Chapter 1: The Central Idea

 People make purposeful choices with scarce resources and interact with others when they
make these choices.
 Economics- The study of how people deal with scarcity.
 Scarcity- A situation in which people’s resources are limited.
 Scarcity implies that people must make a choice to forgo, or give up, one thing in favor
of another.
 Economics interactions between people occur every time they trade or exchange goods
with each other.
 Market- An arrangement by which buyers and sellers can interact and exchange goods
and services with each other.
Scarcity and Choice for Individuals
 Consumer Decisions
 Opportunity Costs- The value of the next best forgone alternative that was not chosen.
Occurs every time there is a choice.
 Gains from a trade: A better allocation
- There are gains from a trade because the trade reallocates goods between the two
individuals in a way that they both prefer.
 Producer Decisions
 Gains from a trade: Greater production
 Specialization- People concentrating their production efforts on what they are good at.
 Division of Labor- Occurs when some workers specialize in one task while others
specialize in another task.
 They divide the overall production into parts, with some workers concentrating on one
part and other workers concentrating on another part.
 Comparative Advantage- Occurs if a person or group can produce that good with
comparatively less time, effort, or resources than another
person or group can produce that good.
 International Trade- Trading between multiple people or groups in two different
countries.
 The gains from international trade are of the same kind as the gains from trade within a
country.
 By trading, people can better satisfy their preferences for goods, or they can better utilize
their comparative advantage.

Scarcity and Choice for the Economy as a Whole

 Just as individuals face scarcity and choice, so does the economy as a whole (the total
amount of resources is an economy- workers, land, machinery, factories- is limited).
 Production Possibilities
 Production Possibilities- Alternative combinations of production of various goods that
are possible, given the economy’s resources.
 The Production Possibilities Curve
 Shows the maximum number of good #1 that can be produced for each quantity of good
#2 produced.
 The opportunity cost of producing good #1 increases as more of good #1 is produced.
 As resources move from good #1 making to good #2 making to good #2 making, each
additional good #2 means a greater loss of good #1 production.
 The production possibilities curve shows the effects of scarcity and choice in the
economy as a whole.
 Points inside the curve are inefficient and points on the curve are efficient.
 Points on the curve represent the maximum amount that can be produced with available
resources. Thus, the only way to raise production of one good is to lower production of
the other good (points on the curve show a tradeoff between one good and another).
 Points to the right and above the production possibilities curve are impossible. The
economy does not have the resources to produce those quantities.
 The production possibilities curve is not immovable. It can shift out or in.
 More resources- more workers- would shift the production possibilities curve out. A
technological innovation that allowed one to be more efficient would also shift the curve
outward.
 When the production possibilities curve shifts out, the economy grows because more
goods and services can be produced.
 As the production possibilities curve shifts out, impossibilities are converted into
possibilities.
 Scarcity, Choice, and Economic Progress
 The conversion of impossibilities into possibilities is also an economic problem of choice
and scarcity: If we invest less now- in machines, in education, in children, in technology-
and consume more now, then we will have less available in the future.
 The production possibilities curve represents a tradeoff, but it does not mean that some
people win only if others lose.

Market Economies and the Price System

 Market Economy- Most decisions about what, how, and for whom to produce are made
by individual consumers, firms, governments, and other organizations
interacting in markets.
 Command Economy- Most decisions about what, how, and for whom to produce are
made by those who control the government, which, through a
central plan, commands and controls what people do.
 Command economies often resulted in shortages or surplus of products and, as a by-
product, in political unrest.
 Key Elements of a Market Economy
 In a market economy, most prices are freely determined by individuals and firms
interacting in markets.
 These freely determined prices are an essential characteristic of a market economy.
 Property rights are another key element of a market economy. Property rights give
individuals the legal authority to keep or sell property, whether land or other resources.
 Without property rights people could take whatever they wanted without paying.
 Property rights also provide an incentive.
 If there were no property rights, people would not have incentives to specialize and reap
the gains from the division of labor. Any extra earnings from specialization could be
taken away.
 Allowing people to interact freely is another necessary ingredient of a market economy.
 In virtually all market economies, the government provides defense and police protection.
The government also helps establish property rights.
 Market Failure- The market economy does not provide good enough answers to the
“what, how, and for whom” questions, and the government has a role to
play in improving on the market.
 Government Failure- When the government does worse than the market.
 The Price System
 A market economy is said to use the price system to solve what, how, and for whom
something is produced.
1) Prices serve as signals about what should be produced and consumed when there
are changes in tastes or changes in technology.
2) Prices provide incentives to people to alter their production or consumption.
3) Prices affect the distribution of income, or who gets what in the economy.
 No single individual knows the information that is transmitted by prices. Any economy
is characterized by limited information, where people cannot know the exact reasons why
prices for certain goods rise or fall.
 A higher price for goods will increase the incentives for firms to produce those goods.
Because they will receive more money for these goods, they will produce more of them.
 Workers who find the production of the good they make increasing because of the higher
demand will earn more. However, the workers who are employed by the competitors will
earn less.