Chapter 1. Economic Issues and Concepts

Chapter 1:
Economic Issues
and Concepts
Copyright © 2014 Pearson Canada Inc.

Chapter Outline/Learning Objectives
Section Learning Objectives
After studying this chapter, you will be able to
1.1 What is Economics? 1. explain the importance of scarcity, choice, and

opportunity cost, and how all three concepts are
illustrated by the production possibilities boundary.
1.2 The Complexity of 2. view the market economy as self-organizing in the

Modern Economies sense that order emerges from a large number of
decentralized decisions.
3. explain how specialization gives rise to the need for
trade, and that trade is greatly facilitated by money.
4. identify the economy's decision makers and see how
their actions create a circular flow of income and
expenditure.
1.3 Is There an Alternative 5. see that all actual economies are mixed economies,
to the Market having elements of free markets, tradition, and
Economy? government intervention.
Copyright © 2014 Pearson Canada Inc. Chapter 1, Slide 2
Economic issues that are of pressing concern:
• Productivity Growth
• Population Aging
• Climate Change
• Global Financial Stability
• Rising Government Debt
• Globalization
Many of the challenges we face in Canada and around the world

are primarily economic.

1.1 What is Economics?
Economics is the study of the use of scarce resources to satisfy

unlimited human wants.
Resources
A society's resources are usually divided into land, labour, and capital.
Economists refer to resources as factors of production.
Outputs are goods (tangibles) or services (intangibles).

Scarcity and Choice
Resources can produce only a fraction of the goods and services
desired by people.
Scarcity implies the need for choice.
Every choice has an associated cost—opportunity cost.
Opportunity cost is defined as the benefit given up by not using

resources in the best alternative way.

Fig. 1-1 Choosing Between Pizza and Beer
Consider the choice David must make when he has only has $16 to spend.
He wishes to spend it all on pizza and beer. A beer costs $4 and each slice of
pizza costs $2.
Combination A is unattainable.

Fig. 1-1 Choosing Between Pizza and Beer
All points that lie on or

inside the line would be
attainable combinations.
The negatively sloped line

A provides a boundary
Unattainable combinations
between attainable and
Get 1
extra unattainable combinations.
beer
Give up 2
slices of pizza The opportunity cost of
Attainable combinations getting 1 extra slice of pizza
is half of a beer that must
be given up.

Fig. 1-2 A Production Possibilities Boundary (PPB)
The PPB illustrates:

• scarcity
• choice
• opportunity cost
Points e and f show scarcity;

they are unattainable with
current resources.
Points a, b, c, d show choice.
They are all attainable, but
which one will be chosen?
The negative slope illustrates
opportunity cost.

APPLYING ECONOMIC CONCEPTS 1-1
The Opportunity Cost of Your University Degree
Economists use graphs to illustrate theories and to show data.

MyEconLa For a quick refresher about how to use graphs, look for A Brief
b Introduction to Graphing in the Additional Topics section of this
book's MyEconLab.
www.myeconlab.com

Four Key Economic Problems
1. What Is Produced and How?
• Resource allocation determines the quantities of various

goods that are produced.
• In terms of our previous illustration, what combination

of civilian and military goods will be chosen?
• Will the economy be inside the production possibilities

boundary—inefficiently used resources?

2. What Is Consumed and By Whom?
• What determines how economies distribute total

output? Why do some people get a lot while others
get only a little?
• Will the economy consume exactly what it produces?
• Microeconomics is the study of the allocation of

resources as it is affected by the workings of the
price system.

3. Why Are Resources Sometimes Idle?
• An economy is operating inside its production

possibilities boundary if some resources are idle.
• Under what circumstances are workers seeking jobs

unable to find them?
• Should governments worry about idle resources?

Is there anything governments can do about it?

4. Is Productive Capacity Growing?
Fig. 1-3 The Effect of Economic Growth on the PPB
• Growth in productive
capacity is shown by an
outward shift of the PPB.
• Point d was initially
unattainable. But after
sufficient growth, it
becomes attainable.
Macroeconomics is the study of determination of economic aggregates.

Economics and Government Policy
The design and effectiveness of government policy is relevant to
discussing all four problems.
• It can alter the allocation of the economy's resources to

make society as a whole better off.
• It can be used to improve the distribution of consumption

across individuals.
• It is also part of the discussion of why economic resources

are sometimes idle (e.g., unemployment).
• It can affect the overall output and income.

1.2 The Complexity of Modern Economies
The Nature of Market Economies
Self-Organizing
Who or what provides the goods and services individuals desire?
Early economists noticed that the interaction of self-interested

people creates a spontaneous social order—the economy is
self-organizing.
Self-interest, not benevolence, is the foundation of economic order.

Adam Smith (1723–1790)
In The Wealth of Nations, Smith was the first to develop this
insight fully: "It is not from the benevolence of the butcher, the
brewer, or the baker, that we expect our dinner, but from their
regard to their own interest. We address ourselves, not to their
humanity but to their self-love, and never talk to them of our
own necessities but of their advantages."
Efficiency
Loosely speaking, efficiency refers to organizing available resources
to produce the goods and services that people most value, when
they most want them, and by using the fewest possible resources
to do so.
The Nature of Market Economies
Incentives and Self-Interest
• Self-interest guides individuals.
• Individuals respond to incentives.
• Prices and quantities are set in (relatively) free markets

in which individuals trade voluntarily.
• Institutions, created by the state, protect private property

and enforce contractual obligations.

The Decision Makers and Their Choices
Three broad groups of decision makers:
• Consumers
• Producers
• Government
In order to achieve their objectives, maximizing consumers and

producers make marginal decisions.
 they decide whether they will be made better off by buying

or selling a little less of any given product.

Fig. 1-4 The Circular Flow of Income and Expenditure

The Flow of Income and Expenditure
Individuals own factors of production. They sell the services of
these factors to producers in factor markets and receive payment
in return.
These are the (factor) incomes of individuals.
Producers transform factor services into goods and services, which

they then sell to individuals in goods markets, receiving payment in
return.
These are the incomes of producers.

Production and Trade
Production usually displays two characteristics noted long ago
by Adam Smith: specialization and division of labour.
Specialization is the allocation of different jobs to different people.

It is more efficient than self-sufficiency because:
• Individual abilities differ—comparative advantage.
• Focusing on one activity leads to improvements—
learning by doing.
Division of labour extends the idea of specialization for the

production of a single good or service.

Money and Trade
Specialization must be accompanied by trade.
Money eliminates the cumbersome system of barter by separating

the transactions involved in the exchange of products, thereby
facilitating specialization and trade.

Globalization
Underlying modern globalization is the rapid reduction of

transportation and communication costs in the last half of
the 20th century.
Today, no country can take an isolationist economic stance

and hope to take part in the global economy.
In this course we will discuss the extent to which the process of

globalization changes markets and changes the way government
policy can influence economic outcomes.

1.3 Is There an Alternative to the Market Economy?
Types of Economic Systems

There are three pure types of economic systems:
• Traditional
• Command
• Free-Market
In practice, every economy is a mixed economy, in the sense that it

combines significant elements of all three systems.

The Great Debate
A century after Adam Smith, Karl Marx (1818–1883) argued that
free-market economies could not be relied upon to generate a
"just" distribution of output.
He argued the benefits of a centrally planned system.
Beginning with the Soviet Union in the 1920s, many countries

inspired by Marx adopted socialist/communist systems.
By the last few decades of the 20th century, most of these countries
were unable to provide their citizens the rising living standards that
existed in the more free-market economies.
In the last two decades of the 20th century, most governments

replaced their systems of central planning with much freer markets.
LESSONS FROM HISTORY 1-1
The Failure of Central Planning
The failure of the centrally planned economies does not demonstrate

the superiority of completely free-market economies.
Instead, it shows the superiority of mixed economies, with large

elements of free markets.
The debate between government involvement and free markets

MyEconLa figures prominently in the discussion of progress in today's
b developing countries. For a detailed discussion of Challenges Facing
the Developing Countries, see the Additional Topics section of this
www.myeconlab.com
book's MyEconLab.

Government in the Modern Mixed Economy

Chapter 1. Economic Issues and Concepts

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Chapter 1:

Copyright © 2014 Pearson Canada Inc.

1.1 What is Economics? 1. explain the importance of scarcity, choice, and

1.2 The Complexity of 2. view the market economy as self-organizing in the

Many of the challenges we face in Canada and around the world

Copyright © 2014 Pearson Canada Inc. Chapter 1, Slide 3

Economics is the study of the use of scarce resources to satisfy

Economists refer to resources as factors of production.

Outputs are goods (tangibles) or services (intangibles).

Copyright © 2014 Pearson Canada Inc. Chapter 1, Slide 4

Scarcity implies the need for choice.

Every choice has an associated cost—opportunity cost.

Opportunity cost is defined as the benefit given up by not using

Copyright © 2014 Pearson Canada Inc. Chapter 1, Slide 5

Copyright © 2014 Pearson Canada Inc. Chapter 1, Slide 6

All points that lie on or

The negatively sloped line

Copyright © 2014 Pearson Canada Inc. Chapter 1, Slide 7

The PPB illustrates:

Points e and f show scarcity;

Copyright © 2014 Pearson Canada Inc. Chapter 1, Slide 8

Economists use graphs to illustrate theories and to show data.

Copyright © 2014 Pearson Canada Inc. Chapter 1, Slide 9

• Resource allocation determines the quantities of various

• In terms of our previous illustration, what combination

• Will the economy be inside the production possibilities

Copyright © 2014 Pearson Canada Inc. Chapter 1, Slide 10

• What determines how economies distribute total

• Will the economy consume exactly what it produces?

• Microeconomics is the study of the allocation of

Copyright © 2014 Pearson Canada Inc. Chapter 1, Slide 11

• An economy is operating inside its production

• Under what circumstances are workers seeking jobs

• Should governments worry about idle resources?

Copyright © 2014 Pearson Canada Inc. Chapter 1, Slide 12

Macroeconomics is the study of determination of economic aggregates.

• It can alter the allocation of the economy's resources to

• It can be used to improve the distribution of consumption

• It is also part of the discussion of why economic resources

• It can affect the overall output and income.

Copyright © 2014 Pearson Canada Inc. Chapter 1, Slide 14

The Nature of Market Economies

Who or what provides the goods and services individuals desire?

Early economists noticed that the interaction of self-interested

Self-interest, not benevolence, is the foundation of economic order.

Copyright © 2014 Pearson Canada Inc. Chapter 1, Slide 15

• Individuals respond to incentives.

• Prices and quantities are set in (relatively) free markets

• Institutions, created by the state, protect private property

Copyright © 2014 Pearson Canada Inc. Chapter 1, Slide 17

In order to achieve their objectives, maximizing consumers and

 they decide whether they will be made better off by buying

Copyright © 2014 Pearson Canada Inc. Chapter 1, Slide 18

Copyright © 2014 Pearson Canada Inc. Chapter 1, Slide 19

These are the (factor) incomes of individuals.

Producers transform factor services into goods and services, which

These are the incomes of producers.

Copyright © 2014 Pearson Canada Inc. Chapter 1, Slide 20

Specialization is the allocation of different jobs to different people.

Division of labour extends the idea of specialization for the

Copyright © 2014 Pearson Canada Inc. Chapter 1, Slide 21

Specialization must be accompanied by trade.

Money eliminates the cumbersome system of barter by separating

Copyright © 2014 Pearson Canada Inc. Chapter 1, Slide 22