2. 1-2
The Goals of This Course
• To understand how the economy really works.
• To determine how markets shape economic
outcomes.
• To examine the role that government can and
does play in (re)shaping economic
performance.
• To understand how we ourselves can make
better economic decisions.
3. 1-3
Learning Objectives
• 01-01. Know how scarcity creates
opportunity costs and forces economic
choices.
• 01-02. Know what the production
possibilities curve represents.
• 01-03. Know the three core economic
questions that every society must answer.
• 01-04. Know how market and government
approaches to economic problems differ.
4. 1-4
The Core Issues
• The purpose of an economy is to produce
goods and services that satisfy peoples’
wants using the limited resources available.
• There are three core choices that 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.
5. 1-5
What Is the Economy?
• The economy is us.
• It is the grand sum of all our production and
consumption activities.
• For the United States, it is the collective
behavior of the 310 million individuals who
participate in it.
• Economics: the study of how best to allocate
scarce resources among competing uses.
6. 1-6
Scarcity: The Core Problem
• Scarcity: lack of enough resources to satisfy all
desired uses of those resources.
– There aren’t enough resources available to satisfy
all our desires.
• Scarcity of resources limits the amount of
goods and services that can be produced.
– Somebody’s wants will have to go unfulfilled.
• Whose?
– Scarcity requires economic choices to be made.
• Who will decide?
7. 1-7
Factors of Production
• Factors of production: resource inputs used
in the production of goods and services, the
desired outputs.
• Four types.
– Land – all natural resources.
– Labor – skills and abilities of all humans at work.
– Capital – goods produced for use in further
production.
– Entrepreneurship – the assembling of resources to
produce new or improved products and
technologies.
8. 1-8
Opportunity Cost
• When we choose to use resources to produce
one thing, we must give up producing
something else with those resources. This
trade-off comes with a cost.
• Opportunity cost: the value to you of the next
most desired good forgone to obtain some
other higher-priority good.
– 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.
9. 1-9
Production Possibilities
• Production possibilities: the various
combinations of final goods and services
that could be produced in a given time
period with all available resources and
technology.
10. 1-10
Trucks vs. Tanks
• One factory can produce either trucks or
tanks, or some of each with the limited
resources available to it.
• To increase truck production, resources
must be shifted away from tank production,
and vice versa.
– Note the opportunity cost in this trade-off.
11. 1-11
Production Possibilities Curve (PPC)
A
B
C
D
E
F
OUTPUT
OF
TRUCKS
5
4
3
2
1
0 1 2 3 4 5
OUTPUT OF TANKS
Point Trucks Change Tanks Change
A 5 0
B 4 -1 2.0 +2
C 3 -1 3.0 +1
D 2 -1 3.8 +0.8
E 1 -1 4.5 +0.7
F 0 -1 5.0 +0.5
Note that as we move from
A to F, each time we give
up the same amount but
get back less and less in
return.
The trade-off gets worse
and worse.
12. 1-12
• The opportunity cost of producing additional
units of one good increases.
– Each time we give up one truck, we get less back in
tank production.
• Resources are specialized to produce one good
better than another.
– Good tank resources are shifted first.
– Later shifts involve resources less good for tank
production.
– Accounts for the bowed shape of the PPC.
Law of Increasing Opportunity Costs
13. 1-13
Step 1: give up one truck
Step 2: get two tanks
Step 3: give up another truck
Step 4: get one more tank
A
B
C
D
E
F
OUTPUT
OF
TRUCKS
5
4
3
2
1
0 1 2 3 4 5
OUTPUT OF TANKS
Law of Increasing Opportunity Costs
14. 1-14
Production Possibilities Curve (PPC)
• The PPC illustrates two essential principles:
– Scarce resources: there is a limit to the amount
we can produce in a given time with available
resources and technology.
• This limitation positions the PPC.
– Opportunity costs: we can obtain additional
quantities of one of the goods only by reducing
production of another good.
15. 1-15
OUTPUT OF TANKS
A
B
C
Y
5
4
3
2
1
0 1 2 3 4 5
OUTPUT
OF
TRUCKS
Points inside the PPC
represent incomplete
or inefficient use of
available resources.
Surveying Points on the PPC
X
Points outside the PPC
are unattainable with
available resources and
technology.
Only points on the PPC represent maximum efficient use of our production possibilities.
16. 1-16
Economic Growth
• Economic growth: an increase in output; an
expansion of production possibilities.
– Raises our standard of living.
– Satisfies more wants and needs.
– Creates more jobs.
• Economic growth is caused by increasing the
resources available or by producing better
technology.
– The PPC pushes outward.
17. 1-17
Economic Growth
0
PPC1
PPC2
OUTPUT OF TANKS
OUTPUT
OF
TRUCKS
Either increase resource inputs or
improve technology, or both
(B to X).
B
X
Y
Put idle resources
to work (Y to B).
First, reach the current PPC by putting idle
resources to work.
Second, add resources or technology to achieve
previously unattainable combinations.
18. 1-18
Three Basic Decisions
• WHAT to produce: the point we choose on the
production possibilities curve determines what
mix of output gets produced.
• HOW to produce: someone must decide which
production methods and technologies to use.
• FOR WHOM to produce: there must be a
mechanism to determine whose wants and
needs will be satisfied and who must go
without.
19. 1-19
The Market
• Adam Smith called it “the invisible hand.”
– It is as if we are “guided” to the correct point on the
PPC.
– In fact, we get there by the interaction of millions of
decisions made by buyers, sellers, and producers in
their own self-interest (i.e., to make themselves
better off).
• We call this the market mechanism:
– The use of market prices and sales to signal desired
outputs and resource allocations.
20. 1-20
The Market
• Here is how the market answers the three
basic questions:
– WHAT to produce? Produce goods and services
that customers want.
– HOW to produce? Profitably; produce an
acceptable good or service while keeping
production costs low.
– FOR WHOM to produce? Produce for those
who are both willing and able to pay for it.
21. 1-21
The Government
• At its extreme, government could dictate
answers to all three questions.
– Such decisions would be made by political leaders
and bureaucrats.
– Most likely these decisions would not mirror the
individual desires of the people.
– The FOR WHOM decision would lean heavily
toward favoritism: goods for those the government
favors and none for those not in favor.
22. 1-22
A Mixture of Both
• The market is highly efficient in production of
wanted goods and services.
• The government acts as a maintainer of
balance in the economy.
– Makes sure the market does not go to excesses
either in underproduction or overproduction.
– Regulates production to ensure that goods and
services are safe.
– Acts to redress excessive inequalities.
23. 1-23
What Mix Is Best?
• Few governments have relied exclusively on
either pure market or pure government to
manage the economy.
• Public opinion around the world indicates that
the free-market economic system is best.
• The Index of Economic Freedom ranks nations
according to economic freedom.
– Market-dominated economies rank high;
government-run economies rank low.
24. 1-24
Market Failure and
Government Failure
• If the market does not produce the mix of
goods that society desires, market failure is
said to occur.
• This provides an opening for government to
step in.
– If government can move us closer to the mix society
desires, the intervention is successful.
• However, government can do the opposite, or
impose such high costs that the market simply
ceases to produce. This is government failure.
25. 1-25
What Economics Is All About
• Society and its leaders set the nation’s
economic goals. Economics focuses on the
means of achieving those goals.
• Macroeconomics will focus on “big picture”
economics while microeconomics will focus
on economic interactions of consumers and
producers.
26. 1-26
Types of Economic Analysis
• Positive analysis in economics focuses on
“what is” and is based on facts.
• Normative analysis focuses on “what should
be” and is based on opinions and judgments.
Editor's Notes
It is always good to start out with a specific set of goals.
Emphasize the interaction of market forces and government intervention in the marketplace.
Emphasize that individuals are economic players who initiate action by making decisions.
The learning objectives will be revisited at the end of the chapter.
Covering these objectives is a good way to organize your classroom.
Emphasize how it takes production to create satisfaction.
Schiller returns to the three questions again and again.
So stress them now and again as a course organizer.
Most students view the economy as something out there, something esoteric – nothing to do with them.
Here is a chance to bring the students into the economic discussion.
6
7
8
9
This is obviously an example from industry.
You could add an example from the home. For example, the kids want cake and cookies, and parents must set up to produce. How many cakes and how many cookies?
Or an example from government. WWII gives us a good one: rationing consumer goods to boost production of military goods.
11
Divide the resources used into three categories: those great for truck production but not much for tank production, those OK for either production, and those great for tank production but not much for truck production. Shift each category and identify what is lost and what is gained.
13
14
15
The limitation for the PPC was the amount of available resources and technology.
Increase either and the PPC shifts outward.
17
Again the three questions.
In each question, emphasize that choices must be made.
It might be worthwhile to take 10 minutes or so and introduce your students to Adam Smith, the father of economics, and how he opposed the mercantilist system of the day. The conventional wisdom was that the wealth of a nation was the gold in the king’s treasury. He said the wealth of the nation was in the productive capability and ingenuity of the people. His recommendation was for the king to get out of the way and let the people “truck and barter.”
A good way to drive these points home is to discuss their opposites: What happens to a company that produces goods that customers don’t want? What happens to a company that produces goods unprofitably? Does a company need to produce the perfect product, or is acceptable (by the consumer) enough? Someone doesn’t get goods in this market. Who?
Favoritism? The dictator’s friends get things; his enemies do not. Government passes laws authorizing payments to specific groups and companies; other groups and companies don’t get the payments.
Now blend the two. Emphasize excesses: excessive pollution, unsafe products, etc. Introduce the safety net. Talk about those groups who don’t get products in the market system.
There is plenty of ammo here for a good discussion about how different countries organize themselves.
“We elected you people to go to Washington to fix our problems. Why haven’t you done so?”
Someone said that the government can tackle any problem, but the cost of doing so will always be high.
And there is no guarantee that the government will succeed in fixing the problem.
This is a brief overview of macro.
You really need to contrast the difference between facts and opinions.
“The unemployment rate is 10%” versus “the unemployment rate is too high.”