Economics & Choice
1. Economic Way of Thinking
The concept of scarcity is an issue you confront in everyday life. Suppose you have $20
to cover the cost of lunches for the week. How would you use the money to cover your
wants Monday through Friday? How would buying a late afternoon snack for $1 on two
of the days affect your lunch choices?
This section corresponds to Chapter 1: Sections 1 & 2.
OBJECTIVES
01. Explain the role of scarcity in economic decision making.
02. Describe the four factors of production and their uses.
03. Explain how incentives and utility influence people's economic choices.
I. Scarcity is the situation that exists because wants are unlimited and resources are
limited.

KEY CONCEPTS
o Wants — desires that can be met by consuming products
o Needs — things necessary for survival
o Scarcity — lack of resources available to meet all human wants. It is
not a temporary shortage
o Economics — study of how people use resources to satisfy wants. It
examines how individuals and societies choose to use resources. It
organizes, analyzes, interprets data about economic behaviors. It
develops theories, economic laws to explain economy, predict future.
A. Principles of Scarcity
1. Principle 1: People Have Wants. People make choices about all their
needs and wants. ★
2. Principle 2: Scarcity affects everyone, and affects which goods and
services are provided.
a. Goods — physical objects that can be bought
b. Services — work one person does for another for pay
c. Consumer — person who buys good or service for personal use
d. Producer — person who makes a good or provides a service
B. Because scarcity affects society and producers as well as individuals, scarcity
leads to three economic questions
1. ★
a. Societies must decide on mix of goods to produce; the mix
depends, in part, on their natural resources.
b. Some countries allow producers and consumers to decide. In
other countries, governments decide.
c. Must also decide how much to produce; choice depends on
societies’ wants
2. ★
a. Decisions on production methods involve using resources
efficiently; the decisions are influenced by a society’s natural
resources.
b. Societies adopt different approaches. With unskilled labor force,
might use labor-intensive methods; with skilled labor force, might
use capital-intensive methods
3. ★
a. How should each person’s share be determined?
b. How will goods and services be delivered to people?
II. The Factors of Production: The resources needed to produce goods and services.

KEY CONCEPTS
o The Factors include land, labor, capital, entrepreneurship. But the
supply of each is limited.
A. Factor 1: Land: all natural resources on or under the ground. ★
B. Factor 2: Labor: all the human time, effort, talent used to make products. ★
C. Factor 3: Capital: a producer’s physical resources. It includes tools, machines,
offices, stores, roads, vehicles. It is sometimes called physical capital or real
capital. Workers invest in human capital — both knowledge and skills. ★
D. Factor 4: Entrepreneurship: The vision, skill, ingenuity, willingness to take
risks. Entrepreneurs anticipate consumer wants, satisfy these in new ways. They
develop new products, methods of production, marketing or distributing, as well
as risk time, energy, creativity, money to make a profit. (Some economists
consider this an “intangible”, and do not include it in the Factors of Production—
W)
III. Making Choices

KEY CONCEPTS
o Economic choices shaped by: Incentives — benefits that encourage
people to act in certain ways; and Utility — benefit or satisfaction
gained from using a good or service
o To make choices, people economize. They make decisions according
to best combination of costs and benefits.
o Trade-off is alternative people give up when they make a choice. It
usually means giving up some, not all, of a thing to get more of
another.
o Cost-benefit analysis — examination of costs, expected benefits of
choices. It is one of most useful tools for evaluating relative worth of
economic choices.
A. The circumstances
1. Factor 1: Motivations for Choice; People are motivated by incentives,
expected utility, desire to economize. They weigh costs against benefits to
make purposeful choices. They are motivated by self-interest: look for
ways to maximize utility.
2. Factor 2: No Free Lunch; All choices have a cost. Choosing one thing
means giving up another, or paying a cost. ★
B. Trade-Offs and Opportunity Cost
1. Example: Making Trade-Offs. Shanti wants to earn college credit over
summer. A semester-long university course offers more credits, while a
six-week high school course leaves time for vacation.
2. Example: Counting the Opportunity Cost. Opportunity cost is value of
next-best alternative a person gives up. It is not the value of all possible
alternatives. If Dan chooses to work for six months so he can travel for six
months, his opportunity cost is six months of salary.
3. Example: Max’s Decision-Making Grid. A decision-making grid shows
what one gets, gives up with each choice. Max has 6 extra hours a week
for either studying or socializing. Max’s grid shows all possible choices for
his free hours each week; it lists choices, benefits and opportunity cost of
each choice. With time, costs and benefits change; also goals and
circumstances. Changes influence decisions, make people alter original
choices
4. Example: Marginal Costs and Benefits. Marginal cost is the additional
cost of using one more unit of a good or service. Marginal benefit is the
additional benefit of using one more unit of a good or service. When Max
chose to study 3 extra hours—giving him a B with the opportunity cost of 3
hours with his squad. The marginal cost of 1 more hour of study adds a
marginal benefit of raising his grade from a B to B+. That was not enough
for Max to give up an hour with his friends.
Economics & Choice
2. The Economist’s Toolbox
An old joke notes that economics is everything we already know expressed in a
language we do not understand. While many economists might disagree with the
second part of this joke, they probably would have little argument with the first part.
Economics is something that everybody engages in every day, and in that way
everyone has knowledge of it. Individuals, business owners, and government officials
make economic decisions all the time. Economists study these decisions and look for
logical ways to explain why some nations are rich while others are poor, or why some
consumers want one kind of product while others want another.
This section corresponds to Chapter 1: Sections 3 & 4.
OBJECTIVES
04. Describe and analyze production possibilities curves.
05. Demonstrate how and why economists use economic models, statistics, charts,
tables, and graphs.
06. Compare macroeconomics to microeconomics and positive economics to normative
economics.
IV. Graphing the Possibilities

KEY CONCEPTS
o Economic models — simplified representations of economic forces
o A Production Possibilities Curve (PPC) shows the maximum goods or
services that can be produced from limited resources. It is also called
production possibilities frontier.
o PPC based on assumptions that simplify economic interactions: That
resources are fixed, that all resources are fully employed, that only two
things can be produced, and that technology is fixed.
o Efficiency — producing the maximum amount of goods and services
possible
o Underutilization — producing fewer goods and services than possible
A. Production Possibilities Curve
1. PPC runs between extremes of producing only one item or the other.
a. Data is plotted on a graph; lines joining points is PPC. ★
b. PPC shows opportunity cost of each choice; choosing more of
one product means less of the other.
2. What We Learn from PPCs
a. Example: Efficiency and Underutilization
1) Each point on PPC represents efficiency. Points inside
curve mean underutilization; outside curve cannot be met.
2) Law of increasing opportunity costs: ★
b. Example: Increasing Opportunity Costs
1) Increase in opportunity cost — each new unit costs more
than last one.
2) Reasons for increasing cost of making more of one
product may include a need for new resources, machines,
factories, or that the company must retrain workers.
3) Those costs are paid by making less and less of other
product.
B. Changing Production Possibilities
1. Example: A Shift in the PPC. A country’s supply of resources changes
over time. For instance, U.S. in 1800s grew, gained resources, workers,
new technology. New resources mean new production possibilities beyond
frontier.
2. Increased production shown on PPC as shift of curve outward.
3. ★
V. Working with Data

KEY CONCEPTS
o Statistics — numerical data or information to show patterns of human
behavior
o Economic models help organize and interpret data
A. Using Economic Models
1. Economic models focus on a limited number of variables; they are
based on assumptions and use simplification
2. ★
B. Using Charts and Tables
1. Economists look for statistical relationships, trends, connections.
2. Charts and tables display data in rows and columns; they can reveal
patterns by showing numbers in relation to other numbers.
C. Using Graphs
1. Graphs use two sets of variables: along horizontal, vertical axes
a. Line graphs useful for showing changes over time. In economics,
line referred to as a curve, even if straight
b. Bar graphs good for showing comparisons
c. Pie graph (or pie chart, circle graph) shows numbers in relation
to whole
2. ★
VI. Fields of Economics

KEY CONCEPTS
o Microeconomics — studies behavior of individual players in an
economy. It includes individuals, families, businesses.
o Macroeconomics — studies behavior of economy as a whole. Topics
include inflation, unemployment, aggregate demand and aggregate
supply.
o Positive economics describes and explains economic behavior as it is.
Positive economics uses verifiable facts; does not make judgments.
o Normative economics studies what economic behavior should be.
Normative economics makes value judgments to recommend future
actions.
A. Microeconomics and Macroeconomics
1. Microeconomics examines ★
a. Subjects of study include prices, costs, profits, competition,
consumer and producer behavior
b. Some Topics of Interest: business organization, labor markets,
environmental issues
2. Macroeconomics studies sectors —★
a. Subjects of study include consumer, business, public or
government sectors
b. Topics of interest include national or global topics: monetary
system, business cycle, tax policies, international trade
B. Positive Economics and Normative Economics
1. ★
a. observe data, hypothesize, test, refine, continue testing
b. Statements tested against real-world data to prove (or strongly
supported) or disprove (or strongly questioned) questions.
2. Normative Economics studies facts, asks if course of action is good. ★
People and ideas in Economics
Adam Smith: Founder of Modern Economics

An Inquiry into the Nature and Causes of the Wealth of Nations, 1776
o challenged mercantilism; argued for free trade

Invisible hand guides free marketplace, benefits sellers and buyers
o ★
o producers sell at prices that satisfy them and that consumers will pay
Economics & Choice
3. Economic Systems
In his book Utopia, 16th-century writer St. Thomas More describes a society without
scarcity, where wants are limited and easily fulfilled. It is no accident, however, that the
word utopia means “no place” in Greek. In the real world, scarcity is a fact of life. To
address scarcity, societies must answer three questions: What should be produced?
How should it be produced? For whom will it be produced? A society’s economic
system the answers to these three questions. Although every country today uses a
mixture of economic systems, some mixed systems provide more economic and
political freedom and create more wealth than others.
This section corresponds to Chapter 2: Sections 1-4.
OBJECTIVES
07. Identify and differentiate the three types of economic systems.
08. Analyze the circular flow model in a market economy.
09. Explain why modern economies are becoming increasingly global.
VII. Types of Economic Systems

KEY CONCEPTS
o Economic system—how society uses resources to satisfy people’s
wants.
o Three basic systems: traditional, command, and market economies.
o Mixed economies have features of more than one system.
A. TYPE 1: Traditional Economy: centers on families, clans, or tribes
1. Decisions are based on customs and beliefs. Everyone has a set role,
and there is no chance of deviating from pattern. They tend to be
inefficient and do not adapt to change.
2. Early societies all had traditional economies. Traditional systems help
societies survive. ★
3. Advantages and Disadvantages
a. Advantages: little disagreement over goals, roles, or methods of
production. Distribution of resources are determined by custom.
b. Disadvantages: as result of resistance to change, they are less
productive, resulting in a low standard of living. Traditional
economies do not use new methods, and people are not in jobs
they are best suited to do.
4. Many traditional economies are under pressure to change. EXAMPLE:
Kavango people of Namibia lived as subsistence farmers for centuries, but
modern telecommunications brought Kavango images of outside world.
Most are still subsistence farmers, but a few have turned to commercial
farming. Now, thousands have abandoned their traditional life and lands,
moving instead to cities.
B. TYPE 2: Command Economy: government makes economic decisions, such
as what to produce; how to produce; who gets products. The government owns
and/or controls means of production: resources and factories.
1. ★
2. Centrally planned economy—central government makes all decisions. It
decides for whom to produce in part by setting wages. Only some people
have money to buy available products.
3. Government Planning: In all societies, government exerts some control
over people’s lives. But in a centrally planned economy, government
exerts great control. It determines businesses to operate, amount
produced each month; it determines who is employed, work hours, pay
scales
4. Socialism and Communism: Karl Marx influenced some societies to
adopt command economies.
a. Socialism— ★
b. Communism—There is no private property and little political
freedom. ★
c. Democratic socialism established under democratic political
process, where government owns basic industries, but other
industries are privately owned. Central planners make decisions for
government-owned industries, and may control other sectors such
as health care or transportation.
5. Today, there are no pure command economies. Modern
telecommunications are bringing about change. Some economies still
have mostly command elements. EXAMPLE: North Korea. Communist
North Korea used resources for military, not necessities. They built large
army; nuclear weapons program. In 1990s and early 2000s, millions died
of hunger, malnutrition. In 1990s, production decreased and economy
shrank. Since 2003, some market activity allowed
6. Impact of Command Economies: In theory, command systems are fair
to everyone; in practice, there are many disadvantages.
a. ★
b. Workers have little motivation to be productive or conserve
resources.
c. Artificially low prices lead to shortages.
d. People are sacrificed to carry out centrally planned policies.
C. TYPE 3: Market Economy: driven by choices of consumers and producers.
Consumers spend money, go into business, sell their labor as they wish.
Producers decide how to use their resources to make the most money. ★
1. Market—The place or situation where people buy and sell goods,
services.
2. Private property rights are the rights to own businesses and resources,
including material objects, money, intellectual property, and labor. The
rights are defined and protected by law.
a. Buyers must be sure that the sellers have the right to sell
products they offer.
b. Sellers must be sure they will be paid for their products.
3. Market economies prefer to work limited government involvement.
Called “Laissez faire”, it promotes the belief that government should not
interfere in economy. ★
4. Voluntary exchange—traders believe they get more than they give up.
In market economy, most trade is exchange of product for money to earn
profit—financial gain from business transaction.
5. Competition and Consumer Sovereignty
a. Competition—sellers’ try to get business by offering the best
deal. Competition for self-interest from both parties.
b. Consumer sovereignty—buyers choose products, control what is
produced. Sellers offer low price or high value to please consumers
and (hopefully—W) make a profit.
6. Market economies encourage specialization, where people concentrate
their efforts in the activities they do best. ★
VIII. Circular Flow in Market Economies

KEY CONCEPTS
o The circular flow model illustrates how interactions occur in a market
o It represents the two key decision makers: households, businesses,
and shows the markets where households and businesses meet
A. Circular flow model shows how market economies operate. Outside arrow
shows flow of money. Inside arrow shows flow of resources and products.
B. Product Markets are where goods and services bought and sold. ★
C. Factor markets are for the factors of production: land, labor, capital, and
entrepreneurship. In the factor market, individuals own all factors of production.
They own some outright, such as labor; and some indirectly, such as stocks.
Here, individuals are producers; businesses are customers.
IX. Modern Economies

KEY CONCEPTS
o Late 1940s to early 1990s, many countries had command systems.
e.g., U.S.S.R., Eastern Europe, China, much of SE Asia, Cuba, North
Korea. Most of these countries have now adopted market systems.
The remaining communist countries using some market measures.
o Traditional, command, market economies adopt elements from each
other. The mixed economy, with elements of all three, is most common
type of economic system.
o Economies change in response to natural, social, political changes.
For instance, East European economies changed after fall of
communism.
A. Modern Market Economies
1. Advantages
a. Individuals free to make economic choices and pursue their own
work interests.
b. Less government control means more political freedom and less
bureaucracy.
c. Locally made decisions are more productive and efficient
d. Profit motive ensures resources used efficiently, rewards hard
work; ★
2. Disadvantages
a. ★
b. During U.S. industrial boom, business owners rich, workers low
pay, and businesses did not address problems caused by
industrialization.
c. Industrialized societies allow some government controls.
B. Today’s Mixed Economies
1. ★
2. Many European countries greater mix of market and command
elements
a. France—government controls some industries; provides social
services
b. Sweden—state owns part of all companies; lifelong benefits, high
taxes
c. Namibia—traditional; state supports market, foreign investment
C. Trends in Modern Economies
1.TREND 1: Changes in Ownership: ★
a. To nationalize is to change from private to government
ownership
b. To privatize is to change from government to private ownership
2. TREND 2: Increasing Global Ties: Growth of global economy—
economic actions across national boundaries
a. recent agreements open up world markets to trade among
countries
b. fast, safe, cheap transport of resources, products eases
distribution
c. phone, computer links make financial transactions quick,
inexpensive
d. ★
People and ideas in Economics
Karl Marx: Economic Revolutionary with a new view of economics


Marx lived during Industrial Revolution, and argued that factory owners used
workers as resource, exploiting them by keeping wages low to increase
profits.
★

Marx wrote The Communist Manifesto (with Friedrich Engels), Das Kapital
Economics & Choice
4. The American System
Free enterprise is all around you, from huge suburban malls to industrial developments
to neighborhood corner stores. Think about ways that the American economic system
affects your day-to-day life. Consider where you shop, what you buy, where you work,
and what you do there. What do you think allows this huge economic engine to run?
This section corresponds to Chapter 3: Sections 1 and 2.
OBJECTIVES
10. Identify the legal rights that safeguard the free enterprise system in the United
States.
11. Analyze how producers and consumers affect the system.
12. Analyze a circular flow model of the U.S. economy.
X. The American Free Enterprise System

KEY CONCEPTS
o Free enterprise system is another name for capitalism. This name is
used because anyone is free to start a business or enterprise.
A. The American free enterprise system is based on the idea of freedom:
producers and consumers are free to pursue their economic self-interest. Certain
legal rights have been established to protect and encourage this freedom.
1. Open opportunity— ★
2. Legal equality— ★
3. Free contract— ★
B. System gives right to own and exchange private property voluntarily
XI. Buyers and Sellers

KEY CONCEPTS
o Profit motive, the incentive to gain from economic activities, motivates
people to start a business.
o Profit is the money left after production costs subtracted from sale
price.
A. Going into business
1. Profit motive is the incentive that encourages people and organizations
to improve their material well-being by seeking to gain from economic
activities.
2. Producers, motivated by profit, seek the highest possible price for their
products. Competition offsets the drive to earn profits, since it forces
prices down.
3. This helps producers find a price that is not so high that it deters buyers
and ★
B. The Roles of Producers and Consumers: Consumers try to get the best deal
for their money, while producers try to earn the most profits.
1. When producers seek opportunities to earn profits, they help allocate
scarce resources in the economy. The money they spend to develop their
business might otherwise be used in other ways—so, ★
2. When consumers choose to buy a product, they are “voting” for their
choice against competing products. These “votes” help determine what
will be produced in the future, since producers, seeking opportunities to
profit, try to provide what consumers want.
XII. Circular Flow Model: The Government in the US Economy

KEY CONCEPTS
o Government is an important element in the American economic
system, but its role is relatively limited.
o A modified free enterprise economy includes some government
protections, provisions, and regulations to adjust the free enterprise
system.
A. The government has an important, but with limited, role in U.S. economy.
1. Modified free enterprise economy: A mixed economy, including some
government protections, provisions, regulations to adjust capitalism.
2. ★
a. as consumer, buys factors of production in resource market
b. as consumer, buys products in product market
c. as producer, provides goods and services to businesses,
households
d. collects taxes in payment, uses these to pay for resources,
products
B. The government fits into the circular flow model of money moving between
businesses and households. ★
1. Households [right side] (owners of resources) and businesses [left side]
(makers of products) are the two main economic decision-makers. The
two markets in the economy, the product market (for goods and services)
and the factor market (for economic resources), are located at the top and
bottom of the chart. The outer green arrows show the flow of money. The
inner blue arrows show the flow of resources and products.
2. The government is a consumer in the resource market, spending
money to buy the factors of production. It is also a consumer in the
product market, spending money in exchange for products.
3. Arrows run between government and households, and government and
business firms.
a. Government is a producer here, ★
b. Government collects money from households and businesses, in
the form of taxes, as payment for these goods and services. It
covers the costs of what it produces with this money.
c. Government also uses this money to make purchases in the
resource and product markets, ★
4. Government is a major consumer of both resources and products. All
levels of government, local, state, and federal, employ almost 22 million
workers—equal to about 16% of the labor force. Government
consumption—what all levels of government spend on goods and
services—is about two trillion dollars.
Economics & Choice
5. The Government’s Role
In the USA, most economic decisions are made in the marketplace through the
interactions of buyers and sellers. But some decisions are made in other levels of
government.
This section corresponds to Chapter 3: Section 3.
OBJECTIVES
13. Explain why governments provide public goods and infrastructure.
14. Explain how governments seek to decrease negative externalities and increase
positive externalities.
XIII. Providing Public Goods

KEY CONCEPTS
o Public sector—branches of government that make production
decisions
o Market failure—outsiders benefit from or pay for marketplace
interaction
o Public goods—products provided by government, consumed by public,
paid for or funded with taxes
o Free rider—person who benefits but does not pay for good or service
o Infrastructure—goods and services needed for society to function
A. The nature of Public Goods
1. Characteristics
a. ★
b. ★
2. Examples include street lighting and national defense. It is impossible to
determine the price or benefit per user.
B. There is no incentive for business to produce public goods—people will not
pay. This causes the “free rider” problem, ★
1. EXAMPLE: If you wanted to start a 4th of July Fireworks Show business
and charge admission for your events, you would have a hard time
collecting ticket fees, because people can easily watch your show for free
from somewhere else. They are free riders—they get to watch your show
without buying your ticket.
2. EXAMPLE: Law Enforcement is a free rider issue—if a neighborhood is
safe, everyone benefits, whether you pay for the policing or not. For both
policing and fireworks, the most obvious solution is to have the
government provide the services and distribute the cost through the tax
base.
C. Some matters are shared responsibilities between the Public & Private
Sectors. ★
1. EXAMPLE: Toll Roads are open to anyone, but people who do not pay
tolls can be excluded from the road.
2. EXAMPLE: Infrastructure like water and sewer services, utility
companies, health care, fire and ambulance coverage, garbage collection,
etc.
XIV. Managing Externalities

KEY CONCEPTS
o Externality—side effect on someone other than producer or buyer
o Negative externality—people uninvolved in the transaction pay costs
o Positive externality—benefits people uninvolved in transaction
o Subsidy—government payment to help cover cost of economic activity
o Safety net—government programs designed to protect people from
economic hardship
A. Market failure occurs when ★
1. Governments try to limit negative externalities through regulations,
incentives, fees, and fines. EXAMPLE: Factory owners have little incentive
to pay to cut industrial pollution. It is the people of region who pay cleanup
cost, have illnesses, and medical bills. So governments attempt to limit
negative externalities through taxes and fines, offsetting medical costs,
and providing incentives to reduce pollution.
2. Governments try to increase positive externalities through methods like
subsidies. EXAMPLE: Spreading Positive Externalities. A new college
benefits local businesses and the community as whole. Or, governments
may make subsidies to drug company to make flu vaccines, yielding fewer
sick people.
B. One of the limitations of free enterprises is that people who are unable to
contribute do not have access to all economic opportunities. ★
1. Transfer Payments redistribute income by moving income from person
or group to another. The recipient does not provide product in return.
EXAMPLE: if your grandmother gives you money for your birthday, you
receive a transfer payment.
2. Public transfer payments are made by governments with tax money.
Most public transfer payments in area of social spending. They usually go
to poor, aged, disabled, or people who lose their jobs.