Chapter 1: The Nature and Methods of Economic

Chapter 1: The Nature and Methods of Economic Definition of Economics The social science concerned with the efficient use of limited or scarce resources to achieve maximum satisfaction of human needs. Human wants are unlimited, but the means to satisfy the wants are limited.

Got stuff? • Who made it? • How was it made? • How did you get it?

I. The Economic Problem • the basic economic problem is scarcity: -- wants are unlimited, but resources are limited • so with scarcity, we must make choices, • and with choices, come costs

Products are sometimes classified as luxuries or necessities, but the division is subjective. Services satisfy wants as well as goods. Businesses and governments also have wants. 5. Over time, wants change and multiply.

B. the second fundamental fact: Scarce resources: 1. Economic resources are limited relative to wants. Economic resources are sometimes called factors of production (inputs) and include four categories:

Scarcity and choice • Resources can only be used for one purpose at a time. • Scarcity requires that choices be made. we have to decide (make a choice) what we will have and what we will forgo • The cost of any good, service, or activity is the value of what must be given up to obtain it (opportunity cost).

Cost is the opportunity cost • -- what you give up when you make a choice • -- “there’s no such thing • as a free lunch”

Cost of going to college • -- what you can buy with tuition & fees • -- what you could earn by working • -- what you could do with the free time

you are willing to give up • -- tuition • -- wages • -- leisure time • to go to college • -- b/c you expect higher income or more rewarding career

economics is the study of choices • of how to allocate scarce resources • choices made by -- consumers -- businesses -- governments

What are resources? • use resources to produce goods and services • factors of production -- land -- labor -- capital -- entrepreneurship

Land • all natural resources -- land -- minerals -- water -- wildlife

Labor • size of labor force (quantity) • skills of labor force (quality) -- human capital • the value of time

Capital • physical capital -- goods used to make other goods -- factories -- machines -- infrastructure

NOT financial capital • -- stocks, bonds, bank loans • financial capital facilitates building of physical capital

entrepreneurship • human resource • ideas -- doing things better -- e-commerce -- new products

PROPERTY RESOURCES LAND CAPITAL HUMAN RESOURCES LABOR ENTREPRENEUR RESOURCE PAYMENTS Rent or Rental Income Interest Income WAGES PROFIT & LOSS

Three Questions to answer: 1. What to produce? 2. How to produce the stuff in #1? 3. For whom to produce? (who gets the stuff in #1?)

Example: A Bentley 1. What to produce? • Bentley Motorsdesigns a luxury car with buyers in mind • Bentley Motorsdecides how much to produce give the price and their costs • Buyers decide how many to buy, based on price, their income, tastes, etc.

2. How to produce? • Bentley Motorsdesigns factory, uses machinery, & trains workers to minimize cost BUT retain a certain quality • government restricts this decision: • Pollution laws • safety laws • labor laws

3. Who gets the Bentley? • Those who are willing and able to pay K.D 50,000 for one. • (this is why I don’t have it)

Who answers #1-3? • pure capitalism • when buyers and sellers interact to answer these questions • markets unrestricted • private property • prices coordinate #1-3

the U.S. is a mixed market economy, since government plays a role • enforces property rights • regulates markets • taxes to provide goods & services

command system • the government answers questions 1-3 • former U.S.S.R., N. Korea • reduced incentives for efficiency • coordination failures

Why Study Economics?Economics for citizenship Most political problems have an economic aspect, whether it is balancing the budget, fighting over the tax structure (Kuwait is planning to introduce income tax), welfare reform, international trade, or concern for the environment. 2. Both the voters and the elected officials can fulfill their role more effectively if they have an understanding of economic principles.

Why Study Economics? Professional and personal applications Economics helps people to make sense of every day activity they observe around them Economic principles enable business managers to make more intelligent decisions.

Economics can help individuals make better buying decisions, better employment choices, and better financial investments. Economics is to examine problems and decisions from a social rather than personal point of view.

Policy economics applies economic facts and principles to help resolve specific problems and to achieve certain economic goals. Steps in formulating economic policy: State goals. Recognize various options that can be used to achieve goals. Evaluate the options on the basis of specific criteria important to decision-makers.

Macroeconomics and Microeconomics Macroeconomics examines the economy as a whole. It includes measures of total output, total employment, total income, aggregate expenditures, and the general price level. Microeconomics looks at specific economic units. It is concerned with the individual industry, firm or household and the price of specific products and resources.

Specialization • How do we get the most out of our resources? • We specialize in what we do best and trade that for what we need

I teach. • I get paid for it. • I use the money to buy • food • oil changes • clothes

If I • grew my own food • made my own clothes • fixed my own car • I would not consume as much • Specialization produces gains! • I can consume more • than what I could make • on my own

Who specializes in what? • Comparative advantage • if you produce a good at a lower opportunity cost then you should specialize in it

Example: married couple • Husband: surgeon • $250,000 /year • Wife: 5th grade teacher • $50,000 /year • who should run the household? • Who has lower opportunity cost? The wife.

with specialization, • division of labor • different people specialize in different things • people become very good at their task • efficiency gains -- get more out of same resources

specialization is everywhere • doctors • neurosurgeon, obstetrics, pediatrics,… • lawyers • divorce, real estate, patent law, personal injury...

The bottom line: • Scarcity & opportunity cost are unavoidable. BUT • efficiency & specialization make the most of scarce resources

Employment and Efficiency Economics is a science of efficiency in the use of scarce resources. Efficiency requires full employment of available resources and full production. Full employment means all available resources should be employed. 2. Full production means that employed resources are providing maximum satisfaction of our economic wants. Underemployment occurs if this is not so.

PRODUCTION POSSIBILITIES in table form PIZZA 0 1 2 3 4 (in hundred thousands) ROBOTS 10 9 7 4 0 (in thousands) 39

PRODUCTION POSSIBILITIES in table form PIZZA 0 1 2 3 4 (in hundred thousands) ROBOTS 10 9 7 4 0 (in thousands) graphical form Robots (thousands) 40 Pizzas (hundred thousands)

PRODUCTION POSSIBILITIES Limited Resources means a limited output... At any point in time, a full-employment, full-production economy must sacrifice some of productX to obtain more of product Y. 46

Choices will be necessary because resources and technology are fixed. A production possibilities table illustrates some of the possible choices. A production possibilities curve is a graphical representation of choices. 1. Points on the curve represent maximum possible combinations of robots and pizza given resources and technology. 2. Points inside the curve represent underemployment or unemployment. 3. Points outside the curve are unattainable at present. 47

Optimal or best product-mix: 1. It will be some point on the curve. 2. The exact point depends on society; this is a normative decision. 48

PRODUCTION POSSIBILITIES Q 14 13 12 11 10 9 8 7 6 5 4 3 2 1 Unattainable A B C W Attainable & Efficient Robots (thousands) D Attainable but Inefficient E Q 1 2 3 4 5 6 7 8 Pizzas (hundred thousands) 49

Notes... LAW OF INCREASING OPPORTUNITY COSTS The amount of other products that must be forgone or sacrificed to obtain 1 unit of a specific product is called the opportunity cost of that good. PRODUCTION POSSIBILITIES Q 14 13 12 11 10 9 8 7 6 5 4 3 2 1 Unattainable A B C W Attainable & Efficient Robots (thousands) D Attainable but Inefficient E Q 1 2 3 4 5 6 7 8 Pizzas (hundred thousands) 50

Chapter 1: The Nature and Methods of Economic