Economic Decision Making - BIG RED LIVE - Home...stadiums, the Rolling Stones had to make decisions...

Economic Decision MakingWhy can’t you always get what you want?

Vocabulary

Glossary Vocabulary Cards

goods

services

factors of production

entrepreneurship

capital

productivity

opportunity cost

production possibilities frontier (PPF)

Introduction

E C O N O M I C D E C I S I O N M A...

2020 Teachers' Curriculum Institute Level: A

Before they sold outstadiums, the Rolling Stoneshad to make decisions aboutwhich career to pursue.

Since the 1960s, the Rolling Stones have been considered one of themost iconic musical acts in the world. Many of their songs still remainpopular, several decades after they were released. Rolling Stonemagazine even listed one of the band’s songs “You Can’t Always GetWhat You Want” as one of the greatest songs of all time. As simple as itsounds, the title explains why everyone has to make choices—evenMick Jagger, Keith Richards, and the other members of the self-styled“Greatest Rock and Roll Band in the World.”

What you may not know about Michael Philip Jagger is that he was oncea student of economics. Born into a middle-class family in Dartford,England, Jagger was raised to be a teacher like his father, earning highenough marks in school to win a scholarship to the prestigious LondonSchool of Economics.

Jagger was studying accounting and finance in 1961 when a chancemeeting with Keith Richards, a boyhood friend, changed his life. “So Iget on the train to London one morning, and there’s Jagger and underhis arm he has four or five albums,” Richards later recalled. “He’s gotChuck Berry and Little Walter, Muddy Waters.”


Level: A 2020 Teachers' Curriculum Institute

Jagger invited Richards to join a few of his friends who played musictogether for fun. Once Richards did so, life began to change. “You couldfeel something holding the band together,” a friend observed. “Keithsounded great.” This worried Jagger’s mother, who had noticed thatafter teaming up with Richards, her son had begun to think of music asmore than just a hobby. A year after this meeting, a new R&B bandbilling itself as the Rolling Stones began to appear in London clubs.Then, in 1963, the Stones released their first record. Jagger now faced adifficult choice: finish his degree or drop out of college to pursue acareer in music. He later said of his decision,

It was very, very difficult because my parents obviouslydidn’t want me to do it. My father was furious with me,absolutely furious. I’m sure he wouldn’t have been so madif I’d have volunteered to join the army. Anything but this.He couldn’t believe it. I agree with him: It wasn’t a viablecareer opportunity.

Despite his parents’ misgivings, Jagger chose music—and the rest, asthey say, is history.

This lesson is about the choices and decisions we all face in our lives. Itexplores why, as the song says, we can’t always get what we want.And, it looks at how we can use the economic way of thinking to decidewhat we want most and what we are willing to give up to get it.

1. Why Is What We WantScarce?Every time we go shopping, most of us come up against the hard truththat we can’t always get what we want. But why is this so? Why do anyof us have to choose at all?

Our Wants Always Exceed Our Resources The simple answer tothat question is that our wants—our desire for things that meet ourneeds or make us happy—are unlimited, while our means of fulfillingthose desires are not. Some of our wants are necessary for survival.Each of us, for example, needs food, water, and shelter to survive fromday to day. However, beyond those basic necessities, what we desire tohave, use, or experience is limited only by our imaginations.

Although our wants may be unlimited, our ability to satisfy them is not.We have only finite amounts of resources at our disposal. Time, for



example, is a limited resource. Whether rich or poor, a person has only24 hours available each day. Money is also limited. Even the very richcan’t afford an endless supply of everything. They, like the rest of us,experience scarcity, a situation in which the supply of something is notsufficient to satisfy their wants.

With Resources Limited, Scarcity Is Everywhere It is hard formost people to see scarcity the way economists do. You may shop instores that are overflowing with goods, or physical objects producedfor sale. You might look around your classroom and see that nearlyeveryone has paper and pencils. Many, if not all, of your classmateshave cell phones. How can these goods be scarce if everyone seems tohave them?

Similarly, most of us have access to a multitude of services, oractivities done for us by others. Teachers, doctors, hair stylists, busdrivers, plumbers, nurses, and police officers all provide services wetake for granted. Some are even offered to us without charge. So, howcan economists see these services as scarce?



It may seem like cell phones are an unlimited good because almosteveryone has one and there are constantly new cell phone releases.However, the materials and labor needed to build them are scarce,which makes phones scarce as well.



During Atlantic hurricaneseason, many stores sell outof bottled water as peoplestock up to prepare for anincoming storm. During thistime, scarcity is a visible andinescapable fact of life.

And yet, goods and services are scarce. They are scarce because theresources needed to produce them—land, labor, materials, andmachines—are scarce. Should you doubt that this is true, try askingsomeone who owns one of these resources to turn it over for free. Theanswer will almost surely be no.

Scarcity would exist even if everyone in the world suddenly becameextremely wealthy. Suppose every new multimillionaire wanted to buildan elegant mansion to live in. Could they all do so? Probably not. Whileone essential resource for such a project (money) is now less scarce,other essential resources (such as land, lumber, concrete, glass, skilledworkers, and time) are still just as scarce.

Shortages Are Temporary, While Scarcity Is Forever Whilescarcity may seem like an abstract idea, most of us have experienced ashortage. A shortage is a lack of something that is desired, a conditionthat occurs when there is less of a good or service available thanpeople want at the current price. When a venue runs out of concerttickets while the band is performing in that city, the result is ashortage.

Shortages occur for many reasons. A fashion fad can cause a shortageby suddenly increasing the number of people who want to buy thetrendy item. The shortage lasts until either enough items are producedfor everyone who wants them or the fad ends.



Wars and natural disasters can cause shortages by disrupting theproduction or movement of goods. Each year before the Atlantichurricane season, for example, people prepare for it by buying bottledwater. However, because so many people are trying to buy water at thesame time, many stores often completely sell out. Some people have torely on donations to get the water they need.

Shortages are usually a temporary condition, however. A shortage endsonce production is resumed or new sources of supply are found. Incontrast, scarcity is forever. No matter how well people use their limitedresources, there will never be enough.

2. How Do We Satisfy EconomicWantsTake a quick break from reading and let your eyes wander aroundwherever you happen to be just now. What do you see? Walls, windows,furniture, books, desks, paper, pens, pencils . . . the list could likely goon and on. None of these goods magically appeared at this moment foryour comfort and convenience. All of them were produced to satisfysomebody’s wants. The question is, how is this done?

Inputs, Outputs, and the Production Equation Economistsanswer this question by looking at the inputs and outputs of theproduction process. Inputs are the scarce resources that go into theproduction process. Economists call these productive resources thefactors of production and divide them into three basic categories:land, labor, and capital. Outputs are the goods and services producedusing these resources. Economists use the production equation torepresent the process of combining resources (inputs) to produce goodsand services (outputs). In its simplest form, the production equationlooks like this:

land + labor + capital = goods and services

Some economists consider entrepreneurship—the willingness to takethe risks involved in starting a business—to be a fourth factor ofproduction. Entrepreneurs are people who assemble the other inputsto create new goods and services.

Land Resources: The “Gifts of Nature” As seen by economists,land is far more than real estate. It means all of the natural resourcesthat are used to produce goods and services. These resources include



familiar natural resources as air, soil, minerals, water, forests, plants,animals, birds, and fish. Others are less obvious, such as solar energy,wind, geothermal energy, and the electromagnetic spectrum used totransmit communication signals.

The company that owns thisoil field is harvesting bothnonrenewable and renewableenergy resources. The oilbeing pumped out of theground cannot be replaced.In contrast, the wind drivingthe turbines that generateelectricity will never be usedup.



Natural resources vary in their abundance and availability. A few, suchas sunlight and wind, are perpetual resources that are both widelyavailable and in no danger of being used up. Others, including forests,fresh water, and fish, are renewable resources that, with carefulplanning, can be replenished as they are used. A few resources, mostlymetals, can be recycled for use again and again. Still others, especiallyfossil fuels such as oil, coal, and natural gas, are nonrenewableresources. Once they are used, they are gone forever.

The value of natural resources depends on someone knowing how toincorporate them into the production process. Vast pools of oil have lainunder the surface of Earth for millions of years. But until someonedeveloped the tools and technology needed to extract that oil fromdeep under the ground and turn it into a useful fuel, it had little value.

Labor Resources: Putting Human Capital to Work The time andeffort people devote to producing goods and services in exchange forwages is called labor. This includes both physical labor, such asplanting crops and building houses, and mental labor, such as writinglegal briefs and programming video games.

The quantity of labor available in a country depends on the size of itspopulation and people’s willingness to work. The quality of that labordepends on how skilled these workers are, otherwise known as humancapital. Human capital is the knowledge and skill that people gainfrom education, on-the-job training, and other experiences. “It is whatyou would be left with if someone stripped away all of your assets,”says author Charles Wheelan, “and left you on a street corner with onlythe clothes on your back.”

The importance of human capital is almost impossible to overstate.Workers with high human capital are more productive and earn moremoney than those with fewer skills. This is why an airline pilot makesmore money than a taxi driver even though they offer similar services.Airline pilots not only require much more intensive training, but theyalso move more people across further distances per day than docabbies.



Figure 2.2AThe common pencil is produced by assembling natural resources frommany parts of the world. The resources that come from plants arerenewable. The mineral resources— zinc, copper, pumice, clay, andgraphite—are not.

There is a strong correlation, or relationship, between a country’slevel of human capital and its standard of living. A country like Japan,which is poor in resources but rich in human capital, can be among theworld’s wealthiest nations. In contrast, the correlation between acountry’s natural resources and living standards is weak. For example,Nigeria, which is rich in oil but poor in human capital, has a very lowstandard of living.

Economist Gary Becker, who won a Nobel Prize for his work in humancapital, estimated that about 75 percent of the wealth of a moderneconomy consists of the education, training, and skills of its people.“We really should call our economy a ‘human capitalist economy,’ forthat is what it mainly is,” he said. “Indeed, in a modern economy,human capital is by far the most important form of capital in creatingwealth and growth.”

Capital Resources: Tools, Machines, and Buildings When mostAmericans use the word capital, they are thinking about money thatthey could invest in stocks, bonds, real estate, or businesses to producefuture wealth. Economists sometimes refer to money used in this way



as financial capital.

To an economist, however, money by itself does not produce anything.What matters in the production process are the tools, machines, andfactory buildings that money can buy. To avoid confusion, theseconcrete productive resources are sometimes called physical capitalor capital goods.

Looked at this way, capital consists of the tools, machines, andbuildings used in the production of other goods and services. That lastpart—used in the production of other goods and services—matters. Ifyou buy a car to drive to school and social events, it is a consumergood. If you buy a car to deliver pizzas for a restaurant, it is a capitalgood.

Figure 2.2BSince 1940, this country’s human capital—as measured by formalschooling—has increased steadily. Americans with college degrees canexpect to earn at least one million dollars more over their lifetimesthan high school graduates.

Capital takes a surprising number of forms. It includes tools as simple



as a screwdriver to technology as complicated as a supercomputer.Factories, office towers, warehouses, bakeries, airports, and powerplants are forms of capital. So are roads, electrical grids, sewersystems, and the internet.

You can become anentrepreneur at any age.Facebook was created in2004 by Mark Zuckerbergwhile a student at HarvardUniversity. The site began asa networking site for Harvardstudents, but quicklyexpanded to include studentsat other schools, and then thepublic at large. By 2018,Facebook had over 2 billionactive users every month.



Since the beginning of the Industrial Revolution, capital has replacedlabor in one area after another. This process began in the textileindustry in England, where water-powered spinning machines andmechanical looms replaced spinners and weavers in the production ofcloth. More recently, ATMs and online banking have taken over manyservices once handled by bank tellers. Robots have replaced assembly-line workers in automobile assembly plants. Each advance in physicalcapital, however, has created new needs for labor. Now, employees areneeded to design, produce, and maintain the new machines.

Putting It All Together: Entrepreneurship Entrepreneurship is aspecialized and highly valued form of human capital. It involves thecombining of land, labor, and capital in new ways to produce goods andservices. Entrepreneurs perform several roles in the production process,including the four listed below.

Innovator. Entrepreneurs think of ways to turn new inventions,technologies, or techniques into goods or services that people will want.

Strategist. Entrepreneurs supply the vision and make the keydecisions that set the course for new business enterprises.

Risk taker. Entrepreneurs take on the risks of starting new businesses.They invest their time, energy, and abilities— not to mention their ownand often other people’s money—not knowing whether they willsucceed or fail.

Sparkplug. Entrepreneurs supply the energy, drive, and enthusiasmneeded to turn ideas into realities. As entrepreneur Nolan Bushnell,founder of Atari and Chuck E. Cheese’s Pizza Time Theaters, hasobserved,

The critical ingredient is getting off your butt and doingsomething. It’s as simple as that. A lot of people haveideas, but there are few who decide to do something aboutthem now. Not tomorrow. Not next week. But today. Thetrue entrepreneur is a doer, not a dreamer.

Working Smarter Boosts Productivity Because all three factors ofproduction are scarce, we will never be able to produce all of the goodsand services people might want. However, we can increase theproductivity of our economy by using these inputs more efficiently.Productivity is a measure of the output of an economy per unit ofinput. It is determined by dividing total output by one of the threeinputs involved in its production: land, labor, or capital.



productivity =

outputinput

Productivity is stated as a ratio of output per unit of input. For example,in measuring the productivity of a lumber mill, you would begin with itsoutput in a given period of time—in this case, the number of board feetof lumber produced in a week. You would then divide the output by oneinput, such as the hours of labor needed to produce that output. Themill’s productivity would be the ratio of board feet produced per hour.

Because productivity is a ratio of output to input, it can be raised in twoways. The first is by getting more output from the same inputs. In thecase of the lumber mill, this might be accomplished by organizing theproduction process in a more efficient manner. By doing so, the samenumber of hours of labor (one of the mill’s inputs) could produce moreboard feet of lumber (the mill’s output) each week.

The second way to raise productivity is by getting the same output fromfewer inputs. Looking again at the lumber mill, this could be done byfinding a way to get more board feet of lumber out of each tree that themill workers harvest. This improvement would enable the mill toproduce the same amount of lumber (its output) using fewer trees (aninput) and fewer workers to cut down the trees (another input).



In the guns-versus-buttertradeoff, societies have tochoose between security(“guns”) and civilian goods(“butter”). Most nations,however, try to find ways tobalance security and livingstandards.

3. What Do We Give Up WhenWe Make a Choice?Some decisions in life are easy. You probably don’t fret much overwhich option to choose from a school lunch menu. Other decisions areagonizing. Think back to the choice facing Mick Jagger when he realizedhe did not have enough time to both continue his studies and be thelead singer in a band. It was “very, very difficult,” he said later, sincehis parents wanted him to stay in college. But there was another reasonthis decision was so tough. In making his choice, Jagger had to give upsomething he valued (education) to get something he valued evenmore (a chance to become a rock star).

Maximizing Utility: What We Want When We Choose The wayeconomists see the world, people seek to make themselves as well offas possible by maximizing the utility of their decisions. They usuallydefine utility as the satisfaction or pleasure one gains from consuminga product or service or from taking an action. But utility is more thanthat. We also gain utility by making choices that, while not all thatpleasurable, are likely to improve our lives. Getting a vaccination orstudying for a test may not be your idea of fun, but both should makeyou better off in the long run.



Maximizing utility is seldom easy. Whether choosing which televisionprogram to watch or which college to attend, we seldom have enoughinformation to be absolutely sure we have made the best choice.

Tradeoffs: What We Give Up When We Choose Every decision wemake—even one as simple as deciding to read this text—involvesgiving up one thing for another. To gain time to read, you are giving upa variety of other things that you could be doing right now. Each ofthose other alternatives is a tradeoff.

Like individuals, businesses face tradeoffs as they try to maximize theutility of their land, labor, and capital. Suppose an automaker decidedthat it could best use all of its factories and workers to build pickuptrucks instead of cars. The tradeoff of its decision would be the loss ofits passenger car business.

Societies face tradeoffs as well. The classic example used byeconomists is the guns-versus-butter tradeoff, in which a society mustchoose between using its resources to produce guns (military goods) orbutter (civilian goods). The term allegedly originated during World WarI, when the American government had to decide to invest in either thewar effort abroad or local interests. If the society chooses guns, itmaximizes its security, but at the cost of lowering living standards. If itchooses butter, the society maximizes living standards, but at the costof reducing security.

Opportunity Cost: The Best Thing We Give Up to Get What WeWant You may have noticed that each decision made by a society inthe gunsversus- butter example involved a cost. The same is true forthe decisions you make. When you choose one course of action, youlose the utility, or benefits, of the alternatives you did not choose. Wereyou to rank those alternatives, one would likely stand out as moreattractive than the rest. While you might think of this option as yoursecond-best choice, an economist would see it as your opportunity cost.

The opportunity cost of any action is the value of the next bestalternative that you could have chosen instead. Whether you have 2alternatives or 200, your opportunity cost is simply the value of thenext best one. Similarly, the opportunity cost of the automobilecompany that decided to produce only trucks was the money it wouldhave made by continuing to produce passenger cars.

Understanding the opportunity costs of the choices you face every daycan help you make better decisions. Put yourself in this situation. Youare in charge of dinner tonight. You can order food in for $45.00 plus $7



for delivery. You can go out to a restaurant and pick up the foodyourself for $35.00 plus $3.00 for gas, but you will have to spend about30 minutes driving to the restaurant and back. Or, you can drive to thegrocery store and buy ingredients to cook dinner for $20.00 total.Between going to the grocery store, cooking dinner, and cleaning upafterward, you will have to spend another 2 hours with this option.

One way to sort through these alternatives is to lay them out on adecision matrix like the one in Figure 2.3. The matrix lists all of thealternatives involved in the decision as well as the criteria, or factors,that might be used in evaluating those alternatives. In this instance, thefactors are price, delivery cost, transaction time (how long it will takeyou to complete the purchase), and delivery time. The decision matrixdoes not tell you which alternative to choose, but it does clarify whatyou will gain and lose by choosing one over another.

After analyzing the alternatives, you decide you really do not want tocook. If you choose to get delivery, your opportunity cost is $14 youwould have saved by driving to pick up your food at a restaurant. If youchoose to drive to the restaurant, your opportunity cost is the 30minutes you spent driving. Knowing the opportunity cost of eachalternative still does not tell you what to do. That depends on the valueof $14 or 30 minutes of time to you. Should you have a better use forthat half hour, such as doing homework, you probably would be betteroff having food delivered. If not, you might decide that trading a halfhour of your time for a savings of $14 is the better choice.



Figure 2.3This decision matrix shows the tradeoffs associated with each of threepurchase alternatives.

Making “How Much” Decisions at the Margin Note that in thedinner scenario, you were not facing an all-or-nothing, “have dinner ordo without” decision. Instead, you were employing the thinking-at-the-margin principle by looking at the marginal utility of one purchasealternative over another. Marginal utility is the extra satisfaction orpleasure you will get from an increase of one additional unit of a goodor service. One alternative in the scenario left you with more timecompared to the others. Another left you with more money.



An understanding of marginal utility begins with the recognition thatthe amount of satisfaction we get from something usually depends onhow much of that something we already have. Suppose you are sothirsty after a workout that you buy yourself a large bottle of applejuice. The first glass provides you with a high level of utility byquenching your thirst. The second glass is still satisfying, but itsmarginal utility is less because you are no longer so thirsty. The third orfourth glass has less utility as your thirst disappears and your stomachfills up. The fifth glass, should you continue drinking, might have anegative utility by making you feel sick.

As this example shows, the marginal utility of something diminishes aswe accumulate more of it. This explains why a homeless person is morelikely to pick up a dollar bill off the sidewalk than a millionaire is. Thedollar has a relatively high marginal utility to a person with little or nomoney. Conversely, the marginal utility of an extra buck to a personwho already has a million dollars is relatively low. An economist wouldsee this difference in behavior as an example of the law ofdiminishing marginal utility. According to this law, as the quantity ofa good consumed increases, the marginal utility of each additional unitdecreases.

Most of the choices we face every day are “how much” decisions at themargin. Think back to the dinner example. How much more would yoube willing to pay to eat dinner without having to invest time in gettingit? How much time would you be willing to spend to eat dinner for less?Whenever you find yourself asking “how much” questions like thesewhile considering a choice, you are thinking at the margin.

4. How Can We Measure WhatWe Gain and Lose When MakingChoices?In 1719, novelist and journalist Daniel Defoe published what wouldbecome one of the great classics of English literature: The Life andStrange Surprising Adventures of Robinson Crusoe. The novel tells thestory of a sailor who spent 28 years marooned on a remote tropicalisland.

In the novel, Crusoe survives using whatever resources the island hadto offer. He becomes, in essence, a one-person economy. This makeshim the ideal subject for exploring an economic model used to measure



what we gain and lose when we decide how to use the resourcesavailable to us. Economists call this model a Robinson Crusoe economy.

Measuring Tradeoffs Using the Production PossibilitiesFrontier The production possibilities frontier (PPF) is aneconomic model, in the form of a line graph, that shows how aneconomy might use its resources to produce two goods. The graphshows all possible combinations of those goods that can be producedusing the available resources and technology fully. It also helps us seethe tradeoffs involved in devoting more resources to the production ofone good or the other.

Figure 2.4A shows a PPF for Robinson Crusoe’s one-person economy. Itfocuses on the production of two foods that Crusoe had access to whileon the island: coconuts and fish. In this hypothetical example, Crusoecan use the four hours he spends each day for food production bygathering coconuts or fishing. With the items at his disposal, he canharvest an average of 10 coconuts an hour in the forest or catch 10 fishan hour on the beach.

The sloping line on the graph shows the various combinations ofcoconuts and fish that Crusoe can produce in a day. That line, known asthe production possibilities curve , is straight in this simple case. Inthe more complex example you will look at next, the line bows outwardin a curve. This line is also called the production possibilities frontierbecause it represents the best that this economy can do with itscurrent factors of production. Without better tools (capital) or moretime devoted to food gathering (labor), Crusoe will never produce morethan any combination of coconuts and fish shown along the line graph.



Figure 2.4ASelkirk’s production possibilities frontier shows all the combination ofcoconuts and fish that his one-person economy can produce.• At Points A and E, Selkirk devotes his time to producing just onefood, either 40 coconuts or 40 fish.• At Point C, he divides his time evenly between coconuts and fish. Histradeoff compared to Point A is a loss of 20 coconuts in exchange for again of 20 fish.

Measuring Opportunity Costs Using the PPF A PPF can also beused to measure the opportunity costs of different production choices.Consider a hypothetical country that can use its resources to producejust two goods: cell phones and bananas. Its land can be used for cellphone factories, banana plantations, or some combination of both. Itsworkers can be trained to assemble phones, raise bananas, or both. Itscapital goods consist of assembly-line equipment, farm machinery, orsome of each.



Consider an economic model in which only two goods are produced:bananas and cell phones. What resources are needs to produce thegoods? How might the resources be allocated?

The graphs in Figure 2.4B show the different production possibilities forthis two-goods economy, depending on how the country’s resources areallocated. Notice the bowed-out shape of the curve in this PPF. Thisshape indicates that the tradeoffs in this economy are not the same atevery point on the curve. As a result, the opportunity cost—what thecountry gives up—when choosing to produce more of either goodchanges as one moves along the curve.

One reason for this might be that not all of the country’s land is equallywell-suited for bananas and factories. Banana trees planted on poorland may not produce well. Factories located far from city centers mayhave difficulty finding workers.

Another reason might be that the country’s workers are not equallywelltrained for banana and cell phone production. Suppose the countrydecides to increase its output of bananas. To do so, it would have tomove workers from its factories to its plantations. The factory workerswould arrive at the plantations with very different skills (such asknowing how to assemble electronic components) than the experiencedplantation workers. They therefore would likely be less productive thanworkers who have been growing bananas for some time.

Measuring Economic Efficiency Using the PPF The productionpossibilities frontier can also help us see how efficient our choices are.Economic efficiency is the result of using resources in a way thatproduces the maximum amount of goods and services. Every point onthe PPF represents an efficient use of resources to produce that specificcombination of outputs. But what if an economy does not use its



resources efficiently—or wishes to produce more than is currentlypossible given its resources? Both of those situations are illustrated inthe second graph of Figure 2.4B.

Every point in the shaded area inside the PPF represents a less efficient,but still attainable, production possibility. This reduced efficiency mightbe the result of a natural disaster or of a slowdown in the economy anda resulting rise in unemployment. Whatever the reason, within thisshaded area, the economy is not functioning at full efficiency. Everypoint outside the PPF represents an unattainable production possibility.The economy’s resources are already being used to the max in order toreach the points on the curve. Beyond those points, the economycannot produce more without added resources or improvements inefficiency.



Knowledge you gain fromyour education and fromwork experience help youbuild human capital.Maximizing your humancapital is one way to ensureyou can get what you need.

Reflecting Economic Change Using the PPF A PPF is a snapshot



of an economy’s production possibilities at a specific moment in time.In the real world, these possibilities are constantly changing aseconomic conditions change. Improvements in productivity might meanmore of one good can be produced using the same resources. Or theeconomy as a whole might expand or shrink. Both of these situationsare illustrated in Figure 2.4C.

When an economy grows, economists say that the PPF has “shifted tothe right.” Productivity increases, jobs are more plentiful, and livingstandards improve. Likewise, when an economy shrinks, the PPF “shiftsto the left.” Productivity falls, unemployment rises, and living standardsdecline. A number of factors can cause such shifts.

What is important to remember is that while you cannot always haveeverything you want, the decisions you make in life may influence whatyou get. The most important of those decisions, from an economicpoint of view, is how to maximize your human capital. You may nevermake enough money to get everything you want. But with enoughhuman capital, you should be able to get what you need.

Lesson SummaryLife is full of choices and decisions. The study of economics helps ussee why we have to choose among alternatives. It also gives us toolsfor thinking about what we stand to gain and lose when making life’sdecisions.

Why is what we want scarce? Scarcity exists because our wants,which are infinite, exceed our resources, which are finite. Unlikeshortages, which are temporary in nature, scarcity is an inescapablefact of life. It means we can never have everything we might want.

How do we satisfy economic wants? Goods and services areproduced by bringing together the three factors of production: land,labor, and capital. Entrepreneurship is an essential part of theproduction process. Entrepreneurs combine land, labor, and capital innew ways to create products that satisfy economic wants.

What do we give up when we make a choice? Every choiceinvolves tradeoffs among alternatives. When making a decision, peoplegenerally try to maximize the utility, or satisfaction, they hope to gainby choosing one alternative over another. The opportunity cost of anydecision is the value of the next-best alternative.



How can we measure what we gain and lose when makingchoices? Economists use an economic model known as theproduction possibilities frontier to measure what we gain and lose whendeciding how to use the factors of production in different ways. Themodel shows the tradeoffs and opportunity costs involved in producingmore of one good at the expense of another. It also reminds us thateven when an economy is working at peak efficiency, it will not be ableto produce everything that we might want.Processing math: 100%



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