Chapter 1: What is
Economics?
Here we go! Get ready!
Section 1: Scarcity and the
Factors of Production
What is Economics?

What do you know about the subject of
economics?
Scarcity and Choice

Primary idea: We can’t have everything
we need and want!

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???


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??...
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.
Goods and Services

Goods – physical objects


Services – actions or activities that one
person performs for another


Shoes and shirts
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.
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
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.
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
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
Artist’s creation of a painting
Repair of a television
Capital


Capital – any human-made resource
used to produce other goods and
services
There are two kinds:


Physical
and
Human
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
Capital

Human Capital

Knowledge and skills a worker gains
through education and experience
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
Scarce Resources

No matter what good or service, the
supplies of land, labor, and capital used
to produce it are scarce.
Section 2

Opportunity Cost
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.
Trade-Offs: Who makes
them?


Individuals
Businesses


How to use land, labor, and capital
resources
Society

Guns or butter?
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?
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
Section 3
Production
Possibility
Curves…
It’s your first
graph in Econ.
Get excited.
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 didn’t just have
all that stuff sitting
around!)
Now that you know some
economic concepts…

…you probably
realize that we can’t
just suddenly make
a bunch of military
stuff without giving
up something!
(ahhemm…tradeoffs)
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)
And that’s what Production
Possibilities in Econ is all about


Excited yet? Well, here’s a definition
for you:
Production Possibilities curve – shows
alternative ways to use an economy’s
productive resources
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
The classic example is “Guns v. Butter”
What the heck does that mean?



It’s supposed to show that
every society has to
choose what to produce.
Guns represent military
expenditures.
Butter represents money
spent on domestic
(consumer) things.
Now you get to learn how to draw a
Production Possibilities Curve!

We’re 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
Drawing a Production
Possibilities Curve

Determine points of possible production

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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?
Drawing a Production
Possibilities Curve

So this country can produce:

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15 million pairs of shoes
OR
21 million tons of watermelons
Do they have any other choices of
production?...
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 it’s usually a good idea to be
producing at one of the extremes or
somewhere in between? Why?
Drawing a Production
Possibilities Curve



Options of
production for this
country
What is the best
combination??
Hmmm…well, that
takes some
analyzing!
Watermelons
Shoes
0
8
14
18
20
21
15
14
12
9
5
0
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
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

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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??
Trade-Offs

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…because of scarcity!
Land, labor, and capital are scarce
Using factors of production to make one
product leaves fewer resources to make
something else
It’s all about making decisions!
Efficiency, Growth, and Cost

Why are production possibility curves
important?

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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
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
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
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 can’t get there
with current land, labor,
and capital
Growth



Production possibilities
curves represent only a
country’s 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.
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
Growth

When an economy
grows, the entire
curve “shifts to the
right”

Why???
Growth

A country’s production capacity can
decrease, too



When a country goes to war and loses land
as a result
If a country’s population ages, supply of
labor and human capital decreases
When this happens, the curve shifts to
the left.
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
Cost

How many shoes do
we have to give up
to go from
producing no
watermelons to 8
million
watermelons?
Watermelons
Shoes
0
8
14
18
20
21
15
14
12
9
5
0
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
8
14
18
20
21
15
14
12
9
5
0
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
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
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.