Chapter 1:

Economic Issues
and Concepts

Copyright 2017 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 each is illustrated by the production
possibilities boundary.

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

- in the sense
that order emerges from a large number of decentralized
Modern Economies
decisions.

3. explain how specialization gives rise to the need for

trade, and how trade is facilitated by money.

4. identify the economys decision makers and see how their

actions create a circular flow of income and expenditure.

1.3 Is There an Alternative 5. describe how all actual economies are mixed economies,
to the Market having elements of free markets, tradition, and
Economy? government intervention.
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 Issues of pressing concern

Productivity Growth
Population Aging
Climate Change
Global Financial Stability
Rising Government Debt
Globalization
Growing Income Inequality

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

are primarily economic.

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 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 often divided into land, labour, and capital.
Land includes all natural endowments, such as arable land, forests,
lakes, crude oil, and minerals.
Labour includes all mental and physical human resources, including
entrepreneurial capacity and management skills.
Capital includes all manufactured aids to production, such as tools,
machinery and buildings.

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 1.1 What is Economics?

Resources
Economists call such resources factors of production.
We divide what is produced into goods and services.
Goods are tangible and services are intangible.
The act of making goods and services is called production, and the act
of using them is called consumption.

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 Scarcity and Choice
Relative to our desires, existing resources are scarce. There are
enough resources to produce only a fraction of the goods and
services that we want.

Scarcity implies the need for choice.

Every choice has an associated costopportunity cost.

Opportunity cost is the value of the next best alternative that is

forgone when one alternative is chosen.

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 Fig. 1-1 Choosing Between Pizza and Beer

The graph shows Davids budget line for beer and pizza when David
has only $16 to spend on these two goods. The price of a beer is $4
and the price of a slice of pizza is $2.

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 Fig. 1-1 Choosing Between Pizza and Beer

The negatively sloped line indicates the boundary

between attainable and unattainable combinations.

Points that lie on or inside the budget line are attainable.

Points that lie outside the
A
Unattainable combinations
budget line are
Get 1 unattainable.
extra
beer The opportunity cost of
Give up 2
slices of pizza an additional beer is the 2
Attainable combinations
slices of pizza given up to
obtain it.

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 APPLYING ECONOMIC CONCEPTS 1-1
The Opportunity Cost of Your University Degree

Your university degree does not include only the out-of-pocket expenses on tuition and books.

What else are you forced to give up to attend university?

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 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?

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 Four Key Economic Problems
1. What Is Produced and How?
Resource allocation determines the quantities of various
goods that are produced.
What determines which goods are produced and which
ones are not?
Is there some combination of goods that is better than
others?

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 Four Key Economic Problems
2. What Is Consumed and By Whom?
What determines the distribution of a nations total
output among its people?
Who gets a lot and who gets a little, and why?
Should governments care about this distribution of
consumption and if so, what tools do they have to alter
it?
Will the economy consume exactly the same goods that it
produces?

Copyright 2017 Pearson Canada Inc. Chapter 1, Slide 12

 Four Key Economic Problems
3. Why Are Resources Sometimes Idle?
An economy is operating inside its production
possibilities boundary if some resources are idle.

Why are some resources idle?

Should governments worry about idle resources?

Is there some reason to believe that occasional idleness is

necessary for a well-functioning economy?

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 Four Key Economic Problems
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.
Points e and f were initially
unattainable. But after
sufficient growth, it
becomes attainable.

Copyright 2017 Pearson Canada Inc. Chapter 1, Slide 14

 Economics and Government Policy
Questions relating to what is produced and how, and what is
consumed and by whom, fall within the realm of microeconomics.

Microeconomics is the study of the causes and consequences of the

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

Questions relating to the idleness of resources and the growth of the

economys productive capacity fall within the realm of
macroeconomics.

Macroeconomics is the study of the determination of economic

aggregates such as total output, employment, and growth.

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 1.2 The Complexity of Modern Economies

The Nature of Market Economies

Self-Organizing
How are scarce resources allocated among competing uses?

Early economists noted that an economy based on free-market

transactions is self-organizing.

When individual consumers and producers act independently to

pursue their own self-interests, the collective outcome is
coordinated.

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 Adam Smith (17231790)
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."

Adam Smith is saying that the massive number of economic

interactions that characterize a modern economy are not all
motivated by benevolence.

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 The Nature of Market Economies

Efficiency
Adam Smith hinted that the spontaneously generated economic
order is relatively efficient.

Loosely speaking, efficiency means that the resources available to

the nation are organized so as to produce the various goods and
services that people want to purchase and to produce them with the
least possible amount of resources.

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 The Nature of Market Economies
Incentives and Self-Interest
Individuals generally pursue their own self-interest.

Individuals respond to incentives.

Sellers usually want to sell more when prices are high and
buyers usually want to buy more when prices are low.

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 The Decision Makers and Their Choices
Three types of decision makers operate in any economy:

Consumers
Producers
Government
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 more or a little less of any given
product.

Copyright 2017 Pearson Canada Inc. Chapter 1, Slide 20

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

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 The Circular Flow of Income and Expenditure
Factor services flow from individuals through factor markets to
firms, who use them to produce goods and services.

The goods and services flow from firms through goods markets to
households.

Money payments flow from firms to individuals through factor

markets.

And when households use this income to buy goods and services,
the money flows from households to firms through goods markets.

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 Production and Trade
Production usually displays two characteristics noted long ago
by Adam Smith: specialization of labour and division of labour.

Specialization is the allocation of different jobs to different people.

It is more efficient than self-sufficiency because:

Individual abilities differcomparative advantage.

Focusing on one activity leads to improvements

learning by doing.

Division of labour is the breaking up of a production process into a

series of specialized tasks.

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 Production and Trade
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.

Money greatly facilitates trade, which facilitates specialization.

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 Production and Trade
Globalization

Globalization is used loosely to mean the increased importance

of international trade.

Two major causes of globalization are:

The rapid reduction in transportation costs

The revolution in information technology

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 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.

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 The Great Debate
A century after Adam Smith, Karl Marx (18181883) 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, 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 for 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.

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 Government in the Modern Mixed Economy
Key government-provided institutions in market economies are
private property and freedom of contract.

Governments also intervene to:

correct market failures

provide public goods

offset the effects of externalities

Markets often work well, but sometimes government policy can

improve the outcome for society as a whole.

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