Understanding Economics

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1 Understanding Economics 4 th edition by Mark Lovewell, Khoa Nguyen and Brennan Thompson Chapter 1 The Economic Problem

2 Learning Objectives In this chapter, you will: 1. consider the economic problem that underlies the definition of economics 2. learn about the way economists specify economic choice 3. examine the production choices an entire economy faces, as demonstrated by the production possibilities model 4. analyze the three basic economic questions and how various economic systems answer them

3 1.1 Economics Defined Economics is the study of how to distribute scarce resources among competing ends. Microeconomics the branch of economics that focuses on the behaviour of individual consumers and businesses. Macroeconomics the branch of economics that takes a broad view of the economy, studying the behaviour of economic sectors households, business, government, foreign markets.

4 The Economic Problem conomics1.swf Economists deal with the economic problem. Economic agents must continually make choices. Their wants are unlimited. They face a limited supply of economic resources.

5 Terms Economic Resources basic items used in all types of production Natural resources includes raw materials and natural processes Capital resources materials, equipment and buildings used in production Human resources Labour people employed in the production Entrepreneurship initiative, risk-taking and innovation necessary for production

6 Economic Models Are generalizations or simplifications of economic reality Also known as laws, principles or theories Help explain economic trends and behaviour by including two or more variables or factors Variables are connected by a causal relationship where one variable is assumed to affect another Propose what effect one variable will have on another

7 Cause and Effect/Inverse and Direct Relationships show how dependent variables (the variable in a causal relationship that is affected by another variable) are affected by independent variables (the variable in a causal relationship that is affected by another variable) e.g. price (independent) of cell phones, # purchased (dependent) include inverse (a relationship in which a change in the independent variable causes a change in the opposite direction of the dependent variable) and/or direct (a relationship in which a change in the independent variable causes a change in the same direction of the dependent variable) relationships

8 The Need for Assumptions In order to focus on the relationship between two variables, economists assume ceteris paribus bus the assumption that all other things remain the same

9 Positive and Normative Economics Two types of economic enquiry: positive (the study of economic facts and why the economy operates as it does) economics Also called descriptive economics normative (the study of how the economy ought to operate) economics Also called policy economics Review and Practice Question 1.1 page 6

10 1.2 Economic Choice Economists assume that economic decisionmakers maximize their own utility. Decision-makers must keep in mind the opportunity cost of each alternative. Utility the satisfaction gained from any action Self-interest motive the assumption that people act to maximize their own welfare Opportunity cost the utility that could have been gained by choosing an actions best alternative nitycost.swf

11 Activity Step 1 How many of you never seem to have enough time to do all the things you want to do? Imagine you find yourself with an hour of free time tonight that you did not expect to have What you might like to do with this hour of free time?

12 Activity Step 2 Why can t you do all of the things listed? Write down four or five activities you would most like to do with one hour of free time

13 Activity Step 3 Place a star beside the one thing you would most like to do Circle your second choice Lesson 1 Activity 1 Groups

14 High School Economics Lesson 1 Scarcity not being able to have all of the goods and services one wants Exists because human wants for goods and services exceed the quantity of goods and services that can be produced using all available resources The opportunity cost of a choice is the value of the best alternative given up Choices involve trading off the expected value of one opportunity against the expected value of its best alternative

15 Presentation Tradeoff involves giving up some of one thing to get more of another. What tradeoffs did your group have to make? What was the opportunity cost of each of your decisions? (the 2 nd choice in each category) How did your group preferences influence decisions?

16 Dance Choices Group Band/DJ Place Food Project A--Daniel Good Vibrations The Hilton Hotel Package Deal B Wesley Pig Sty The Knob Hill Country Club Package Deal Children s Charity C Ali Good vibration School gym Catered $3000 Trips (snow boarding, swimming) D Harris Good Vibrations The Hilton Hotel Package Deal E Crystal Good Vibrations The Hilton Hotel Catered $3000 Books for the Library

17 1.3 The Production Possibilities Model The production possibilities model is based on three assumptions: 1. an economy makes only two products 2. resources and technology are fixed but can be moved from the production of one good to the other 3. all resources are employed to their fullest capacity The production possibilities model illustrates the tradeoffs that society faces in using its scarce resources It is an abstraction of the real world based on various simplifications

18 The Production Possibilities Curve (a) The production possibilities curve shows a range of possible output combinations for an economy. It highlights the scarcity of resources. It has a concave shape, which reflects the law of increasing opportunity costs.

19 Hamburgers The Production Possibilities Curve (b) Figure 1.1, page 8 Production Possibilities Schedule Hamburgers Computers point on graph a Production Possibilities Curve a b f 600 c e unattainable b c 0 3 d inefficient Computers d

20 Interpretation of Production Possibilities Model A society must choose among possible combinations of two goods. These combinations are shown in the production possibilities curve. Both the schedule and the curve show that more computers can be assembled only if fewer hamburgers are produced. Any points within the curve (e), are feasible but those outside the curve are not (f).

21 The Role of Scarcity The production possibilities curve highlights the scarcity of economic resources The curve is a boundary between all those output combinations that are within the reach of an economy and all those combinations that are unattainable Anywhere inside the curve represents a feasible combination of the two products

22 Law of Increasing Opportunity Costs The concept that as more of one item is produced by an economy, the opportunity cost of additional units of that product rises Economics resources do not transfer perfectly from one use to another e.g. making hamburgers requires different training/skills than making computers

23 Hamburgers The Law of Increasing Costs Figure 1.2, page 10 Production Possibilities Schedule Hamburgers Opportunity Computers point Cost of on graph Computers a b c d Production Possibilities Curve a b Computers c As the quantity of computers rises, so does their opportunity cost. d

24 Economic Growth An increase in an economy s total output of goods and services Either due to a rise in the amount of available resources or an improvement in technology Both trends cause an outward shift in the production possibilities curve More of both items can now be produced Page 10 Thinking about Economics, page 11 Review, Practice Questions

25 Homework ault.aspx?id=887b88dc3f1240f186ea962752b 7f17d Go to the graphing website shown on the wiki Choose a scatter graph Coconut data goes on the Y axis and Fish on the X axis your completed graph to smcrae@pembinatrails.ca

26 Hamburgers Shifts in Production Possibilities Figure 1.2, page 10 Production Possibilities Curve 1000 With more computers, the curve shifts out in the next period. 0 3 Computers

27 1.4 The Basic Economic Questions There are three basic questions any society must answer: what to produce decide how much of each possible good and service is to be supplied how to produce which resources should be employed and in what combinations for whom to produce how will the total output of goods and services distributed onomics2/swiftfile/economicsystemsbook2.swf

28 Economic Systems The organization of an economy which represents a country s distinct set of social customs, political institutions, and economic practices There are three systems to choose from: 1. Traditional economies focus on non-economic concerns and have tight social constraints An economic system in which economic decisions are made on the basis of custom Still used in some underdeveloped South American nations and Asian and African countries

29 Economic Systems (cont d) 2. Market economies are consumer-centered and innovative but create inequality and instability. An economic system based on private ownership and the use of markets in economic decision-making Market: a set of arrangements between buyers and sellers of a certain item Product Markets: markets in which consumer products are traded Resource Markets: markets in which economic resources are traded

30 Benefits of a Market Economy Consumer Sovereignty the decision of what to product is ultimately guided by the needs and wants of households in their role as consumers. The incentive to make a profit in a market economy encourages innovation and entrepreneurship which helps advances in technology

31 Drawbacks of a Market Economy Income Distribution if households incomes are based solely on the ability to supply economic resources, then some individuals in the economy might not earn enough to provide even for their basic needs Market Problems negative external effects of economic activity (e.g. pollution) may require intervention from government Instability in the total output produced from year to year with fluctuations affecting prices and employment levels

32 3. Command Economies equalize incomes but often have a lack of freedom Based on public ownership and central planning The former Soviet Union is the best example of a command economy North Korea and Cuba are examples of largely centrally planned economies

33 Benefits of Command Economy Income Distribution a country that adopts a command system can choose to distribute income among its citizens on the basis of considerations other than purely economic ones Economic Growth central planners can focus on promoting the rate of economic growth by devoting more resources to capital goods than would be the case in a market economy

34 Drawbacks of a Command Economy Planning Difficulties planning an entire economy is a difficult task Inefficiencies government ownership of productive property can lead to wast and inefficiency since command economies cannot depend on the lure of profit to promote the efficient use of resources No market control can lead to corruption of government officials Lack of Freedom too much power in the hands of government

35 The Range of Economic Systems (a) Most countries have mixed economies Modern mixed economies include both private and public sectors. Combines aspects of a market economy and a command economy; production decisions are made both in private markets and by government Traditional mixed economies combine traditional sectors with private and/or public sectors.

36 The Range of Economic Systems (b) Figure 1.4, page 16

37 Economic Goals There are seven major economic goals: economic efficiency income equity price stability full employment viable balance of payments economic growth environmental sustainability

38 Complementary and Conflicting Economic Goals Economic goals may be complementary. An example is the relationship between full employment and economic growth. Economic goals may be conflicting. An example is the relationship between price stability and full employment.

40 The Founder of Modern Economics Adam Smith: explained how the division of labour increases production argued that self interest is transformed by the invisible hand of competition so that it creates significant economic benefits stressed the principle of laissez faire, which means that governments should not intervene in economic activity

Understanding Economics

Understanding Economics 4th edition by Mark Lovewell, Khoa Nguyen and Brennan Thompson Understanding Economics 4 th edition by Mark Lovewell, Khoa Nguyen and Brennan Thompson Chapter 1 The Economic Problem