chapters in this unit 1. what is economics? 2. economic ... c… · economics is the study of how...

1

You have to make a decision . . .

When you hear the word economics, whatare the first ten words that you think of?Compare your list with those of your class-mates. Do the words on your lists fall intoany obvious categories?

Focus ActivityFocus Activity

YYour favorite band is giving a concert intown, and you really want to go! The

tickets are expensive though, and there are so many things you could do with that money.You could buy a concert ticket or . . .

■ Use the money to see five movies

■ Use the money to buy the band’s new CDplus a pair of jeans

■ Save the money for your vacation

The choice you will make is rooted in econom-ics. At its core, economics is the study of howpeople choose to use their limited resources. Inthis unit you’ll read more about the tools thateconomics offers to help you make decisionsas a consumer, seller, worker, and citizen.

You have to make a decision . . .

Chapters in This Unit1. What Is Economics?

2. Economic Systems

3. American Free Enterprise

1. What Is Economics?

2. Economic Systems

3. American Free Enterprise

Chapters in This Unit

ECON_07NA_se_U1_UO 8/3/05 8:28 AM Page 2

WW hich CD to buy? How many hours to study? Which movie to see? If you’re like most people, you

constantly face decisions because you don’t have enoughtime and money to do everything. At its most basic level,economics is the study of how people make choices whenthey face a limited supply of resources. In this chapter youwill begin your study of economics by investigating twobasic economic ideas: scarcity and trade-offs.

What Is Economics?

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Quickly jot down three decisions youmade within the last 24 hours. Foreach decision, list two choices youdecided against when you made thedecision.

Economics JournalEconomics Journal

ECON_07NA_se_CH01_CO 8/3/05 8:30 AM Page 1

AAs you begin your study of economics,consider three scenes: In the first scene,

members of a household work together todo the laundry, purchase groceries, makemeals, earn money, decide how to spendtheir money, and decide who gets to holdthe TV remote.

In the second scene, the leaders of a largecorporation sit at a table for their monthlymeeting. They discuss whether to add anew product to their product line andadvertising options on television and theInternet.

In the third scene, senators in the UnitedStates Congress gather to debate the impor-tant issues of the day: How can we ensurethat people are well fed and have access tohealth care? What limits should the govern-ment place on businesses and internationaltrade? Who gets to control the Internet?Economists look at the decisions made ineach of these scenes and study those deci-sions in greater detail.

Scarcity and ChoiceThe study of economics begins with theidea that people cannot have everythingthey need and want. A need is something likeair, food, or shelter that is necessary forsurvival. A want is an item that we desire

but that is not essential to survival. Becausepeople cannot have everything they need orwant, they must consider their options anddecide which choice will fill their needs best.

To look at the world economically, wecan focus on the decisions that peoplemake. You, for example, have to decidewhat to do with your time—go to a movieor study for a test. Businesses have todecide how many people to employ andhow much to produce. A city governmentmay have to decide whether to spend itsbudget to build a school or a park.

Economics is the study of how people seekto satisfy their needs and wants by makingchoices. Because people act individually, ingroups (such as businesses), and throughgovernments, economists study each ofthese groups. But why must people makesuch choices? The reason is scarcity.

ScarcityLiving in a relatively wealthy country, manyAmericans may find it hard to understandthe idea of scarcity. Store shelves brim withgoods. Goods are physical objects such asshoes and shirts. We have access to count-less services. Services are actions or activi-ties that one person performs for another.Haircuts, dental checkups, and tutoring are

need something likeair, food, or shelter thatis necessary forsurvival

want an item that wedesire but that is notessential to survival

economics the studyof how people seek tosatisfy their needs andwants by makingchoices

goods physical objectssuch as clothes orshoes

services actions or activities that oneperson performs foranother

Scarcity and theFactors of Production

Preview ObjectivesAfter studying this section you will be able to:1. Explain why scarcity and choice are basic

problems of economics.2. Identify land, labor, and capital as the three

factors of production, and identify the twotypes of capital.

3. Explain the role of entrepreneurs.4. Explain why economists say all resources

are scarce.

Section FocusPeople, businesses, andgovernments mustchoose among limited orscarce resources.Economics describeshow people seek tosatisfy their needs andwants by choosingamong many alternatives.

Key Termsneedwanteconomicsgoodsservices scarcityshortagefactors of

production

landlaborcapitalphysical capitalhuman capitalentrepreneur

Chapter 1 ■ Section 1 3

ECON_07NA_se_CH01_S1 8/3/05 8:32 AM

all services. Indeed, we see ads everywhereurging us to purchase goods and services.Yet scarcity exists in all places, at all times.

Defining ScarcityAll of the goods and services we produceare scarce. Scarcity implies limited quanti-ties of resources to meet unlimited wants.While one person might be able to buyhundreds of basketballs or pencils orpianos, no one can have an endless supplyof everything. Sooner or later, a limit isalways reached. At its core, economics isabout solving the problem of scarcity.

Scarcity Versus ShortagesScarcity is not the same as a shortage. Ashortage occurs when producers will not orcannot offer goods or services at thecurrent prices. Shortages can be temporaryor long-term. During the holiday season, acustomer may see an empty shelf onTuesday, but return on Friday to find thatsame shelf filled to overflowing. Wars anddroughts can also create shortages that lastfor many years.

Scarcity, in contrast, always existsbecause our needs and wants are alwaysgreater than our resource supply. Goodsand services are scarce because they are allmade from resources that are scarce.

LandEconomists call the resources that are usedto make all goods and services the factors ofproduction, or factor resources. The factorsof production are land, labor, and capital.

Economists use the term land to refer toall natural resources used to produce goodsand services. Natural resources are mate-rials found in nature. They include fertileland for farming and products that are in oron the land, such as coal, water, and forests.

Labor Another factor of production is labor. Laboris the effort that a person devotes to a taskfor which that person is paid. Laborincludes the medical aid provided by adoctor and the tightening of a clamp by anassembly line worker. It is an artist’s creationof a painting or the repair of a television.

Capital Capital is any human-made resource that isused to produce other goods and services.The two categories of capital are physicalcapital and human capital.

Physical Capital Human-made objects used to create othergoods and services are called physicalcapital. (The term capital goods is asynonym for physical capital.) Physicalcapital includes buildings and tools. A shoefactory building and all of the sewingmachines and other specialized machineryfor making shoes make up part of the shoecompany’s physical capital.

Physical capital is an important factor ofproduction because it can save people andcompanies a great deal of time and money.A building is physical capital because ithelps workers do their work by providingprotection and space. Similarly, tools suchas tractors, conveyor belts, and pencils arephysical capital because they, too, helpworkers produce a good or a service.

When we create or buy physical capital toaccomplish a job, we usually become moreproductive. Suppose that your family of 6

scarcity limitedquantities of resourcesto meet unlimited wants

shortage a situation inwhich a good orservice is unavailable

factors of productionland, labor, and capital;the three groups ofresources that areused to make all goodsand services

land natural resourcesthat are used to makegoods and services

labor the effort that people devote to a taskfor which they are paid

capital any human-made resource that isused to create othergoods and services

physical capital allhuman-made goodsthat are used toproduce other goodsand services; tools andbuildings

4 What Is Economics?

� While people’s needs and wants are unlimited, the resources availableto meet those wants are limited, or scarce. Which scarce resources wereused to produce the fruits and vegetables shown here?

ECON_07NA_se_CH01_S1 8/3/05 8:32 AM

human capital theskills and knowledgegained by a workerthrough education andexperience

Figure 1.1 The Factors of Production Figure 1.1 The Factors of Production

Land, labor, and capital, also known as the factors of production, are the “inputs,” orresources, used to create all goods and services. Entrepreneurs What role do entrepreneurs play in producing goods and services?

LandAll of the natural resourcesthat are used to produce goods and services

LaborAny effort a person devotesto a task for which thatperson is paid

CapitalAny human-made resourcethat is used to create othergoods and services

EntrepreneurA person who assembles thefactors of production to createnew goods and services

Goods and Services

people washes dishes by hand every day afterevery meal—breakfast, lunch, and dinner—for a total of 21 meals per week. It takes 30minutes per meal for two family membersworking together to scrape, stack, wash,rinse, dry, and put away the dishes. That’s 21hours per week that could have been spenton other more productive activities.

Now, suppose that your family decides tobuy a dishwasher that costs $400. Using thedishwasher, it will take 15 minutes for asingle family member to clean up after eachmeal. At this rate, it will take the entirefamily only 5 hours per week to handlethis chore. The benefits that your familyreaps from the free time will cover the costof the new dishwasher, which provides thetypical benefits of physical capital:1. Extra time Your family no longer hasto spend 21 hours per week doing thedishes. Instead, the family gains 15 hourseach week to use for other activities.2. More knowledge By learning how towash the dishes by machine, familymembers learn more about using householdappliances in general. They can apply that

knowledge to the use of other labor-savingdevices, such as washing machines, dryers,and microwaves.3. More productivity Because familymembers now have extra time and extraknowledge, they can use their resources andlabor to do additional chores or other activ-ities that are beneficial to the family.

Human Capital In addition to producingphysical capital, people caninvest in themselves. Humancapital is the knowledge andskills a worker gains througheducation and experience.

An economy requires bothphysical and human capital toproduce goods and services.Doctors use stethoscopesand their schooling in orderto provide their services.Assembly-line workers useequipment as well as skillsacquired through training andpractice to produce goods.

34

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In the News Read more about capital in “Humans Need Not Apply,” an article in The Wall Street Journal Classroom Edition.

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ECON_07NA_se_CH01_S1 8/3/05 8:32 AM

entrepreneurambitious leader whocombines land, labor,and capital to createand market new goodsand services


Section 1 Assessment

Key Terms and Main Ideas1. What is the difference between a good and a service?2. Why is the idea of scarcity a starting point for thinking

economically?3. How is scarcity different from shortages?4. Describe the three factors of production.5. What special advantages does physical capital offer?6. What role do entrepreneurs play in the economy?

Applying Economic Concepts7. Critical Thinking Why might an economist look at

hundreds of cars moving along an assembly line and say,“There is an example of scarcity”?

8. Decision Making Which factor of production is repre-sented by each of the following? (a) an office building (b) an assembly line worker (c) a tree used to make paper(d) unused soil (e) an artist (f) a student

9. Try This Leaving class today, you decide to start aneconomics tutoring business. Your first step is to get thetwo categories of capital. Next you need to obtain theother factors of production. Specifically, what do you needin terms of land, labor, and capital?

10. Critical Thinking Do you agree or disagree with thefollowing statement? Creating capital is like depositingmoney in a savings account. You save now in order tohave more in the future.

EntrepreneursIf land, labor, and capital arethe essential ingredients forcreating all goods and services,who pulls these resourcestogether? The answer is entre-preneurs. Entrepreneurs areambitious leaders who decidehow to combine land, labor,and capital resources to createnew goods and services. Theyare the individuals who take

risks to develop original ideas, start busi-nesses, create new industries, and fueleconomic growth.

You need not be Bill Gates of Microsoftor Henry Ford to be considered an entrepre-neur. An individual who opens a cornerfood store and transforms it into a 10-storesupermarket chain is an entrepreneur.

Scarce ResourcesEconomists say that all goods and servicesare scarce because the land, labor, andcapital used to create them are scarce.Consider French fries. A typical portion ofFrench fries started as a potato in a field in

Idaho. Seven and one-half gallons of waterirrigated the half-foot plot where the potatogrew. Nurtured with fertilizers and protectedby pesticides, the potato was harvested,processed, frozen, and then transported toSeattle. In Seattle, it was fried in corn oilfrom Nebraska, sprinkled with salt fromLouisiana, and eaten in a restaurant.

All of the economic resources, or factorsof production, that were used to create theFrench fries are scarce. First, the quantityof the land and water available for growingpotatoes is limited. Second, the labor avail-able to grow the crop and to process andtransport the potatoes is limited by the size,time, age, and energy of a population.Finally, because land and labor are limited,the amount of physical capital available tocreate the French fries, such as farm equip-ment, is also limited.

While we have been talking about Frenchfries, we could easily have been talkingabout a pair of blue jeans or a new spaceshuttle. No matter what good or service wewere to look at, we would discover that thesupplies of land, labor, and capital used toproduce it are scarce, and that eachresource has many alternative uses.

After fishing in sub-zero temperatures in Labrador during 1912, a man named Clarence Birdseye was astounded that his frozen fish was tasty when he thawed and cooked it weeks later. This entrepreneur soon patented a “quick-freeze machine” and started his own seafood company. The result? An entire frozen foods industry was born.

FAST FACT

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ECONOMICEconomist

ECONOMIC

Gary BecGary Beckkerer (b. 1930)

Nobel Prize-winning economist Gary Becker looks at daily life andsees economics at work in all we do. Becker even sees marriage as an economic decision that many people make based on opportunitycosts. To understand how Becker arrived at this intriguing conclusion, you have to look at how he came to see the world.

Economics and Social IssuesLike many high school seniors, Becker knewwhat he was good at—mathematics—butwanted some practical way to apply it.Leaving his small Pennsylvania hometown,Becker went to Princeton University anddecided to pursue economics. But he lostinterest in the subject because it didn’t “dealwith important social problems.”

Becker briefly considered a degree insociology, but found the subject “too diffi-cult.” Later, as a graduate student at theUniversity of Chicago, he realized that eco-nomics could indeed help answer socialquestions. His first book, based on his stud-ies at Chicago, was an economic analysis ofracial discrimination.

“It started me down the path of applyingeconomics to social issues,” states Becker, “apath that I have continued to follow.” In1992, that path led to the Nobel Prize ineconomics, which Becker received for usingeconomic analysis to study a wide range ofhuman behavior. “Economy is the art ofmaking the most of life,” he says.

Economics and Personal DecisionsBecker maintains that economics guideseven life’s most personal decisions. He seesthe process of dating as part of a

“marriage market.” Most people do notmarry the first prospect they meet, henotes. The opportunity cost of such amarriage would be high because betterprospects are likely to exist. Instead, people try to search for better prospects.

Considering Costs and Benefits An extended search for a mate, however,consumes time, effort, and other resources.It involves expenditures on personalappearance, in social situations, for educa-tion, and for other things that help attract amate. A person decides to marry, Beckersays, when the cost of searching exceeds thepossible benefits of finding a better mate.

People measure the benefits of a poten-tial spouse by criteria such as job, appear-ance, education, and family, Becker says,and they try to judge other traits by thesefactors. For example, the probability that aperson is honest and good-natured may bejudged by looking at the person’s family.Intelligence is gauged by the person’s educa-tion. Becker maintains that this processcauses people to marry on the basis ofimperfect information. Not until later dothey truly learn about their partner’s per-sonality and compatibility, qualities thattake longer to assess.

1. Source Reading Interpret the fol-lowing passage from an article byBecker that appeared in BusinessWeek: “Human capital is asmuch a part of the wealth of nations asare factories, housing, machinery, andother physical capital.”

2. Critical Thinking How does whatyou’ve read in this introductory chapteron economics support or conflict withBecker’s idea that “economy is the artof making the most of life”?

3. Decision Making Do you agree or disagree with Becker’s idea that economics guides even life’s mostpersonal decisions? Support yourposition with two or three examplesof your own.

CHECK FOR UNDERSTANDING

7

Economist

Entrepreneur

ECON_05_se_PR_CH01 6/16/05 2:28 PM

SS everal years ago, a few hotels inWashington, D.C., offered a special

service to their guests. A popular art exhibitwas in town, but the only way to get ticketswas to wait in line for several hours. Manyof the hotel’s guests were unable orunwilling to do this. Instead, the hotelshired people to stand in line to purchase the$5 tickets. The hotels then sold the ticketsto guests for $50 apiece. These guests spentmoney rather than time in order to get theirexhibit tickets. Similarly, when we decideon one alternative, we gain one thing butlose something else.

Trade-OffsEconomists point out that all individuals,businesses, and large groups of people—even governments—make decisions thatinvolve trade-offs. Trade-offs are all thealternatives that we give up whenever wechoose one course of action over another.

Individuals and Trade-OffsEvery decision we make involves trade-offs. For example, if you choose to spendmore time at work, you give up watchinga movie or going to a baseball game.Choosing to play soccer might preventyou from working on the yearbook orhaving a part-time job.

Businesses and Trade-OffsThe decisions that businesspeople makeabout how to use land, labor, and capitalresources also create trade-offs. Farmerswho plant broccoli cannot use the sameland at the same time to grow cauliflower.A manufacturer who decides to use all herequipment to build chairs eliminates thepossibility of building tables or desks atthat same time.

Society and Trade-Offs Countries also make decisions that involvetrade-offs. Economists simplify theirexplanations of the trade-offs countriesface by using the example of guns or butter.In short, a country that decides to producemore military goods (“guns”) has fewerresources to devote to consumer goods(“butter”) and vice versa. (Remember,resources are limited!) The steel used tomake a tank is no longer available forbuilding the dairy equipment needed tomake butter.

trade-off an alternativethat we sacrifice whenwe make a decision

guns or butter aphrase that refers tothe trade-offs thatnations face whenchoosing whether toproduce more or lessmilitary or consumergoods

Opportunity CostPreview ObjectivesAfter studying this section you will be able to:1. Describe why every decision involves

trade-offs.2. Explain the concept of opportunity cost.3. Explain how people make decisions by

thinking at the margin.


What are some of thetrade-offs of buying

a car? �

Section FocusAll human decisions involve trade-offs. The next best alternative to anychoice is called an opportunity cost.Decision-making grids can make iteasier to identify the trade-offs andopportunity cost of a decision.

Key Termstrade-offguns or butteropportunity costthinking at the margin

ECON_07NA_se_CH01_S2 8/3/05 8:37 AM

Defining Opportunity CostWhenever individuals, businesses, orgovernments decide on a course of action,they face many trade-offs. One alternative,though, is usually more desirable than allthe others. The most desirable alternativegiven up as the result of a decision is calledthe opportunity cost.

If a family buys a computer, familymembers cannot use the same money to payfor their second choice, going on a trip. Thetrip, then, is the opportunity cost of buyingthe computer. The farmer who chose togrow broccoli instead of cauliflower experi-enced the opportunity cost of plantingcauliflower. If a government decides toproduce more “guns,” then having less“butter” is the opportunity cost.

Similarly, every ordinary decision thatwe make every day involves an opportunitycost. For each of the following choices,which alternative would you choose?

• Sleep late or wake up early for a ski trip?• Sleep late or wake up early to eat your

breakfast?• Sleep late or wake up early to study for a

test?

Most likely, you did not choose “sleep late”for all three decisions. Your decisiondepended on the specific opportunity cost—whatever you were willing to sacrifice.

Using a Decision-Making GridAt times, a decision’s opportunity cost maybe unclear or complicated. Using a decision-making grid like the one in Figure 1.2 canhelp you determine whether you are willing

to accept the opportunity cost of a choiceyou are about to make. In this particulargrid, Karen is trying to decide whether tosleep late or get up early to study for a test.Karen likes to sleep. Getting up early istough. However, getting up early to studywould probably improve her test score.

Karen knows that she is choosingbetween her two top alternatives: sleepinglate and waking up early to study. Becauseof scarcity, she cannot do both. The timecan only be occupied in one way.

To help her decide, Karen lists thebenefits of each alternative on the grid.Waking up early to study will probablyresult in a better grade. Also, she willreceive teacher and parental approval andexperience the personal satisfaction thatcomes with doing well on a test. However,she knows she would enjoy sleeping laterand that the extra sleep would give hermore energy during the day.

opportunity cost themost desirablealternative given up asthe result of a decision

� Becausedecisions are notalways as clear-cutas the one in thiscartoon, economistsencourage us toconsider the trade-offs and opportunitycost of a decisionbefore we make it.

Global Trade-Offs The same decision made in two different coun-tries can have vastly different opportunity costs. Malaysia bought twowarships in 1992, paying a price equal to the cost of providing safe drinkingwater for the 5 million Malaysians lacking it. In other words, the opportunitycost of the warships was safe drinking water for 5 million people. The opportu-nity cost of building warships in wealthier countries is not nearly so high.However, there are still costs to consider. In the United States, the number ofpeople employed by the military decreased dramatically following the end ofthe cold war. In response, the Pentagon developed a new program, “Troops toTeachers,” to help former soldiers get jobs teaching in schools. The switchfrom army duty to teaching reminds us that the opportunity cost of a soldiermay be a teacher and vice versa. Why does the opportunity cost of a decisionvary from one situation to another?

Global Connections


ECON_07NA_se_CH01_S2 8/3/05 8:37 AM

Making the DecisionKaren is a practical person. After consid-ering the opportunity cost, she decides thatwaking up early to study offers the mostdesirable benefits. She is willing to acceptthe opportunity cost: extra sleep time. Sheknows that she is giving up the benefits ofsleeping late, namely the pleasure of moresleep and the extra energy it provides.

Karen might have made a differentdecision when choosing between sleepingand breakfast or sleeping and getting upearly to study on a Saturday. With eachnew situation, the opportunity costs andbenefits change.

We always face an opportunity cost,though. When we select one alternative, wehave to sacrifice at least one alternative andforgo its benefits. By recognizing what weare sacrificing, we can decide whether thedecision is worth it. An economist mightsay, “Choosing is refusing.”

Thinking at the MarginWhen economists look at decisions, theypoint out one more characteristic inaddition to opportunity cost. Many deci-sions involve adding one unit or subtracting

one unit, such as one minute or one dollar.From an economist’s point of view, whenyou decide how much more or less to do,you are thinking at the margin.

To understand what it means to think atthe margin, you might picture a piece ofpaper with a line drawn down the left side.That line separates the space used forwriting from extra space on the paper. Youcould use some of that extra space or youcould leave it blank. Similarly, thinking atthe margin means you are thinking aboutusing one additional unit.

Making a Decision at the Margin When deciding whether or not to study,Karen used the “all or nothing” approachas shown in Figure 1.2. She was eithergoing to wake up early to study or sleeplate and not study at all that morning.

In reality, Karen could have decided fromamong several options rather than just two.She could have decided to get up one, two,or three hours earlier to study or to sleepinstead. She could have made her decisionby looking specifically at how many extrahours to study that morning. Making adecision about each extra hour would meanthat she was thinking at the margin.

thinking at the margindeciding whether to door use one additionalunit of some resource


Wake up early to study

Benefits

Decision

Opportunity cost

Benefits forgone

Sleep late

• Enjoy more sleep• Have more energy during

the day

Sleep late Wake up early to study for test

Extra study time Extra sleep time

• Better grade on test• Teacher and parental

approval• Personal satisfaction

• Enjoy more sleep• Have more energy during

the day

• Better grade on test• Teacher and parental

approval• Personal satisfaction

Alternatives

Figure 1.2 Karen's Decision-Making GridFigure 1.2 Karen's Decision-Making Grid

Using a decision-making grid can help us see what we gain and lose when we have tochoose between alternatives.Opportunity Cost What benefits will Karen forgo if she chooses to sleep later?

ECON_07NA_se_CH01_S2 8/3/05 8:37 AM

To make a decision at the margin,Karen should look at the opportunity costof each extra hour of studying andcompare it to the benefit. In Figure 1.3, wecan see that one hour of studying meansan opportunity cost of an hour of sleepand a benefit of probably passing the testwith a C. Two hours of studying “cost”two hours of sleep and perhaps getting aB. Three hours of studying mean sacri-ficing three hours of sleep and probablygetting only a slightly higher grade of B+.

What should Karen decide? At threehours, the cost is no longer worth thebenefit to Karen because her grade willimprove only slightly. Thus, Karen decidesto awaken two hours earlier.

Cost and Benefit at the MarginComparing opportunity costs and benefitsat the margin enabled Karen to decide howmany hours to study. Such a comparisoncould help someone decide how muchmoney to spend on a car, how many hoursto work, and how much time to spendwatching television. Employers think atthe margin when they decide how manyextra workers to hire. Legislators think at

the margin when deciding if a governmentprogram should include more of a partic-ular benefit. This decision-making processis sometimes called cost/benefit analysis.

Deciding by thinking at the margin isjust like making any other decision.Decision makers just have to compare theopportunity costs and the benefits—whatthey will sacrifice and what they will gain.Once the opportunity cost outweighs thebenefits, no more units should be added.


1st hour of extrastudy time

2nd hour of extrastudy time

3rd hour of extrastudy time

Grade of C on test

Grade of B on test

Grade of B+ on test

One hour of sleep

2 hours of sleep

3 hours of sleep

Options Opportunity costBenefit

Figure 1.3 Decision Making at the MarginFigure 1.3 Decision Making at the Margin

This person has to decide how many extra hours to study.By comparing the opportunity cost to the benefit of eachextra hour, she can decide how much is the right amount. Opportunity Cost At what point is this person paying anadded cost with little extra benefit?

Key Terms and Main Ideas1. Present three examples that illustrate how all decisions

involve trade-offs.2. Why must the opportunity cost of a decision always be

something desirable?3. How do economists use the phrase "guns or butter"?4. What does it mean to "think at the margin"?

Applying Economic Concepts5. Problem Solving Suppose that you can save $50 by

buying your car in a different city. If the trip requires only$10 in gasoline, is the trip worthwhile? Why or why not?

6. Decision Making Determine an opportunity cost for eachof the following. (a) eating pizza (b) going to see a movieon a Tuesday (c) going to see a movie on a Saturday(d) watching television

7. Try This Create a decision-making grid like the one inFigure 1.2 to defend a decision you will make today.

8. Critical Thinking Decide whether to work 2, 4, or 6 hours at an after-school job by comparing the opportunity cost and benefit of each alternative.

9. Decision Making Which factors would an employerconsider if he or she were trying to decide whether to hire an additional worker?


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1. Identify the type of informationpresented on the graph. Before you canbegin to interpret the information ona graph, you must identify specificallywhat is being shown. The graph titleand the axes’ labels indicate themeanings of the points and lines onthe graph. Answer the following ques-tions. (a) What do the numbers onthe horizontal axis (across) represent?(b) What do the numbers on the verti-cal axis (up and down) represent? (c) What relationship does the linegraph describe?

2. Read the data shown on the graph. Studythe graph’s axes carefully. Before study-ing the overall patterns, look carefullyat specific points on the graph.

Answer the following questions. (a) What is the maximum number of points per game that can be shownon the graph? (b) How many hours aweek did Player B practice? (c) Howmany points per game did Player Eaverage?

3. Study the data shown on the graph tolook for relationships or draw conclu-sions about a topic. Use the graphbelow to draw conclusions about therelationship between time spent prac-ticing and the number of points scoredper game. What could you concludefrom the information on the linegraph about the relationship betweenpractice and points per game?

Note that the points on the graphdo not form a perfectly straight line.For example, Player D did not scoreas many points per game as PlayerC, although Player D practicedmore hours each week. Why mightthis be so? What does this informa-tion say about the conclusions wecan draw from line graphs?

Additional Practice

LIFESkills for

0 2 4 6 8 10 12 1614

Ave

rage

Poi

ns p

er G

ame

Hours of Practice per Week

25

20

15

10

5

0

Skills: Hours of Practice vs. Points ScoredSkills: Hours of Practice vs. Points Scored

Player A

Player BPlayer D

Player E

Player F

Player C

12

Interpreting Line Graphs

L ine graphs easily and clearly present a large quantity of statistical data.Economists use line graphs to illustrate patterns or trends over time and to

explain the relationship between two or more variables. A variable is a factorwith a value that can change. Use the following steps to read and interpret theline graph below.

ECON_05_se_SK_CH01 7/20/05 7:11 AM

AA s the United States entered World War IIin 1941, it faced an urgent task: create

the weapons and equipment needed to winthe war or face defeat. Government agenciestook the lead in switching the output ofAmerica’s factories, farms, and mines fromthe production of consumer products to theproduction of military products.

Whether at war or not, nations mustchoose what to produce. In 2002, farmersin the United States grew about 2 milliontons of watermelons. Could they haveproduced more? If they had, what wouldhave been the opportunity cost?

Production PossibilitiesEconomists often use graphs to analyze thechoices and trade-offs that people make.Why? Because graphs help us see how onevalue relates to another value. A productionpossibilities curve, or graph, shows alterna-tive ways to use an economy’s productiveresources. The axes of the graph can showcategories of goods and services, such as farmgoods and factory goods or capital goods andconsumer goods. The axes can also displayany pair of specific goods or services, suchas hats on one axis and shoes on the other.

production possibilitiescurve a graph thatshows alternative waysto use an economy’sresources

ProductionPossibilities Curves

Preview ObjectivesAfter studying this section you will be able to:1. Interpret a production possibilities curve.2. Demonstrate how production possibilities

curves show efficiency, growth, and cost.3. Understand that a country’s production

possibilities depend on its availableresources and technology.

� During World War II, consumergoods were in shortsupply as the nationshifted resources toincrease productionof planes, ships,artillery, and ammu-nition. Rationcoupons (far left)were used to ensurethat civilians got afair share ofconsumer goods.


Section FocusDecisions about which goods andservices to produce affect each of usevery day. Production possibilitiesgraphs can help us examine theopportunity cost of these decisions.

Key Termsproduction

possibilities curveproduction

possibilities frontierefficiencyunderutilizationcostlaw of increasing costs

ECON_07NA_se_CH01_S3 8/3/05 8:39 AM

Drawing a Production Possibilities Curve To draw a production possibilities curve,an economist begins by deciding whichgoods or services to examine; for example,farm goods and factory goods. In thisexample shoes and watermelons becomethe values shown on the two axes of thegraph. If the vertical axis in Graphs A andB in Figure 1.4 represents shoes, Graph Aindicates that this fictional country,

Capeland, could produce 15 million pairsof shoes if it used all of its resources toproduce only shoes.

The horizontal axis represents water-melons. Graph B indicates that Capelandcould produce 21 million tons of water-melons if that’s the only product it chose toproduce. So Capeland can produce amaximum of:

15 million pairs of shoes OR

21 million tons of watermelons

A third, more likely, alternative appearsin Figure 1.5. The citizens of Capelandcould also produce both shoes and water-melons, and this range of choices appears inthe table and graph in that figure. It showssix different ways that Capelanders coulduse their resources to produce watermelonsand shoes. Using the made-up data from thetable, we can plot points on the graph andthen connect them to draw the line shownin Figure 1.5. This line that we can draw,called the production possibilities frontier,shows combinations of the production ofboth shoes and watermelons. Any spot on


25

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Watermelons (millions of tons)2520151050

a (0, 15)

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Graph A Graph B

No watermelons,all possible shoes

No shoes, all possible watermelons

Shoe

s (m

illio

ns o

f pai

rs)

Shoe

s (m

illio

ns o

f pai

rs)

Figure 1.4 Production Possibilities Curve Step 1Figure 1.4 Production Possibilities Curve Step 1

You can begin to build a production possibilities curve by plotting two of the productionchoices on a grid. Graph A reflects a decision to produce 15 million pairs of shoes. GraphB reflects a decision to produce 21 million tons of watermelons.Opportunity Cost What is the opportunity cost of the decision shown in Graph A?

production possibilitiesfrontier the line on a production possibilitiesgraph that shows themaximum possibleoutput

“We feel he’s either going to be an artist or an economist.”

� Why do economists use graphs?

ECON_07NA_se_CH01_S3 8/3/05 8:39 AM

that line represents a point at whichCapeland is using all of its resources toproduce a maximum combination of thosetwo products.

Trade-OffsEach point in Figure 1.5 reflects a trade-off.Near the top of the curve (points a and b),shoe factories produce more shoes, butfarms grow fewer watermelons. Movingdown the curve, farms grow more water-melons, but factories make fewer shoes.Why? Because land, labor, and capital arescarce. Using the factors of production tomake one product means that fewerresources are left to make something else.

Efficiency, Growth, and CostProduction possibilities graphs tell usimportant information. They can showhow efficient an economy is, whether aneconomy has grown or shrunk, and theopportunity cost of a decision to producemore of one good or service.

Efficiency A production possibilities frontier repre-sents an economy working at its mostefficient level of production. Efficiencymeans using resources in such a way asto maximize the production or output ofgoods and services. However, sometimeseconomies operate inefficiently. Forexample, what would happen if somefarmers and factory workers were laidoff? The farms and factories where theyworked would produce fewer goods. Thistrade-off is represented by drawing apoint inside the production possibilitiesfrontier.

Any point inside the line indicates an underutilization of resources. Under-utilization means using fewer resourcesthan the economy is capable of using.Point g in Figure 1.6 shows that Capelandis harvesting 5 million tons of water-melons and manufacturing 8 million pairsof shoes—much less than the maximumpossible production.

efficiency usingresources in such away as to maximize theproduction of goodsand services

underutilization usingfewer resources thanan economy is capableof using


Shoes(millions of pairs)

Watermelons(millions of tons)

0

8

14

18

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9

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0

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2520151050

f (21,0)

a (0,15)b (8,14)

c (14,12)

e (20,5)

d (18,9)

A productionpossibilities frontier

Shoe

s (m

illio

ns o

f pai

rs)


The table above shows six different combinations of watermelon and shoes thatCapeland could produce using all of its factor resources. Each combination ofnumbers in the table is drawn as a point on the graph. Connecting the points formsa line known as the production possibilities frontier. Opportunity Cost What is the opportunity cost of choosing to produce the combi-nation of goods shown at point c instead of that shown at point d?

ECON_07NA_se_CH01_S3 8/3/05 8:39 AM

Growth A production possibilities curve reflects thecountry’s current production possibilities asif the country’s resources were frozen in

time. In the real world,however, the quantity ofresources a country has isconstantly changing. If thequantity or quality of avail-able land, labor, or capitalchanges, then the curve willmove. For example, if immi-grants pour into a country,then more labor becomesavailable. In this way, themaximum amount of goodsthe nation can produceincreases. Likewise, newinventions can allow workersto produce more goods atlower costs. When an

economy grows, economists say that theentire production possibilities curve has“shifted to the right.” Line T in Figure 1.6shows such a shift.

By contrast, when a country’s productioncapacity decreases, the curve shifts to theleft. A decrease could occur, for example,when a country goes to war and loses partof its land as a result. Likewise, if acountry’s population ages, or becomes lesshealthy or less educated, the supply of laborand human capital would decrease, and thecurve would shift to the left.

Cost Speaking economically, note that cost isnot necessarily money. Rather, to an econ-omist, cost is the alternative we give upwhen we choose one option over the other.This statement should sound familiar. Toan economist, cost always means opportu-nity cost. We can use production possibili-ties graphs to see the opportunity costinvolved in a decision.

Looking at the table in Figure 1.5, we cansee that the cost of moving from producingno watermelons to producing 8 million tonsof watermelons is 1 million pairs of shoes. Inother words, we had to sacrifice 1 millionpairs of shoes to produce 8 million tons ofwatermelons. In the same way, if we decideto produce 14 million tons of water-melons—an increase of only 6 milliontons—it costs 2 million pairs of shoes. In thefirst step, those 8 million tons of water-melons cost 1 million pairs of shoes. In thesecond step, an increase of only 6 milliontons of watermelons cost an additional 2 million pairs of shoes. This amounts to 3 million pairs of shoes for 14 million tonsof watermelons.

Everyone would agree that switchingfrom shoes to watermelons costs something.An economist looking at Capeland’seconomy would say that the switch hasincreasing costs. Each time we grow morewatermelons, the sacrifice in terms of shoesincreases. Finally, at the bottom of the table,it costs an additional 5 million pairs of shoesto increase watermelon production by only1 million tons.

2520150

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0105

f (21,0)

a (0,15) b (8,14)

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Watermelons (millions of tons)

T

S

g (5, 8)


A point of underutilization

Future productionpossibilities frontier

Shoe

s (m

illio

ns o

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rs)

At point g on this graph, not all factorresources are being used, and the outputof farm and factory goods is less thanwhat is possible. Line S represents theeconomy’s current production possibilities.

Line T represents future production possibilities if moreland, labor, or capital resources become available. Investment How does a society benefit when it investsmoney in the development of new technologies?


cost to an economist,the alternative that isgiven up because of adecision

In the News Read more aboutefficiency growth, and cost in “A New Scholarship Strategy,” an article in TheWall Street Journal Classroom Edition.

The Wall Street JournalClassroom Edition

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Economists explain these increasinglyexpensive trade-offs with the law ofincreasing costs. This law states that asproduction switches from one item toanother (for example, from shoes towatermelons), more and more resourcesare necessary to increase production of thesecond item (watermelons). Therefore, theopportunity cost increases.

Why does the cost increase? In thisexample it is because some resources arebetter suited for use in farming, whileothers are more appropriate for manufac-turing. Moving resources from factory tofarm production means that farmers must

use resources that are not as suitable forfarming. For example, say that at first thiseconomy used its most fertile land forgrowing watermelons. After the best landwas used up, farmers had to use poorerland that could produce less per acre thanthe fertile land could. To increase output onthe poorer land, farmers had to use moreland and other resources.

The law of increasing costs explainswhy production possibilities frontiers,such as the one in Figure 1.5, usuallycurve. As we move along the curve, wetrade off more and more to get less andless additional output.

law of increasing costslaw that states that aswe shift factors ofproduction from makingone good or service toanother, the cost ofproducing the seconditem increases


The law of increasing costs states that as production shifts from one item toanother, in this case from shoes to watermelons, more and more resources arenecessary to increase production of the second item, in this case, watermelons.Opportunity Cost According to this diagram, what is the cost of increasingwatermelon production?

Figure 1.7 The Law of Increasing CostsFigure 1.7 The Law of Increasing Costs

Initially, resources are usedefficiently to make a balanceof watermelons and shoes.

S T E P 1

A decision is made to grow morewatermelons. Less suitableresources are shifted to farm production. Farm productionincreases. Shoe productiondecreases.

A decision is made to grow evenmore watermelons, and moreresources are shifted to farm production. Because the addedland is less productive, a greateramount of it must be cultivated.Farm output increases. Shoeoutput decreases by an evengreater amount.

S T E P 3

S T E P 2

The most suitable land forfarming is used to growwatermelons.

Land with rocky soil andpoor drainage is now usedto grow watermelons.

Land with rocky soil is nowused to grow watermelons.

Shoe factories

ECON_07NA_se_CH01_S3 8/3/05 8:39 AM

Resources and TechnologyWhen economists collect data to createproduction possibility curves, they must firstdetermine which goods and services acountry can produce, given its currentresources. A country’s resources include itsland and natural resources, its work force,and its physical and human capital. Bothhuman and physical capital reflect a vitalingredient—technology. At any time, coun-tries have different ways to produce shoes orwatermelons or any of the thousands ofproducts in the world. Each productionmethod uses different technology, or know-how, to create products. So economists alsomust assess each country’s level of technolog-ical know-how: whether Capeland makesshoes and plants watermelons by hand orwhether they have machines to help. Acountry’s production possibilities depend onboth its technological level and the resourcesit has available.


Figure 1.8 Personal Computers per 1,000 PeopleFigure 1.8 Personal Computers per 1,000 People

SwitzerlandUnited States

SwedenAustraliaDenmarkNorwayCanada

GermanyIceland

New ZealandJapan

FrancePoland

HungaryRussia

MexicoBrazilChina

IndonesiaIndia

100 200 300 400 500 600 7000

Source: International Telecommunication Union

800

108.488.783.074.8

11.927.6

7.2

142.0347.1

382.2

451.4484.7487.0

528.3576.8

601.8621.3

413.8

708.7659.8The United States

and WesternEurope are

the heaviestcomputer-using

regions of the world.

Opportunity Cost What opportunity

cost might a poorercountry face if it

chose to purchase or produce more

computers?

Key Terms and Main Ideas1. How is underutilization depicted on a production possi-

bilities frontier? 2. How does a production possibilities curve illustrate how

efficient an economy is? 3. How does a production possibilities curve illustrate

opportunity cost?

Applying Economic Concepts4. Using the Databank Turn to the charts showing the

number of farms and the average size of farms on page535. If the number of farms has decreased since 1950,does this mean that the production possibilities for farmoutput have also decreased? Why or why not?

5. Problem Solving How would you illustrate the impact ofeach of the following events on a production possibilitiescurve for factory goods and farm goods? (a) the computeris invented (b) 1 million farm workers remain unemployedfor six months (c) a drought

6. Critical Thinking Describe a specific event that wouldmake each of the following happen to a production

possibilities curve. (a) a point moves down and to the left(b) the frontier shifts to the right

7. Decision Making Assume that graphs A and B beloweach represent a production trade-off made by a societyfor its economy. Write a brief description of eachsociety. Include specific examples of what the society is producing.


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Consumer Goods

Capi

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oods

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PHSchool.com

For: Research ActivityVisit: PHSchool.comWeb Code: mnd-1013


PHSchool.com

Web Code: mng-1012

ECON_07NA_se_CH01_S3 8/22/05 10:06 AM

Safety at Any Cost?

When you buy a car, you face trade-offs: Do you buy thenew subcompact that may not have enough room for

your gear or the larger used sedan that needs a paint job?The features that make a car safer may also involve trade-offs. Economists urge consumers to consider the trade-offsand opportunity costs of each of their purchase decisions.Most of these opportunity costs fall into one of three cate-gories: cost and convenience, size, and personal freedom.

Safety Devices Versus Cost and Convenience Over 40,000people are killed every year in crashes on our roads.Safety features like antilock brakes and dual-side air bagsmay save lives, but they also make cars more expensive.Some features like seatbelts are sometimes seen as aninconvenience, so consumers do not always use them.Manufactures would like to produce safe cars, but theymust sell them at a price that buyers are willing to pay.Safety features are defeated if travelers ignore or disable them.

Size Versus Pollution Heavier cars are generally safer cars—they tend to hold up betterwhen there is an accident and provide passengers with more protection. SUVs havebecome increasingly popular because they are heavy and taller, giving the driver a betterview of the road. On the other hand, they are also more expensive to buy and more costlyto run because they have lower fuel efficiency.

Burning extra fuel also means increasing auto emissions. TheU.S. currently generates more greenhouse gas emissions than anyother country in the world, and the amount is growing. Also,“gas guzzlers” increase our dependence on foreign oil.

Safety Laws Versus Personal Freedom Many states have struggledwith laws requiring the use of seatbelts in cars, carseats forinfants and young children, or helmets for motorcyclists. Thereis considerable evidence that these safety precautions reduce theseverity of injury if there is an accident. However, laws requir-ing people to use seatbelts or helmets also restrict individualfreedom, so there is a trade-off between a national interest inkeeping people safe and a personal interest in being able tomake your own life choices.

Applying Economic Ideas1. Suppose you are buying a car. How would the trade-offs

discussed above affect your decision?

2. The table at the right shows the specific costs of variousoptional auto safety devices. On what basis would you decidewhich, if any, of these safety options to buy?

The Costs of Auto Safety

Cost of vehicle: $10,000

Safety feature CostAntilock brakes $400.00Side impact air bags $350.00Traction control $1,200.00


Safety feature CostAntilock brakes $645.00Side impact air bags $295.00Traction control n/a


Safety feature CostAntilock brakes $600.00Side impact air bags $390.00Traction control $600.00

� Safety devices save lives but alsoinvolve some opportunity costs.

19

Opportunity Cost

ECON_07NA_se_CH01_CS 7/20/05 9:12 AM

PhysicalCapital

Chapter SummaryChapter Summary

AA summary of major ideas in Chapter 1 appearsbelow. See also the Guide to the Essentials

of Economics, which provides additional review andtest practice of key concepts in Chapter 1.

Section 1 Scarcity and the Factors of Production (pp. 3–6)Economics is the study of how people seek to satisfytheir needs and wants by making choices. People,businesses, and governments must make choicesbecause all resources are scarce. Scarcity means lim-ited quantities of resources to meet unlimited needsor desires. Economists call the resources that areused to make all goods and services the factors ofproduction. The three factors of production areland, labor, and capital. Entrepreneurs are leaderswho combine the three factors of production to cre-ate new goods and services.

Section 2 Opportunity Cost (pp. 8–11)Every decision involves trade-offs. Trade-offs are allthe alternatives that we give up when we choose onecourse of action over another. The most desirablealternative given up as the result of a decision iscalled the opportunity cost. If a decision involveschoosing one more or one fewer unit of an input,economists say we are thinking at the margin.Employers think at the margin to decide how manyworkers to hire.

Section 3 Production Possibilities Curves (pp. 13–18)Economists draw curves or graphs in order to helpthem analyze the choices and trade-offs people make.A production possibilities curve shows the alternativeways in which an economy’s resources can be used.The production possibilities frontier is the line or curve onthe graph that represents the maximum amount thatan economy can produce. Points inside the frontierreflect an underutilization of resources. If the amount ofavailable land, labor, or capital increases, the entirecurve can shift to the right. The law of increasing costsstates that as production shifts from one item to a sec-ond item, more and more resources are necessary toincrease production of the second item.

Key TKey TermsermsComplete each sentence by choosing the correctanswer from the list of terms below. You will notuse all of the terms.

1. Economists define as “limited quan-tities to meet unlimited wants.”

2. All decisions involve because wemust give up some alternatives when wechoose a certain course of action.

3. The term refers to all naturalresources that are used to produce goodsand services.

4. Economists use the phrase to describethe trade-offs a country is forced to makewhen choosing between military and con-sumer production.

5. A(n) is the most important sacrificethat results from making a decision.

6. A person who starts a new business ordevelops an original idea is known as a(n)

.7. of resources occurs when an econ-

omy uses fewer resources than it is capableof expending.

Using Graphic OrganizersUsing Graphic Organizers8. On a separate sheet of paper, copy the tree

map below to help you organize informationabout the factors of production. Completethe tree map by writing descriptions andexamples for each of the headings shown.

capitalentrepreneurgoods“guns or butter”land

opportunity costscarcitytrade-offsunderutilizationeconomics

Factors of Production

Land Labor Capital

HumanCapital

20

ECON_07NA_se_CH01_CA 8/3/05 8:50 AM

Reviewing Main IdeasReviewing Main Ideas9. Using examples of land, labor, and capital,

explain why economists believe that all goodsand services are scarce.

10. Explain how each of the following people wouldtalk about scarcity and trade-offs. (a) thePresident of the United States (b) the leader of adeveloping nation (c) a U.S. citizen whoseincome is in the top one percent (d) a U.S. citizenwhose income is in the bottom 5 percent

11. What three important pieces of information can we learn by reading a production possibilitiesgraph?

12. Explain the law of increasing costs.

Critical ThinkingCritical Thinking13. Testing Conclusions Review the typical benefits

of physical capital described in Section 1. Givespecific examples of how the first railroads in the United States created or did not create thebenefits of physical capital.

14. Predicting Consequences Describe three servicesthat the government provides to its citizens.Identify some of the opportunity costs of provid-ing each of those services.

15. Drawing Conclusions Some economists considerentrepreneurship to be a fourth factor of pro-duction in addition to land, labor, and capital.Other economists consider entrepreneurship tobe a special category of labor. Which group ofeconomists do you agree with? Why?

Problem-Solving ActivityProblem-Solving Activity16. Suppose that you lent $100 to a friend, and he or

she paid you back one year later. What was thecost of lending your friend this money?

Skills for LifeSkills for LifeInterpreting Line Graphs Review the steps shown onpage 12; then answer the following questions about theline graph shown below.

17. What relationship does the line graph describe?18. What is the average annual income of men with

16 years of education?19. How many years of schooling result in an aver-

age annual income of $73,000 for women?20. What could you conclude from the line graph

about the relationship between income and education?

21. Use this graph to practice thinking at the margin.Suppose you have just completed grade 12. Ifyou spend one more year in school, by howmuch will your lifetime income increase (assum-ing you work until age 65)?

21

Essay Writing Review your Economics Journalentry for Chapter 1. Write a brief essay describingthe opportunity cost for each of the three decisionsthat you noted in your journal.

Economics Journal

Income and Education, 2003Income and Education, 2003

1201101009080706050403020100

Ave

rage

ann

ual i

ncom

e(in

thou

sand

s of

dol

lars

)

Source: Bureau of the Census

86 10 12 14 16 18 20 22

Years of school completed

MenWomen

Progress Monitoring Online

As a final review, take the Economics Chapter 1 Self-Testand receive immediate feedback on your answers. Thetest consists of 20 multiple-choice questions designed totest your understanding of the chapter content.

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chapters in this unit 1. what is economics? 2. economic ... c… · economics is the study of how...

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