instructions attached

Description

attached is the discussion instructions. respond substantively to the instructions using the reading materials provided to support claims.

Supply and Demand:
Analyze how the law of demand applies to a recent purchase that you made. Describe how the
product has changed in price and explain whether the price change is due to supply or demand.
Did the change in price affect your decision to purchase the item?
Your initial post should be at least 250 words in length. Utilize the required reading material as
well as the article to support your claims.
Design Pics/Con Tanasiuk/Getty Images
1
Economics, Economic Methods,
and Economic Policy
Learning Objectives
By the end of this chapter, you will be able to:
• Define economics and recognize the value of studying economics.
• Explain the relationship between scarcity and choice, and the role of opportunity costs.
• Understand how the production possibilities curve is used to help understand an economic system.
• Understand and follow the steps to proper policy analysis.
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CHAPTER 1
Section 1.1 What Is Economics?
Introduction
C
onsider this. . . Why are some people rich and others poor? Why do doctors earn
higher salaries than newspaper reporters? Why do Republican congressional representatives attack the economic policy proposals of the Democrats? Why do some
companies make lots of profits, while others file for bankruptcy? Why is welfare only temporary? And perhaps most importantly, why can’t you have everything you want—now?
These are all important personal, societal, and even global issues. Economics can help you
understand the answers to these and many other questions. By the time you finish this
chapter, you will have some idea about the way economists address these questions, and
by the time you finish this textbook, you will be able to develop answers of your own.
1.1 What Is Economics?
E
conomics is the study of how people, individually and through institutions, make
decisions about producing and consuming goods and services and how they face
the problem of scarcity. Scarcity, or the inability to satisfy everyone’s wants, is a
fundamental economic problem in a world with limited resources. The study of economics is divided into microeconomics and macroeconomics.
Microeconomics focuses on the choices made by individuals and businesses. It describes
the interactions of producers and consumers in individual markets, such as the market
for cars. It also examines interactions between such markets—for example, the impact of
changes in the demand for steel on the price of aluminum.
The study of the economy as a whole is called macroeconomics. Macroeconomics is
concerned with the aggregate or total effect, determined by adding across many markets. Macroeconomics studies
the behavior of variables that
describe the whole economy,
such as the value of the total output that the economy produces
in a given time period (which is
called gross domestic product,
or GDP). Macroeconomics also
examines the behavior of such
aggregates as the price level and
unemployment.
Fancy Collection/SuperStock
The study of microeconomics focuses on a micro level while the
study of macroeconomics focuses on the aggregate level. An
analogy can be made to studying flowers: Consider the analysis
of all the components of a single flower versus the analysis of
the combined impact of all the flowers in a garden together.
ama80571_01_c01_001-036.indd 2
In microeconomics, the most
important tools are demand
and supply. Demand and supply help to explain prices and
outputs in individual markets.
These tools also explain the
relationship between prices and
outputs in different markets. In
microeconomics, you may look
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Section 1.1 What Is Economics?
CHAPTER 1
at the demand for the output of a single industry, such as bicycle manufacturing. In macroeconomics, you look at the level of prices and output for the economy as a whole, using
aggregate demand and aggregate supply as the main tools. Even though microeconomics
and macroeconomics are often studied separately, they are closely related.
Economics is a social science. This classification makes economics an academic relative of
political science, sociology, psychology, and anthropology. All of these fields look at the
behavior of human beings, both individually and in groups. They study different subsets
of the actions and interactions of human beings. (For this reason, they are also sometimes
termed behavioral sciences.)
Economics focuses on the consumption, production, and use of scarce resources by individuals and groups. It is also concerned with the processes by which households and
firms make decisions about the use of scarce resources. This definition of economics leads
to some overlap with the other social sciences; psychologists and economists share an
interest in what leads people to take certain actions. However, economists are primarily
interested in actions that are reflected in market activity or in economic decisions made
through government. Sociologists are interested in all facets of organized human activity,
whereas economists are interested mainly in organized activities that relate to the production and consumption of goods and services.
Check Point: Microeconomics Versus Macroeconomics
•
•
•
•
Microeconomics focuses on the choices made by individuals and businesses.
The primary tools of microeconomics are demand and supply.
Macroeconomics is the study of the economy as a whole.
The primary tools of macroeconomics are aggregate demand and aggregate supply.
Economics in Action: What Is Economics?
Economics is not just the study of finance; in fact, economics is another form of social studies.
Economics studies people’s desires in a world of limited resources. Find out more with Dr. Mary J.
McGlasson’s video at http://www.youtube.com/watch?v=yoVc_S_gd_0.
Why Study Economics?
Economics is a required course for many different majors. You may be wondering why
this is so. One reason is that economics interacts with almost all other academic subjects. It
affects and is affected by current events. Also, it has a major effect on politics, both domestic and international.
A second reason for studying economics is the impact that economic ideas and theories
have on world leaders. Much of what political decision makers do is based on economic
theory. As John Maynard Keynes, an economist who has had great influence on macroeconomic policy in this century, wrote:
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Section 1.1 What Is Economics?
CHAPTER 1
The ideas of economists and political philosophers, both when they are right and
when they are wrong, are more powerful than is commonly understood. Indeed,
the world is ruled by little else. Practical men, who believe themselves to be quite
exempt from any intellectual influences, are usually the slaves of some defunct
economist. Madmen in authority, who hear voices in the air, are distilling their
frenzy from some academic scribbler of a few years back. (Keynes, 1936, p. 383)
Keynes was saying that if you want to understand what politicians, great or mad, are trying to do, you must understand the economic theories upon which their actions are based.
A third reason for studying economics is that it provides a better understanding of how
society functions. Economic theory is very useful in understanding behavior because it
allows the development of models with predictive power. As Alfred Marshall, another
influential economist, wrote, “Economics is the study of mankind in the ordinary business
of life” (1890, p. 323).
Finally, economics is incredibly useful. People who are trained in economics find rewarding
jobs and careers. If you like to think in a logical fashion, you will enjoy studying economics.
Global Outlook: The Internationalization of Studying Economics
This box, Global Outlook, represents a feature that you will find throughout the book. In Global
Outlook boxes, we will examine how an institution, a culture, a product, a policy, or a way of doing
business in another country differs from its counterpart in the United States. This chapter is devoted
to concepts and ideas that are universal, because scarcity exists in all countries and in all times. Many
of the examples in this book are drawn from experiences of people living in the United States. As you
read Global Outlook boxes, you will see that some differences in the ways things are done in other
countries can be explained by economic incentives.
If you travel to Italy, you will be struck by the fact that houses have significantly fewer closets than comparable houses in the United States. Is this because Italians prefer fewer closets than U.S. Americans?
What if we went into predominately Italian neighborhoods in New York? Would we find fewer closets
in these neighborhoods than we would in an Asian neighborhood in New York? This is a ceteris paribus
experiment. So the question is, all things being equal, do Italians prefer fewer closets than U.S. Americans? If we looked around in the United States, we would conclude that, at least in the United States,
Italians don’t exhibit any different behavior in building homes with closets than other ethnic groups.
We could then ask if Italians in the United States are different from Italians in Italy. This is something
a psychologist might do. An economist would expect that there is some government policy driving
these choices. The economist would, therefore, look deeper. What the economist would find is that
the Italian government (in part) determines the property tax on a home on the basis of the number
of closets it has. Therefore, if you do not build closets, but instead buy armoires (an armoire is a piece
of furniture that is a stand-alone closet), you can avoid paying taxes—a better explanation than a
difference in tastes!
As you study economics and as you read these Global Outlook boxes, look for examples of your own.
When you learn how to see these economic forces at work, you will be amazed at the analytical
power of economic theory.
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Section 1.2 Scarcity: Limited Resources, Unlimited Wants
CHAPTER 1
Check Point: The Direction of Microeconomics
The study of economics
• interacts with almost all other academic subjects,
• impacts ideas and theories of world leaders, and
• is useful in understanding behavior.
1.2 Scarcity: Limited Resources, Unlimited Wants
W
hether you are just taking one course or planning a career in economics, the
most important single problem you will address is that of scarcity. That is,
there are not enough resources to produce all the goods and services people
would like to consume. The first tool we will develop is an economic model that is used to
explain how any economic system deals with the basic problem of scarcity. Human wants
and desires are vast, relative to the resources available to satisfy them. Thus, in every economic system there has to be some method for making choices among alternative actions.
Resources are whatever can be used to produce goods and services for human consumption. We live in a world of limited resources. Some resources, such as oil and coal, are
converted to energy and used up in the course of production or consumption. Others
are not used up in that sense but are virtually fixed in quantity, like land, diamonds, and
copper. At any given time, even the quantity of resources created by people—roads, factories, machines, and skilled labor—cannot be
changed quickly or cheaply.
Limited resources conflict with unlimited
wants. Human wants are said to be unlimited because no matter how much people
have, they always want more of something.
You may know people who seem perfectly
content with what they have. If you questioned them carefully, however, you would
probably find that they would like cleaner
air, more time to play tennis or golf, or
more shelters for the homeless. Since not all
wants can be satisfied, individuals have to
choose which ones to satisfy with limited
available resources. In fact, every society
is faced with the problem of scarcity and
choice. An example of this is China’s onechild policy. Without scarcity, there would
be no need to make choices about which
desires or needs to satisfy—and thus no
need to study economics.
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iStockphoto/Thinkstock
Central planners say the one-child policy has
spared China from the pressures of hundreds of
millions of additional people.
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Section 1.2 Scarcity: Limited Resources, Unlimited Wants
CHAPTER 1
Opportunity Cost
Every decision to produce or consume something means sacrificing the production or
consumption of something else. Economists use the term opportunity cost to denote the
full value of the best alternative that is given up, or forgone. For example, the cost of going
to a football game includes the value of what is given up in order to attend. Part of the cost
of attending the game is the price of the ticket; this price represents the other goods and
services you could have purchased with that money instead. However, there is another
important part of the cost. This second part is the most valuable alternative use of those 3
hours. The opportunity cost of attending the game consists of both the price of the ticket
and the difference in your test grade that three more hours of studying would have produced. Even if the ticket were free, going to the game would still have an opportunity cost.
Many people have problems grasping the concept of opportunity cost because they are
used to thinking of cost only as the amount of money spent on an item or an activity. In
economics, however, the concept of cost is much broader. It includes not only the dollar
outlay (the other goods you could have purchased) but also the value of the next best
alternative. These alternatives include time cost (the earnings or satisfaction you could
have produced for yourself in some other activity) and other sacrifices you might have
made. Sometimes it is difficult to place a dollar value on these other costs, but they still
play an important role in economic decisions.
Some Applications of Opportunity Cost
Your everyday life provides many illustrations of the concept of opportunity cost. For
example, what is the opportunity cost of attaining a college degree? It is not simply the
dollar figure. Money spent on books and tuition is certainly one part of the opportunity
cost; however, the expense of your room, meals, and clothing is not, because you would
have incurred those costs even if you were not in college. Economists do not count them
because they are not opportunity costs.
One important opportunity cost is the income you could have earned during the years
you spend in classes. For most students, that lost income will eventually be made up
in higher future earnings. However, right now it is an opportunity cost that should be
included. Even if you can earn only $10 an hour, if you have to cut your working hours by
20 hours a week during the 32 weeks a year you are in school, the lost earnings represent
a cost of $6,400 a year.
For some students, the opportunity cost of going to college is even higher. Suppose you
are a talented athlete who could play professionally right after high school, as many baseball and tennis players do. Your college education may cost as much as $200,000 (or more)
a year in lost earnings. After 2 or 3 years of college, many football and basketball players
face this dilemma. Even if they are straight A students, the opportunity cost of completing
a degree in terms of lost income is very high. It is not surprising that many of them choose
to turn pro and postpone or abandon getting a degree.
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CHAPTER 1
Section 1.2 Scarcity: Limited Resources, Unlimited Wants
Opportunity Cost and the Choice Curve
We can illustrate the concept of opportunity cost and its relationship to choice using a very
simple example. Assume that you have $50 to spend and you have two choices: pizza and
cola. Pizzas cost $10 each, and a 20-oz bottle of cola costs $2.50. To keep things simple, we
assume that you wish to spend the whole $50. Figure 1.1 shows the various combinations
of pizza and cola that you can buy with $50. If you spend the entire $50 on pizza, you can
purchase five pizzas and no cola (Point P at the y-intercept). On the other hand, you can
buy 20 bottles of cola and no pizza (as shown by Point R at the x-intercept). Other possibilities lie along the line that connects these two intercepts. The line represents all possible
combinations of pizza and cola that total $50. It is easy to see that Points A and B represent
attainable combinations, because both contain whole numbers of colas and pizzas (for
example, Point A represents the combination of three pizzas and eight colas). Connecting
all these points with a continuous line implies that you can purchase fractional units of
cola and pizza. This is merely a convenient assumption.
Figure 1.1: Choice among alternatives
Pizzas
5
P
4
A
3
Unattainable
Combinations
2
B
1
R
0
4
8
12
16
20 Cola (20 oz. bottles)
If a 20-oz bottle of cola costs $2.50 and a pizza costs $10, a person with $50 to spend has many
attainable combinations of cola and pizza. The line PR represents the boundary between attainable and
unattainable combinations. Along line PR, the opportunity cost of one pizza is four bottles of cola.
Of course, all combinations in the shaded area of Figure 1.1 are also attainable. However,
these combinations would not exhaust your entire budget of $50. We have ruled out the
possibility of saving part of the $50 because we are assuming only two alternative choices:
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Section 1.3 Society’s Choices: The Production Possibilities Curve
CHAPTER 1
cola and pizza. Combinations above and to the right of the line are not attainable, because
they cost more than $50.
Figure 1.1 illustrates the array of choices and the concept of opportunity cost. The price of
one pizza is the same as the price of four colas. The decision to purchase a pizza means the
sacrifice of those colas that could have been purchased. Opportunity cost is measured by
the slope of the choice line.
Check Point: Summarizing Opportunity Cost
• The opportunity cost of a decision is the full value of the best alternative that is given up or
forgone.
• The opportunity cost of consumption or production includes the cost in dollars and the value
of the next best alternative.
• Opportunity cost is measured by the slope of the choice line.
1.3 Society’s Choices: The Production Possibilities Curve
F
rom the perspective of the economy as a whole, the choice is not how to spend
income between alternative purchases but how to allocate available productive
resources between alternative goods that could be produced. This problem is illustrated by a close relative of the choice curve in Figure 1.1. Society’s choice curve is called
a production possibilities curve. This curve shows the various output combinations of
two goods or groups of goods that can be produced in an economy with the available
resources. This economic model is based on a few assumptions:
1. All of the economy’s productive resources are fully employed. This means that
everyone who wants a job has one. Also, factories, land, and other resources are
being used to full capacity.
2. There are only two goods (or types of goods) in the economy.
3. The resources used in production are interchangeable. One worker is the same as
another, one machine can be substituted for another, and all land is equally useful for producing the two goods.
4. We are looking at the economy at a specific period of time (the short run). During this time period, both the quantity and quality of resources are fixed, and the
technology does not change.
Given these four assumptions, we can look at an example of a production possibilities
curve. These assumptions allow us to consider a simplified model of an economic system.
Table 1.1 shows combinations of levees and soybeans that an economy can produce. (Here,
levees are used as an example of government-built infrastructure and soybeans represent
food supplies.) Figure 1.2 plots the numbers of Table 1.1 on a graph. Line PR in Figure 1.2 is
a production possibilities curve. It represents all the combinations of levees and soybeans
that can be produced in this economy when the available resources are fully employed.
In Figure 1.2, Points A and B represent two different combinations of levees and soybeans
that lie on the production possibilities curve. They are both output combinations that can
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CHAPTER 1
Section 1.3 Society’s Choices: The Production Possibilities Curve
be attained in this economy with the available resources. Point C is also attainable. Since
it lies inside of line PR, however, production at Point C means that some resources are
unemployed. There are points on line PR that have to be better than C because they represent either more levees, more soybeans, or more of both. The economy can do better—that
is, can produce more. Therefore, the combination at Point C is inferior to all points on the
production possibilities curve from P to R.
Table 1.1: Production possibilities curve
Soybeans (tons)
Levees
20
0
16
1
12
2
8
3
4
4
0
5
Figure 1.2: Production possibilities curve
Levees
5
P
A
4
Unattainable
Combinations
C
3
B
2
Attainable
Combinations
1
R
0
4
8
12
16
20 Soybeans (Tons)
A production possibilities curve shows combinations of two goods that can be produced in an economy,
with fixed resources and technology. Points on the curve represent the full employment of resources.
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Section 1.3 Society’s Choices: The Production Possibilities Curve
CHAPTER 1
Line PR in Figure 1.2 can also be used to measure opportunity cost for the economy. It is a
straight line; this fact implies that the opportunity cost of one product in terms of the other
is constant. That is, the number of levees given up to get another ton of soybeans does
not change along line PR. Each time the production of soybeans is increased by 1 ton, one
quarter of a levee is sacrificed. The opportunity cost of one more ton of soybeans is one
quarter of a levee. Conversely, the opportunity cost of one more levee is 4 tons of soybeans.
Opportunity cost of one good in terms of another is constant along line PR in Figure 1.2
because we assume here that all resources are alike for production purposes. That is, any
unit of resources is just as good as any other unit in producing either soybeans or levees.
This assumption produces a straight-line production possibilities curve.
After an economist has constructed a model, the next step is to go back and relax some
of the assumptions to see what difference they make. Consider what happens when we
drop the third assumption stated earlier—that productive resources are interchangeable.
That is, we no longer assume that one unit of labor or land is just as productive as another
for producing either good. Table 1.2 shows a different set of combinations of levees and
soybeans that can be produced in this economy. These combinations are plotted on the
graph in Figure 1.3. At Point A in Figure 1.3, output is 10 levees and 200 tons of soybeans.
At Point B, output consists of more levees, 100, but fewer soybeans, only 100 tons.
The production possibilities curve in Figure 1.3 is bowed, or curved, instead of being a
straight line. This new shape reflects the change in the assumption that resources are alike.
Here we are being more realistic and assuming that some resources are better suited to the
production of levees and others to the production of soybeans. This change in assumptions
produces a model that differs from the first one in what it implies about opportunity cost.
Increasing Opportunity Costs
If the economy is at Point A in Figure 1.3, we can get another 10 levees by shifting resources
from soybean production to levee production. In moving from Point A to Point C, we
must give up only a small amount of soybeans: 5 tons. But to move from Point B to Point
D, producing another 10 levees requires a larger sacrifice of soybeans, 23 tons instead of
5. This curved production possibilities curve illustrates the very important principle of
increasing opportunity cost. That is, the more levees that are already being produced, the
larger the sacrifice of soybeans that is required to build additional levees. Table 1.2 shows
that between Points A and C, 10 more levees cost 5 tons of soybeans. Between Points B and
D, however, 10 more levees cost 23 tons of soybeans.
Table 1.2: Hypothetical scenario of increasing opportunity cost
Soybeans (tons)
Levees
205
0
200 (Point A)
195 (Point C)
187
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
25
10
20

110
30
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CHAPTER 1
Section 1.3 Society’s Choices: The Production Possibilities Curve
Table 1.2: Hypothetical scenario of increasing opportunity cost (continued)
Soybeans (tons)
Levees
179
40
169
50
158
60
146
70
133
80
117
90

100 (Point B)
223
77 (Point D)

100
110
110
50
120
0
130
Figure 1.3: Production possibilities and increasing opportunity costs
Levees
130
110
100
20
P
D
B
E
A
10
0
C
R
77 100
195 200 205 Soybeans (Tons)
On this production possibilities curve, the opportunity cost of additional tons of soybeans increases
as the economy becomes more specialized in soybeans: Producing each additional ton of soybeans
requires a larger sacrifice of levees than before (increasing opportunity cost). If the economy is inside
the production possibilities curve at some point, such as E, more of both goods could be produced.
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Section 1.3 Society’s Choices: The Production Possibilities Curve
CHAPTER 1
Increasing opportunity costs are frequently observed in wartime. As more war goods are
demanded, civilian sacrifices increase. Initially, as military production expands, additional
labor and other resources are used that are relatively more productive for making weapons,
like missiles, and relatively less productive for producing other goods. As the switch to missiles continues, however, military production takes resources that are relatively less productive for making missiles, although they were highly productive for other purposes, such as
making civilian goods or growing food—for instance, soybeans. Under wartime conditions
like these, soybean production falls by larger and larger amounts because more resources are
stripped away from soybeans for every extra missile produced. These resources are increasingly those best suited to producing soybeans and least adaptable to missile production.
Unemployment
The production possibilities curve can also illustrate unemployment and the effect of
reducing it. Suppose the economy is at Point E in Figure 1.3. This point is inside the
production possibilities curve because some workers, factories, land, and machines are
unemployed. If the economy could move from Point E to Point C, it would be possible
to have more soybeans (195 tons instead of 100) with no sacrifice of levees. Moving from
Point E to Point B would mean producing the same amount of soybeans (100 tons) but
more levees (100 instead of 20). Finally, at Point E more of both levees and soybeans could
be produced. At Point E the opportunity cost of both soybeans and levees is zero, because
none of either good has to be sacrificed to increase production of the other.
From a macroeconomic perspective, unemployed resources are wasteful. They represent
extra production that could be attained simply by putting them to work. The opportunity
cost of the goods gained is zero. Thus, economists believe that full employment is an
important goal. It is important not just for the individual who needs to work in order to
earn income, but also for the aggregate economy.
One of the main concerns of macroeconomics is explaining how an economy can find
itself inside the production possibilities curve at a point such as E in Figure 1.3. How can
an economic system avoid the idleness and waste of unemployed resources? If an economy finds itself at a point such as E, what policies can be implemented to get back on the
production possibilities curve? These are important questions in the study of macroeconomics, and the production possibilities curve is a useful technique for identifying them.
Economic Growth
Another macroeconomic issue that can be illustrated by the production possibilities model
is economic growth. If technology can improve or the quantity of resources can increase,
then output can grow beyond the limits of the production possibilities curve. Better technology or more resources means a change in the fourth assumption stated earlier—that
both resources and technology are fixed. As labor becomes more skilled and productive,
and as producers acquire new machines and plants embodying the latest technology, the
production possibilities curve shifts outward.
An outward shift of a production possibilities curve is shown in Figure 1.4. If the economy
is at Point A on PR, production consists of D1 tons of soybeans and C1 units of levees.
With the shift of the curve to P1R1, it is possible to reach some point, such as Point B, that
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CHAPTER 1
Section 1.3 Society’s Choices: The Production Possibilities Curve
includes more of both soybeans (D2 tons) and levees (C2 units). Other possible combinations on the new production possibilities curve include the same amount of one good and
more of the other (such as Point E or F) and less of one good and more of the other (such
as Point H or J). No matter which combination is produced, the important thing about an
outward shift of a production possibilities curve is that it increases the economy’s capacity
to respond to human wants.
Added resources, usually labor or capital, are sources of economic growth. New technology can also shift a production possibilities curve outward and account for economic
growth. Invention, innovation, discovery of resources, and improvements in productivity
all contribute to economic growth and allow us to produce and consume beyond Point A.
Figure 1.4: Shift of the production possibilities curve
Levees
P1
P
H
E
B
C2
C1
F
A
Attainable
Region
0
J
D1 D2 R
R1
Soybeans (Tons)
An outward shift of the production possibilities curve from PR to P1R1 means that the economy can
produce more of both soybeans and levees (economic growth).
Check Point: The Production Possibilities Curve
The production possibilities curve shows
•
•
•
•
ama80571_01_c01_001-036.indd 13
attainable combinations (points on the curve),
opportunity cost (the slope of the curve),
unemployment of resources (points below or inside the curve), and
economic growth (a shift of the curve outward).
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CHAPTER 1
Section 1.3 Society’s Choices: The Production Possibilities Curve
Ceteris Paribus
Unlike physical scientists, social scientists rarely have the chance to conduct controlled
experiments to validate their models. Thus, economists most often test hypotheses by
looking at actual experiences in markets. Such experiments are often referred to by economists as ceteris paribus experiments. Ceteris paribus is a Latin phrase that means “all else
being equal.” An economist changes one variable in a theoretical model (for example, the
technology for producing levees in the production possibilities model). The economist
then predicts what would happen ceteris paribus, or if everything else remained constant.
The ceteris paribus assumption is the most common and most important assumption in
economic models. If the technology of soybean production improved but there was no
change in the technology of producing levees, the production possibilities curve would
shift out, as from PR to PR1 in Figure 1.5. The economist would predict an increase in output of both commodities, but a relatively larger increase in the output of soybeans. The
economist must then untangle the effects of the change in soybean technology on the mix
of output (levees and soybeans) from anything else that changed in the real world in the
time period when this model was being tested.
Figure 1.5: Technological change and the production possibilities curve
Levees
P
0
R
R1
Soybeans (Tons)
A change in the technology of producing soybeans shifts the production possibilities curve from PR to
PR1. This shows that if all resources were devoted to soybeans, more could be produced. If all resources
were devoted to levees, however, no increase in output could occur. Depending on the starting point,
increases in both are also possible.
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Section 1.4 Basic Elements of the Economic Approach
CHAPTER 1
In addition to the ceteris paribus assumption, one other assumption is a basic part of most
economic models. This assumption is that most people behave in a self-interested way. In
general, self-interested behavior consists of people trying to get the most of something they
want (to maximize some goal) out of available resources. For consumers, self-interested
behavior means maximizing their satisfaction. For owners of productive resources, selfinterest is expressed by seeking to maximize income. For business firms, self-interest means
maximizing profits. In the production possibilities model, self-interested behavior will direct
the decision as to which combination to produce out of all possible combinations. That combination is the one that maximizes the welfare or satisfaction of consumers.
The self-interest assumption has given economics, and economists, a good deal of undeserved bad press. This has occurred because self-interest is often confused with selfishness. Critics of market economies argue that encouraging and rewarding self-interested
behavior is a basic flaw in such systems. In fact, concern for others and for the community
as a whole is not incompatible with self-interest, because individuals define their own
self-interest in terms of what is satisfying to them. Some individuals derive their greatest satisfaction from material possessions, others from leisure or enjoyment of the arts,
and still others from helping people and building better communities. Some people may
derive satisfaction from all of these! Then self-interested behavior is not inconsistent with
volunteer work or charitable contributions. Such unselfish activities are not, by our definition, un-self-interested. This definition of self-interest is broad enough to cover the actions
of Albert Schweitzer and Mother Teresa as well as the most unlovable of capitalists.
When economists use the self-interest assumption in developing a theory, they are simply saying that they expect behavior to be influenced by costs and benefits. If the cost of
a course of action declines or the benefits rise, relative to alternatives, more people will
choose that course of action. For example, if the price of soybeans rises relative to that of
corn, some farmers will switch production from corn to soybeans, attracted by the higher
price. If salaries for public school teachers rise relative to those of accountants, more people are likely to prepare for a teaching career and fewer to study accounting. If the penalty
for speeding falls, ceteris paribus, more people are likely to drive faster than the posted
speed limit. If the cost of giving to charity rises because it is no longer tax deductible, less
will be given to charity.
Furthermore, economists do not use the concept of self-interest to predict any one person’s
or one firm’s behavior, but rather to predict average or group behavior. Such predictions
are similar to the use of attributes of certain groups by insurance companies to predict how
often certain events will occur. Insurance companies develop norms for various groups—
life expectancies, accident rates, or numbers of house fires—and use them to set prices for
policies. These norms say nothing about how likely any particular member of a group is to
live past the age of 80, run a car off the road, or have a house burn to the ground.
1.4 Basic Elements of the Economic Approach
T
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his discussion of theories and models suggests that economics is much like other
sciences in its methods. What is unique or different about the economic approach?
There are a few emphases and ideas that help set economics apart.
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Section 1.4 Basic Elements of the Economic Approach
CHAPTER 1
1. Like the natural sciences, economic theory is positive, or nonnormative. Positive statements are if-then propositions about what is. In contrast, normative statements
describe what ought to be. In other words, economic theory strives to be scientific. However, when economists try to apply economic theory to policy questions, they often find it difficult to keep their work positive. Economic theory is
value free, but appliers of the theory are often tempted to mix in their values in
order to favor a preferred outcome or policy. It is a positive statement to say that
production of more levees will require increasing sacrifices of soybeans. It is a
normative statement to say that more levees and fewer soybeans should be produced. One easy way to separate the two is to look for words like should or ought
to, which identify a normative statement.
2. Economic theory cannot predict the future. It can only explain the effects of certain
events. Economic theory consists of statements of the if-A-then-B type. The
prediction that B will occur depends on whether or not A happens. (Note that
theory does not predict the occurrence of A; economists do not have a crystal
ball.) In the production possibilities model, an increase in resources will result in
economic growth, ceteris paribus. In this case, part of the ceteris paribus assumption is that the increased resources will be put to work and not left unemployed.
There is, however, some difference between what economics is and what many
economists actually do. Many economists, especially macroeconomists, spend
a great deal of time forecasting future conditions. To do this, they make use of
economic theory. In forecasting, an economist guesses the likelihood that A will
occur and then uses economic theory to predict the occurrence of B. Sometimes,
however, forecasts are wrong. This does not necessarily mean that the theory is
incorrect: The forecaster may have been wrong in expecting A to occur.
3. Most economists look first to market processes for solutions to social problems. This market bias reflects a preference for the freedom and efficiency arising from decentralized processes. However, most economic theory is applicable to nonmarket
systems as well, even though the legal and political institutions differ. Economists can apply tools developed for analyzing market economies to the workings
of socialist economies and to a wide variety of nonmarket behavior.
4. Economists pay a great deal of attention to cost. The emphasis on opportunity cost,
scarcity, and choice is fundamental to economics. Nobel Prize winner Milton
Friedman underscored the importance of opportunity cost in this famous remark:
“There is no such thing as a free lunch” (Kelso & Verjee, 1993). Focusing on the
subject of cost often puts economists in conflict with policy makers. Environmentalists do not like to hear economists talk about the opportunity cost of environmental purity in terms of forgone output. College admissions officers seeking
students do not like economists reminding students that the opportunity cost of a
college education includes income not earned while in college.
5. Economists are very interested in chances to substitute among alternatives. Substitution and cost are closely related because the decision to substitute is based on
the costs of the various alternatives. Sometimes substitutes are obvious, such as
plastic for aluminum or electric heat for gas. Other substitutes are less apparent.
A tree, for example, can substitute for gas or oil as heat, or for aluminum siding
on houses. Trees can also substitute for air conditioning or awnings by providing
shade. An important task of economic analysis is identifying alternatives that can
serve as substitutes and evaluating the costs of substituting one for another.
6. Economists think in terms of marginal analysis. The marginal approach means
looking at the effects on other variables of small increases or decreases in one
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Section 1.4 Basic Elements of the Economic Approach
CHAPTER 1
important variable. Should we produce one more levee? If we do, what will
be the (marginal) cost in terms of soybeans not produced? Most decisions in
economics are not all-or-nothing choices but are made at the margin. Decisions
about how to spend the next hour, whether to eat another slice of pizza, and
whether to hire an extra worker are all marginal decisions.
7. Economists take the individual, rather than the group, the industry, or the community, as
the basic decision-making unit. They regard the behavior of individuals as an important influence on public policy and on decisions made in the private sector. The
emphasis on individuals rather than groups reflects the importance of incentives
in economics. Changes in prices, costs, profits, wages, substitutes, and opportunities are the driving forces behind individual economic decisions. It is the individual, not the group or community, that responds to incentives.
Check Point: Core Values of Economics
•
•
•
•
•
•
•
Economic theory is positive.
Economic theory cannot predict the future.
Economists look to markets for solutions to social problems.
Economists emphasize opportunity cost, scarcity, and choice.
Economists evaluate the costs of substituting one good or service for another.
Economists think on the margin.
Economics considers the individual to be the basic decision-making unit.
One of the most important uses of economics is to help to analyze possible solutions to
public policy problems and to develop recommendations. Some of the most famous economists in history—Adam Smith, David Ricardo, John Maynard Keynes, Milton Friedman,
and Paul Samuelson—became interested in economics because it offered tools with which
to develop solutions to policy issues. When economic models are applied to public policy
issues, it is difficult to decide when the economist’s task ends and the policy maker takes
over. When economic methods are used for policy analysis, there is a five-step process.
1. State the problem. The choice of what problem to consider and how to state it is the
task of the policy maker. How a problem is stated often determines what tools
the economist applies and what solutions are considered. For example, suppose
the problem is illegal parking, such as parking without a permit or in a space not
designated for parking. Let us follow that problem through the next four steps.
2. Apply the relevant economic model. The economist turns to the tool kit to select
the most useful theoretical model. In this case, there is a fairly simple technique
called cost-benefit analysis. This technique simply assumes that people are
self-interested, that they are aware of the opportunity costs and benefits of their
actions, and that they will choose the course of action that maximizes the excess
of benefits over opportunity costs. This simple model predicts that an increase in
the opportunity cost of illegal parking or a reduction in benefits will reduce the
amount of such parking.
3. Identify solutions. The most common error at this stage is to leave out some alternative solutions. Cost-based solutions to illegal parking might include higher
fines. Do you think a person would be less likely to park without a permit if
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Section 1.4 Basic Elements of the Economic Approach
CHAPTER 1
the fine were $500 instead of $50? More police officers would raise the cost by
increasing the probability of being caught. The city could reduce the benefits of
illegal parking by providing more bicycle racks or free bus transportation to and
from commuter parking lots.
4. Evaluate solutions. This is the stage where economists are most useful, pointing
to costs, substitutes, and incentives. A good economic model predicts how various alternative solutions will affect the amount of illegal parking, who will gain
and who will lose, and which solution costs the least to implement. For example,
more police officers would be more expensive than higher fines. Bicycle racks are
cheaper than shuttle buses. However, racks are not as helpful as buses would be
for commuters, unless the commuters live very close to the city center.
5. Choose and implement one or more solutions. This step is not the task of the economist, although it is hard to stop after carrying the process this far. The policy
maker (who may have been trained as an economist) takes the economist’s list of
possible solutions and the evaluation and makes a policy choice.
Most arguments among economists occur when they overstep the boundaries of scientific
analysis and advocate a particular solution to an economic problem. Newspapers and television news programs often quote economists who disagree. However, economists agree
far more often than they disagree. Disagreements make headlines; agreement is not news.
Throughout this book, we will point out where most economists agree and also where and
why they disagree. The models we describe represent a broad range of agreement among
most economists on how markets work and how individuals respond to incentives.
Check Point: Using Economics to Dictate Policy
• Economics offers tools with which to develop solutions to policy issues.
• Economics can be used to develop policy recommendations.
• It is up to the policy maker to take the economist’s list of possible solutions and make a policy
choice.
Policy Focus: Economists as Policy Advisors
Paul A. Samuelson (1915–2009) and Milton Friedman (1912–2006) were two of the best-known
American economists. They were both very active in the major macro and micro policy debates of
the past four decades. Both were winners of the Nobel Prize in economics. The two men represented
polar extremes with respect to economic policy. Samuelson saw an important role for government
in modern industrial society. Friedman advocated a laissez-faire economic policy. He argued that the
market economy operates very well and that the interventions supported by Samuelson do more
harm than good. Samuelson was a leader of the liberal (policy) school of economics. Friedman represented the conservative or free-market school, which is sometimes called the Chicago School.
Samuelson, once a professor at the Massachusetts Institute of Technology, had an undergraduate
degree from the University of Chicago and MA and PhD degrees in economics from Harvard University. His PhD dissertation—Foundations of Economic Analysis, written when he was (continued)
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CHAPTER 1
Summary
Policy Focus: Economists as Policy Advisors (continued)
only 23 years old—was published as a book. It still ranks as a monumental work in the application
of mathematics to economics. Graduate students still study it. Many of today’s economists were
introduced to economics with Samuelson’s textbook Economics. Samuelson is largely responsible for
making the economics department at the Massachusetts Institute of Technology one of the best in
the country.
Friedman was a professor at the University of Chicago, where he taught for 30 years. He was also a
senior research fellow at the Hoover Institution at Stanford University. Friedman received an undergraduate degree from Rutgers, an MA degree from the University of Chicago, and a PhD from Columbia
University. He made notable contributions to economic theory. His policy ideas are readily available in
three books: Essays in Positive Economics (1953), Capitalism and Freedom (1962), and Free to Choose
(1980). Before his passing, Friedman angered some of the conservatives who usually agreed with him
by arguing that illegal drugs should be legalized. He argued that legalizing such drugs would reduce
both the profits in selling them and the crime and violence among sellers and users.
Bachrach/Archive Photo/Getty Images
George Rose/Getty Images
Paul Samuelson (left) and Milton Friedman (right), were both Nobel Prize–winning economists.
Summary
C
onsider again . . . You now know why you cannot have everything! We live in a
world of scarcity. You must make choices, managers of firms must make choices,
and leaders of countries must make choices. As we proceed, you will become more
adept at understanding the trade-offs involved in making choices—whether for personal
consumption, business decisions, or public policy. The policy focus in each chapter will
remind you that one of the important functions of economics is to help you understand
and improve public policy.
Economics is an exciting social science. As you begin to understand the economic way of
thinking you will gain insights into an endless array of interesting policy questions. We
wish you well. Let’s get on with it!
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Key Terms
CHAPTER 1
Key Points
1. Economics is the study of how decisions about producing and consuming goods
and services are made and how individuals and groups face the problem of
scarcity. Microeconomics looks at the interactions of producers and consumers
in individual markets. Macroeconomics is the study of the economy as a whole
and is concerned with aggregates, numbers that are determined by adding across
many markets.
2. Social or behavioral sciences look at the behavior of human beings, individually
and in groups. They study different subsets of the actions and interactions of
human beings. Together, macroeconomics and microeconomics make up one of
the social sciences.
3. Economics interacts with almost all other academic subjects, and much of what
both domestic and international political decision makers do is based on economic theory. Economics also provides an understanding of how society functions. Economics is useful; people who are trained in economics find rewarding
jobs and careers.
4. Resources are limited, but human wants are unlimited. This conflict is the basic
economic problem of scarcity. People cannot have everything they want, and
they must make choices. In order to have more of one good, people must settle
for less of another. The cost of extra units of one good is the number of units of
the other sacrificed, or the opportunity cost. The principle of increasing opportunity cost says that the more of one good people have, the greater the amount of
other goods they must sacrifice to obtain one more unit of that good.
5. The production possibilities curve illustrates the problem of scarcity. The curve
shows the various output combinations of two goods or groups of goods that
can be produced in an economy with the available resources. Unemployment of
resources is shown by a point inside the curve; economic growth is indicated by a
shift of the curve to the right.
6. The economic approach is positive and marginal, and cannot be used to predict
the future. Economists tend to look to the market for solutions, pay a great deal
of attention to cost, are interested in substitution among alternatives, and look at
the individual as the decision-making unit.
7. One of the most important uses of economic theory is to develop models that can
be used for policy analysis. An issue is analyzed in five steps: State the problem,
apply the relevant economic model, identify solutions, evaluate solutions, and
choose and implement solutions.
Key Terms
ceteris paribus assumption A Latin phrase
that means “all else being equal.” It is an
important assumption in economic models.
normative statements A set of propositions about what ought to be (also called
value judgments).
increasing opportunity cost The principle
that as production of one good rises, larger
and larger sacrifices of another are required.
opportunity cost The value of the other
alternatives given up in order to enjoy a
particular good or service.
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CHAPTER 1
Critical Thinking and Discussion Questions
positive statements A set of propositions
about what is, rather than what ought to
be.
scarcity The central economic problem
that there are not enough resources to produce everything that individuals want.
production possibilities curve A graph
that depicts the various combinations of
two goods that can be produced in an
economy with the available resources.
self-interested behavior A basic assumption of economic theory that individual decision makers do what is best for themselves.
resources Inputs used to produce goods
and services.
unlimited wants The needs and desires of
human beings, which can never be completely satisfied.
Critical Thinking and Discussion Questions
1. Do you think people exhibit behavior patterns that confirm the self-interest
assumption? Does your own behavior confirm this assumption? Is a contribution
to charity or volunteer work a contradiction of the self-interest assumption?
2. Why do economists theorize rather than attempt to describe reality exactly?
3. Do assumptions have to be realistic in order for a theory to work?
4. What is the difference between using theory to predict and forecasting?
5. Consider the following simple predictive model: If the speed limit is reduced,
fewer highway deaths will occur. What assumptions are being made? What
ceteris paribus conditions could change and make this prediction invalid?
6. Which of the following quantities are microeconomic and which are macroeconomic? Which might fall between the two?
a. price of shoes
b. number of men aged 18 to 24 in the U.S. labor force
c. level of interest rates
d. unemployment in Tulsa, Oklahoma
e. production of agricultural products
f. average level of prices
g. production of butter
h. average price of imported goods
i. unemployment in the United States
j. total output
k. unemployment of carpenters
l. number of nurses in the U.S. labor force
m. unemployment in the northeastern states
7. What is the opportunity cost of working 10 hours a week flipping burgers while
in college? If you worked more hours per week, would you experience increasing
or constant opportunity cost? That is, would the extra hours require giving up
alternative uses of your time that have the same value or an increasing value?
8. Try developing a simple economic model to predict how students will respond to
an increase in dormitory rents. What are your assumptions? What will happen to
the number of dormitory spaces rented? What will happen to the number of offcampus apartments rented and their prices?
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Chapter 1 Appendix: Economic
Relationships and Graphs
E
conomic theories and models are often expressed in the form of mathematical relationships
among variables. These relationships can be described by algebraic equations. Economists
more often express them visually in the form of graphs. Graphs make it possible to illustrate
economic theories and models in ways that make them easier to remember and to apply to the real
world. Remember that everything that can be said in graphs can also be said in words. Graphs are
only an aid to understanding the theory. Mastering and applying the theory is what you should be
trying to achieve. If you can learn to feel comfortable with graphs as visual presentations of economic ideas, reading this textbook and understanding your professor’s lectures will be much easier.
1.1A Relationship Between Two Variables
A
relationship between two variables, variable x and variable y, can be expressed in a number of ways. One is a table of values of x and y. For example, Table 1.1A shows the various
amounts of fertilizer applied per acre and the corresponding yields of corn per acre. What
does this table mean? It means that different amounts of fertilizer were applied to different plots of
land and that those plots of land yielded varying amounts of corn.
Table 1.1A: Relationship between two variables
x-variable
Fertilizer (100 lbs/acre)
y-variable
Corn (bushels/acre)
1
1
2
10
3
40
4
80
5
100
6
110
7
115
8
110
9
100
10
70
This relationship could also be expressed in the form of a graph. A graph shows how the quantity
of one variable changes when another variable changes. Figure 1.1A shows the system most commonly used for graphing. The vertical line is referred to as the y-axis (or vertical axis). The horizontal line is referred to as the x-axis (or horizontal axis). The x-axis and y-axis divide the graph into
four quadrants.
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CHAPTER 1 APPENDIX
Section 1.1A Relationship Between Two Variables
Figure 1.1A: Quadrant system
Quadrant II
y
Quadrant I
H
E(–3, 5)
B(2, 4)
A(0, 1)
0
G
F(6, 0)
x
D(–6, –4)
C(0, –6)
Quadrant III
Quadrant IV
A four-quadrant system makes it possible to represent combinations of positive and negative values in
two dimensions. Point C represents an x-value of 0 and a y-value of –6. The quadrants are labeled I to IV
in the counterclockwise direction.
The point where the axes cross (or intersect) is the origin. At the origin, the values of both
the x-variable and the y-variable are zero. Above the x-axis, the y-variable has positive
values. Below the x-axis, the x-variable has negative values. To the right of the y-axis, the
x-variable has positive values. To the left of the y-axis, the x-variable has negative values.
Both x and y have positive values in Quadrant I and negative values in Quadrant III. In
Quadrant IV, x takes on positive values, and y takes on negative values. In Quadrant II, x
has negative values, and y positive values. In this book, most of the graphs will use only
Quadrant I because most economic data takes on only positive values.
Each point on a graph has a set of coordinates, a pair of numbers representing the
x-value and the y-value. For example, Point B on Figure 1.1A represents the value 2
for the x-variable and the value 4 for the y-variable. The x-value is always given first.
For example, Point E represents x 5 23, y 5 5. See if you can determine the coordinates
of Points G and H.
With this background, we can plot the relationship between fertilizer applied and corn
output given in Table 1.1A. The first decision to make is which variable goes on which
axis. If there is a cause-and-effect relationship, we usually put the “causing” variable on
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CHAPTER 1 APPENDIX
Section 1.1A Relationship Between Two Variables
the horizontal axis and the variable being affected on the vertical axis. In mathematics, the
causing variable is the independent variable, and the affected variable is the dependent
variable. Since we think that fertilizer causes increased corn yields, we plot it on the horizontal axis (x-axis). Corn yield is plotted on the vertical axis (y-axis).
The next decision concerns establishing a scale for each axis. The scales can be whatever is
convenient and do not need to be the same. In this case, the fertilizer units are hundreds
of pounds per acre, and the corn units are bushels per acre. Once a scale is established
and the axes are labeled, we can plot the coordinates of the points in Table 1.1A. Then we
connect the plotted points with a smooth curve to produce a graph, shown in Figure 1.2A.
Figure 1.2A: Fertilizer and corn output
Corn
(Bushels/Acre)
130
120
110
100
90
80
70
60
50
40
30
20
10
0
1
2
3
4
5
6
7
8
9
10
Fertilizer (Hundreds of lbs./Acre)
A graph is usually plotted with the dependent variable on the y-axis and the independent variable on
the x-axis. Here, as the independent variable (fertilizer) increases, the dependent variable (corn output)
first increases and then decreases.
The value of a graph is that it gives you a visual picture of the mathematical relationship
between the variables. In Figure 1.2A, you can easily see that as fertilizer is increased up
to 700 pounds per acre, corn output increases. After that level, more fertilizer causes a
decrease in output. The corn plants grow too rapidly and don’t produce many ears, or the
roots suffer fertilizer burn.
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CHAPTER 1 APPENDIX
Section 1.1A Relationship Between Two Variables
Not all relationships produce as tidy a graph as the one for fertilizer and corn yield. Sometimes researchers plot data to see if there is any visual pattern before trying to understand
what, if any, is the relationship between the two variables. Such a plot of actual data is
called a scatter diagram. Scatter diagrams are useful in searching for possible mathematical relationships between two variables.
Figure 1.3A plots data on the rate of inflation (vertical axis) and the rate of unemployment
(horizontal axis) for a hypothetical country. In this diagram, there doesn’t seem to be a
consistent relationship of any kind between the rate of inflation and the rate of unemployment, at least for the years plotted. Figure 1.4A plots the relationship between the money
supply and total output, or GDP. As you can see, there appears to be a more consistent
relationship between these two variables.
Figure 1.3A: Inflation and unemployment
Inflation
Rate (%)
14
12
10
8
6
4
2
0
5
6
7
8
9 Unemployment
Rate (%)
A scatter diagram plots the coordinates for the values of two variables that may or may not have
a consistent relationship. This diagram plots a hypothetical country’s unemployment rate and the
inflation rate. As you can see, there is no consistent relationship between these two variables.
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Section 1.2A Positive and Negative Relationships and Slopes
CHAPTER 1 APPENDIX
Figure 1.4A: GDP and money supply
(Billions)
$6,500
GDP
$6,000
$5,500
$5,000
MI
Money
Supply
$4,500
$4,000
$3,500
$3,000
$2,500
$2,000
1999
2005
2010
Year
This scatter diagram plots a hypothetical country’s money supply and GDP. Unlike the diagram in Figure
1.3A, this one seems to show a rather consistent relationship between the two variables.
1.2A Positive and Negative Relationships and Slopes
A
graph shows how two variables are related. This relationship may be positive
or negative. A positive relationship means that an increase in the value of the
x-variable is associated with an increase in the value of the y-variable, as in Figure 1.4A. A negative relationship means that an increase in the value of the x-variable is
associated with a decrease in the value of the y-variable. Some relationships in economics,
such as the one between fertilizer and corn output plotted in Figure 1.2A, are positive for
some values of the x-variable and negative for others.
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CHAPTER 1 APPENDIX
Section 1.2A Positive and Negative Relationships and Slopes
Figure 1.5A: Positively sloped lines
y
B
A
5
3
1
2
x
0
The slope of a line is the ratio of change in the y-value to the change in the x-value. A line sloping
upward to the right has a positive slope, indicating a positive relationship between the two variables.
Most of the economic relationships you will encounter in this book are represented by
straight lines. A straight line can have a positive slope, as in Figure 1.5A, or a negative
slope, as in Figure 1.6A. The slope is a measure of the steepness of the line. It is the ratio of
the change in the dependent variable (y) to the change in the independent variable (x). If
the slope is designated by the letter m, then the equation of a straight line can be written as
y 5 mx 1 b
where b is the value of y when x 5 0. (The value b is also known as the y-intercept, because
at this value the line crosses the y-axis.)
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Section 1.2A Positive and Negative Relationships and Slopes
CHAPTER 1 APPENDIX
Figure 1.6A: Negatively sloped line
y
2
–1
0
x
A negative slope represents a relationship between the variables in which an increase in the value of
the independent variable is associated with a decrease in the value of the dependent variable.
Even though both lines in Figure 1.5A are positively sloped, the relationship between the
x-variable and the y-variable represented by line A is very different from that represented
by line B. The same amount of change in x leads to a larger change in y along line B than it
does along line A. In Figure 1.5A, the slope of line A is equal to 11/2 because the y-value
changes by one unit for each two-unit change in the x-value. The slope of line B is 11.67.
The steeper slope of line B indicates that a larger change in the value of y will result from
a given change in the value of x than it will along line A. The sign of the slope is also very
important. It indicates whether the relationship between the two variables is positive or
negative. A slope with a positive sign designates a positive relationship. A slope with a
negative sign, as in Figure 1.6A, indicates a negative relationship. The slope of the line in
Figure 1.6A is 21/2.
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CHAPTER 1 APPENDIX
Section 1.3A Nonlinear Graphs and Maxima and Minima
1.3A Nonlinear Graphs and Maxima and Minima
A
straight-line graph, such as those in Figures 1.5A and 1.6A, has the same slope
along the entire line. The slope of a curved line, on the other hand, varies along
the curve. The slope of a curve at a particular point is the slope of the straight line
tangent to the curve at that point. A tangent line is a straight line that touches a curve at
only one point without crossing it. The slope of the curved line in Figure 1.7A is 11 at
Point A and 23/2 at Point C.
Figure 1.7A: Nonlinear graphs: Slope and maximum
y
B
y1
A
C
3
–3
3
2
0
x1
x
On a nonlinear graph, the slope changes along the curve. The slope at any point is the slope of a straight
line tangent to the curved line at that point. When the slope is zero, the value of the y-variable is either
at a maximum or at a minimum. At Point B, y is at its maximum value, y1, when x has the value x1.
The slope of the curve in Figure 1.7A at Point B is equal to zero. A small change in the
value of x results in no change in the value of y along the straight line tangent to the
curve at Point B. Point B is a maximum because the y-variable reaches its highest value
at that point. The highest value of y, y1, is associated with an x value of x1. Recall that we
described self-interested behavior as consumers maximizing satisfaction, resource owners
maximizing income, and firms maximizing profit. Being able to find the maximum is very
important in economics.
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CHAPTER 1 APPENDIX
Section 1.4A The 45Ëš Line
Figure 1.8A: Nonlinear graphs: Minimum
y
y1
B
0
x1
x
This nonlinear graph also has a slope of zero at Point B. In this case, Point B represents the minimum
value of y, y1, which is associated with an x-value of x1.
Sometimes a slope of zero is associated with a minimum rather than a maximum, as in
Figure 1.8A. The y-variable assumes its lowest value, y1, at Point B in Figure 1.8A. This
y-value is associated with an x-value of x1. A firm that is trying to minimize costs, or losses,
may be interested in finding a minimum point. It is also important for many kinds of economic questions to determine whether a point of zero slope is a maximum or a minimum.
1.4A The 458 Line
A
geometric construction that proves very useful in economic analysis is a 458 line.
This is a straight line through the origin that divides Quadrant I into two equal
sections. If both axes are measured in the same units, the values of the x-variable
and the y-variable will be equal at any point on the line, and the slope will be 11. A 458
line is shown in Figure 1.9A. Suppose, for example, you want to know whether the value
of x is less than, equal to, or greater than the value of y at Point C. A 458 line gives you
a quick answer to that question. The value of x is greater than the value of y at Point C
because Point C lies below the 458 line.
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CHAPTER 1 APPENDIX
Section 1.4A The 45Ëš Line
Figure 1.9A: The 458 line
y
20
B
C
10
A
45
degrees
0
10
20
x
The 458 line drawn in the first quadrant has a slope of 11. If both axes are measured in the same units,
the 458 line shows all points where the x-value and the y-value are equal.
Graphs Without Numbers
The graph in Figure 1.2A and the scatter diagrams in Figures 1.3A and 1.4A were constructed from sets of numbers. Other graphs in this section only give a few numerical
values from which to calculate slopes. Figures 1.7A and 1.8A have no numbers on them
at all. In economics, graphs of theoretical concepts often use no numbers. For example,
we might theorize that there is a negative relationship between the price of any good
that people consume and the quantity demanded. If price is the y-variable and quantity
demanded the x-variable, a negatively sloped line such as the one in Figure 1.6A could
represent this theoretical relationship. It doesn’t matter that we don’t have specific coordinates to plot. We have instead graphed an abstract idea. Many graphs in economics are
of this abstract type.
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CHAPTER 1 APPENDIX
Section 1.4A The 45Ëš Line
On graphs without numbers, symbols are used for values, line segments, and areas. For
example, Figure 1.10A is similar to graphs you will study in Chapter 3. The y-axis shows
the price per loaf of bread, and the x-axis shows the quantity of loaves consumed per
week. Particular prices are represented by symbols such as P1. Quantities consumed are
represented by symbols such as Q 1, Q 2, and Q 3.
Figure 1.10A: Effects of changes in price on the demand for bread
Price/
Loaf
P1
D2
D1
D3
0
Q3
Q1
Q2
Loaves/Week
Many graphs in economics use symbols rather than numbers on the axes. The symbol P1 represents a
hypothetical price, and Q1, Q2, and Q3 represent hypothetical quantities.
In addition to using symbols to represent quantities, we will also make frequent use of
the symbol delta, D, to represent changes in a variable. For example, the symbol DQ is a
shorthand expression for the change from Q 1 to Q 2 in Figure 1.10A.
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CHAPTER 1 APPENDIX
Section 1.5A Pie Charts and Bar Charts
1.5A Pie Charts and Bar Charts
A
ll of the graphs considered so far, except for the scatter diagrams, represent theoretical relationships of one kind or another. Economists also use graphs to describe
the real world. Such graphs display descriptive statistics. These include the allocation of government funds between types of programs, the growth of output or the money
supply over time, and the different growth rates of imports and exports.
Two common types of descriptive graphs encountered in economics are pie charts and
bar charts. Pie charts are used to show the division of some whole into parts, usually designated by percentages. Figure 1.11A is a pie chart depicting the sources of hypothetical
household income. Pie charts have become very popular because they are easy to create on
a personal computer. This visual representation often conveys a clearer sense of the relative sizes of various components than you could obtain from reading a table of numbers.
Figure 1.11A: Pie chart of hypothetical household income
Interest, Rent, and Dividends 16.8%
Wages and Salaries 63.6%
Transfer Payments 12.0%
Proprietor’s Income 8.2%
A pie chart depicts the division of a whole into parts (percentages). This pie chart shows that the largest
component of a household income is wages and salaries. Transfer payments and interest are much smaller.
Another popular type of descriptive graph is a bar chart, such as Figure 1.12A. This diagram describes the behavior of two variables, hypothetical federal government revenue
and expenditures, in a series of “snapshots.” This graph gives a much more vivid impression of how much expenditures have grown relative to revenues than you could derive
from a set of numbers.
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Section 1.6A Caution: Graphs and Numbers Can Mislead as Well as Inform!
CHAPTER 1 APPENDIX
Figure 1.12A: Bar chart of hypothetical federal revenues and expenditures
(Billions)
$1,600
$1,400
$1,200
$1,000
$800
$600
$400
$200
$0
2008
2009
2010
2011
Federal Revenues
Federal Expenditures
A bar chart can be used in a variety of ways to present economic data in a visual manner. This bar chart
compares hypothetical federal revenues and expenditures for various years.
Theoretical graphs, such as those in Figures 1.5A through 1.10A, and descriptive graphs,
such as Figures 1.11A and 1.12A, are spread throughout this book. Both types are also
common in textbooks in social sciences and business, and in popular magazines such as
Time and Business Week. Economics is a very visual subject. Be sure that you feel secure
with reading and interpreting graphs before proceeding further.
1.6A Caution: Graphs and Numbers Can Mislead as Well as Inform!
G
raphs and statistics can be very informative. They put some concrete, real-world
content into abstract models and economic relationships. However, it is very easy
to present data in a misleading way. The choice of a scale along an axis can make
changes look bigger than they really are. The use of averages conceals a great deal of information about variation. For example, three families with incomes of $24,000, $25,000, and
$26,000 have an average income of $25,000. Three incomes of $5,000, $5,000, and $65,000
also average to $25,000. The same average income describes two very different distributions of income.
A classic guide to the use and abuse of numbers and graphs is How to Lie With Statistics, by Darrell Huff and Irving Geis. This book has been through numerous paperback
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Key Terms
CHAPTER 1 APPENDIX
editions since it was first published in 1954. It should be required reading for anyone
taking courses in the social sciences. It is a useful guide through the pitfalls of the means,
medians, averages, bar charts, surveys, samples, and growth rates that are the daily news
of the economic and political worlds.
Always be very cautious in accepting someone’s graphs or numbers. Consider carefully
what that person may be trying to persuade you to think or do and how the statistics
could be manipulated to put that position in a more favorable light.
Key Terms
458line A line in the first quadrant, passing through the origin, with a slope of 11,
which divides the quadrant in half. If the
scales on the axis are the same, the value
of the x-variable is equal to the value of the
y-variable along the 458line.
bar chart A graphic representation that
expresses data using columns of different
heights.
coordinates The values of x and y that
define the location of a point in a coordinate system.
dependent variable The variable, usually
plotted on the vertical axis, that is affected
or influenced by the other variable.
independent variable The variable, usually plotted on the horizontal axis, that
affects or influences the other variable.
maximum The point on the graph at
which the y-variable, or dependent variable, reaches its highest value.
minimum The point on the graph at
which the y-variable, or dependent variable, reaches its lowest value.
negative relationship A relationship
between two variables in which an
increase in the value of one is associated
with a decrease in the value of the other.
ama80571_01_c01_001-036.indd 36
origin The intersection of the vertical and
horizontal axes of a coordinate system, at
which the values of both the x-variable and
the y-variable are zero.
pie chart A graphic representation in the
shape of a pie that expresses actual economic data as parts of a whole. The sizes
of the slices of the pie correspond to the
percentage shares of the components.
positive relationship A relationship
between two variables in which an
increase in one is associated with an
increase in the other and a decrease in one
is associated with a decrease in the other.
scatter diagram A graph that plots actual
pairs of values of two variables to determine whether there appears to be any
consistent relationship between them.
slope The ratio of the change in the
dependent variable (y) and the independent variable (x).
tangent line A straight line just touching a
curve (nonlinear graphic relationship) at a
single point. The slope of the tangent line is
equal to the slope of the curve at that point.
x-axis The horizontal line in a coordinate
system that shows the values of the independent variable; the horizontal axis.
y-axis The upright line in a coordinate
system that shows the values of the dependent variable; the vertical axis.
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iStockphoto/Thinkstock
2
Markets, Governments, and
Nations: The Organization of
Economic Activity
Learning Objectives
By the end of this chapter, you will be able to:
• Identify the four types of productive resources, or factors of production, and the income paid to
each for its role in producing goods and services.
• Understand the basic economic questions that must be addressed by every economic system.
• Use a circular flow model to show the relationships between firms and households in markets in
an economy.
• Explain and give examples of the basic functions of government.
• Evaluate the benefits of specialization and exchange based on comparative advantage.
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Section 2.1 Limited Resources
CHAPTER 2
Introduction
C
onsider this. . . Suppose you were hired by Raúl Castro to advise him on how
he should organize production in Cuba. What would you tell him? What things
would you tell him the government should do and what things should he let
markets do? What goods should the government produce or subsidize, if any? Should
the Cuban people be allowed to buy goods from foreign firms? How should Castro
decide what goods should be imported and what goods should be exported? Transitioning the Cuban economy appears to be very complicated. The concepts in this
chapter will help you develop an understanding of how countries face these economic
questions.
2.1 Limited Resources
T
o examine the process of choice, we can begin by identifying the scarce resources
that exist. The productive resources are divided into four broad categories: labor,
land, capital, and entrepreneurship. All resources used to produce goods and services fit into one of these four categories, or factors of production. Goods are objects that
people value. Services are tasks performed for people. For example, a hairstylist provides
a service of cutting a client’s hair; the scissors that the hairstylist uses are goods.
Labor
Labor is the resource of production with which you are probably most familiar. It is the
physical and mental work of human beings. The efforts of a factory worker, a professional
basketball player, a university professor, and a carpenter are all labor.
Wages are the payments labor receives for its productive services. Some labor is valued
(and paid) more than other labor. Why? One reason is that some labor is more productive. Workers are born with different talents and abilities: some are more intelligent;
others are physically stronger or better coordinated; still others have artistic or musical
ability. It is also possible to make labor more productive by devoting money and time
to improving skills. Individuals invest in their labor skills by going to college, serving
as apprentices, or practicing. Economists refer to this development of labor skills as
an investment in human capital. Human capital consists of knowledge and skills that
increase labor’s productivity. A large part of wage differences can be explained by differences in human capital.
Land
The second resource is land. Land, to an economist, is not just rocks and soil, but all natural
resources that can be used as inputs to production. By this definition, land includes minerals, water, air, forests, oil, and even rainfall, temperature, and soil quality. The income paid
to this factor of production is called rent.
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Section 2.1 Limited Resources
CHAPTER 2
A key distinction between land and other productive resources is that land consists of
natural resources or conditions, unimproved by any human activity. For example, acreage
in Arizona that has been irrigated represents more than land. It also represents capital, the
third resource. Thus, part of the payment that is called rent is a return to land, but part of
it may be a return to capital.
Capital
The third resource, capital, is
defined as all aids to production
that are human creations rather
than resources found in nature.
Capital includes tools, factories,
warehouses, and inventories.
You have also seen that capital
can become attached to land or
to labor (human capital) when
investment is made in improvements or in skills and training.
In common usage, real capital
is often confused with financial capital. Financial capital
is money lent to purchase real,
physical capital. Economists
reserve the term capital for real
inputs to production, not for
financial assets.
iStockphoto/Thinkstock
Land refers to all natural resources, such as water, soil, and
minerals. Capital can become attached to land or to labor.
Capital, like land, receives a flow of income. The payments to capital are called interest. Interest is a reward for giving up present consumption in order to make resources
available for the creation of more capital for future production. Investment is the act
of adding to capital. Although the term investment is often used for such activities as
buying stocks and bonds, to an economist the term means the creation of real, physical
assets, such as machines, factories, or inventories, that can be used to produce other
goods and services.
Entrepreneurship
The last factor of production is entrepreneurship, which consists of the activities of combining the other productive resources to produce goods and services, taking risks, and
introducing new methods and new products (innovation). Entrepreneurs combine other
resources by buying or renting them to produce a saleable product. The reward for innovation, risk taking, and organization is profit.
Profit is the most difficult of the four productive resources to measure in practice because
it is whatever is left over after paying for land, capital, and labor. Accountants frequently
count profit as what is left after the bills are paid. However, this measure is likely to overlook such opportunity costs as the value of the owner’s labor (wages) or the return to the
owner’s capital (interest).
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Section 2.2 The Basic Economic Questions
CHAPTER 2
Check Point: The Four Factors of Production
•
•
•
•
Labor is paid wages.
Land is paid rent.
Capital is paid interest.
Entrepreneurship is paid profit.
2.2 The Basic Economic Questions
T
•
•
•
he process of choosing how to allocate scarce resources can be broken down into
three broad economic questions:
What goods and services will be produced and in what quantities?
How will they be produced? (That is, what methods of production and combinations of inputs will be used?)
For whom will they be produced? (That is, who gets what share of the goods and
services produced?)
Different kinds of economic systems answer these three questions in different ways. However, people in all economic systems are faced with the problem of how to allocate scarce
resources among an unlimited number of wants.
The production possibilities curve introduced in Chapter 1 shows attainable levels and
combinations of outputs. It does not, however, explain how to choose among these combinations. What determines whether an economy is at one particular point on the production possibilities curve instead of another, and who makes that choice?
The market provides at least a partial answer to the three basic questions in many societies. A market is any setting in which buyers and sellers meet to exchange goods, services,
or productive resources. A market system is an economic system that relies primarily on
market transactions to answer the three basic economic questions.
What, How, and for Whom?
The what question asks exactly what mix of goods and services is to be produced—how
many tons of wheat, thousands of e-books, hours of television programming, pairs of
jeans, and gallons of milk will make up the total national output. It is a difficult enough
question in the simple two-product world of the production possibilities curve. With thousands and thousands of possible combinations of outputs, the what question is extremely
complex. In a market system, the answer to the what question is determined by consumers, who “vote” in the marketplace by using their dollars to obtain particular goods and
services. In other economic systems, other methods are used to determine what kinds of
goods and services are produced and in what amounts.
A market economy may result in choices about the output mix that some economists or
policy makers find peculiar or distasteful. Many policy makers may not share the public’s
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CHAPTER 2
Section 2.2 The Basic Economic Questions
taste for rock videos, gambling palaces, country music, or skateboards. However, unless
people’s consumption of these items can be shown to be harmful to others, a market society
does not pass normative judgment on tastes. Markets produce what people want to buy.
The how question asks what input combination will be used to produce the chosen goods
and services. Should levees be produced by combining many workers with a few units of
capital or by a more capital-intensive method? Is it better to produce soybeans using lots of
machinery intensely cultivating a few acres of land or using more land and workers and relatively little capital? Should college students be taught in large classes by professors (highly
skilled labor) or in small sections by teaching assistants (substituting less skilled labor)?
Such questions must be answered in a systematic way. In a market system, prices guide suppliers and buyers of resources to decisions that maximize profits or minimize costs.
iStockphoto/Thinkstock
Some policy makers may not share the public’s taste for
gambling places. However, unless people’s consumptions of
such items can be shown to be harmful to others, markets
produce what people want to buy.
The for whom question asks who
will get the goods and services
produced and how much each
person will receive. This is a
way of asking which of many
possible distributions of income
will be chosen. Should the distribution be equal or unequal?
Should an individual’s share be
based on contributions to production, on need, or on some
combination of the two? A pure
market system answers this
question directly: A person’s
rewards depend on contributions to production. Other systems, including a mixed market
system, use a mixture of guidelines to determine the distribution of income.
The answers to the three questions are not independent of one another. The distribution
of income will determine whether there is more demand for bread and milk or luxury
yachts. The production process chosen may determine the amount of each kind of output
that can be produced.
Tradition, Command, and the Market
Every society has to find a way to answer the three basic economic questions. The study of
the different ways of organizing economic activity, or answering these questions, is called
comparative economic systems. One way to classify economic systems is by the method
used to answer the three basic economic questions. This classification identifies three
broad types of economies: the traditional economy, the command (or planned) economy,
and the market economy. Of course, no economy fits neatly into any one of these categories. All economies are mixed in that they all contain elements of traditional, command,
and market processes.
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Section 2.2 The Basic Economic Questions
CHAPTER 2
Traditional Economy
A traditional economy answers the basic economic questions by tradition, or custom. That
is, the answers are determined by how the questions have been answered in the past. What
is produced is whatever parents have taught their children to produce on the basis of customs. A heavily traditional society is usually not highly sophisticated. Most of people’s
efforts are devoted to production of food, clothing, and shelter. Tradition determines what
kinds of food are grown, what kinds of clothing are made, and what kinds of houses are
built. It also determines what combination of these three is produced in any given period.
The techniques of production (how to produce) are also passed on, with little change, from
one generation to the next. In many parts of Asia and Africa, the methods of building houses
and of farming have been the same for many generations. Traditional societies also have
established answers to the distribution question (for whom): They often have rules on how
to divide the spoils of the hunt or the fruits of the harvest. Medieval Europe was a highly
traditional society, with shares of crops assigned to various claimants. In such a traditional
society, a person’s claim on society’s resources was determined primarily by status in the
hierarchy, from a peasant up to a king. You may recognize elements of tradition that persist
even in modern industrial societies. An example of this can be seen in the country of Bosnia
and Herzegovina. Traditionally, Herzegovinians breed goats and sheep for the production
of cheese and wool. Due to the country’s economic crisis in the early 2000s, many of Bosnia
and Herzegovina’s citizens returned to these traditional ways of production.
Command Economy
A command economy, or planned economy, answers the basic economic questions through
central command and control. A central planning authority makes all decisions regarding
what and how to produce. Individual production units receive detailed plans and orders
that carry the weight of law. The question concerning income distribution is answered in
the process of determining what and how to produce. The central planners also set wage
rates and levels of production. This planning process was the primary method of organization in the former Soviet Union, as well as in China before the rapid movement toward
market economies in the late 1990s and early 2000s. Command systems are disappearing
very rapidly. North Korea and Cuba still make extensive use of central commands, but
even these nations seem to be inching towards the use of markets to allocate goods.
In any economy, people plan. That is, they think about the future and prepare for it. In a
traditional society, people plan for a future that will be much like the past. In a command
economy, the government plays the primary role in planning how to answer the production and consumption questions for society. This kind of planning is very different from
the individual planning that goes on in a market economy.
Market Economy
The third type of economic system is the market economy. A market economy relies on
incentives and the self-interested behavior of individuals to direct production and consumption through market exchanges. Consumers, “voting” with their dollars, determine
what is produced. The result of this market process determines what goods and services
are available.
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Section 2.2 The Basic Economic Questions
CHAPTER 2
Suppliers determine how to produce. Since suppliers are self-interested and seek to maximize their profits, they tend to combine resource inputs so as to produce a good or service at the lowest possible cost. The answer to the how question depends on the prices of
productive resources. Suppliers will use more of abundant resources because they are
relatively cheap.
The goods and services are distributed to consumers who have the purchasing power to
buy them. Households that have more purchasing power (because they own more valuable productive resources) receive more goods and services. The quantity and quality
of the labor skills an individual sells are the most important determinants of individual
income. In 2011, about 80% of income in the United States was wages and salaries (Bureau
of Economic Analysis, 2012). People with higher earnings have more “votes” in the form
of dollars spent in the marketplace. Those with high-quality, scarce skills that are in great
demand receive high salaries and have more influence on output.
One essential condition for undirected markets to answer the basic economic questions
is the institution of property rights. In a command economy, almost all property belongs
to the state. In a market economy, however, private property and property rights play an
essential role. Markets will only function if individual buyers and sellers possess the property rights to the goods and services they want to exchange.
In a market economy, productive resources are owned by individuals. The owners of
capital will not invest unless they are certain that they can claim the ownership of that
capital and the products that it produces. They also need to be assured that their capital and its interest will not be taken away by the state or by force or violence. Workers
will not offer their labor for hire if their right to be paid cannot be enforced or if they
know their earnings are likely to be stolen. What a market system needs, then, is a legal
system that defines property rights and enforces them against any violations. Defining
and enforcing property rights is an important function of government even in a pure
market economy.
Responding to Change
One way to compare the workings of these three types of economic systems is to consider
how each responds to change. Suppose an earthquake closes some copper mines, and the
supply of copper is suddenly cut in half. A traditional economy would only use copper for
jewelry and would probably have rules to ensure that the most respected members of the
group had first use of any copper. In a command economy, government officials would
decide which uses of copper had the highest priority and make sure that the available
copper was distributed properly.
Contrast these processes with what occurs in a market economy. When the mines close
and less copper is available, copper prices will rise. The higher price leads consumers
to search for cheaper substitutes. It also attracts a sudden flow of imported copper or
scrap copper to the market. The allocation of copper might not meet the traditional
economy’s criterion of fairness or the command economy’s priorities. However, the
market response is much faster. Substitution and increased supplies occur very quickly,
with no need for the government to process and send information. A market system
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Section 2.2 The Basic Economic Questions
CHAPTER 2
economizes on the amount of costly information needed to make production and consumption decisions.
The market system has advantages over command and traditional economies in flexibility
and capacity for dealing with change. However, the market system also has some drawbacks. Many observers criticize the distribution of income that results from the workings
of the market, which can create extremes of wealth and poverty. Market systems have
also been criticized for encouraging self-centered behavior at the expense of community
interests.
Mixed Economies
Because of the advantages of the market system, even primarily traditional or command
economies incorporate some elements of markets. Conversely, the pure market system is
often modified to soften some of the harshness of pure capitalism.
The blend of tradition, command, and market
decision methods varies, but most modern industrial countries, such as Canada, Japan, the United
States, Australia, and the nations of Western
Europe, have mixed economies. In a mixed economy, the basic decision method is the market,
but some economic choices are made by government. The goal is to leave economic decisions to
the market when it works well, but to intervene
in the economy when the market outcome is not
acceptable. On a macroeconomic level, a high rate
of unemployment is an example of an unacceptable market outcome. On a microeconomic level,
air pollution caused by coal-fired power plants is
an example of an undesirable market outcome. In
both instances, some people argue that the government should step in to correct the performance
of the market and alter its results.
All noncommunist nations can be classified as
having mixed economies. The mix varies signifiChip Somodevilla/Getty Images
cantly from country to country. Governments are
Shifts in division of labor between the
much more heavily involved in the economy in market and the public sector are often
Poland, Sweden, and France than in the United seen when presidential leadership shifts
States and the United Kingdom. The differences from one political party to another.
in the degree of governmental involvement in
economic decisions reflect variety in political systems, national values, and historical experiences. Even within economies, the division of
labor between the market and the public sector changes from time to time. In the United
States, this is most often seen when the presidential leadership changes from Republican
to Democratic (and vice versa).
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Section 2.3 The Circular Flow of Economic Activity
CHAPTER 2
Check Point: Comparing Economic Systems
All economies contain elements of traditional, command, and market processes.
• A traditional economy allows tradition, or custom, to determine the types and combination
of goods and services produced in any given period.
• In a command (or planned) economy, a central planning authority makes all decisions regarding what and how to produce.
• A market economy allows individuals to direct production and consumption through market
exchanges to determine which goods and services are available.
2.3 The Circular Flow of Economic Activity
C
hapter 1 discussed the use of models by economists in developing simple descriptions from which wider conclusions and inferences can be made. One model that
is often used to describe a mixed economy in which the market is the primary
source of decisions is the circular flow model. This model provides an overview of the
central concerns of both macroeconomics and microeconomics. The circular flow model
is a visual picture of the relationships between the resource market, in which income is
earned, and the product market, in which income is used to purchase goods and servi…
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  • Money-back and Privacy guarantees
  • Unlimited Amendments upon request
  • Satisfaction guarantee

How it Works

  • Click on the “Place Order” tab at the top menu or “Order Now” icon at the bottom and a new page will appear with an order form to be filled.
  • Fill in your paper’s requirements in the "PAPER DETAILS" section.
  • Fill in your paper’s academic level, deadline, and the required number of pages from the drop-down menus.
  • Click “CREATE ACCOUNT & SIGN IN” to enter your registration details and get an account with us for record-keeping and then, click on “PROCEED TO CHECKOUT” at the bottom of the page.
  • From there, the payment sections will show, follow the guided payment process and your order will be available for our writing team to work on it.