1999 Addison Wesley Longman

Slide 1.1
The
Economic Problem
The
Economic
Problem
CHAPTER 1
1999 Addison Wesley Longman
Slide 1.2
Why Study Economics?
To understand the role of government and
the role of markets in the economy.
To understand many of the economic issues,
such as government deficit, taxes, free
trade, money, inflation, and unemployment.
Studying economics can help you to choose
your occupation; to invest your saving
etc.
1999 Addison Wesley Longman
Slide 1.3
What is Economics?
A more common definition of economics is
that Economics is the study of the use of
scarce resources to produce goods and
services that satisfy unlimited human wants.
1999 Addison Wesley Longman
Slide 1.4
What is Economics?
Resources:
A societys resources are divided into land
(natural endowments), labor, and capital.
Natural resources represent the gift of
nature to our productive processes.
It consists of the land for farming, houses,
schools and roads; forests, and energy
resources like oil; and minerals like copper
and iron ore and sand.
1999 Addison Wesley Longman
Slide 1.5
Resources

Human resources, both mental and physical spent
in production.
Working in factories, teaching in schools etc
many of occupations and tasks are performed by
labor.
Capital resources, form the durable goods of an
economy produced in order to produce other
goods.
Capital goods include tools, machines, roads,
computers, and buildings.
1999 Addison Wesley Longman
Slide 1.6
Resources

Economists refer to resources as factors of
production because they are used to
produce the outputs that people desire.
We divide these outputs into goods and
services.
Goods are tangible (e.g., cars and shoes),
and services are intangible (e.g., education).
1999 Addison Wesley Longman
Slide 1.7
Resources

People use goods and services to satisfy
many of their wants.
The act of making goods and services is
called production, and the act of using them
to satisfy people wants is called
consumption.
1999 Addison Wesley Longman
Slide 1.8
Scarcity
Scarcity:
The available resources to any economy are
scarce (limited) in relation to unlimited
peoples wants and desires.
Existing resources can produce only a
fraction of the goods and services desired by
people.
1999 Addison Wesley Longman
Slide 1.9
Scarcity
It is important that an economy must make
the best use of its limited resources, so that
it must use its resources efficiently to
produce goods and services to satisfy
peoples wants and needs.
Efficiency means that the resources are
organized so as to produce the largest
possible amount of the goods and services
that people want to purchase.
1999 Addison Wesley Longman
Slide 1.10
Choice
Choice:
Because resources are scarce, all societies face the
problem of deciding what to produce and how
much each person will consume.
Societies differ in who makes the choices and how
they are made, but the need to choose is common
to all.
Scarcity implies the need for choice, and making
choices implies the existence of cost.
1999 Addison Wesley Longman
Slide 1.11
Choice
A decision to have more of something
requires a decision to have less of something
else.
The less of something else can be
regarded as the cost of having the more of
something. and is called the opportunity
cost.
1999 Addison Wesley Longman
Slide 1.12
Opportunity Cost
Opportunity Cost:
The idea of opportunity cost is one of the
central insights of economics.
The opportunity cost of using resources for
a certain purpose is defined as the benefit
given up by not using them in the best
alternative use.
1999 Addison Wesley Longman
Slide 1.13
Opportunity Cost
It the cost of producing one additional unit
of one good measured by giving up some
units of the other goods and services.
If, for example, resources that could have
produced 20 miles of road are used instead
to produce 2 small hospitals, the
opportunity cost of a hospital is 10 miles of
road.
1999 Addison Wesley Longman
Slide 1.14
Production possibilities
Production possibilities:
The production possibility boundary, or
production possibility curve (or PP) curve, is a
curve that shows the maximum amount of
production of different goods and services that can
be produced by an economy, if all resources are
fully and efficiently employed, given its
technological knowledge and quantity of resources
available.
1999 Addison Wesley Longman
Slide 1.15
Production possibilities
Consider, for example, the important choice
between producing two economic goods, military
goods (guns), and civilian goods (cars).
Because the economy decides to use all resources
fully to produce these two goods, it is not possible
to have more of both.
However, as the government cuts defense
production, resources needed to produce civilian
goods will be freed up.
The opportunity cost of increased civilian goods
(cars) is therefore the forgone military output
(guns).
1999 Addison Wesley Longman
Slide 1.16
Production possibilities
The maximal amount of cars that can be
produced per year depends on the quantity
and quality of the economys resources and
the productive efficiency with which they
are used.
Suppose 15 millions of cars are the
maximum amount that can be produced,
when production of guns equals to zero.
1999 Addison Wesley Longman
Slide 1.17
Production possibilities
At the other extreme, assume that all
resources are instead devoted to the
production of guns, and the economy can
produce 5 millions guns, if no cars are
produced.
The different possibilities of using all
resources to produce different units of guns
and cars together can be illustrated in the
following Table, and Figure 1:
1999 Addison Wesley Longman
Slide 1.18
Production possibilities
A Production Possibility
Choices

Possibilities Civilian
goods
(Millions)
Military
goods
(Millions)
A
B
C
D
E
F
15
14
12
9
5
0
0
1
2
3
4
5
1999 Addison Wesley Longman
Slide 1.19
Production possibilities
The limited resources, with a given
technology, imply that the production of
guns and cars is limited.
As we move from points A to B . to F we
are transferring labor, machines and land
from cars industry to guns industry; we can
thereby increase guns output and give up
cars output.
1999 Addison Wesley Longman
Slide 1.20
Figure 1-1
A Choice Between Bubble Gum and Chocolates
1999 Addison Wesley Longman
Slide 1.21
Figure 1-2
A Production Possibility Boundary
1999 Addison Wesley Longman
Slide 1.22
Production possibilities
The production possibility curve is the
curve that connects the points of the
numerical production possibilities.
Each point on the PP curve describes an
alternative mix of output that could be
produced if all available resources are fully
employed.
1999 Addison Wesley Longman
Slide 1.23
Production possibilities
The negatively sloped (pp) curve provides a
boundary between the attainable
combinations of goods, such as a and b,
from unattainable combinations, such as d.
Points on the curve such as a and b can just
be attained if all the available societys
resources are fully and efficiently used.
1999 Addison Wesley Longman
Slide 1.24
Production possibilities
Points above and to the right of this curve,
such as d cannot be attained because there
are not enough resources for their
production.
Points below and to the left of the curve
such as c can be attain without using all of
the available resources, and represent either
inefficient use of resources, or failure to use
all the available resources.
1999 Addison Wesley Longman
Slide 1.25
Production possibilities
The (PP) curve is sloping downward because the
amount of civilian production (cars) must be given
up to achieve equal successive increases in military
production (guns).
The shape of the (pp) curve in Figure 1, is concave
to the origin, implies that an increasing amount of
civilian production (cars) must be given up to
achieve equal successive increases in military
production (guns), and indicates that the
opportunity cost of producing either good rises as
more of that good is produced.
1999 Addison Wesley Longman
Slide 1.26
Production possibilities
This means that as we produce more and
more of a particular good (guns), we must
give up ever-increasing quantities of other
goods (cars).
That is, the opportunity cost of producing
one good rises as more of that good is
produced.
1999 Addison Wesley Longman
Slide 1.27
Production possibilities
A straight-line boundary indicates that the
opportunity cost of one good in terms of the other
good stays constant, no matter how much of it is
produced.
The (PP) curve illustrates three essential
principles:
Scarcity, which means that there is a limit to the
amount of total output we can produce in a given
time period with the available resources and
technology.
Scarcity is indicated by the unattainable
combinations above the boundary.
1999 Addison Wesley Longman
Slide 1.28
Production possibilities
Choice is indicated by the need to choose
among the alternative attainable
combinations along the boundary.
Opportunity cost is indicated by the
negative slope of the boundary, which
equals to the negative value of the
opportunity cost.
1999 Addison Wesley Longman
Slide 1.29
Four Key Economic Problems
Four Key Economic Problems.
Modern economies involve thousands of
complex production and consumption
activities.
Although this complexity is important, the
most problems studied by economists can be
grouped under four main headings.
1999 Addison Wesley Longman
Slide 1.30
Four Key Economic problems
1- What is Produced and How?
The allocation of scarce resources among
alternative uses, called resource allocation,
determines the quantities of varies goods that are
produced.
What determines which goods and services get
produced?
Choosing to produce a particular combination of
goods and services means that choosing a
particular allocation of resources among the
industries or regions producing the goods.
1999 Addison Wesley Longman
Slide 1.31
Four Key Economic problems
Farther, because resources are scarce, it
should be used efficiently.
Hence, a society must determine how to
produce the goods and services selected,
which of the available methods of
production is used to produce each of the
goods, and who will do the production.
1999 Addison Wesley Longman
Slide 1.32
Four Key Economic problems
In terms of Figure 1, these questions relate
to where the economy will produce.
Will the economy be inside the (PP) curve
because resources are used inefficiently?
If resources are used efficiently, at which
point on the boundary will production take
place?
1999 Addison Wesley Longman
Slide 1.33
Four Key Economic problems
2- What Is Consumed and by Whom?
For whom goods and services are
produced?
Economists seek to understand what
determines the distribution of a nations
total output between its people.
Who gets more, who gets little, and why?
1999 Addison Wesley Longman
Slide 1.34
Four Key Economic problems
If production takes place on the (PP) curve,
then how about consumption?
Will the economy consume exactly the same
goods as it produces?
Or it will trade with other countries permit
the economy to consume a different
combination of goods.
1999 Addison Wesley Longman
Slide 1.35
Why Are Resources Sometimes Idle?

3- Why Are Resources Sometimes Idle?
When an economy is in recession, many
workers who would like to have jobs are unable
to find employers to hire them.
At the same time, managers and owners of
offices and factories would like to produce more
goods and services.
Similarly, during recessions many resources
such as labor, factories, equipment, and raw
materials are idle.
1999 Addison Wesley Longman
Slide 1.36
Why Are Resources Sometimes Idle?
In terms of Figure 1, the economy is operating
within its production possibility boundary.
Why resources are sometimes idle?
Should governments worry about such idle
resources?
What can the government do to reduce such
idleness?
1999 Addison Wesley Longman
Slide 1.37
Is Productive Capacity Growing?
Is Productive Capacity Growing?
The capacity to produce goods and services
grows rapidly in some countries, expands
slowly in others, and actually decline in
others.
Growth in productive capacity can be
represented by an outward shift of the (PP)
curve, as shown below.
1999 Addison Wesley Longman
Slide 1.38
Figure 1-3
The Effect of Economic Growth on the Production Possibility Boundary
1999 Addison Wesley Longman
Slide 1.39
Is Productive Capacity Growing?
If an economys capacity to produce goods
and services is growing, combinations that
are unattainable today will become
attainable tomorrow.
Growth makes it possible to have more of
all goods.
What are determinates of growth?
What can the government do increase
economic growth?
1999 Addison Wesley Longman
Slide 1.40
Types of Economic Systems
Types of Economic Systems
Every economy must answer the questions of what
to produce, how to produce, and for whom.
Different economies are organized through
alternative economic systems in which economic
decisions are coordinated, and economics studies
the various mechanisms that a society can use to
allocate its scarce resources.
1999 Addison Wesley Longman
Slide 1.41
Types of Economic Systems
The most important forms of economic
organization today are called traditional,
command, Command, Market, and Mixed
economies.
1- Traditional systems. A traditional economy
is one in which behavior is based primarily
on tradition, custom, and habit. There are
little changes in the pattern of goods
produced over time.
1999 Addison Wesley Longman
Slide 1.42
Types of Economic Systems
In short, the answers to economic questions of
what to produce, how to produce, and how to
distribute are determined by traditions.
Traditional systems were common in earlier
times.
Today, only a few small, self-sufficient
communities, and in many less-developed
countries, significant aspects of economic
behavior are still governed by traditional
patterns.

1999 Addison Wesley Longman
Slide 1.43
Types of Economic Systems
2- The command systems. A command economy is one
in which the government makes all important
decisions on what to produce, how to produce it,
and who gets it, through a comprehensive
government planning of an entire economy.

Such economies are characterized by the
centralization of decision making.
In a command, or centrally planned economy, the
government owns most of the means of production
(land and capital);
1999 Addison Wesley Longman
Slide 1.44
Types of Economic Systems
it also owns and directs the
productions of enterprises in most
industries;
it is the employer of most workers and
tell them how to do their jobs; and it
decides how the output of the society is
to be divided among different goods
and services.
1999 Addison Wesley Longman
Slide 1.45
Types of Economic Systems
The former Soviet Union, the countries of
Eastern Europe, and China were command
economies for much of this century.
Today, the number of such countries is
small, even in some countries such as China
and Cuba, rely heavily on planning,
increasing amounts of market
determination are being permitted.
1999 Addison Wesley Longman
Slide 1.46
Types of Economic Systems
3- Market Systems. The market economy is
one which individuals and private firms
make the major decisions about production
and consumption, through the market
mechanism.
The decisions about resource allocation are
made without any central direction.
1999 Addison Wesley Longman
Slide 1.47
Types of Economic Systems
This system is known as a free-market
economy in which private individuals and
firms make most decisions; they determine
what, how, and for whom.
The main coordinating device is the set of
market-determined prices, which is why
free-market systems are often called price
systems.
1999 Addison Wesley Longman
Slide 1.48
Types of Economic Systems
The productive resources, such as basic raw
material, productive assets of the society,
and the goods produced in the economy are
privately owned.
Firms produce the commodities that yield
the highest profits (the what), by using the
techniques of production that are lest costly
(the how).
1999 Addison Wesley Longman
Slide 1.49
Types of Economic Systems
Consumption is determined by individuals
income from wages and property income
generated by their labor and property ownership
(the for whom).
If you have more income you can buy more
amount of goods and services, if you have less
income you can buy only a less amount of goods
and services.
The United States, Canada, and most of the
countries of Western Europe are primarily market
economies.
1999 Addison Wesley Longman
Slide 1.50
Types of Economic Systems
4- Mixed Systems.
In a mixed economy most decisions are
made in the marketplace, but the
government plays an important role in
overseeing the functioning of the market;
government pass laws that regulate
economic life, produce education, police,
army, and health services.
1999 Addison Wesley Longman
Slide 1.51
Microeconomics
Microeconomics:
Question related to what is produced and
how, and what is consumed and by whom,
fall within the area of microeconomics.
Microeconomics studies how the prices and
quantities of different goods and services
are determined in individual markets, and
the relationship between these markets.
1999 Addison Wesley Longman
Slide 1.52
Microeconomics
It asks why some prices go up and others go
down, how much labor is employed in each
industry, and why the amount is increasing.
Microeconomics looks at demand and
supply with regard to particular goods and
services.

1999 Addison Wesley Longman
Slide 1.53
Macroeconomics
Macroeconomics
Questions relating to the idleness of
resources during recessions, and the growth
of productive capacity, fall within the area of
macroeconomics.
Macroeconomics is the study of the
determination of economic aggregates such
as total output, total employment, the
average price level of all prices, and the rate
of economic growth.
1999 Addison Wesley Longman
Slide 1.54
Macroeconomics
It looks at aggregate demand and aggregate
supply for all final goods and services
produced in the economy in a given time
period.