SAYRE | MORRIS Seventh Edition

The Economic Problem

CHAPTER 1

1-1© 2012 McGraw-Hill Ryerson Limited

Learning Objectives:

The Economic Problem

LO1: Understand the relevance of economics

LO2: Define economics, microeconomics, and macroeconomics and understand the importance of the scientific method

LO3: Realize that scarcity, choice, and opportunity cost are at the heart of economics and that efficiency is a cornerstone

CHAPTER 1

1-2© 2012 McGraw-Hill Ryerson Limited

Learning Objectives:

The Economic Problem

LO4: Understand why trade results in economies being more productive

LO5: Explain the three fundamental questions and the four ways economies can be organized

LO6: Use the production possibilities model to explain choice, opportunity cost, efficiency, and unemployment

CHAPTER 1

1-3© 2012 McGraw-Hill Ryerson Limited

Learning Objectives:

The Economic Problem

LO7: List the economic goals of society and explain why they are often difficult to achieve

CHAPTER 1

1-4© 2012 McGraw-Hill Ryerson Limited

What is Economics?

Positive Statement – Can be verified with empirical data

Normative Statement– Based on a person’s beliefs or value system

– Cannot be verified with data

1-5© 2012 McGraw-Hill Ryerson Limited

LO2

What is Economics?

Economic Theory – Looks at how positive statements are related

– Uses the scientific method:

• Set up a hypothesis

• Define terms, state assumptions

• Gather data to test hypothesis

• Accept, reject, or modify theory

1-6© 2012 McGraw-Hill Ryerson Limited

LO2

What is Economics?

Macroeconomics – How the major components of an economy interact

– Unemployment, inflation, interest rates

Microeconomics – Outcomes of decisions by people and firms

– Supply and demand, costs of production, market structures

1-7© 2012 McGraw-Hill Ryerson Limited

LO2

Scarcity and Choice

Resources are Scarce: – Resources, or “factors of production”, are

anything used to produce goods and services

– Do not have enough resources to produce everything everybody wants

–Must have some way to ration scarce resources

1-8© 2012 McGraw-Hill Ryerson Limited

LO3

Economic Resources

Labour - Human mental and physical effort

Land – Any natural resource used to produce goods or services

Capital – Tools, equipment, factories, and buildings used in production process

Enterprise – The human resource that innovates and takes risks

1-9© 2012 McGraw-Hill Ryerson Limited

LO3

Economic Resources

1-10© 2012 McGraw-Hill Ryerson Limited

RESOURCE: EARNS:

Labour Wages

Land Rent

Capital Interest

Enterprise Profit

LO3

wages - the payment made and the income received for the use of labour.

rent - the payment made and the income received for the use of land.

interest - the payment made and the income received for the use of capital.

profit - the income received from the activity of enterprise.

© McGraw Hill Publishing Co, 2011 1-11

Economic Resources

Technology - A method of production - The way in which resources are combined to

produce goods and services

Opportunity Cost - The value of the next-best alternative that is given

up as a result of making a particular choice

1-12© 2012 McGraw-Hill Ryerson Limited

LO3

© McGraw Hill Publishing Col, 2011 1-13

Efficiency

Productive Efficiency - Production of an output at the lowest possible

average cost

Allocative Efficiency - Production of that combination of outputs that

best satisfies consumers’ demands

1-14© 2012 McGraw-Hill Ryerson Limited

LO4

Trade

- Voluntary trade benefits both parties - The more trade, the greater the benefits - Applies to individuals as well as to nations

1-15© 2012 McGraw-Hill Ryerson Limited

LO4

Benefits of Trade

1-16© 2012 McGraw-Hill Ryerson Limited

LO4

Maximum Output:Bread Plows

Athens 20 OR 10

Sparta 10 OR 20

Without Trade:Bread Plows

Athens 10 AND 5

Sparta 5 AND 10

Total Output 15 AND 15

Benefits of Trade

1-17© 2012 McGraw-Hill Ryerson Limited

LO4

Maximum Output:Bread Plows

Athens 20 OR 10

Sparta 10 OR 20

With Trade:Bread Plows

Athens 20 AND 0

Sparta 0 AND 20

Total Output 20 AND 20

Three Fundamental Questions

1. What to produce

2. How to produce

3. For whom

1-18© 2012 McGraw-Hill Ryerson Limited

LO5

Four Types of Economies

1. Cooperation

2. Custom

3. Command

4. Competition

1-19© 2012 McGraw-Hill Ryerson Limited

LO5

Production Possibilities Model

Production Possibilities Curve: – A graphical representation of the various

combinations of maximum output that can be produced from the available resources and technology

– Assumptions: • Full employment

• Use of the best technology available

• Productive efficiency

1-20© 2012 McGraw-Hill Ryerson Limited

LO6

Production Possibilities Model

1-21© 2012 McGraw-Hill Ryerson Limited

LO6

Figure 1.1

Unattainable

x

ab

c

d

e

Wheat

Cars

Attainable

2019

8

17

13

f

10 2418 3028

LO6

© 2012 McGraw-Hill Ryerson Limited 1-22

- points on the curve represent maximum output possible with available resources

Production Possibilities Model

Scarcity – Represented by points outside the curve

Choice – Represented by points on the curve (efficient) and

points within the curve (inefficient)

Opportunity Cost – Represented by the downward slope of the curve

1-23© 2012 McGraw-Hill Ryerson Limited

LO6

Law of Increasing Opportunity Costs

–Factors of production are not equally suitable

–As output increases, the per unit costs of additional units increases

–Gives the production possibilities curve its bowed out shape

1-24© 2012 McGraw-Hill Ryerson Limited

LO6

Figure 1.2

aWheat

Cars

2019

8

17

13

f

10 2418 3028

+8-2b

c

d

e

+6-4

+4

-5

Law of Increasing Opportunity Costs

LO6

© 2012 McGraw-Hill Ryerson Limited 1-25

- as more cars are produced, an increasing amount of wheat must be given up

PPC and Economic Growth

1-26© 2012 McGraw-Hill Ryerson Limited

LO6

Growth means the economy is able to produce more of everything

PPC and Technological Change

1-27© 2012 McGraw-Hill Ryerson Limited

LO6

- Improvement in technology shifts curve to PP2- can produce more of either good, or more of both

© 2012 McGraw-Hill Ryerson Limited 1-28

• Understand why economics is such a relevant discipline in our society

• Learn a definition of economics and distinction between micro and macro

• Appreciate that groups of people can have differing underlying values

• Realize that scarcity, choice and opportunity cost are at the heart of economics

• Understand why greater trade results in economies being more productive

Chapter 1 Summary

© 2012 McGraw-Hill Ryerson Limited 1-29

• Explain the three fundamental questions that all societies must address

• Understand the four different ways that economies can be organized

• Use the production possibilities model to illustrate opportunity cost, efficiency, and unemployment

• List the economic goals of society and understand why they are often difficult to achieve

Chapter 1 Summary