Chapter 1: What is Economics? Here we go! Get ready!
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 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: 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 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 …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? 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.
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