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Econ Chap01


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Econ Chap01

  1. 1. CHAPTER 1 What Is Economics? CHAPTER 2 Economic Systems and Decision Making CHAPTER 3 Business Organizations As you read this unit, learn how the study of economics helps answer the following questions: How do you make the decision between buying gas for your car or taking your friend out for pizza? Why is your friend from Russia stunned by all the shoes available at your local shoe store? Why is an item at a department store less expensive than that same The factors of production—land, labor, capital, and entrepreneur- item at a specialty shop? ship—make production possible. 2 UNIT 1 FUNDAMENTAL ECONOMIC CONCEPTS
  2. 2. To learn more about basic economic concepts through information, activities, and links to other sites, visit the Economics: Principles and Practices Web site at
  3. 3. The study of economics will help you become a better decision maker—it helps you develop a way of thinking about how to make the best choices for you. To learn more about the scope of economics, view the Chapter 2 video lesson: What Is Economics? Consumers must make choices from many alternatives. Chapter Overview Visit the Economics: Principles and Practices Web site at and click on Chapter 1—Chapter Overviews to preview chapter information.
  4. 4. Scarcity and the Science of Economics Main Idea Key Terms Scarcity forces us to make choices. We can’t have scarcity, economics, need, want, factors of production, everything we want, so we are forced to choose land, capital, financial capital, labor, entrepreneur, what we want most. production, Gross Domestic Product (GDP) Reading Strategy Objectives Graphic Organizer As you read the section, com- After studying this section, you will be able to: plete a graphic organizer like the one below by list- 1. Explain the fundamental economic problem. ing and describing the three economic choices every 2. Examine the three basic economic questions every society must make. society must decide. Applying Economic Concepts Economic choices Scarcity Read to find out why scarcity is the basic economic problem that faces everyone. D o you think the study of economics is worth Cover Story your time and effort? According to the Harris poll in the cover story, a huge percentage of Americans think it is. They must know what econo- terest Harris Poll Shows High In mists know—that a basic understanding of economics in Economics can help make sense of the world around us. American adults The Fundamental Economic Problem have an exceptionally keen interest in eco- Have you ever noticed that very few people nomics. More than are satisfied with the things they have? seven in ten say they Someone without a home may want a small one; share the same high someone else with a small home may want a larger level of interest in one; someone with a large home may want a man- economics as they do sion. Others want things like expensive sports cars, politics, business and finance. A full 96% lavish jewelry, and exotic trips. Whether they are rich ca- The focus on economics edu believe basic econom- or poor, most people seem to want more than they tion is growing. in ics should be taught already have. In fact, if each of us were to make a list high school. Yet, half of all the things we want, it would include more ool two out of three high sch of these same adults and iz on basic economic things than we could ever hope to obtain. ntary qu students flunked an eleme e [to] place eco- The fundamental economic problem facing all Clearly the time has com concepts. nda. the national education age societies is that of scarcity. Scarcity is the condition nomic literacy higher on that results from society not having enough resources ase, The National Council —April 27, 1999 press rele on Economic Education to produce all the things people would like to have. CHAPTER 1: WHAT IS ECONOMICS? 5
  5. 5. ECONOMICS “There Is No Such Thing as a Free Lunch” Figure 1.1 AT A GLANCE AT A GLANCE Because resources are limited, virtually every- thing we do has a cost—even when it seems as if we Scarcity are getting something “for free.” For example, you may think you are getting a Unlimited Limited free lunch when you use a “buy one, get one free” Wants Resources coupon. However, while you may not pay for the extra lunch then and there, someone had to pay the farmer for raising the food, the truck driver for delivering the food, the chef for preparing the food, and the server for serving the food. How does business recover these costs? Chances Scarcity are that the price of the giveaway is usually hidden somewhere in the prices the firm charges for its products. As a result, the more a business gives away “free,” the more it has to raise the prices for Choices the items it sells. In the end, someone always pays for the supposedly “free” lunch—and that someone may be you! What How For Whom Unfortunately, most things in life are not free to Produce to Produce to Produce because someone has to pay for the production in the first place. Economic educators use the term TINSTAAFL to describe this concept. In short, Using Charts Scarcity is the fundamental this term means that There Is No Such Thing As A economic problem that forces consumers Free Lunch. and producers to use resources wisely. Why is scarcity a universal problem? Three Basic Questions As shown in Figure 1.1, scarcity affects almost Because we live in a world of relatively scarce every decision we make. This is where the study of resources, we have to make wise economic economics comes in. Economics is the study of choices. Figure 1.1 presents three of the basic ques- how people try to satisfy what appears to be seem- tions we have to answer. In so doing, we make deci- ingly unlimited and competing wants through the sions about the ways our limited resources will be careful use of relatively scarce resources. used. Needs and Wants WHAT to Produce Economists often talk about people’s needs and The first question is that of WHAT to produce. wants. A need is a basic requirement for survival Should a society direct most of its resources to the and includes food, clothing, and shelter. A want is production of military equipment or to other a way of expressing a need. Food, for example, is a items such as food, clothing, or housing? Suppose basic need related to survival. To satisfy the need the decision is to produce housing. Should its lim- for food, a person may “want” a pizza or other ited resources be used for low-income, middle- favorite meal. Because any number of foods will income, or upper-income housing? How many of satisfy the need for nourishment, the range of each will be needed? A society cannot have every- things represented by the term want is much thing its people want, so it must decide WHAT to broader than that represented by the term need. produce. 6 UNIT 1 FUNDAMENTAL ECONOMIC CONCEPTS
  6. 6. HOW to Produce not created by humans. “Land” includes deserts, fertile fields, forests, mineral deposits, livestock, A second question is that of HOW to produce. sunshine, and the climate necessary to grow crops. Should factory owners use mass production meth- Because only so many natural resources are avail- ods that require a lot of equipment and few work- able at any given time, economists tend to think of ers, or should they use less equipment and more land as being fixed, or in limited supply. workers? If an area has many unemployed people, For example, there is not enough good farm- the second method might be better. On the other land to adequately feed all of the earth’s popula- hand, mass production methods in countries where tion, nor enough sandy beaches for everyone to machinery and equipment are widely available can enjoy, nor enough oil and minerals to meet our often lower production costs. Lower costs make expanding energy needs indefinitely. Because the manufactured items less expensive and, therefore, supply of a productive factor like land is relatively available to more people. fixed, the problem of scarcity is likely to become worse as population grows in the future. FOR WHOM to Produce The third question deals with FOR WHOM to Capital produce. After a society decides WHAT and HOW to produce, the things produced must be allocated Another factor of production is capital—the to someone. If the society decides to produce hous- tools, equipment, machinery, and factories used in ing, should it be distributed to workers, profes- the production of goods and services. Such items sional people, or government employees? If there are also called capital goods to distinguish them are not enough houses for everyone, a choice must from financial capital, the money used to buy the be made as to who will receive the existing supply. tools and equipment used in production. These questions concerning WHAT, HOW, and FOR WHOM to produce are not easy for any soci- Economic Choices ety to answer. Nevertheless, they must be answered as long as there are not enough resources to satisfy people’s seemingly unlimited wants. The Factors of Production The reason people cannot sat- isfy all their wants and needs is the scarcity of productive resources. The factors of production, or resources required to produce the things we would like to have, are land, capital, labor, and entrepre- neurs. As shown in Figure 1.2, all four are required if goods and serv- ices are to be produced. Making Decisions If we cannot have everything we want, Land then we have to choose what we want the most. Why must a society face the choices about what, how, and for whom to In economics, land refers to the produce? “gifts of nature,” or natural resources CHAPTER 1: WHAT IS ECONOMICS? 7
  7. 7. ECONOMICS Figure 1.2 AT A GLANCE AT A GLANCE The Factors of Production Land Capital Labor Entrepreneurs Land includes the Capital includes the Labor includes people Entrepreneurs are “gifts of nature,” or tools, equipment, and with all their efforts individuals who start a natural resources not factories used in and abilities. new business or bring created by human production. a product to market. effort. Synthesizing Information The four factors of production are necessary for production to take place. What four factors of production are necessary to bring jewelry to consumers? Capital is unique in that it is the result of pro- Entrepreneurs duction. A bulldozer, for example, is a capital Some people are special because they are the inno- good used in construction. It also was built in a vators responsible for much of the change in our factory, which makes it the result of earlier produc- economy. Such an individual is an entrepreneur, a tion. Like the bulldozer, the cash register in a risk-taker in search of profits who does something neighborhood store is a capital good, as are the new with existing resources. Entrepreneurs often are computers in your school that are used to produce thought of as being the driving force in an economy the service of education. because they exhibit the ability to start new busi- nesses or bring new products to market. They pro- vide the initiative that combines the resources of Labor land, labor, and capital into new products. A third factor of production is labor—people with all their efforts, abilities, and skills. This cat- egory includes all people except for a unique Production group of individuals called entrepreneurs, which When all factors of production—land, capital, we single out because of their special role in the labor, and entrepreneurs—are present, production, or economy. the process of creating goods and services, can take Unlike land, labor is a resource that may vary place. In fact, everything we produce requires these in size over time. Historically, factors such as pop- factors. For example, the chalkboards, desks, and ulation growth, immigration, famine, war, and audiovisual equipment used in schools are capital disease have had a dramatic impact on both the goods. The labor is in the form of services supplied quantity and quality of labor. 8 UNIT 1 FUNDAMENTAL ECONOMIC CONCEPTS
  8. 8. by teachers, administrators, and other employees. dollar value of all final goods and services, and Land, such as the iron ore, granite, and timber used structures produced within a country’s borders in a to make the building and desks, as well as the land 12-month period. GDP is the most comprehensive where the school is located, is also needed. Finally, measure of a country’s total output and is a key entrepreneurs are needed to organize the other three measure of the nation’s economic health. factors and make sure that everything gets done. Economics is also concerned with what is pro- duced and who gets how much, as well as with top- ics such as unemployment, inflation, international The Scope of Economics trade, the interaction of business and labor, and the effects of government spending and taxes. Economics is the study of human efforts to Description is important because we need to satisfy what appear to be unlimited and know what the world around us looks like. competing wants through the careful use of rela- However, description is only part of the picture tively scarce resources. As such, it is a social science because it leaves many important “why” and “how” because it deals with the behavior of people as questions unanswered. they deal with this basic issue. There are four key elements to this study: description, analysis, expla- Analysis nation, and prediction. In order to answer such questions, economics must focus on the analysis of economic activity as Description well. Why, for example, are prices of some items Economics deals with the description of eco- high while others are low? Why do some people nomic activity. For example, you will often hear earn higher incomes than others? How do taxes about the Gross Domestic Product (GDP)—the affect people’s desire to work and save? Italy 3.4% Britain 3.3% UNITED STATES LEADS Germany 2.2% Denmark 2.0% IN ENTREPRENEURS France 1.8% Finland 1.4% A vast majority of the owners of the nearly 20 U.S. 8.5% Canada million businesses in the United States are entre- 6.8% preneurs. Most either work for themselves or Source: 1999 Global Entrepreneurship Monitor have a few employees. A 10-nation study found that the United States Critical Thinking leads when it comes to entrepreneurs. According to the survey, nearly 1 in 12 Americans is trying to start 1. Analyzing Information In which nation is a new business. In second place is Canada. The study entrepreneurial activity strongest? Weakest? also shows a strong link between business start-up 2. Making Comparisons How does the level rates and overall economic growth. The graph of North America’s entrepreneurial activity shows the percentage of the adult population start- compare with Europe’s? ing new businesses. 3. Drawing Conclusions Do you think there is a link between business start-up rates and overall economic growth? Why or why not? CHAPTER 1: WHAT IS ECONOMICS? 9
  9. 9. the future. When it comes to the GDP, you will soon discover that economists spend much of their time explaining why the measure is, or is not, per- Capital forming in the manner expected. “Capital” comprises the tools, equipment, and factories used to produce goods and services. As the economy changes, some economists are Prediction adjusting the definition to include “tools” such Finally, economics is concerned with prediction. as knowledge and intellectual property. An For example, we may want to know if people’s example of such knowledge and intellectual incomes are going to rise or fall in the future, property are databases and software. affecting their spending habits in the marketplace. Or, perhaps a community trying to choose between higher taxes on homeowners or higher taxes on businesses needs to know the consequences of each The importance of analysis is that it helps us to alternative before it makes its choice. discover why things work and how things happen. The study of economics can help to make the This, in turn, will help us deal with problems that best decision in both situations. Because econom- we would like to solve. ics deals with the study of what is, or what tends to be, it can help predict what may happen in the Explanation future, as well as the likely consequences of differ- ent courses of action. Economics is also concerned with the explana- Finally, it is also important to realize that the tion of economic activity. After economists under- actual decisions about the economic choices to be stand why and how things work, it is useful and made are the responsibility of all citizens in a free even necessary to communicate this knowledge to and democratic society. Therefore, the study of others. If we all have a common understanding of economics helps all of us to become more the way our economy works, some economic prob- informed citizens and better decision makers. lems will be much easier to address or even fix in Checking for Understanding Applying Economic Concepts 7. Scarcity How does scarcity affect your life? 1. Main Idea Using your notes from the graphic Provide several examples of items you had to organizer activity on page 5, explain why a do without because of limited resources. society must face the choices about WHAT, Explain how you adjusted to this situation. HOW, and FOR WHOM to produce. For example, were you able to substitute 2. Key Terms Define scarcity, economics, need, other items for those you could not have? want, factors of production, land, capital, financial capital, labor, entrepreneur, produc- tion, Gross Domestic Product (GDP). 3. Describe the fundamental economic problem. 8. Synthesizing Information Give an example of a supposedly “free” item that you see 4. List the three basic economic questions every every day. Explain why the item is not really society must answer. free by stating who or what actually pays 5. Describe the factors of production. for it. 6. List the four key elements of economics. Practice and assess key social studies skills with the Glencoe Skillbuilder Interactive Workbook, Level 2. 10 UNIT 1 FUNDAMENTAL ECONOMIC CONCEPTS
  10. 10. Newsclip Alexis de Tocqueville, a French traveler, Changes in the rules of the business game are putting wrote about his travels in the United a premium on the States during the 1830s. His book, entrepreneurial quali- Democracy in America, a two-volume ties of [the smaller] study of the American people and their companies. Today’s institutions, is still relevant today. successful enterprises are nimble, innova- tive, close to the cus- tomer, and quick to the The Role of the market. They’re not bureaucratic, centrally con- Entrepreneur trolled institutions that are slow to change. It adds us to a new manage- ment catechism with many of the hallmarks of What astonishes me in the United States is small business. . . . not so much the marvelous grandeur of such Sure, some industries, such as auto making and undertakings as the innumerable multitude petrochemicals, still require size and scale. But the of small ones. swift pace of technological change and the frag- —Alexis de Tocqueville, 1835 mentation of markets are eroding the traditional economies of scale. Indeed, some management What [de Tocqueville noticed nearly 160 thinkers now speak of the “diseconomies of years ago]—before the advent of Apple scale,” the unresponsiveness, sluggishness, and Computer, Genentech, Microsoft, or Nucor—is high costs that come with bureaucracy. While the just as true today. The only difference is that the behemoths try to adjust to new competitive reali- spirit of enterprise is more than ever a global ties, younger and smaller companies have phenomenon with few bounds. emerged as the agents of change in economies From the row of kiosks selling goods on nearly around the world. . . . every block in Moscow to the cramped factories in Taiwan, Russian biznez-men and Chinese chang- —Reprinted from Small Business Trends and Entrepreneurship, by the editors of Business Week, copyright © 1995 by shang are reshaping their nations’ economies in The McGraw-Hill Companies, Inc. much the same way as those ingenious old Yankees created the basis for America’s business cul- Examining the Newsclip tures just after independ- ence was won. 1. Summarizing Information What are the Any [de Tocqueville of entrepreneurial qualities of small companies? modern times] would 2. Finding the Main Idea What does the writer notice something else mean by “diseconomies of scale”? about this global shift: 11
  11. 11. Basic Economic Concepts Main Idea Key Terms An economic product is a good or service that is use- economic product, good, consumer good, capital ful, relatively scarce, and exchangeable. good, service, value, paradox of value, utility, wealth, market, factor market, product market, economic Reading Strategy growth, productivity, division of labor, specialization, Graphic Organizer As you read the section, describe human capital, economic interdependence three different transactions that could take place in Objectives the factor market. Use a web like the one below to help you organize your answer. After studying this section, you will be able to: 1. Explain the relationship among scarcity, value, utility, and wealth. Effect 2. Understand the circular flow of economic activity. Factor market Effect Applying Economic Concepts Specialization Read to discover how specialization Effect increases production. E conomics, like any other social science, has its own vocabulary. To understand econom- Cover Story ics, a review of some key terms is necessary. Fortunately, most economic terms are widely used, On Specialization and many will already be familiar to you. . One man draws out the To take an example, . . rth it, a third cuts it, a fou Goods, Services, and Consumers wire, another straightens it at points it, a fifth grinds Economics is concerned with economic for receiving the the top products—goods and services that are useful, head; to make the head relatively scarce, and transferable to others. requires two or three distinct operations; Economic products are scarce in an economic to put it on, is a sense. That is, one cannot get enough to satisfy peculiar business, to individual wants and needs. Because of these char- whiten the pins is acteristics, economic products command a price. another; it is even a trade by itself to put them into the paper; Goods and [the making of] a The first type of economic product is a good— pin is, in this manner, an item that is economically useful or satisfies divided into about eight- an economic want, such as a book, car, or com- een distinct operations. pact disc player. A consumer good is intended Adam Smith lth of —Adam Smith, The Wea for final use by individuals. When manufactured Nations, 1776 goods are used to produce other goods and serv- ices, they are called capital goods. An example 12
  12. 12. of a capital good would be a robot welder in a fac- Economists knew that scarcity is required for tory, an oven in a bakery, or a computer in a high value. For example, water was so plentiful in many school. areas that it had little or no value. On the other Any good that lasts three years or more when hand, diamonds were so scarce that they had great used on a regular basis is called a durable good. value. The problem was that scarcity by itself is not Durable goods include both capital goods, such as enough to create value. robot welders, and consumer goods such as auto- mobiles. A nondurable good is an item that lasts Utility for less than three years when used on a regular basis. Examples of nondurable goods include food, It turned out that for something to have value, it writing paper, and most clothing items. must also have utility, or the capacity to be useful and provide satisfaction. Utility is not something that is fixed or measurable, like weight or height. Services Instead, the utility of a good or service may vary The other type of economic product is a service, from one person to the next. One person may get or work that is performed for someone. Services a great deal of satisfaction from a home computer; include haircuts, home repairs, and forms of enter- another may get very little. One person may enjoy tainment such as concerts. They also include the a rock concert; another may not. A good or service work that doctors, lawyers, and teachers perform. does not have to have utility for everyone, only The difference between a good and a service is that utility for some. a service is intangible, or something that cannot be For something to have value, economists touched. decided, it must be scarce and have utility. This is the solution to the paradox of value. Diamonds are Consumers scarce and have utility—and therefore they possess a value that can be stated in monetary terms. Water The consumer is a person who uses goods and has utility, but is not scarce enough in most places services to satisfy wants and needs. As consumers, to give it much value. Therefore, water is less people indulge in consumption, the process of expensive, or has less value, than diamonds. using up goods and services in order to satisfy wants and needs. Value, Utility, and Wealth INFOBYTE In economics, value refers to a worth that can be expressed in dollars and cents. Why, however, does something have value, and why are Durable Goods Orders The Department of Com- some things worth more than others? To answer merce’s report on durable goods orders highlights the number of new orders placed with domestic these questions, it helps to review an early problem manufacturers for goods intended to last over faced by economists. three years. The report is divided into broad cate- gories; these include defense, nondefense, and Paradox of Value capital and noncapital goods. Noncapital goods are generally of the consumer spending variety At first, early economists were puzzled by a con- and include automobiles and large appliances. tradiction between necessities and value called the Capital goods tend to be of the investment spend- paradox of value. The paradox of value is the situa- ing nature, while defense goods indicate govern- tion where some necessities, such as water, have little ment spending. monetary value, whereas some non-necessities, such as diamonds, have a much higher value. CHAPTER 1: WHAT IS ECONOMICS? 13
  13. 13. Wealth The Circular Flow of Economic Another concept is wealth. Wealth, in an eco- Activity nomic sense, is the accumulation of those products The wealth that an economy generates is that are tangible, scarce, useful, and transferable from made possible by the circular flow of eco- one person to another. Consequently, a nation’s nomic activity. The key feature of this circular flow wealth is comprised of all items, including natural is the market, a location or other mechanism that resources, factories, stores, houses, motels, theaters, allows buyers and sellers to exchange a certain eco- furniture, clothing, books, highways, video games, nomic product. Markets may be local, regional, and even footballs. national, or global. More recently, markets have While goods are counted as wealth, services are evolved in cyberspace, with buyers and sellers inter- not because they are intangible. However, this does not mean that services are not useful. Indeed, when acting through computer networks without leaving Adam Smith wrote The Wealth of Nations in 1776, he the comfort of their homes. was referring specifically to the ability and skills of a nation’s people as the source of its wealth. To illustrate, if a country’s material possessions were Factor Markets taken away, its people, through their skilled efforts, How does this circular flow operate? As shown could restore these possessions. On the other hand, in Figure 1.3, individuals earn their incomes in if a country’s people were taken away, its wealth factor markets, the markets where productive would deteriorate. resources are bought and sold. This is where entre- preneurs hire labor for wages and salaries, acquire land in return for rent, and borrow money for Wealth interest. The concept of a factor market is a sim- plified version of the real world, of course, but it is nevertheless realistic. To illustrate, you partici- pate in the factor market whenever you go to work and sell your labor to an employer. Product Markets After individuals receive their income from the resources they sell, they spend it in product markets, markets where producers sell their goods and serv- ices to consumers. Thus, the money that individu- als receive from businesses in the factor markets returns to businesses in the product markets. Businesses then use this money to produce more goods and services—and the cycle, through eco- nomic activity, repeats itself. As you can see from Figure 1.3, markets serve as the main links between individuals and businesses. Note that money circulates on the outside, illus- trating payments for goods, services, and the fac- Natural Resources Fertile land is a natural tors of production. The actual factors of resource and an item of wealth. Why are natu- production, and the products made with these pro- ral resources considered part of the nation’s ductive inputs, flow in the opposite direction on wealth? the inside. 14 UNIT 1 FUNDAMENTAL ECONOMIC CONCEPTS
  14. 14. Productivity and Economic Growth Productivity Everyone benefits when scarce resources are Economic growth occurs when a nation’s used efficiently. This is described by the term total output of goods and services increases productivity, which is a measure of the amount of over time. This means that the circular flow in output produced by a given amount of inputs in a Figure 1.3 becomes larger, with more factors of pro- specific period of time. Productivity goes up when- duction, goods, and services flowing in one direc- ever more output can be produced with the same tion, and more payments flowing in the opposite amount of inputs in the same amount of time. For direction. A number of factors are responsible for example, if a company produced 500 units of a economic growth, but productivity is the most product in one period, and if it produced 510 in important. ECONOMICS Figure 1.3 AT A GLANCE AT A GLANCE The Circular Flow of Economic Activity Product $ Consumer Markets Spending $ Business Income Goods Goods Services Services Businesses Individuals Land Capital Buy Labor Productive Entrepreneurs Resources $ Income from Resources $ Payments for Factor Resources Markets Using Charts The circular flow diagram shows the high degree of economic interdependence Using Charts The circular flow diagram shows the high degree of economic interdependence in our economy. In the diagram, the factors of production and the products made from them flow in in our economy. In the diagram, the factors of production and the products made from them flow in one direction. The payments for the factors, which consumers spend on goods and services, flow one direction. The payments for the factors, which consumers spend on goods and services, flow in the opposite direction. As a consumer, what role do you play in the circular flow of in the opposite direction. As a consumer, what role do you play in the circular flow of economic activity? economic activity? CHAPTER 1: WHAT IS ECONOMICS? 15
  15. 15. the next period with the same number of inputs, Specialization takes place when factors of pro- then productivity went up. duction perform tasks that they can do relatively Productivity is often discussed in terms of labor, more efficiently than others. Note that specializa- but it applies to all factors of production. For this tion is not limited to a single factor of production reason, business owners try to buy the most effi- such as labor. For example, complex industrial cient capital goods, and farmers try to use the most robots are often built to perform just one or two fertile land for their crops. simple assembly line tasks. In regional specializa- tion, different regions of the country often special- ize in the things they can produce best—as when Division of Labor and Specialization Idaho specializes in potatoes, Iowa in corn, and Division of labor and specialization can improve Texas in oil, cotton, and cattle. productivity. Division of labor takes place when One of the best examples of the advantages work is arranged so that individual workers do fewer offered by the division of labor and specialization is tasks than before. In most cases, a worker who per- Henry Ford’s introduction of the assembly line into forms a few tasks many times every day is likely to automobile manufacturing. This process cut the time become more proficient than a worker who performs necessary to assemble a car from a day and a half to hundreds of different tasks in the same period. just over 90 minutes. It also cut the price of a new car by more than 50 percent. The result was an improvement in productivity. Another example of the changes ECONOMICS that can result from specialized tools Figure 1.4 can be seen in American agriculture. AT A GLANCE In 1910 it took more than 13 million farmers to feed the U.S. population, Effect of Education on Income at that time about 90 million. Today, 2 million farmers can feed a popula- Average Income For tion that is more than three times as Education Males Females large as it was in 1910. $25,112 $18,227 Less Than 9th Grade $30,656 $23,625 9th to 12th Grade (no diploma) Investing in Human Capital $39,017 $27,525 High School Graduate & Equivalency One of the main contributions to $46,696 $33,002 Some College, no degree productivity comes from investments $48,153 $34,560 Associate Degree in human capital, the sum of the $71,361 $45,778 Bachelor’s Degree skills, abilities, health, and motivation of people. Government can invest in $87,099 $57,874 Master’s Degree human capital by helping to provide $130,764 $72,689 Professional Degree education and health care. Businesses $104,237 $70,302 Doctorate Degree can invest in training and other pro- Source: U.S. Department of Commerce, Bureau of the Census, 2003 grams that improve the skill and motivation of its workers. Individuals Using Tables Education is can invest in their own education by one way to invest in human completing high school, going to capital. How does this type technical school, or going to college. of invest-ment pay off for investment pay off Figure 1.4 shows that investments both employers and their Visit and click on both employers and in education can have substantial Textbook Updates—Chapter 1 for employees? payoffs. According to the data in the an update of the data. table, high school graduates have substantially higher incomes than 16 UNIT 1 FUNDAMENTAL ECONOMIC CONCEPTS
  16. 16. nongraduates, and college graduates make even more than high school graduates. Educational investments require that we make a sacrifice today so First and Biggest The world’s first programmable we can have a better life in the future—and few computer, the Electronic Numerical Integrator and investments generate higher returns. Computer (ENIAC), was developed in 1946. Standing almost 10 feet tall and 80 feet wide, ENIAC could perform up to 5,000 operations per second. Personal Investing in the Future computers today easily outperform ENIAC. Businesses, government, and other organiza- tions face many of the same choices that individu- als do. Investments in human capital and physical capital can eventually increase production and pro- the lives of tens of thousands of people who park mote economic growth. Faster economic growth, cars, sell tickets, serve food at the games, and sell in turn, increases the amount of goods and services NBA apparel and memorabilia all across the country. available to us. Or, bad weather in countries where sugar cane is grown can affect sugar prices in the United States, Economic Interdependence which in turn can affect the price of snack foods and The American economy has a remarkable degree the demand for sugar substitutes elsewhere. of economic interdependence. This means that we This does not mean that economic interdepen- rely on others, and others rely on us, to provide the dence is necessarily bad. The gain in productivity goods and services that we consume. and income as a result of increased specialization Events in one part of the country or the world almost always offsets the costs associated with the often have a dramatic impact elsewhere. To illustrate, loss in self-sufficiency. However, we need to under- a labor dispute between several hundred professional stand how all the parts fit together, which is one basketball players and a handful of owners can affect reason why we study economics. Checking for Understanding Applying Economic Concepts 1. Main Idea Using your notes from the graphic 6. Specialization Provide at least three examples organizer activity on page 12, explain the each of specialized workers and capital that different transactions that take place in the are used in your school to provide the service product market. of education. Would productivity go up or down if these specialized capital goods and 2. Key Terms Define economic product, good, workers were not available to your school? consumer good, capital good, service, value, Explain why or why not. paradox of value, utility, wealth, market, factor market, product market, economic growth, productivity, division of labor, specialization, human capital, economic 7. Making Comparisons What is the differ- interdependence. ence between a durable good and a non- 3. Discuss the relationship among scarcity, value, durable good? utility, and wealth. 8. Drawing Conclusions In what way do busi- 4. Describe the circular flow of economic activity. nesses and households both supply and 5. Explain why productivity is important to eco- demand in the circular flow model? nomic growth. Practice and assess key social studies skills with the Glencoe Skillbuilder Interactive Workbook, Level 2. CHAPTER 1: WHAT IS ECONOMICS? 17
  17. 17. The Father of Classical Economics: Adam Smith (1723–1790) Take a look at a Scottish penny and you’ll be surprised by what you see. The person pictured was not a political or military figure, but an economist: Adam Smith. It is a fitting tribute to a man who contributed so much to economics. productive as each worker becomes competitive market—operating with HIS LIFE more skilled at a single job. He said a minimum of government inter- Smith was born in Kirkcaldy, that new machinery and the divi- vention—would bring about the Scotland. After graduating from sion of labor and specialization greatest good for society as a whole. Glasgow University, he traveled would lead to an increase in produc- The English aristocracy ridiculed to England and enrolled at Oxford tion and greater “wealth of nations.” The Wealth of Nations. Business peo- University. Six years later, Smith Smith also put forth what was then ple, however, were delighted to returned to Scotland to lecture a radical new idea: that the wealth have a moral justification for their at Edinburgh University and at of a nation should be defined as the growing wealth and power. Soon, his alma mater, where he was sum of its labor-produced goods, Smith’s doctrine of laissez-faire immensely popular with his stu- not by who owned those goods. (French, “let it be”), meaning mini- dents. Smith became a tutor to a Smith’s most influential contri- mal government intervention in young duke, and traveled through- bution, however, concerned com- economic affairs, became the eco- out Europe. petition in the marketplace. Every nomic watchword in Europe, and is individual, Smith wrote, “intends today the economic watchword of HIS IDEAS only his own gain, and he is in this much of the world. Smith met and exchanged ideas . . . led by an invisible hand. . . . with French writer Voltaire, By pursuing his own interest he fre- Benjamin Franklin, and the French quently promotes that of the soci- Examining the Profile economist Quesnay. His travels ety. . . .” Smith argued that a free 1. Summarizing Ideas Summarize helped him formulate the ideas put market isn’t chaotic, but that com- Smith’s contribution to economic forth in The Wealth of Nations (1776). petition acts as an “invisible hand” thought. In The Wealth of Nations, Smith that guides resources to their most 2. Synthesizing Information Explain observed that labor becomes more productive uses. A truly free, how Smith’s ideas are evident in the workings of the American economy. 18 UNIT 1 FUNDAMENTAL ECONOMIC CONCEPTS
  18. 18. Economic Choices and Decision Making Main Idea Key Terms Trade-offs are present whenever choices are made. trade-off, opportunity cost, production possibilities frontier, cost-benefit analysis, free enterprise econ- Reading Strategy omy, standard of living Graphic Organizer As you read this section, complete Objectives a graphic organizer similar to the one below by explaining what you need to know to become a After studying this section, you will be able to: good decision maker. 1. Analyze trade-offs and opportunity costs. 2. Explain decision-making strategies. Making decisions Applying Economic Concepts Opportunity Costs Read to find out how your deci- sions are measured in terms of opportunity costs. T he process of making a choice is not always Cover Story easy. Still, individuals, businesses, and gov- ernment agencies, like the Chicago Child- Parent Center program, who try to satisfy people’s Cost Benefit Analysis wants and needs, must make decisions. Because resources are scarce, consumers need to make wise Research has choices. To become a good decision maker, you long demonstrated need to know how to identify the problem and the educational value then analyze your alternatives. Finally, you have to of early interven- tion for America’s make your choice in a way that carefully considers at-risk children, but the costs and benefits of each possibility. a new study also shows the federal Trade-Offs and Opportunity Cost programs are a wise public investment. There are alternatives and costs to every- [A] cost-benefit thing we do. In a world where “there is no analysis of the fed- such thing as a free lunch,” it pays to examine these de-offs erally funded Chi- Social programs involve tra t concepts closely. ts. cago Child-Paren and opportunity cos Center program, which serves chil- Trade-Offs y ilies in Chicago’s inner cit dren from low-income fam per e annual cost of $6,730 The first thing we must recognize is that peo- [shows that] an averag large al return to society at child … generated a tot ple face trade-offs, or alternative choices, when- nt. of $47,759 per participa ever they make an economic decision. To help make the decision, constructing a grid such as e 26, 2001 - AScribe Newswire, Jun that in Figure 1.5 shows one way to approach the CHAPTER 1: WHAT IS ECONOMICS? 19
  19. 19. problem. This grid summarizes a decision to be Opportunity Cost made by Jesse, a newspaper carrier, whose dilemma is People often think of cost in terms of dollars how to spend a gift of $50 in the best way possible. and cents. To an economist, however, cost often Jesse realizes that several alternatives are appeal- means more than the price tag placed on a good ing—a soccer ball, jeans, a portable CD player, sev- or service. Instead, economists think broadly in eral CDs, or concert tickets. At the same time, he terms of opportunity cost—the cost of the next realizes that each item has advantages and disad- best alternative use of money, time, or resources vantages. Some of these items are more durable when one choice is made rather than another. than others, and some might require his parents’ When Jesse made his choice and decided to pur- consent. Some even have additional costs while chase the jeans, his opportunity cost was the next others do not—the CD player would require batter- best choice—the soccer ball or the CD player—that ies and the concert tickets would require the use of he gave up. his parents’ car. Suppose you spend $5,000 on a used car. The To help with his decision, Jesse draws a grid that opportunity cost of the purchase is the value of the lists his alternatives and several criteria by which to stereo, apartment, vacation, or other items and judge them. Then he evaluates each alternative activities that you could have purchased with the with a “yes” or “no.” In the end, Jesse chooses the money spent on the car. jeans because they satisfy more of his criteria than Even time has an opportunity cost, although any other alternative. you cannot always put a monetary value on it. The Using a decision-making grid is one way to ana- opportunity cost of taking an economics class, for lyze an economic problem. Among other things, it example, is the history or math class that you could forces you to consider a number of relevant alter- not take at the same time. Thus, part of making natives. For another, it requires you to identify the economic decisions involves recognizing and eval- criteria used to evaluate the alternatives. Finally, it uating the cost of the alternatives as well as making forces you to evaluate each alternative based on the choices from among the alternatives. criteria you selected. ECONOMICS Figure 1.5 AT A GLANCE AT A GLANCE Jesse’s Decision-Making Grid Criteria Alternatives Costs $50 Will parents Future expense Can use Durable? or less? approve? unnecessary? anytime? Several CDs yes yes yes yes no Concert tickets yes no no no no CD player yes yes yes no yes Soccer ball yes yes yes yes no Jeans yes yes yes yes yes Adapted from A Framework for Teaching Basic Economics, Economics America National Council on Economic Education, 1996 Using Tables A decision-making grid is a good way to list and then evaluate alternatives when a decision must be made. What do economists mean when they talk about costs? 20 UNIT 1 FUNDAMENTAL ECONOMIC CONCEPTS
  20. 20. Economic Choices Trade-Offs In this cartoon, the king faces a trade-off between crops and catapults. What is the oppor- tunity cost of obtaining two more catapults? Production Possibilities Alpha has many alternatives available to it, which is why the figure is called a production “pos- A popular model economists use to illus- sibilities” frontier. Eventually though, Alpha will trate the concept of opportunity cost is the have to settle on a single combination such as production possibilities frontier, a diagram repre- point a, b, or any other point on or inside the senting various combinations of goods and/or curve, because its resources are limited. services an economy can produce when all pro- ductive resources are fully employed. In the classic Fully Employed Resources example shown in Figure 1.6, a mythical country All points on the curve such as a, b, and c repre- called Alpha produces two goods—guns and butter. sent maximum combinations of output possible if all resources are fully employed. To illustrate, sup- Identifying Possible Alternatives pose that Alpha is producing at point a and the Even though Alpha only produces two goods, people would like to move to point d, which rep- the country has a number of alternatives available resents the same amount of guns, but more butter. to it. For example, it could choose to use all of its As long as all resources are fully employed at resources to produce 70 units of guns and 300 units point a, however, there are no extra resources avail- of butter, which is shown as point a in Panel A of able to produce the extra butter. Therefore, point d Figure 1.6. Or, it could shift some of its resources out cannot be reached, nor can any other point outside of gun production and into butter, thereby mov- the curve. This is why the figure is called a produc- ing to point b. Alpha could even choose to produce tion possibilities “frontier”—to indicate the maxi- at point c, which represents all butter and no guns, mum combinations of goods and/or services that or at point e, which is inside the frontier. can be produced. CHAPTER 1: WHAT IS ECONOMICS? 21
  21. 21. homework and spending time with your friends. If Opportunity Cost you decide to spend extra hours on your home- work, the opportunity cost of this action is less time with your friends. The Cost of Idle Resources If some resources were not fully employed, then it would be impossible for Alpha to reach its poten- tial. To illustrate, suppose that Alpha was producing at point b in Panel A of Figure 1.6 when workers in the butter industry went on strike. Butter production would fall, causing total output to change to point e. The opportunity cost of the unemployed resources would be the 100 units of lost production. Production at e could also be the result of other idle resources, such as factories or land that are available but are not being used. As long as some resources are idle, the country cannot produce on its frontier—which is another way of saying that it cannot reach its full production potential, although it can produce at some point inside it. Economic Growth The production possibilities frontier represents potential output at a given point in time. Eventually, however, population may grow, the cap- Making Choices The nation incurs opportunity ital stock may grow, and productivity may increase. costs when it makes choices. The money spent If this happens, then Alpha will be able to produce on defense cannot at the same time be spent on more in the future than it can today. health services; money spent on health services The effect of economic growth is shown in cannot be spent on education, and so on. Why does every choice involve an opportunity cost? Panel C of Figure 1.6. Economic growth made pos- sible by having more resources or increased pro- ductivity causes the production possibilities frontier to move outward. Economic growth will Opportunity Cost eventually allow Alpha to produce at point d, Suppose that Alpha was producing at point a which it could not do earlier. and that it wanted to move to point b. This is clearly possible so long as point b is not outside the frontier. As shown in Panel B of Figure 1.6, the opportunity cost of producing the 100 additional units of butter is the 30 units of guns given up. As you can see, opportunity cost is a general concept that is expressed in terms of trade-offs, or Student Web Activity Visit the Economics: Principles in terms of things given up to get something else. and Practices Web site at and click Opportunity cost is not always measured in terms on Chapter 1—Student Web Activities to learn more of dollars and cents. For example, you need to bal- about what economists do. ance the time you spend studying and doing 22 UNIT 1 FUNDAMENTAL ECONOMIC CONCEPTS
  22. 22. ECONOMICS Thinking Like an Economist Figure 1.6 AT A GLANCE AT A GLANCE Because economists study how people sat- The Production isfy seemingly unlimited and competing wants with the careful use of scarce resources, they Possibilities Frontier are also concerned with strategies that will help us make the best choices. Some of these strategies are A Alternative Possibilities discussed here; others will be discussed in later chapters. a d 70 Guns e b Build Simple Models 40 One of the most important strategies of econo- Production can take place anywhere on or mists is the economic model. A model is a simpli- inside the frontier. fied theory or a simplified picture of what c something is like or how something works. Simple 300 400 models can often be constructed that reduce com- Butter plex situations to their most basic elements. To illustrate, the circular flow diagram in Figure 1.3 is B Opportunity Cost an example of how complex economic activity can be reduced to a simple model. a 70 Another basic model is the production possibil- ities frontier illustrated in Figure 1.6. Realistically, Guns of course, economies are able to produce more b 40 than two goods or services, but the concepts of The opportunity cost of producing 100 units trade-offs and opportunity costs are easier to illus- of butter is the 30 guns trate if only two products are examined. As a result, given up. c simple models such as these are sometimes all that 300 400 economists need to analyze or describe an actual Butter situation. It is important to remember that models are C Economic Growth based on assumptions, or things that we take for granted as true. We use them as facts even though we can’t be sure that they are. For example, you d a might assume that a restaurant is out of your price range. You might not even try it because you Guns Increased productivity b assume you cannot afford it. However, you might and additional factors be wrong—the prices at the restaurant might be of production expand production possibilities. quite reasonable. The quality of a model is no bet- ter than the assumptions that it is based on. c It is also important to keep in mind that mod- Butter els can be revised. Economists use models to better understand the past or present and to predict the future. If an economic model results in a predic- Using Graphs A production possibilities tion that turns out to be right, the model can be frontier shows the different combinations of used again. If the prediction is wrong, the model two products that can be produced. What might be changed to make better predictions the do points inside the frontier represent? next time. CHAPTER 1: WHAT IS ECONOMICS? 23
  23. 23. Employ Cost-Benefit Analysis Take Small, Incremental Steps Most economic decisions can be made by using Finally, and whenever possible, it also helps to cost-benefit analysis, a way of thinking about a make decisions by taking small, incremental steps problem that compares the costs of an action to toward the final goal. This is especially valuable the benefits received. This is what Jesse did in the whenever we are unsure of the exact, or total, cost decision-making matrix shown in Figure 1.5. This involved. If the cost turns out to be larger than we decision can be made subjectively, as when Jesse anticipated, then the resulting decision can be selected the jeans. Or, the decision can be more reversed, without too much being lost. formal, especially if the costs of the various alter- For example, if someone offers you a hot bev- natives are different. erage, it might be best to take a small sip first. This To illustrate, suppose that you like choices A and will allow you to find out if the beverage is cool B equally well. If B costs less, however, then it enough to drink, without paying too high a price would be the better choice because you would get if it is not. Few decisions are all-or-nothing deci- more satisfaction per dollar spent. Businesses make sions—sometimes it helps to do a little bit at a investment decisions in exactly this manner, choos- time. ing to invest in projects which give the highest return per dollar spent. Cost-benefit studies, like the one described in the cover story, can also be The Road Ahead used to evaluate the effectiveness of many public assistance programs. The study of economics does more than explain how people deal with scarcity. Economics also includes the study of how things are made, bought, sold, and used. It helps answer such questions as, Where do these products come from? Who makes them? How are they made? Economist How do they get to the stores? Who buys them? It provides insight as to how incomes are earned Economists study the way society dis- and spent, how jobs are created, and how the tributes scarce resources to produce economy works on a daily basis. It also provides a goods and services. They carry on more detailed understanding of a free enterprise inquiries, collect and analyze data, economy—one in which consumers and privately and observe economic trends. owned businesses, rather than the government, The Work make the majority of the WHAT, HOW, and FOR Economists in the private sector WHOM decisions. advise businesses and other organi- zations on such topics as energy Topics and Issues costs, inflation, imports, and employ- ment levels. Those who work for var- The study of economics will provide a working ious government agencies may study knowledge of property rights, competition, supply economic conditions in the United and demand, the price system, and the economic States or in other countries to estimate the economic incentives that make the American economy func- effects of new legislation or public policies. tion. Along the way, topics such as unemployment, the business cycle, inflation, productivity, and eco- Qualifications nomic growth will be covered. The role of business, Graduate training is required for most economists in the labor, and government in the American economy private sector. Individuals who wish to secure an entry- also will be examined, along with the relationship level job in the federal government must have a bache- of the United States economy to the international lor’s degree, with a focus on economics and on statistics, community. All of these have a bearing on our accounting, or calculus. 24 UNIT 1 FUNDAMENTAL ECONOMIC CONCEPTS
  24. 24. standard of living—the quality of life based on the Making the Rational Choice possession of the necessities and luxuries that make You have already learned in this chapter that life easier. You will learn how we measure the value economists study how decisions are made. Every of our production and how productivity helps time a choice is made something is given up. determine our standard of living. You will find, Rational choice is taking the things with greater however, that the way the American people make value and giving up those with lesser value. That’s economic decisions is not the only way to make the rational thing to do. these decisions. Economists have identified three But which things have greater value? If everyone basic kinds of economic systems. You will analyze felt the same about what they did and did not these systems in Chapter 2. want, deciding how to use our resources would be simple; the problem is we don’t all agree. When you make a decision for yourself alone, it doesn’t Economics for Citizenship make much difference how others feel. But many of your decisions will affect other people who may The study of economics helps us to become bet- not share your ideas. Making the best choices for ter decision makers—both in our personal lives and groups of people is hard to do. in the voting booths. Economic issues often are Textbook economics can be divided into neat debated during political campaigns, and we need to sections for study, but the real world is not so understand the issues before deciding which candi- orderly. Society is dynamic and things are always date to support. Most of today’s political problems changing. In addition, people have different degrees have important economic aspects: How important of ambition, strength, and luck. Opinions also dif- is it that we balance the federal budget? How can we fer, and some issues never seem to be settled. best keep inflation in check? What methods can we In practice, the world of economics is complex use to strengthen our economy? The study of eco- and the road ahead is bumpy. Studying and under- nomics will not provide you with clear-cut answers standing economics, however, is vital to our to all questions, of course, but it will give you a bet- understanding of how the world around us works. ter understanding of the issues involved. Checking for Understanding Applying Economic Concepts 1. Main Idea Using your notes from the graphic 6. Opportunity Costs Identify several possible organizer activity on page 19, explain what uses of your time that will be available to you people try to achieve when they make deci- after school today. What will you actually do, sions or trade-offs. and what will be the opportunity cost of your decision? Explain how your decision will or 2. Key Terms Define trade-offs, opportunity will not affect your friends and members of cost, production possibilities frontier, cost- your family. benefit analysis, free enterprise economy, standard of living. 3. Describe the relationship between trade-offs and opportunity costs. 7. Making Generalizations Study the decision- 4. List the decision-making strategies that econ- making grid on page 20. Explain the advan- omists use. tages of using such a grid to evaluate alternatives. 5. Explain why the study of economics is impor- tant to the American free enterprise system. Practice and assess key social studies skills with the Glencoe Skillbuilder Interactive Workbook, Level 2. CHAPTER 1: WHAT IS ECONOMICS? 25