What is Economics?
Chapter 1
SECTION 1
The Foundation of Economics
People have unlimited WANTS - things they desire to
have.
• They want the things they think will make them
HAPPY and SATISFIED.
RESOURCES are needed to produce the goods and
services that people want.
The resources available to satisfy our wants are LIMITED.
• In other words, people’s wants are GREATER than
the limited resources available to satisfy all the
wants.
• This condition is called SCARCITY (one of the most
important fundamental economic concepts).
• Scarcity Means Making Choices
• Scarcity exists because wants are UNLIMITED
and resources are LIMITED.
•Therefore, people must make CHOICES.
• Four examples of “wants” that exist in society.
•
•
•
•
HEALTH CARE FOR EVERYONE
REDUCED CRIME
BETTER SCHOOLS
A CLEAN ENVIRONMENT
We must
choose which wants we will try to
satisfy and which wants will be left
unsatisfied, as individuals and as
societies.
• It takes resources to bring these things about.
Making Choices Means Incurring Opportunity Costs
• Every CHOICE we make has on opportunity
cost.
•
OPPORTUNITY COST is the most VALUABLE opportunity or
alternative you give up to do something.
• Another word for opportunity cost is TRADE-OFF. This means that
you can get more of one good only by giving up another good.
EXAMPLES: Big Bang Theory, Extreme
Couponing, Whiplash, Moneyball
Make it your own!
One Diagram, Three Economic Concepts
A PRODUCTION POSSIBILITIES FRONTIER
(PPF) shows ALL possible combinations of TWO
goods that an economy can produce in a certain
period of time.
• If this economy produces 40,000 skis per year, how many snowboards can it
produce?
• If this economy produces 50,000 snowboards per year, how many skis can it
produce?
Any point on the PPF itself (A-D in the example) is AVAILABLE to us.
We can also have the combination of goods represented by any point
BELOW the PPF, such as point _____.
Because resources are limited, we don’t have enough to produce at point ___
which is BEYOND the PPF.
If we narrow our choices to only points B and C. Then we make a final
decision to produce at point B, what is the opportunity cost of a set of skis
over this range? ________
A Consequence of Scarcity: The Need for a Rationing Device
• A RATIONING DEVICE is a way to decide WHO
gets what portion of all resources and goods
available and how MUCH each gets.
• The most common way to determine this in our society
is by price (the most widely used rationing device).
• By using price, all products are rationed out to the
people who are WILLING and ABLE to pay.
• If SCARCITY did not exist, a rationing device would not
be necessary because everyone would get everything
he or she wanted.
Another Consequence of Scarcity: Competition
Economists believe that COMPETITION exists because of
scarcity.
Competition means people try to get more of the rationing
device. In other words, people will compete to earn
DOLLARS/MONEY (price).
A Definition of Economics
Economics is the science that studies the choices of
people trying to satisfy their wants in a world of
SCARCITY.
Economics is the study of how people use their limited
RESOURCES to satisfy their unlimited WANTS.
Applying the Principles
6.
How does this PPF illustrate the concept of
opportunity cost?
When an economy increases the
production of one good, it must give
up other goods. In this case, if the
economy chooses to produce more
guns, it must give up some butter; if it
chooses to produce more butter, it
must give up some guns.
7.
If the economy is presently producing 0 units of guns
and 15 units of butter, what is the opportunity cost of
increasing the production of guns from 0 units to 3
units?
The opportunity cost of 3 more units
of guns is 1 unit of butter.
8.
If the economy is presently producing 12 units of
guns and 4 units of butter, what is the opportunity
cost of increasing the production of butter from 4
units to 11 units?
The opportunity cost of 7 more units
of butter is 4 units of guns.
A society makes choices that determine how it will allocate its resources between
guns and butter. For each of the events in questions 12-16, circle either guns or
butter to indicate whether the event would cause a shift along the PPF toward
producing more guns or toward producing more butter.
12. After World War I, America pursues a policy of “return to normalcy” and
defense spending is cut.
Shift towards GUNS or BUTTER
13. America enters World War II.
Shift towards GUNS or BUTTER
14. The Cold War escalates and the number of nuclear warheads increases.
Shift towards GUNS or BUTTER
15. After the prosperous 1990s, the terrorist attacks of September 11, 2001, led
the United States into wars in Afghanistan and Iraq and to increased
spending on homeland security.
Shift towards GUNS or BUTTER
SECTION 2
The Economic Way of Thinking
Thinking in Terms of Costs and Benefits
A person will want to do a particular activity only
if the benefits are greater than the costs. Weighing
the costs and benefits of a decision is a process called costbenefit analysis.
The word marginal, in economics, means additional.
• Suppose that your lunch costs $5, and that you are
considering buying a soda to go with your lunch. This soda
will have a cost that is in addition to your $5 meal. The
additional cost is called the marginal cost.
Thinking in Terms of Incentives
Economists use the word incentive to describe something
that encourages or motivates a person to take action.
• For example, if your parents offer you $10 to mow the
lawn, the incentive, the $10, may motivate or encourage
you to mow the lawn.
• Incentives are important because human choices
are influenced by economic incentives.
Thinking in Terms of Trade-Offs
Individuals face trade-offs. More of one thing necessarily
means less of something else. Often you make decisions
between something you like and something you dislike. What
trade-offs have you faced today?
Societies also face trade-offs.
• For example, the federal government has only so much
money from tax revenues. If more of its tax dollars go to
education, fewer are available to be spent on road and
highway maintenance. What other types of trade-offs might
the government consider when determining if more tax
dollars should be spent on education?
• Answers: health care, defense, etc.
Thinking in Terms of What Would Have Been
When you think in terms of “what would have been,” you begin to
understand the opportunity costs for “what is.”
It takes a certain kind of vision to see what would have been, using your
mind, and not your eyes.
• For example, suppose the federal government sets aside funds for a new
interstate highway system. Thousands of people are hired to work on
the project, and the benefits are easy to see—more jobs and better
roads.
• However, there is more than meets the eye in this scenario. The
taxpayers had to pay for the new highway system. What did the
taxpayers give up by paying taxes to fund the new highway? They gave
up the opportunity to buy goods for themselves, such as clothes,
computers, and books.
• What would have been produced and consumed had the highway not
been built? If more computers had been produced instead of highways,
more people would have worked in the computer industry and fewer
would have worked in highway construction.
Thinking in Terms of Unintended Effects
Economists often look for the unintended effects of actions
that people have taken.
• If a store owner increases prices, will he necessarily make
more money? Often an attempt to increase sales, by
increasing prices, can lead to the unintended effect of fewer
sales.
Thinking in Terms of the Small and the Big
Economics is divided into two branches: microeconomics and
macroeconomics.
Microeconomics is the study of the small picture, such as
the behavior and choices of individuals or a single business or
industry. For example, in microeconomics, an economist
would study and discuss the unemployment that exists within
an industry, such as the auto industry.
Macroeconomics is the study of the big picture.
Economists studying macroeconomics may look at the
behavior and choices of the entire economy. To continue our
example, in macroeconomics, an economist would study the
unemployment that exists in the entire nation.
Two Major Branches of Economics
Thinking in Terms of Theories
Why is the crime rate higher in some countries than in other countries?
What causes some nations to be rich and others to be poor? These questions
do not have easy, obvious answers. To answer them, economists build
theories.
• A theory is
an explanation of how something works,
designed to answer a question for which there is
no obvious answer.
• Theories may not always seem reasonable.
• Suppose you lived during the period of the Roman Empire and
someone proposed to you that the Earth was round. At that time
many would have thought this was an unreasonable theory, but
today most everyone would agree that the Earth is indeed round.
• Scientists believe that we should evaluate theories based not on how
they sound to us, or whether they seem right, but on how well they
predict. If they predict well, then we should accept them.
Applying the Principles
Incentives
Economics - CHAPTER 1, SECTION 2
Most of economics can be summarized in four words: People respond to incentives.
-Steven Landsburg, economist
Governments use economic incentives to influence the behavior of citizens in a way that
benefits society. They create incentives through laws and through taxes.
For example, a government could pass a law prohibiting children from purchasing a product
meant for use by adults. Such a law would make it difficult for children to obtain the product.
A government could also place a tax on a certain good to discourage its use. Such a tax would
increase the cost of the good. For some people, the cost would then be greater than the
benefit, and these people would decrease their consumption of the good.
A government could give tax benefits to encourage an activity. For example, it might provide
a credit by giving taxpayers back a portion of a tax, or it might provide a deduction by
allowing taxpayers to subtract a certain amount from their income before calculating their
taxes. Such a credit or deduction would reduce the cost of the activity. For some people, the
benefit will then be greater than the cost, and these people would increase their participation
in the activity.
For each of the goals in questions 1-6, think of a government incentive that
accomplishes the goal.
EXAMPLE
Goal: Decrease the consumption of alcohol.
Incentive:
The government taxes the manufacture and sale of alcohol. Such taxation increases the cost of alcohol. For some
people, the cost is now greater than the benefit, and these people have decreased their consumption of alcohol.
1. Goal: Decrease smoking.
Incentive:
The government has passed a law that requires people to be 18 years old to purchase
cigarettes. Many cities have passed laws that restrict smoking in public areas. The
government uses taxes to discourage smoking.
2. Goal: Increase the level of education.
Incentive:
The government requires children to attend school and subsidizes the cost of education.
The government gives tax benefits to help pay for education.
3. Goal: Increase the rate of private home ownership.
Incentive:
The government allows homeowners to deduct the interest on home (mortgage) loans
from their income before calculating their income tax. The government regulates many
aspects of the buying process to protect consumers.
4. Goal: Decrease the consumption of fuel oil.
Incentive:
The government taxes gasoline at a higher rate than it taxes most other goods. The
government gives tax incentives for the purchase of efficient hybrid vehicles, which use
less gasoline.
5. Goal: Increase the rate of personal spending.
Incentive:
The government offers various retirement savings plans that allow income to be exempt
from taxation if it is saved until after the taxpayer retires.
6. Goal: Increase donation to charities.
Incentive:
The government allows givers to deduct from their income taxes at least some of what
they donate to charities.
Refer to the goals and incentives in questions 1-6 as you answer questions 7 and 8.
7. What is the trade-off of using tax benefits as incentives?
Tax benefits could reduce tax revenues and that reduction can lead to
higher taxes in other areas, fewer services in other areas, or budget
deficits.
8. Could any of these incentives have unintended effects? Give a specific
example.
An increase in taxes on alcohol or cigarettes could create or expand
black (prohibited) markets for those goods. Also, as the number of tax
loopholes increases, the tax code becomes increasingly complex and
the opportunity for tax cheating increases.
SECTION 3
Basic Economic Language
Goods and Services
All things that people want can be classified as either tangible
or intangible. Something that can be felt by touch is a tangible
item, such as a book or a car. Something that cannot be felt by
touch is intangible. Friendship is intangible, as are knowledge
and experience.
A good is anything that satisfies a person’s wants or brings
satisfaction.
A good can also bring a person satisfaction or happiness, or
utility. The term disutility is used to describe something that
brings dissatisfaction or unhappiness.
Another example of a tangible good is a service. Services are
tasks that you pay other people—such as doctors, hair-stylists,
or car mechanics—to perform for you.
Resources
Goods and services cannot be produced without resources.
The resources used to produce goods and services fall into the
following categories: land, labor, capital, and entrepreneurship.
• Land includes all the natural resources found in nature. An
acre of land, mineral deposits, and water in a stream are all
considered land.
• Labor refers to the physical and mental talents that people
contribute to the production of goods and services.
• Capital is the produced goods that can be used as resources
for further production. Factories, machines, and farm
tractors are capital.
• Entrepreneurship is the special talent that some people
have for searching out and taking advantage of new
business opportunities and for developing new products and
new ways of doing things.
What is the difference between entrepreneurship and labor?
Entrepreneurship is different from labor in that the ordinary
mental and physical talents of people are considered labor. The
special talents and methods unique to an individual describe
entrepreneurship.
Applying the Principles
Resources
Economics - CHAPTER 1, SECTION 3
Use the following key to label each of the resources in questions 24-39 as land, labor, capital, or
entrepreneurship. If a resource is land, identify it as either renewable or nonrenewable. If a resource is
a capital good, identify it as either physical or human. (Hint: Physical capital is a tangible, human-made
resource-such as tools or machinery-used to produce other goods and services. Human capital is the
knowledge and skills a worker gains through education and experience. )
1. coal
Ld-n
2. telephone
C-p
3. natural gas
Ld-n
4. computer
C-p
5. truck driver
Lbr
6. accountant
Lbr
7. forklift
C-p
8. oak trees
Ld-r
9. Corn
Ld-r
10. education
C-h
11. Bill Gates
E
12. cotton
Ld-r
13. gold
Ld-n
14. hammer
C-p
15. Henry Ford
E
16. lawyer
Lbr
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