  • Making decisions – guided by self-interest – looking for ways to maximize utility 


Trade-Offs and Opportunity Costs

Trade-offs –


Example 1:

Example 2:

Opportunity cost –

Alternative over another

*choice – work for year vs. work for 6 months and travel for months

Selects work for 6 months and travel for 6 months – less income, but visits friends

  • *choice – semester long course at university vs. 6 week course at high school

  • selects 6 week course, less credits, but gets summer vacation


Analyzing Choices

-cost-benefits analysis –

-useful tool for individuals, businesses and govt. when to evaluate relative worth of

economic choices


Example: Max’s Decision-Making Grid

  • application of cost-benefit analysis is decision-making grid

  • shows what you get and what you give up when you make choices

  • costs and benefits change over time, as do goals and circumstances

  • changes influence decisions people make


Example: Marginal Costs and Benefits

  • marginal costs –

  • marginal benefit –

  • analysis is central to study of economics

    • helps explain the decisions consumers, producers, and govt. make as they try to meet their unlimited wants with limited resources


Sec. 3: Analyzing Production Possibilities


Graphing the Possibilities

  • Economic models –

  • Production Possibilities Curve(PPC) – a graph used to illustrate the impact of scarcity on an economy by showing the maximum number of goods or services that can be produced using limited resources


PPC assumptions

  • Resources are fixed – no way to increase the availability of land, labor, capital and entrepreneurship

  • All resources are fully employed – there is no waste of any of the factors of production

  • Only two things can be produced – assumption simplifies the situation and suits the graphic format – one variable on each axis

  • Technology is fixed – no technological breakthroughs to improve methods of production

  • -Curve represents border or frontier between what is and what is not possible to produce

    also called a Production Possibilities Frontier

    useful for bus. & govt., but can be used by individual


Production Possibilities Curve

  • Figure 1.3 – 5 production possibilities for loaves of bread and bran muffins

  • Figure 1.4 – graph plotted from data in table – line is the PPC

    • points represent maximum of one product relative to the other

    • also shows opportunity cost of one product compared to the other


What We Learn From PPCs

  • No economy operates according to simplified assumptions of PPC

    • but it spotlights concepts that work in the real world of scarce resources

  • Efficiency –

  • Underutilization –


Example: Efficiency and Underutilization

  • Figure 1.5 – guns vs. butter – military vs. consumer production

    • each point the on curve shows different combination of each, and each represents efficiency

    • each point inside the curve is underutilization, and points outside the curve are impossible because resources are fixed


Law of Increasing Opportunity Costs


Example: Increasing Opportunity Costs

  • Figure 1.5 – switching from guns to butter or butter to guns

    • each additional unit costs more to make than the last, explains bow shape of curve

    • reason – making one is different from making the other – new machines, factories, and retrain Workers


Changing Production Possibilities

  • The PPC represents present PP if resources are fixed, but that usually changes over time

    • additional resources means new PP and the PPC moves outward 

  • Example: A Shift in the PPC

    in the 1700s the US occupied only a small area along the Atlantic

    • 100 yrs. Later, it expanded to the Pacific – meaning the addition of resources, in addition to the added immigrants means additional labor

    • this is shown on the PPC as a shift of the curve outward – this is called economic growth


Sec. 4: The Economist’s Toolbox


Working with Data

  • Economics is something that everyone knows and works with everyday

  • Economists study this to figure out why some nations are rich or poor and why consumers want one product while others want another product

  • Statistics –


Using Economic Models

  • Models are based on assumptions and are simplified because they are based on a limited number of variables

    • models expressed in words, graphs or equations

    • explain why things are as they are, help predict future economic activity


Using Charts and Tables

  • Look for trends, connections and other interesting relationships

  • Showing numbers in relation to other numbers can reveal patterns in the data


Using Graphs

  • Graphs are used to ID trends in statistics

  • Line graph – useful for showing changes over time

  • Line graphs use 2 sets of numbers or variables – one on horizontal and one on vertical axis

  • The numbers of what is being used are plotted on the graph and connected to form a line

    • upward slope – upward trend

    • downward slope – downward trend

    • straight line – same slope

    • curved line – varied slope


  • Bar Graph – useful for comparisons

    • vividly shows changes in data

  • Pie Graph –

    • slices drawn in proportion to the number they represent


Microeconomics & Macroeconomics

-Microeconomics –

-Macroeconomics – is the study of the behavior of the economy as a whole and involves topics such as inflation, unemployment, aggregate demand, and aggregate supply


Microeconomics

  • Micro –

    • examines specific, individuals elements in the economy

    • prices, costs, profits, competition, behavior of consumers and producers

    • areas of specialized concentration

    • business organization, labor markets, agricultural economics, econ of environmental issues


Macroeconomics

  • Macro –

  • examines the big picture – economy as a whole

    • the effect of widespread unemployment on the whole nation

    • a general rise on prices

    • studies the consumer sector (household sector), business sector, and public or govt. sector

  • Sector –

    • bring a national or global perspective to work

    • study monetary system, up and down of business cycles, impact of national tax policies on economy, international trade and effect on rich and poor nations


Positive Economics and Normative Economics

-Positive economics – way of describing and explaining economics as it is and not how it should be, involves verifiable facts

- Normative economics –


Positive economics

Normative economics

Based on value judgments

goes beyond facts to ask if actions are good, values differ, so then recommendations will

  • Uses scientific method –

  • Statements can be tested against real world data and either proved or disproved


Adam Smith: Founder of Modern Economics

  • Born in Kirkcaldy, Scotland in 1723

  • Studied and taught literature, logic, and moral philosophy

  • 1764 – traveled to France – the Enlightenment – result – looked at world in new way


  • -1776 –

    • challenged idea of mercantilism – govt. controlled trade with its colonies

    • said free trade would be better

    • said people behave in ways that satisfy their economic self-interests

    • an invisible hand guides the marketplace

    • buyers and sellers benefit from each transition

    • becomes foundation of modern economics


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