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Chapter 1What Is Economics?

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Did You Know?• We witness scarcity with each year’s “hot”

new toy. Inspired by hunter President Teddy Roosevelt, Americans coveted the teddy bear in 1906. Cabbage Patch dolls were big during the 1980s, as were Tickle Me Elmos in 1996. By 1999 Game Boy’s Pokémon was the rage with a 10-cent trading card. The most-prized first-edition pocket monsters were in such short supply that they commanded from $8 to $182.



The Fundamental Economic Problem

• Economics is the study of how people satisfy wants with scarce resources.

• Scarcity is the condition where unlimited human wants face limited resources.

• Needs are required for survival; wants are desired for satisfaction.

• Someone has to pay for production costs, so There Is No Such Thing As A Free Lunch (TINSTAAFL).

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Discussion Question

Why do you think scarcity is an issue with the rich as well as the poor?

It is a human trait that few people, regardless of their economic status, are satisfied with what they have.

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Three Basic Questions• What must we produce? Society must

choose based on its need.

• How should we produce it? Society must choose based on its resources.

Figure 1.1

• For whom should we produce? Society must choose based on its population and other available markets.

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Discussion Question

How might the economic decisions of a mountainous island society differ from those of a mountainous landlocked society?

An island society has water resources to consider and likely a more limited population.




The Factors of Production

• Land is the society’s limited natural resources—landforms, minerals, vegetation, animal life, and climate.

• Factors of production are resources necessary to produce what people want or need.

• Capital is the means by which something is produced such as money, tools, equipment, machinery, and factories.



• Entrepreneurs are risk-takers who combine the land, labor, and capital into new products.

• Labor is the workers who apply their efforts, abilities, and skills to production.

• Production is creating goods and services—the result of land, capital, labor, and entrepreneurs.

The Factors of Production (cont.)

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The Factors of Production (cont.)

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Figure 1.2Figure 1.2Figure 1.2



The Scope of Economics• Economics deals with the description of

economic activity—Gross Domestic Product, unemployment rate, government spending, tax rates, etc.

• Analysis looks at the “why” and “how” of economic activity—why prices go up and down, for example, or how taxes affect savings.



The Scope of Economics (cont.)

• Explanation refers to how economists communicate knowledge of the economy and its activities to the society’s population.

• Prediction refers to how yesterday’s and today’s economic activities advise us of potential future activity.

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Section Assessment (cont.)

List the three basic economic questions every society must answer.

Every society must ask what to produce, how to produce, and for whom to produce.


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Describe the factors of production.

The factors of production are land, capital, labor, and entrepreneurs.




Goods, Services, and Consumers• Goods are items that are economically

useful or satisfy an economic want. They are tangible and can be classified as consumer/capital and durable/ nondurable.

• Services are work performed for someone and are intangible.

• Consumers use goods and services to satisfy wants and needs.

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Discussion Question

Why do you think the United States has been called a “society of consumption”?

Answers will vary. Students should support their opinions with examples.




Value, Utility, and Wealth• Value is worth expressed in dollars and

cents. Scarcity by itself is not enough to create value. For something to have value, it must also have utility.

• Utility is a good’s or service’s capacity to provide satisfaction, which varies with the needs and wants of each person.

• Wealth is the accumulation of goods that are tangible, scarce, useful, and transferable to another person. Wealth does not include services.



The Circular Flow of Economic Activity

• Markets are locations/mechanisms for buyers and sellers to trade. They are classified as local, regional, national, global, and cyberspace.

• A factor market is where people earn their incomes. Factor markets center on the four factors of production: land, capital, labor, and entrepreneurs.

• A product market is where people use their income to buy from producers. Product markets center on goods and services.



Figure 1.3

The Circular Flow of Economic Activity (cont.)



Productivity and Economic Growth• Productivity is a measure of the amount of

output produced by the amount of inputs within a certain time. Productivity increases with efficient use of scarce resources.

• Specialization and division of labor may improve productivity because they lead to more proficiency (and greater economic interdependence).



Productivity and Economic Growth• Investing in human capital improves

productivity because when people’s skills, abilities, health, and motivation advance, productivity increases.

• Economic growth depends on high productivity. Yet, an economy’s productivity may be affected by its interdependence—reliance on others and their reliance on us to provide goods and services.

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Introduction• The process of making a choice is not

always easy.

• Because resources are scarce, consumers need to make wise choices.

• To become a good decision maker, you need to know how to identify the problem and then analyze your alternatives.

• Finally, you have to make your choice in a way that carefully considers the costs and benefits of each possibility.



Trade-Offs and Opportunity Cost• Trade-offs are the alternative choices

people face in making an economic decision. A decision-making grid lists the advantages and disadvantages of each choice.

• Opportunity cost is the cost of the next best alternative among a person’s choices. The opportunity cost is the money, time, or resources a person gives up, or sacrifices, to make his final choice.



Figure 1.5

Trade-Offs and Opportunity Cost (cont.)



Production Possibilities• The production possibilities frontier diagram

illustrates the concept of opportunity cost. It shows the combinations of goods and/or services that can be produced when all productive resources are used. The line on the graph represents the full potential—the frontier—when the economy employs all of these productive resources.

• Identifying possible alternatives allows an economy to examine how it can best put its limited resources into production.



Production Possibilities (cont.)

• Considering different ways to fully employ its resources allows an economy to analyze the combination of goods and services that leads to maximum output.

• An economy pays a high cost if any of it resources are idle. It cannot produce on its frontier and it will fail to reach its full production potential.

• Economic growth made possible by more resources, a larger labor force, or increased productivity causes a new frontier for the economy.



Figure 1.6The Production Possibilities Frontier


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Describe the relationship between trade-offs and opportunity costs.

All economic decisions involve trade-offs. The opportunity cost of a choice is the cost of the next best use of money, time, or resources.

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Section 1: Scarcity and the Science of Economics

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• The basic economic problem of scarcity is due to the combination of people’s seemingly unlimited wants and relatively scarce resources.

• In a world of scarce resources, There Is No Such Thing As A Free Lunch (TINSTAAFL).

• Because of scarcity, society has to decide WHAT, HOW, and FOR WHOM to produce.

• Land, capital, labor, and entrepreneurs are the four factors of production required to produce the things that people use.



Section 1: Scarcity and the Science of Economics (cont.)

• Entrepreneurs are risk-taking individuals who go into business in order to make a profit; they organize the other factors of production.

• The scope of economics deals with description, analysis, explanation, and prediction.



Section 2: Basic Economic Concepts• Consumers use goods and services to satisfy

their wants and needs. • Something has value when it has utility and is

relatively scarce. • Wealth consists of products that are scarce,

useful, and transferable to others, but wealth does not include services, which are intangible.

• Markets link individuals and businesses in the circular flow of economic activity; the factors of production are traded in factor markets; goods and services are traded in the product markets.



Section 2: Basic Economic Concepts (cont.)

• Productivity and investments in human capital help economic growth; investments in human capital are among the most profitable of all investments.

• Increases in specialization and division of labor cause more economic interdependence.



Section 3: Economic Choices and Decision Making

• The opportunity cost of doing something is the next best alternative, or trade-off, that you give up.

• A decision-making grid can be used to help evaluate alternatives.

• A production possibilities frontier shows the various possible combinations of output that can be produced when all resources are fully employed; production inside the frontier occurs when some resources are idle or are not being used to their maximum capability.



Section 3: Economic Choices and Decision Making (cont.)

• When economic growth takes place, the production possibilities frontier shifts outward, showing that more products are produced than before.

• The economic way of thinking involves simplification with model building, cost-benefit analysis to evaluate alternatives, and incremental decision making.

• The study of economics will make you a better decision maker and will help you to understand the world around you; however, the study of economics will not tell you which decisions to make.

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