chap001 4 (2010)
TRANSCRIPT
Economics and The Three Core Choices
• Economics is the study of how best to allocate scarce resources among competing uses.
• Three core choices confront every nation:● WHAT to produce with our limited resources● HOW to produce the goods and services we
select● FOR WHOM goods and services are
produced; that is, who should
get them
The Economy Is Us
• The economy is the aggregation of individual production and consumption decisions
• Important link between individual choices and collective outcomes
Scarcity: The Core Problem
• Scarcity: Lack of enough resources to satisfy all desired uses of those resources
Factors of Production
• Factors of Production: Resource inputs used to produce goods and services
• Four Types:– Land– Labor– Capital– Entrepreneurship
Factors of Production
• Land: Includes all natural resources– e.g. oil, water, iron ore, energy, etc.
• Labor: Quantity and quality of human resources– Includes physical presence of workers as well
as their skills and abilities
Factors of Production
• Capital: Final goods produced for use in production of other goods and services– Includes equipment and structures, such as:
• Factories• Production machinery• Fleet vehicles
Factors of Production
• Entrepreneurship: Assembling of resources to produce new or improved products and technologies– It’s not just a matter of what resources you
have but also of how well you use them
Limits to Output
• Scarcity of resources limits the amount of production that can be undertaken– Requires choices to be made
• Economics: The study of how best to allocate scarce resources among competing uses
• No matter how an economy is organized there is a limit to how fast it can grow.
Opportunity Costs
• Opportunity cost: The next most desired goods and services foregone to obtain something else– What is given up to undertake a chosen
activity
• Associated with every decision– For example, if we choose to produce bread
then we cannot produce pizza crust with the same flour
Opportunity Costs
• What did you give up to come here tonight?
• What is the opportunity cost for you to take this class?
• What is the opportunity cost by choosing to come to KCC?
• What is the opportunity cost of choosing to go to the movies?
Production Possibilities
• Production possibilities: The alternative combinations of final goods and services that could be produced in a given time period with all available resources and technology
The Production Possibilities Curve
• Production possibilities curve (PPC): Describes the various output combinations that could be produced in a given time period with available resources and technology
• Represents a menu of output choices an economy confronts
• Each point on the production possibilities curve depicts an alternative mix of output.
Production Possibilities
• Production possibilities are the alternative combinations of final goods and services that could be produced in a given period of time with all available resources and technology.
The Production Possibilities Curve
• Illustrates Two Essential Principles:– Scarce resources: Production is limited by
available resources and technology– Opportunity costs: Can obtain additional
quantities of a good only by reducing production of another
A Production Possibilities Curve
A
B
C
D
E
F
OU
TP
UT
OF
TR
UC
KS
5
4
3
2
1
0 1 2 3 4 5OUTPUT OF TANKS
PointTotal Labor
Truck Output x
Labor per Truck =
Total Labor Required
Labor Not Used for Trucks
Potential Output of
Tanks
Increase in Tank Output
A 10 5 2 10 0 0B 10 4 2 8 2 2 + 2C 10 3 2 6 4 3 + 1D 10 2 2 4 6 3.8 + 0.8E 10 1 2 2 8 4.5 + 0.7F 10 0 2 0 10 5 + 0.5
Truck Production Tank Production
Box Score – Team 1
Name PPG RPG APGJones 22 2 8Richardson 8 6 1North 5 4 2Meyers 18 3 5Wenton 12 9 1Total 65 24 17
Name PPG RPG APGJones 32 2 5Richardson 6 4 1North 4 2 1Meyers 12 2 3Wenton 8 7 1Total 62 17 11
1 st 10 games
2 nd 10 games
OUTPUT OF ASSISTS
A
B
CY
1 2 3 4 5
OU
TPU
T O
F PO
INTS
Losses
Law of Increasing Opportunity Costs
• Resources do not transfer perfectly from the production of one good to another.
• Increasing quantities of any good can be obtained only by sacrificing ever-increasing quantities of other goods.
• The shape of the curve illustrates increasing opportunity costs
• Lose some efficiency in the transfer– Resources used for truck production are not
ideally suited for producing tanks
Increasing Opportunity Costs
Step 1: give up one truck
Step 2: get two tanksStep 3: give up another truck
Step 4: get one more tank
A
B
C
D
E
F
OU
TP
UT
OF
TR
UC
KS
5
4
3
2
1
0 1 2 3 4 5OUTPUT OF TANKS
Law of Increasing Opportunity Costs
The Cost of North Korea’s Military
• North Korea’s inability to feed itself is due in part to its large army.
• Resources used for the military aren’t available for producing food.
The Cost of North Korea’s Military
MILITARY OUTPUT
FOO
D O
UTP
UT
A
O B
Reduced food output
Military buildup
N
D
P
H
C
G
Efficiency
• Efficiency: Maximum output of a good from the resources used in production
• Every point on the production possibilities curve is a point of efficiency
Points Inside the Curve
• A production possibilities curve shows potential output
• Actual output can be less than potential due to – Inefficiency: Resources not being used to
maximum potential– Unemployment: Some resources are idle
OUTPUT OF TANKS
A
B
CY
5
4
3
2
1
0 1 2 3 4 5
OU
TP
UT
OF
TR
UC
KS
Some resources are unemployed or used
inefficiently
A Point Inside the Curve
Points Outside the Curve
• Any point outside the production possibilities curve is unattainable with available resources and technology
A Point Outside the Curve
OUTPUT OF TANKS
A
B
C
X5
4
3
2
1
0 1 2 3 4 5
OU
TP
UT
OF
TR
UC
KS
Currently not attainable
Economic Growth
• Economic growth: An increase in output due to an expansion of production possibilities– Production possibilities increase with more
resources or better technology
• The production possibilities curve shifts outward
Basic Decisions
• Production possibilities define the output choices confronting a nation:– WHAT to produce– HOW to produce– FOR WHOM to produce
The Mechanism of Choice
• An economy is largely defined by how it answers the WHAT, HOW and FOR WHOM questions
A Market Economy
• Adam Smith said the “invisible hand” of markets determine the answers
• Market mechanism: The use of market prices and sales to signal desired outputs (or resource allocations)
The Invisible Hand of a Market Economy
• Laissez faire: The doctrine of “leave it alone,” or nonintervention by government in the market mechanism
• Karl Marx felt that markets permit capitalists to enrich themselves at the expense of workers– Argued that government not only had to
intervene, but must own all means of production
• John Maynard Keynes’ less drastic solution:– Government should play an active, but not all-
inclusive role in managing the economy
Government Intervention and Command Economies
Continuing Debates
• The core of most debates is some variation of the WHAT, HOW, or FOR WHOM questions– Conservatives favor Adam Smith’s laissez-
faire approach– Liberals think government intervention is likely
to improve market outcomes
A Mixed Economy
• Countries answer the questions differently• Mixed economy: An economy that uses
both market signals and government directives to allocate goods and resources
Market Failure
• If market signals don’t determine the best answers to core issues, we say the market mechanism has failed
• Market Failure: An imperfection in the market mechanism that prevents optimal outcomes
Government Failure
• Government intervention may move us closer to our economic goals or it may fail
• Government failure: Government intervention that fails to improve economic outcomes
Seeking Balance
• The challenge for society is to minimize failures by selecting the appropriate balance of market signals and government directives
What Economics Is All About
• The basic purpose of studying economics is to understand how economies function, including their– Organization– Behavior– Achievement of basic objectives
End Versus Means
• Rather than formulating an economy’s objectives, economists focus on the means available for achieving given goals– May include helping design policies
Macro Versus Micro
• Macroeconomics: The study of aggregate economic behavior, of the economy as a whole
• Microeconomics: The study of individual behavior in the economy, of the components of the larger economy
Theory Versus Reality
• The economy is much too vast and complex to describe and explain in one course (or one lifetime)
• Economists use theories, or models, of economic behavior to evaluate and design economic policy
Theory Versus Reality
• Ceteris paribus: The assumption of nothing else changing
• Political forces are a necessary ingredient in economic policy decisions
• We may never find an absolute truth• The inner workings of the economy
change over time
HOW
• There are lots of different ways of producing goods and services.
• Someone has to make a decision about which production methods to use.
LO2
The Invisible Hand of a Market Economy
• The market mechanism is the use of market prices and sales to signal desired outputs (or resource allocations).
• The market decides the mix of output in an economy.
LO3
The Invisible Hand of a Market Economy
• Laissez faire is the doctrine of leave it alone — of nonintervention by government in the market mechanism.
LO3
Government Intervention and Command Economies
• Karl Marx argued that the government not only had to intervene but had to own all the means of production.
• Markets permit capitalists to enrich themselves while the proletariat toil long hours for subsistence wages.
LO3
Government Intervention and Command Economies
• John Maynard Keynes offered a less drastic solution.
• In Keynes’ view, government should play an active but not an all-inclusive role in managing the economy.
LO3
Continuing Debates
• The core of most debates is some variation of the WHAT, HOW, or FOR WHOM questions.– Conservatives favor Adam Smith’s laissez-
faire approach.– Liberals tend to think government intervention
is likely to improve the answers.
LO3
Continuing Debates
• Countries answer the basic economics questions differently and their answers change over time.
LO3
A Mixed Economy
• A mixed economy is one that uses both market signals and government directives to allocate goods and resources.
• Most economies use a combination of market signals and government directives to select economic outcomes.
LO3
Market Failure
• We may never find an absolute truth, because the inner workings of the economy change over time.
Government Failure
• Government intervention may move us closer to our economic goals or it may fail.
• A government failure is government intervention that fails to improve economic outcomes.
Seeking Balance
• The challenge for society is to minimize failures by selecting the appropriate balance of market signals and government directives.
What Economics Is All About
• The basic purpose of studying economics is understanding how economies function.– How an economy is organized, how it
behaves, and how successfully it achieves it basic objectives.
– Kindergarten project.– Why study economics??– http://www.youtube.com/watch?v
=zueU0qi7DtcPage 16.
End Versus Means
• Economists don’t formulate an economy’s objectives.
• They focus on the means available for achieving given goals.
Macro Versus Micro
• Macroeconomics is the study of aggregate economic behavior, of the economy as a whole.
• Microeconomics is the study of individual behavior in the economy, of the components of the larger economy.
Theory Versus Reality
• The economy is much too vast and complex to describe and explain in one course (or one lifetime).
• Economists use theories, or models, of economic behavior to evaluate and design economic policy.