Economics

• Economics is the study of how people choose to allocate scarce resources to produce goods and services and how they choose to distribute those goods and services now and in the future.

Economics

• Microeconomics is the branch of economics concerned with the behavior of individual consumers and firms and with the determination of individual prices.

• Macroeconomics is the branch of economics concerned with the study of aggregate economic activities such as economic growth, inflation, and unemployment.

Scarcity and Choice

• The study of economics arises because resources are scarce.– Resources are said to be scarce because they are

finite, while human wants are infinite.• Resources ultimately run out; wants never do.

• Resources are:– Labor, capital, and land.

Economic Resources

• Labor– Human work. Labor is paid a wage.

• Capital– Physical capital such as buildings, machinery,

equipment. Capital is paid interest.

• Land– Natural resources. Land is paid rent.

Economics and the Scientific Method

• Economics uses models or theories to understand and explain economic behavior.

• Theories have four components:– An hypothesis.– One or more assumptions.– A model.– Predictions and/or explanations.

Production Possibilities Model

• Hypothesis: The Law of Increasing Cost– If all resources are fully and efficiently

employed, the existence of scarce resources means that increasing the production of one good requires increasing sacrifices in the production of another good.

Production Possibilities Model

• Assumptions:– Only two goods are produced.

• Consumer goods and non-consumer goods.

– All resources are fully and efficiently employed.

– Resources transfer freely but not perfectly between producing the two goods.

– There is no growth.

Production Possibilities Model

• Model:– The production possibilities model shows the

effect on production caused by the economic problem of scarcity.

– The economic principle illustrated by the model is the concept of opportunity cost.

• Opportunity cost is defined as the value of the best alternative foregone.

Production Possibilities Model

CG

NCG

Consumer goods, CG, aremeasured on the vertical axis

Non-consumer goods, NCG, aremeasured on the horizontal axis.

0

Production Possibilities Model

CG

NCG

A

Z

M

At point A, only CG is produced.

At point Z, only NCG is produced.

At point M, both CG and NCG are produced.

0

Production Possibilities Model

• The Production Possibilities Frontier– The production possibilities frontier shows the

maximum amount of goods and services that can be produced by an economy during a given period of time with available resources and technology.

– We find the PPF by connecting all the points between A and Z.

Production Possibilities Frontier

The PPF slopes down becausewhen resources are fully employed, we must give up some CG to get more NCG and we must give up some NCG to get more CG.

NCG

CG

A

M

Z0

Production Possibilities Frontier

NCG

CG

A

Z

As we move from point A toZ, we give up equal amountsof CG and get increasinglysmaller amounts of NCG.

B C

DE

FG

HJ

K M

N

0

Production Possibilities Model

• As we move from point A to point Z, we produce more NCG and less CG.– In order to do this, resources must move from

CG to NCG.– But, while resources move they do not do so

perfectly.• At some point a given sacrifice of CG results in

smaller and smaller increases in NCG.

• This is why the PPF is bowed-out.

Production Possibilities Model

• Conclusion:– The Law of Increasing Cost

• If all resources are fully and efficiently employed, the existence of scarce resources means that increasing the production of one good requires increasing sacrifices in the production of another good.

Production Possibilities Frontier

NCG

CG

A

Z

U

What does point U represent?

What are the economic implicationsassociated with a point such as U?

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Production Possibilities Frontier

NCG

CG

A

Z

U

What does point U represent?

If we are at point U, resources areunemployed. A move from U to thePPF increases production.

Unemployment decreases everyone’s welfare.

0

Production Possibilities Frontier

NCG

CG

A

Z

What does point G represent?

What are the economic implicationsassociated with a point such as G?

G

0

Production Possibilities Frontier

NCG

CG

G

To get to point G, the PPF mustshift out to the right.

At point G, we have more of both goods.

Growth increases everyone’s welfare.

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Three Economic Decisions

NCG

CG

What to produce?

How to produce?

For whom to produce?

0

How Does Society Answer the Three Questions?

• Markets– Demand and supply

• Government– Regulation– Government incentives and disincentives– Voting

• Tradition

What to Produce

• Our model permits us to choose to produce consumer goods and non-consumer goods.– We may produce lots of CG with small

amounts of NCG, lots of NCG with small amounts of CG, or more or less equal amounts of both.

• Our choice will determine our standard of living now and in the future. Why?

How to Produce• We may choose to produce in an efficient

manner or an inefficient manner.– If we choose policies that permit full and efficient

use of our resources, we will produce on the PPF.– If we choose policies that do not permit full and

efficient use of our resources, we will produce inside the PPF.

• Our choice will determine our standard of living now and in the future. Why?

For Whom to Produce

• For whom to produce is a decision about income distribution.– If we rely on the market to make this decision,

those who best produce the goods and services most wanted by the public will be better compensated than others and will have more goods and services.

• When this income distribution is perceives as being unfair, government may intervene and redistributes income to the less favored.