ECONOMICS

Twelfth Edition, Global Edition

Michael Parkin
1 WHAT IS ECONOMICS?
After studying this chapter, you will be able to:
♦ Define economics and distinguish between
microeconomics and macroeconomics
♦ Explain the two big questions of economics

♦ Explain the key ideas that define the economic way of

thinking
♦ Explain how economists go about their work as social
scientists and policy advisers

© 2016 Pearson Education, Ltd.

 Definition of Economics

All economic questions arise because we want more than

we can get.
Our inability to satisfy all our wants is called scarcity.
Because we face scarcity, we must make choices.

Economics is the social science that studies the choices

that individuals, businesses, governments, and entire
societies make as they cope with scarcity and the
incentives that influence and reconcile those choices.
Economics divides in two main parts:
* Microeconomics * Macroeconomics
© 2016 Pearson Education, Ltd.
 Definition of Economics

Microeconomics is the study of choices that individuals

and businesses make, the way those choices interact in
markets, and the influence of governments.
An example of a microeconomic question is: Why are
people buying more e-books and fewer hard copy books?
Macroeconomics is the study of the performance of the
national and global economies. So, it is the study
economics as a whole and big picture.
An example of a macroeconomic question is: Why is the
unemployment rate in the United States so high?

© 2016 Pearson Education, Ltd.

 Two Big Economic Questions

Two big questions summarize the scope of economics:

▪ How do choices end up determining what, how, and for
whom goods and services get produced?
▪ When do choices made in the pursuit of self-interest
also promote the social interest?

© 2016 Pearson Education, Ltd.

 Two Big Economic Questions

What, How, and For Whom?

Goods and services are the objects that people value
and produce to satisfy human wants.
What?
Agriculture accounts for less than 1 percent of total U.S.
production, manufactured goods for 22 percent, and
services for 77 percent.
In China, agriculture accounts for 11 percent of total
production, manufactured goods for 47 percent, and
services for 43 percent.

© 2016 Pearson Education, Ltd.

 Two Big Economic Questions

How?
Goods and services are produced by using productive
resources that economists call factors of production.
Factors of production are grouped into four categories:
▪ Land
▪ Labor
▪ Capital
▪ Entrepreneurship

© 2016 Pearson Education, Ltd.

 Two Big Economic Questions

The “gifts of nature” that we use to produce goods and

services are land.
The work time and work effort that people devote to
producing goods and services is labor.
The quality of labor depends on human capital, which is
the knowledge and skill that people obtain from education,
on-the-job training, and work experience.
The tools, instruments, machines, buildings, and other
constructions that businesses use to produce goods and
services are capital.
The human resource that organizes land, labor, and
capital is entrepreneurship.

© 2016 Pearson Education, Ltd.

 Two Big Economic Questions

For Whom?
Who gets the goods and services depends on the incomes
that people earn.
▪ Land earns rent.
▪ Labor earns wages.
▪ Capital earns interest.
▪ Entrepreneurship earns profit.

© 2016 Pearson Education, Ltd.

 Two Big Economic Questions

Self-Interest
You make choices that are in your self-interest—choices
that you think are best for you.
Social Interest
Choices that are best for society as a whole are said to be
in the social interest.
Social interest has two dimensions:
▪Efficiency
▪Equity

© 2016 Pearson Education, Ltd.

 Economic Way of Thinking

Six key ideas define the economic way of thinking:

▪ A choice is a tradeoff.
▪ People make rational choices by comparing benefits
and costs.
▪ Benefit is what you gain from something.
▪ Cost is what you must give up to get something.
▪ Most choices are “how-much” choices made at the
margin.
▪ Choices respond to incentives.

© 2016 Pearson Education, Ltd.

 Economic Way of Thinking

A Choice Is a Tradeoff
The economic way of thinking places scarcity and its
implication, choice, at center stage.
You can think about every choice as a tradeoff—an
exchange—giving up one thing to get something else.
On Saturday night, will you study or have fun?
You can’t study and have fun at the same time, so you
must make a choice.
Whatever you choose, you could have chosen something
else. Your choice is a tradeoff.

© 2016 Pearson Education, Ltd.

 The Economic Way of Thinking

Cost: What you Must Give Up

The opportunity cost of something is the highest-valued
alternative that must be given up to get it.
What is your opportunity cost of going to a live concert?
Opportunity cost has two components:
1. The things you can’t afford to buy if you purchase the
concert ticket.
2. The things you can’t do with your time if you attend the
concert.

© 2016 Pearson Education, Ltd.

 The Economic Way of Thinking

To make a choice at the margin, you evaluate the

consequences of making incremental changes in the use
of your time.
The benefit from pursuing an incremental increase in an
activity is its marginal benefit.
The opportunity cost of pursuing an incremental increase
in an activity is its marginal cost.
If the marginal benefit from an incremental increase in an
activity exceeds its marginal cost, your rational choice is to
do more of that activity.

© 2016 Pearson Education, Ltd.

2 THE ECONOMIC
PROBLEM
After studying this chapter, you will be able to:
♦ Define the production possibilities frontier and
use it to calculate opportunity cost
♦ Distinguish between production possibilities and
preferences and describe an efficient allocation
of resources
♦ Explain how current production choices expand
future production possibilities
♦ Explain how specialization and trade expand
production possibilities
♦ Describe the economic institutions that
coordinate decision
© 2016 Pearson Education, Ltd.
 Production Possibilities and
Opportunity Cost
The production possibilities frontier (PPF) is the
boundary between those combinations of goods and
services that can be produced and those that cannot.
To illustrate the PPF, we focus on two goods at a time and
hold the quantities of all other goods and services
constant.
That is, we look at a model economy in which everything
remains the same (ceteris paribus) except the two goods
we’re considering.

© 2016 Pearson Education, Ltd.

 Production Possibilities Frontier
and Opportunity Cost
Figure 2.1 shows the PPF for two goods: cola and pizzas.
 Any point on the frontier such as E and any point inside the PPF
such as Z are attainable.

 Points outside the PPF are unattainable.

© 2016 Pearson Education, Ltd.

 Production Possibilities and
Opportunity Cost
Any point inside the
frontier, such as Z, is
inefficient.
At such a point, it is
possible to produce more
of one good without
producing less of the
other good.
At Z, resources are either
unemployed or
misallocated.

© 2016 Pearson Education, Ltd.

 Production Possibilities and
Opportunity Cost
Tradeoff Along the PPF
Every choice along the
PPF involves a tradeoff.
On this PPF, we must give
up some cola to get more
pizzas or give up some
pizzas to get more cola.

© 2016 Pearson Education, Ltd.

 Production Possibilities and
Opportunity Cost
Opportunity Cost
As we move down along
the PPF,
we produce more pizzas,
but the quantity of cola we
can produce decreases.
The opportunity cost of a
pizza is the cola forgone.

© 2016 Pearson Education, Ltd.

 Using Resources Efficiently

Figure 2.2 illustrates the

marginal cost of a pizza.
As we move along the
PPF, the opportunity cost
of a pizza increases.
The opportunity cost of
producing one more pizza
is the marginal cost of a
pizza.

© 2016 Pearson Education, Ltd.

 Any point on the PPF is attainable,
efficient, and represents full
employment.
Such as ( A,B,C,D,E,F)
G
 Any point inside the PPF is
attainable, but inefficient,
representing unemployment.
Such as Z

 Points outside the PPF are

unattainable or impossible.
such as G

© 2016 Pearson Education, Ltd.

 Economic Growth

The expansion of production possibilities—an increase in

the standard of living—is called economic growth.
Two key factors influence economic growth:
▪ Technological change
▪ Capital accumulation
Technological change is the development of new goods
and of better ways of producing goods and services.
Capital accumulation is the growth of capital resources,
which includes human capital.

© 2016 Pearson Education, Ltd.

 Economic Growth

The Cost of Economic Growth

To use resources in research and development and to
produce new capital, we must decrease our production of
consumption goods and services.
So economic growth is not free.
The opportunity cost of economic growth is less current
consumption.

© 2016 Pearson Education, Ltd.

 Economic Growth

Figure 2.5 illustrates the

tradeoff we face.
We can produce pizzas or
pizza ovens along PPF0.
By using some resources
to produce pizza ovens
today, the PPF shifts
outward in the future.

© 2016 Pearson Education, Ltd.

© 2016 Pearson Education, Ltd.
 Example
The inhabitants of Island grow potatoes and catch fish. The accompanying table shows
the maximum annual output combinations of potatoes and fish that can be produced.

© 2016 Pearson Education, Ltd.

 Example

a. Draw a production possibility frontier with potatoes on the horizontal axis

and fish on the vertical axis illustrating these options, showing points A–F.

b. Can Island produce 50 pounds of fish and 80 pounds of potatoes? Explain.

Where would this point lie relative to the production possibility frontier?

c. What is the opportunity cost of increasing the annual output of potatoes from
60 to 80 pounds?

d. What is the opportunity cost of increasing the annual output of potatoes from
20 to 40 pounds?

© 2016 Pearson Education, Ltd.