Chapter 1: Fundamental Economic Concepts PDF

UNIT Fundamental 1 Economic Concepts CHAPTER 1 What Is Economics? CHAPTER 2 Economic Systems and Decision Making CHAPTER 3 Business Organiz...

UNIT Fundamental 1 Economic Concepts CHAPTER 1 What Is Economics? CHAPTER 2 Economic Systems and Decision Making CHAPTER 3 Business Organizations Because of scarcity, societies have to make careful choices about how to use resources such as energy and land. 2 UNIT 1 Jim Wark/Lonely Planet Images Jim Wark/Lonely Planet Images  CHAPTER 1 What Is Economics? Why It Matters Congratulations on being selected to head up the prom committee! Now you must decide on location, music, and refreshments. What factors do you need to consider when making your choices? In groups of four, determine your budget and identify possible locations, music providers, and food. Read Chapter 1 to learn how your prom selections, like all economic decisions, require you to make choices about how to best use limited resources. The BIG Idea Scarcity is the basic economic problem that requires people to make careful choices about how to use limited resources. Because of limited resources, consumers must make choices. Chapter Overview Visit the Economics: Principles and Practices Web site at glencoe.com and click on Chapter 1—Chapter Overviews to preview chapter information. 4 UNIT 1 Masterfile SECTION Scarcity and the Science of 1 Economics GUIDE TO READING Section Preview Academic Vocabulary In this section, you will learn why scarcity is the basic resource (p. 6) comprehensive (p. 10) economic problem that faces every society and why scarcity requires us to make choices. Reading Strategy Content Vocabulary Listing As you read the section, complete a graphic organizer like the one below by listing and describing scarcity (p. 6) capital (p. 8) the three economic choices every society must make. economics (p. 6) capital good (p. 8) need (p. 6) labor (p. 8) want (p. 6) entrepreneur (p. 9) Economic Choices factors of gross domestic product production (p. 8) (GDP) (p. 9) land (p. 8) PEOPLE IN THE NEWS —moneycentral.msn.com Teens in the Red Like a lot of hard-working women, Andrea Alba has moments of financial despair. Between juggling three jobs, paying her bills and trying to get out of debt, she feels overwhelmed. “I just want to pay everything off,” she says. “I wish I didn’t have to struggle so much.” But Alba is no debt-weary baby boomer. She’s only 19 and a couple of years out of high school. Her financial burdens may be heavier than other teens: She pays her own college tuition and also helps pay the rent and utilities at home. But the sinker was signing that first credit card application before she had even graduated from high school. “It was fine at first,” she says. “I used it mainly for gas. Then it just got deeper and deeper.” Within a year and a half of her 18th birthday, Alba was $2,500 in the hole. You may wonder if the study of econom- The study of economics helps us in many Personal Finance Handbook ics is worth your time and effort. As you ways, especially in our roles as individuals, learned in the news story, though, many as members of our communities, and as See pages R10–R13 for more information young people find out about economic global citizens. The good news is that eco- on credit cards. issues the hard way. They discover, how- nomics is not just useful. It can be interest- ever, that a basic understanding of econom- ing as well, so don’t be surprised to find ics can help them make sense of the world that the time you spend on this topic will they live in. be well spent. CHAPTER 1 What Is Economics? 5 Corbis scarcity fundamental economic The Fundamental make a list of all the things we want, it would most likely include more things problem of meeting Economic Problem than we could ever hope to obtain. people’s virtually unlimited wants with MAIN Idea Societies do not have enough scarce resources Scarcity productive resources to satisfy everyone’s wants and needs. The fundamental economic problem fac- economics social science dealing with ing all societies is that of scarcity. Scarcity Economics & You Can you remember a time how people satisfy is the condition that results from society seemingly unlimited when you saved money to buy something expensive? not having enough resources to produce and competing wants Was the item a necessity or something that you with the careful use of simply wanted to own? Read on to find out how this all the things people would like to have. scarce resources relates to the core concepts of economics. As Figure 1.1 shows, scarcity affects almost every decision we make. This is where eco- need basic nomics comes in. Economics is the study of Have you ever noticed that very few requirement for survival, including people are satisfied with the things they how people try to satisfy seemingly unlim- food, clothing, and have? For example, someone without a ited and competing wants through the care- shelter home may want a small one; someone else ful use of relatively scarce resources. with a small home may want a larger one; want something we would like to have but someone with a large home may want a Needs and Wants is not necessary for mansion. Whether they are rich or poor, Economists often talk about people’s survival most people seem to want more than they needs and wants. A need is a basic require- already have. In fact, if each of us were to ment for survival, such as food, clothing, and shelter. A want is simply something we would like to have but is not necessary for Figure 1.1 Scarcity survival. Food, for example, is needed for survival. Because many foods will satisfy the need for nourishment, the range of things represented by the term want is much broader than that represented by the term need. Unlimited Limited wants resources TINSTAAFL Because resources are limited, every- thing we do has a cost—even when it seems as if we are getting something “for free.” For example, do you really get a free meal SCARCITY when you use a “buy one, get one free” coupon? The business that gives it away still has to pay for the resources that went Choices into the meal, so it usually tries to recover these costs by charging more for its other products. In the end, you may actually be the one who pays for the “free” lunch! Realistically, most things in life are not WHAT HOW FOR WHOM free, because someone has to pay for pro- to produce to produce to produce ducing them in the first place. Economists use the term TINSTAAFL to describe this concept. In short, it means There Is No Such Scarcity is the fundamental economic problem that forces consumers Thing As A Free Lunch. and producers to use resources wisely. Reading Check Contrasting What is the difference Economic Analysis Why is scarcity a universal problem? between a need and a want? Three Basic Questions MAIN Idea Scarcity forces every society to answer the basic questions of WHAT, HOW, and FOR WHOM to produce. Economics & You When you write a report, you usually answer the who, what, when, where, and why questions. Read on to learn about the three basic questions in economics. Because we live in a world of relatively scarce resources, we have to make careful economic choices about the way we use these resources. Figure 1.1 presents three basic questions we need to answer as we make these choices. WHAT to Produce The first question is WHAT to produce. For example, should a society direct most of its resources to the production of military equipment or to other items such as food, clothing, or housing? Suppose the decision is to produce housing. Should the limited resources be used to build low-income, middle-income, or upper-income housing? A society cannot have everything its people want, so it must decide WHAT to produce. WHAT to Produce Societies need to decide whether to include parks in housing areas or to produce more housing. How do the three questions help HOW to Produce societies make choices about scarce resources? A second question is HOW to produce. Should factory owners use automated pro- duction methods that require more machines example, should it be the kind of housing and fewer workers, or should they use fewer that is wanted by low-income workers, machines and more workers? If a commu- middle-income professional people, or nity has many unemployed people, using the very rich? If there are not enough more workers might be better. On the other houses for everyone, a society has to hand, in countries where machinery is make a choice about who will receive the widely available, automation can often existing supply. lower production costs. Lower costs make These questions concerning WHAT, manufactured items less expensive and, HOW, and FOR WHOM to produce are therefore, available to more people. never easy for any society to answer. Nevertheless, they must be answered as FOR WHOM to Produce long as there are not enough resources to The third question is FOR WHOM to satisfy people’s seemingly unlimited wants produce. After a society decides WHAT and needs. and HOW to produce, it must decide who Reading Check Analyzing Why are societies will receive the things produced. If a faced with the three basic questions of WHAT, HOW, society decides to produce housing, for and FOR WHOM? CHAPTER 1 What Is Economics? 7 Corbis  factors of production The Factors of resources are available at any given time, economists tend to think of land as being productive resources Production fixed, or in limited supply. that make up the four categories of land, MAIN Idea Four factors of production—land, capital, labor, and entrepreneurs capital, labor, and entrepreneurs—must be present Capital to produce goods and services. Another factor of production is capital, land natural sometimes called capital goods—the tools, Economics & You When you were younger, did resources or other equipment, machinery, and factories used in “gifts of nature” not you ever sell something or have a paper route to created by human make money? Read on to find out how this relates to the production of goods and services. Capital effort the factors of production. is unique because it is the result of produc- tion. A bulldozer, for example, is a capital capital or capital People cannot satisfy all their wants and good used in construction. When it was built goods tools, equipment, and needs because productive resources are in a factory, it was the result of production factories used in the scarce. The factors of production, or involving other capital goods. The computers production of goods resources required to produce the things in your school that are used to produce the and services we would like to have, are land, capital, service of education also are capital goods. labor people with all labor, and entrepreneurs. As shown in their efforts, abilities Figure 1.2, all four are required to produce Labor and skills goods and services. A third factor of production is labor— people with all their efforts, abilities, and Land skills. This category includes all people except In economics, land refers to the “gifts of a unique group of individuals called entre- nature,” or natural resources not created by preneurs, whom we single out because of people. “Land” includes deserts, fertile their special role in the economy. Historically, fields, forests, mineral deposits, livestock, factors such as birthrates, immigration, fam- sunshine, and the climate necessary to grow ine, war, and disease have had a dramatic crops. Because a finite amount of natural impact on the quantity and quality of labor. Figure 1.2 The Factors of Production Land Capital Labor Entrepreneurs Land includes the Capital includes the Labor includes people Entrepreneurs are “gifts of nature,” or natural tools, equipment, and with all their efforts individuals who start a resources not created by factories used in and abilities. new business or bring human effort. production. a product to market. The four factors of production are necessary for production to take place. Economic Analysis What four factors of production are necessary to bring clothing to consumers? 8 UNIT 1 Fundamental Economic Concepts (l) Corbis, (cl) Neil Beer/Getty Images, (cr) Sie Productions/Zefa/Corbis, (r) Howard Grey/Getty Images  The Global Economy &YOU Global Entrepreneurs Drive the Economy Jordan 18.3% Every time you get paid for baby-sitting, mowing the lawn, or being the deejay at an event, you have joined Brazil 13.5% the “force”—the global entrepreneurial force, that is. A United States 11.3% vast majority of the more than 20 million businesses in Canada 8.9% the United States are owned by entrepreneurs. Most Israel 6.6% either work alone or have a few employees. United Kingdom 6.3% Until recently, the United States led in the percentage Singapore 5.7% of adult entrepreneurs, with an estimated 11.3 percent South Africa 5.4% of Americans starting a new business each year. Today, Germany 4.5% the small country of Jordan has just over half a million Japan 1.5% entrepreneurs, but it can boast the highest percentage of individuals attempting to go it alone. That’s nearly one in every five adults. The bar graph here illustrates Source: 2004 Global Entrepeneurship Monitor (GEM) www.gemconsortium.org the percentage of the adult population in select countries who are starting new businesses. Entrepreneurs The Scope of Economics entrepreneur risk-taking individual in Some people are singled out because search of profits they are the innovators responsible for MAIN Idea Economics analyzes how societies much of the change in our economy. Such satisfy wants through careful use of relatively gross domestic an individual is an entrepreneur, a risk- scarce resources. product (GDP) dollar value of all final taker in search of profits who does some- Economics & You So far, you have learned goods, services, and thing new with existing resources. about the basics of economics. Read on to learn how structures produced Entrepreneurs are often thought of as being economists help us make sense of this information. within a country’s the driving force in an economy because borders during a one-year period they are the people who start new busi- Economics is the study of human efforts nesses or bring new products to market. to satisfy seemingly unlimited and compet- ing wants through the careful use of rela- Skills Handbook tively scarce resources. Economics is also a See page R50 to Production social science because it deals with the learn about Using Everything we make requires the four behavior of people as they deal with this Bar Graphs. factors of production. The desks and lab basic issue. The four key elements to this equipment used in schools are capital study are description, analysis, explana- goods. Teachers and other employees pro- tion, and prediction. vide the labor. Land includes the property where the school is located as well as the Description iron ore and timber used to make the build- One part of economics describes eco- ing. Finally, entrepreneurs are needed to nomic activity. For example, we often hear organize the other three factors and make about gross domestic product (GDP)—the sure that everything gets done. dollar value of all final goods, services, and Reading Check Interpreting What would happen structures produced within a country’s if one of the factors of production was missing? borders in a 12-month period. GDP is the CHAPTER 1 What Is Economics? 9  most comprehensive measure of a coun- they need to communicate this knowledge try’s total output and a key measure of a to others. If we all have a common under- nation’s economic health. Economics also standing of the way our economy works, describes jobs, prices, trade, taxes, and gov- some economic problems will be easier to ernment spending. address or even fix in the future. When it Description allows us to know what the comes to GDP, you will soon discover that world looks like. However, description is economists spend much of their time only part of the picture, because it leaves explaining why the measure is, or is not, many important “why” and “how” ques- performing in the manner that is expected. tions unanswered. Prediction Analysis Finally, economics is concerned with Economics analyzes the economic activ- prediction. For example, we may want to ity that it describes. Why, for example, are know whether our incomes will rise or fall the prices of some items higher than oth- in the near future. Because economics is the ers? Why do some people earn higher study of both what is happening and what incomes than others? How do taxes affect tends to happen, it can help predict what people’s desire to work and save? may happen in the future, including the Analysis is important because it helps us most likely effects of different actions. discover why things work and how things The study of economics helps us become happen. This, in turn, will help us deal with more informed citizens and better decision problems that we would like to solve. makers. Because of this, it is important to realize that good economic choices are the Explanation responsibility of all citizens in a free and Economics also involves explanation. democratic society. After economists analyze a problem and Reading Check Explaining Why is economics understand why and how things work, considered to be a social science? SECTION 1 Review Vocabulary Critical Thinking 1. Explain the significance of scarcity, economics, need, 4. The BIG Idea How can studying economics help us want, factors of production, land, capital, capital good, make better choices about how to use scarce resources? labor, entrepreneur, and Gross Domestic Product (GDP). 5. Synthesizing Information Do you pay to drink from the water fountains at school? Explain why the water is not Main Ideas really free by stating who actually pays for it. 2. Identifying What three basic questions must every 6. Analyzing Visuals Look at Figure 1.2. Identify and society answer, and why? categorize the factors of production for a business you 3. Organizing Use a graphic organizer similar to the one know, such as your place of employment. What would below to identify and describe the factors of production. happen if one of these factors was no longer available? Factor Description Applying Economics Land 7. Scarcity How does scarcity affect your life? Provide several examples of items you had to do without because of limited resources, and explain how you adjusted to this situation. 10 UNIT 1 Fundamental Economic Concepts  NEWSCLIP E ntrepreneurs are willing to take risks because they hope to reap great rewards. These rewards may come more quickly for some than for others. Kevin Plank, founder and CEO of Under Armour Inc., proves that it takes sweat to be a successful entrepreneur. Under Armour—No Sweat Eleven years ago, Kevin A. Plank was a walk-on football player at the University of Maryland who relished throwing his body at hulking opponents. But he hated how the cotton T-shirts under his uni- form got sopping wet with sweat or rain. By then, cycling outfits and football undershorts were made with moisture-wicking synthetic fabrics. Plank, a starter during kickoffs and punts, wondered why not gridiron T-shirts, too? He tore the content label off a pair of his wick-away shorts, bought the same material from a fabric store, and gave a tailor $460 to sew seven shirts. “I set out to build a better foot- ball undershirt,” he says. Plank’s teammates loved the tees. So he drove to Operating at first out of his grandmother’s New York’s garment district, had hundreds more Georgetown house, Plank spent four years tire- samples made, and dubbed his invention “Under lessly pitching his product to college and NFL Armour.” Now, at 33, Plank is the multimillionaire teams. “We convinced these big tough football head of an athletic apparel powerhouse.... players to start wearing tight-fitting synthetic Yet it didn’t happen as fast as Plank originally shirts, which was completely new and different,” expected. “At 23, I was probably the smartest guy he says.... in the world,” he jokes.... “But I learned early on The pros’ acceptance brings Under Armour an [that] this is not about one blast of exposure or one authenticity that advertising alone can’t create.... person wearing the product.” That cachet also gives Plank license to charge $40 for a short-sleeve T-shirt. U NDER A RMOUR R EVENUE —Reprinted from BusinessWeek 300 Revenue (in millions) 250 200 150 Examining the Newsclip 100 50 1. Identifying How did Kevin Plank get his idea for a 0 new product? 2002 2003 2004 2005 Year 2. Analyzing How does Plank exemplify the characteristics of an entrepreneur? Sources: Businessweek.com, www.123jump.com CHAPTER 1 What Is Economics? 11 The McGraw-Hill Companies  SECTION 2 Basic Economic Concepts GUIDE TO READING Section Preview Academic Vocabulary In this section, you will learn about some key transferable (p. 13) mechanism (p. 15) economic terms and concepts. accumulation (p. 14) Content Vocabulary Reading Strategy good (p. 13) factor market (p. 15) Describing As you read the section, describe the consumer good (p. 13) product market (p. 15) factors that lead to economic growth. durable good (p. 13) economic growth (p. 16) nondurable good (p. 13) productivity (p. 16) service (p. 13) human capital (p. 16) value (p. 14) division of labor (p. 17) Economic Growth paradox of value (p. 14) specialization (p. 17) utility (p. 14) economic wealth (p. 14) interdependence (p. 17) market (p. 15) — Asbury Park Press and the PRODUCTS IN THE NEWS New York Times Comic Books a Big Business America may have started the worldwide comics craze when U.S. soldiers scattered them around in foreign countries during World War II. Today, they are a global phenomenon—the most widely read literature in the world. According to one published report, 40 percent of all printed material in Japan consists of comics. In the United States, 375 new comic books are sold every month. The comic-book industry as a whole has had a healthy year. Industry analysts from the Comic Buyer’s Guide reported new comics sales of more than $149 million for the first half of 2005, up 6 percent from the period a year earlier. Marvel Entertainment, a publicly traded company that filed for bankruptcy protection in December 1996 and reorganized in July 1998, has recovered strongly in recent years, largely on the strength of its success with movies based on X-Men and Spider-Man. When you hear the word economics, you Like other social sciences, economics has probably think of “big business”—large cor- its own vocabulary and uses terms such as porations that run banks and petroleum recession, commodity, or utility. To under- refineries, or companies that make automo- stand economics, a review of key terms is biles, computers and, yes, even comic books. necessary. Fortunately, most economic terms Economics does include big business, but it are widely used, and you will already be also includes much more. familiar with many of them. 12 UNIT 1 Fundamental Economic Concepts The McGraw-Hill Companies  Goods, Services, and Any good that lasts three years or more good tangible economic product that when used on a regular basis is called a Consumers durable good. Durable goods include both is useful, relatively scarce, and capital goods, such as robot welders, and transferable to others MAIN Idea Economic products are goods or consumer goods, such as automobiles. A services that are useful, relatively scarce, and consumer good transferable. nondurable good is an item that lasts for good intended for final fewer than three years when used on a regu- use by consumers Economics & You Every time you buy lar basis. Food, writing paper, and most cloth- rather than businesses something in a store, you act as a consumer. Read ing items are examples of nondurable goods. on to learn more about this and other basic economic durable good a vocabulary. good that lasts for at Services least three years when Economics is concerned with economic The other type of economic product is a used regularly products—goods and services that are use- service, or work that is performed for nondurable ful, relatively scarce, and transferable to someone. Services include haircuts, home good a good that others. Economic products help us satisfy repairs, and forms of entertainment such as wears out or lasts for our wants and needs. Because they are both concerts. They also include the work that fewer than three years doctors, lawyers, and teachers perform. when used regularly scarce and useful, they command a price. The difference between a good and a ser- service work or vice is that a good is tangible, or something labor performed for Goods someone that can be touched, while a service is not. There are different types of economic products. The first one is a good—a useful, tangible item, such as a book, car, or com- Consumers pact disc player, that satisfies a want. When Consumers are the people who use manufactured goods are used to produce goods and services to satisfy their wants other goods and services, they are called and needs. As consumers, people indulge capital goods. An example of a capital good in consumption, the process of using up would be a robot welder in a factory, an goods and services in order to satisfy wants Digital Vision/PunchStock oven in a bakery, or a computer in a high and needs. school. Goods intended for final use by Reading Check Interpreting How are goods, individuals are consumer goods. services, and consumers related? Consumer Goods These students are using computers in their school computer lab. Would you consider computers as durable goods or nondurable goods, and why? 13 value monetary worth of a good or Value, Utility, and Wealth from a home computer; another may get very little. One person may enjoy a rock service as determined MAIN Idea The value of a good or service concert; another may not. by the market depends on its scarcity and utility. paradox of value Economics & You Has anyone ever thought apparent contradiction Value between the high you paid too much for something? Read on to learn For something to have monetary value, monetary value of a how the value of an item is determined. economists decided, it must be scarce and nonessential item and the low value of an have utility. This is the solution to the para- In economics, value refers to a worth essential item dox of value. Diamonds are scarce and that can be expressed in dollars and cents. have utility, thus they possess a value that utility ability or Why, then, does something have value, and can be stated in monetary terms. Water has capacity of a good or why are some things more valuable than service to be useful utility but is not scarce enough in most others? To answer these questions, it helps and give satisfaction to places to give it much value. Therefore, to review a problem Adam Smith, a Scottish someone water is less expensive, or has less mone- social philosopher, faced back in 1776. tary value, than diamonds. wealth sum of tangible economic The emphasis on monetary value is goods that are scarce, The Paradox of Value important to economists. Unlike moral or useful, and Adam Smith was one of the first people social value, which is the topic of other transferable from one to describe how markets work. He observed social sciences, the value of something in person to another that some necessities, such as water, had a terms of dollars and cents is a concept that very low monetary value. On the other everyone can easily understand. hand, some nonnecessities, such as dia- monds, had a very high value. Smith called this contradiction the paradox of value. Wealth Economists knew that scarcity was neces- In an economic sense, the accumulation sary for something to have value. Still, of products that are tangible, scarce, useful, scarcity by itself could not fully explain and transferable from one person to another how value is determined. is wealth. A nation’s wealth is comprised of all tangible items—including natural resources, factories, stores, houses, motels, Utility theaters, furniture, clothing, books, high- It turned out that for something to have ways, video games, and even basketballs— value, it must also have utility, or the that can be exchanged. capacity to be useful and provide satisfac- While goods are counted as wealth, ser- tion. Utility is not something that is fixed vices are not, because they are intangible. or even measurable, like weight or height. However, this does not mean that services Instead, the utility of a good or service may are not useful or valuable. Indeed, when vary from one person to the next. One Adam Smith published his famous book person may get a great deal of satisfaction The Wealth of Nations in 1776, he was refer- ring specifically to the abilities and skills of a nation’s people as the source of its wealth. For Smith, if a country’s material posses- sions were taken away, its people, through Value Economists aren’t the only ones obsessed with value. Do a their efforts and skills, could restore these simple Google search of “value,” and you’ll get nearly 2 million hits. possessions. On the other hand, if a coun- You’ll get approximately a quarter million if you search for “measure of try’s people were taken away, its wealth value,” and nearly 140,000 if you search for “measuring value.” Maybe would deteriorate. that’s why economists simply define value as “a worth that can be expressed in dollars and cents.” Reading Check Summarizing How are value and utility related? 14 UNIT 1 Fundamental Economic Concepts The Circular Flow of This is where entrepreneurs hire labor for market meeting place or mechanism wages and salaries, acquire land in return Economic Activity for rent, and borrow money. The concept of that allows buyers and sellers to come a factor market is a simplified but realistic together MAIN Idea The economic activity in markets version of the real world. For example, you connects individuals and businesses. factor market participate in the factor market when you Economics & You When you receive a paycheck, market where the work and sell your labor to an employer. factors of production do you understand how you fit in the larger economy? are bought and sold Read on to learn about the flow of economic activity. Product Markets product market The wealth that an economy generates is After individuals receive their income market where goods made possible by the circular flow of eco- from the resources they sell in a factor mar- and services are ket, they spend it in product markets. bought and sold nomic activity. The key feature of this cir- cular flow is the market, a location or other These are markets where producers sell mechanism that allows buyers and sellers their goods and services. Thus, the wages to exchange a specific product. Markets and salaries that individuals receive from may be local, national, or global—and they businesses in the factor markets returns to can even exist in cyberspace. businesses in the product markets. Businesses then use this money to produce more goods and services, and the cycle of Factor Markets As shown in Figure 1.3, individuals earn economic activity repeats itself. their incomes in factor markets, where the Reading Check Explaining What roles do factor factors of production are bought and sold. markets and product markets play in the economy? Figure 1.3 The Circular Flow of Economic Activity See StudentWorks™ Plus or glencoe.com. Consumer Business Product Markets spending income $ $ Goods Goods Services Services Businesses Individuals Land Buy Capital productive Labor resources Entrepreneurs $ $ Income from Payments for Factor Markets resources resources The circular flow diagram shows the high degree of economic interdependence in our econ- omy. In the diagram, the factors of production and the products made from them flow in one direction. The money consumers spend on goods and services flows in the opposite direction. Economic Analysis As a consumer, what role do you play in the circular flow of economic activity? CHAPTER 1 What Is Economics? 15  economic growth Productivity and Productivity goes up whenever more can be produced with the same amount increase in a nation’s Economic Growth of resources. For example, if a company total output of goods and services over time produced 5,000 pencils in an hour, and it MAIN Idea A nation’s economic growth is due produced 5,100 in the next hour with productivity to several factors. the same amount of labor and capital, measure of the amount Economics & You Have you decided yet what of output produced productivity went up. Productivity is often you will do after graduating from high school? Read discussed in terms of labor, but it applies to with a given amount of productive factors on to learn how investing in more education now can all factors of production. give you a higher lifetime income. human capital sum of people’s skills, Economic growth occurs when a nation’s Investing in Human Capital abilities, health, total output of goods and services increases A major contribution to productivity knowledge and motivation over time. This means that the circular comes from investments in human capital, flow becomes larger, with more factors of the sum of people’s skills, abilities, health, production, goods, and services flowing in knowledge, and motivation. Government Personal Finance Handbook one direction and more payments in the can invest in human capital by providing See pages R16–R19 opposite direction. Productivity is the most education and health care. Businesses can for more information important factor contributing to economic invest in training and other programs that on education. growth. improve the skills of their workers. Individuals can invest in their own educa- Productivity tion by completing high school, going to Everyone in a society benefits when scarce technical school, or attending college. resources are used efficiently. This is described Figure 1.4 shows that investments in by the term productivity, a measure of the education can have substantial payoffs. amount of goods and services produced According to the table, high school graduates with a given amount of resources in a spe- earn substantially more than nongraduates, cific period of time. and college graduates make even more than Figure 1.4 Effect of Education on Income Average income Education Males Females Less than 9th grade $19,746 $11,492 9th to 12th grade (no diploma) $23,747 $13,343 High school graduate or equivalent $34,700 $20,325 Some college, no degree $43,531 $25,111 Associate degree $45,800 $29,031 Bachelor’s degree $65,523 $37,373 Master’s degree $83,189 $48,945 Education is one way to invest in human capital. Professional degree $126,728 $63,322 Economic Analysis How does this type of Doctorate degree $103,939 $67,676 investment pay off for both employers and their employees? Source: U.S. Department of Commerce, Bureau of the Census, 2006 16 UNIT 1 Fundamental Economic Concepts Digital Vision/Getty Images high school graduates. Educational invest- One example of the advantages offered by division of labor ments require that we make a sacrifice today the division of labor and specialization is division of work into a number of separate so we can have a better life in the future, and Henry Ford’s use of the assembly line in auto- tasks to be performed few investments generate higher returns. mobile manufacturing. Having each worker by different workers add one part to the car, rather than a few workers assembling the entire vehicle, cut the specialization Division of Labor and assignment of tasks to assembly time of a car from a day and a half the workers, factories, Specialization to just over 90 minutes—and reduced the regions, or nations that Division of labor and specialization can price of a new car by more than 50 percent. can perform them improve productivity. Division of labor is more efficiently a way of organizing work so that each individual worker completes a separate Economic Interdependence economic The U.S. economy has a remarkable interdependence part of the work. In most cases, a worker mutual dependency of who performs a few tasks many times a degree of economic interdependence. This one person’s, firm’s, or day is likely to be more proficient than a means that we rely on others, and others region’s economic rely on us, to provide most of the goods activities on another’s worker who performs hundreds of differ- ent tasks in the same period. and services we consume. As a result, Specialization takes place when factors events in one part of the world often have of production perform only tasks they can a dramatic impact elsewhere. do better or more efficiently than others. This does not mean that interdependence The division of labor makes specialization is necessarily bad. The gains in productivity possible. For example, the assembly of a and income that result from specialization product may be broken down into a number almost always offset the costs associated with the loss of self-sufficiency. Skills Handbook of separate tasks (the division of labor). See page R40 to Then each worker can perform the specific Reading Check Analyzing What role does spe- learn about Analyzing task he or she does best (specialization). cialization play in the productivity of an economy? Information. SECTION 2 Review Vocabulary Critical Thinking 1. Explain the significance of good, consumer good, durable 5. The BIG Idea How is value related to scarcity and utility? good, nondurable good, service, value, paradox of value, 6. Drawing Conclusions Why is investing in human utility, wealth, market, factor market, product market, capital beneficial? economic growth, productivity, human capital, division of 7. Analyzing Visuals Look at Figure 1.3. How can individu- labor, specialization, and economic interdependence. als increase the flow of circular activity? What effect would Main Ideas this increase have on the other parts of the economy? 2. Explaining How do goods and services differ? 8. Inferring How might major events such as labor strikes 3. Organizing Use a graphic organizer similar to the one affect you and your community? Select a possible event below to describe the different transactions that take and write a brief paragraph about the potential effects. place in product markets. Applying Economics 9. Specialization Provide at least three examples each of Product Market specialized workers and specialized capital that are used in your school to provide the service of education. How 4. Describing How is economic growth related to would productivity change if they were not available to productivity? your school? CHAPTER 1 What Is Economics? 17  ECONOMIST Profiles in Economics Adam Smith (1723–1790) introduced the idea that the division of labor led to the great prosperity of Britain defined the wealth of a nation as the sum of the goods produced by its people Division of Labor Adam Smith did not set out to become an economist. In fact, he focused on philosophy when, at age 14, he earned a scholarship to attend Glasgow University. Travels throughout Europe and talks with notable thinkers helped Smith turn his attention to economics. In 1776 he published his most influential book, An Inquiry into the Nature and Causes of the Wealth of Nations, in which he observed that labor becomes more productive as each worker becomes more skilled at a single job. This made him the first to introduce and recognize the importance of the “division of labor.” Invisible Hand Smith’s most important contribution was the notion that competition and individual self-interest would somehow act as an “invisible hand” to guide resources to their most productive uses. He suggested that the role of government should be limited to enforcing contracts, granting patents and copyrights to encourage inventions and new ideas, and providing public works, such as roads and bridges. Wealth of Nations Smith also put forth the new idea that the “wealth of nations” should be defined as the sum of the goods produced by labor, not the personal financial wealth of those who owned them. Competition in markets, along with the division of labor and the invisible hand, would lead to increased productivity and output. Smith’s doctrine of laissez-faire (French for “let it be”) marked the beginning of modern economic thought, and it still serves as the basis of our free market economy. Adam Smith studied to become a philosopher. Yet Examining the Profile today he is best known for his support of a free market 1. Summarizing Ideas What ideas did Adam Smith contribute to economy. economic thought? 2. Synthesizing Explain how Smith’s ideas are evident in the workings of the American economy. 18 UNIT 1 Fundamental Economic Concepts Bettmann/Corbis SECTION Economic Choices and 3 Decision Making GUIDE TO READING Section Preview Academic Vocabulary In this section, you will learn that you face trade-offs alternative (p. 20) assumption (p. 23) and opportunity costs whenever you make an economic decision. Reading Strategy Identifying As you read this section, complete a Content Vocabulary graphic organizer similar to the one below by identi- fying the ways in which you can make economic trade-off (p. 20) choices and what these strategies allow you to learn. opportunity cost (p. 20) production possibilities frontier (p. 21) Problems Strategy Purpose economic model (p. 23) Trade-offs Decision-making cost-benefit analysis (p. 24) grid free enterprise economy (p. 24) standard of living (p. 24) PEOPLE IN THE NEWS —BusinessWeek The Grease Pits of Academia Students at Belmont Abbey College may have a head start in the race for post-graduation jobs—at least jobs that go VROOM! Starting this fall, the 1,000-student school outside Charlotte, N.C., will offer the nation’s first four-year bachelor’s degree in Motorsports Management. Students will study such topics as sports marketing and racing management. “The program will be NASCAR-focused but will have a broad application to all portions of the motor sports industry,” says Philip Bayster, head of the school’s business department. Charlotte, the NASCAR epicenter, is home to about 250 racing teams and 25 specialized media and marketing firms. Pay is anything but the pits. Annual salaries for the region’s 14,000 motor sports jobs, not including drivers, average $72,000. What will you do after graduating from greater than the income you will earn with high school? Get a job? Go to college? If just a high school diploma. you choose to work, you will benefit by Because resources are scarce, everyone receiving a paycheck right away. If you has to make choices. To become a good decide to earn a college degree—like the decision maker, you need to know how to NASCAR-focused degree at Belmont Abbey identify the problem and then analyze your College—you may give up four years of alternatives. Finally, you have to make your earning potential. The benefit, however, is choice in a way that carefully considers the that your income after college will be costs and benefits of each possibility. CHAPTER 1 What Is Economics? 19 Icon SMI/Corbis trade-off alternative that is available Trade-Offs and criteria by which to judge them. Then he evaluates each alternative with a “yes” or whenever a choice is Opportunity Cost “no.” In the end, Jesse chooses the jersey to be made because it satisfies more of his criteria than MAIN Idea Economic choices involve opportunity cost any other alternative. cost of the next-best trade-offs and the careful evaluation of opportunity costs. Using a decision-making grid is one way alternative use of money, time, or to analyze an economic problem. It forces you Economics & You When you go shopping, to consider a number of alternatives and the resources when making a choice you usually have to make choices, because you criteria you’ll use to evaluate the alternatives. cannot afford to buy everything you want. Read Finally, it makes you evaluate each alterna- on to learn about the terms economists apply to tive based on the criteria you selected. these decisions. There are alternatives and costs to every- Opportunity Cost thing we do. In a world where “there is no People often think of cost in terms of such thing as a free lunch,” it pays to exam- dollars and cents. To an economist, how- ine these concepts closely. ever, cost means more than the price tag on a good or service. Instead, economists think Trade-Offs broadly in terms of opportunity cost, the Every decision we make has its trade-offs, cost of the next-best alternative. When Jesse or alternative choices. One way to help us decided to purchase the jersey, his oppor- make decisions is to construct models such as tunity cost was the MP3 player—the next- the grid in Figure 1.5. This grid shows how best choice he gave up. In contrast, Jesse decides to spend a $100 gift. trade-offs are all of the other alternatives Jesse likes several alternatives: a video that he could have chosen. game, concert tickets, an MP3 player, and a Even time has an opportunity cost, replica NFL jersey. At the same time, he although you cannot always put a mone- realizes that each item has advantages and tary value on it. The opportunity cost of disadvantages. Some of the items can be reading this economics book, for example, used more than once, and some might the history paper or math homework that require his parents’ consent. Some even you could not do at the same time. have additional costs such as batteries. To help with his decision, Jesse can draw Reading Check Summarizing How are trade-offs a grid that lists his alternatives and several and opportunity cost related? Figure 1.5 Jesse’s Decision-Making Grid Criteria Alternatives Costs $100 Will parents Future expense Can use Durable? or less? approve? unnecessary? anytime? Video game yes yes no yes no Concert tickets yes no yes no no MP3 player yes yes yes no yes NFL jersey yes yes yes yes yes A decision-making grid lists alternatives and criteria to help evaluate choices. Economic Analysis What do economists mean when they talk about costs? Production Possibilities resources available to produce the extra production possibilities clothing. Therefore, point d cannot be frontier diagram MAIN Idea Economies face trade-offs when reached, nor can any other point outside representing the deciding what goods and services to produce. the curve. This is why the figure is called a maximum production possibilities “frontier”—to indi- combinations of goods Economics & You You just learned that you and/or services an face trade-offs and opportunity costs when making cate the maximum combinations of goods economy can produce choices. Read on to learn how opportunity cost and services that can be produced. when all productive applies to countries as well as individuals. resources are fully employed The Cost of Idle Resources To illustrate opportunity cost, economists If some resources were not fully use the production possibilities frontier, a employed, then it would be impossible for diagram representing various combinations Alpha to reach its maximum potential pro- of goods and services an economy can pro- duction. Suppose that Alpha was produc- duce when all its resources are in use. In the ing at point b when workers in the clothing example in Figure 1.6, a mythical country industry went on strike. Clothing produc- called Alpha produces two goods—cars tion would fall, causing total output to and clothing. change to point e. The opportunity cost of the unemployed resources would be the Identifying Possible Alternatives 100 units of lost clothing production. Even though Alpha produces only two Production at point e could also be the goods, the country has a number of result of other idle resources, such as facto- alternatives available to it. For example, it ries or land that are available but not being could choose to use all of its resources to used. As long as some resources are idle, produce 70 units of cars and 300 units of the country cannot produce on its fron- clothing, which is shown as point a in tier—which is another way of saying that it Figure 1.6. Or it could shift some of its cannot reach its full production potential. resources out of car production and into clothing, thereby moving to point b. Alpha could even choose to produce at point c, Figure 1.6 Production Possibilities which represents all clothing and no cars, Frontier or at point e, which is inside the frontier. Alpha has many alternatives available to T HE P RODUCTION P OSSIBILITIES F RONTIER it, which is why the figure is called a pro- duction “possibilities” frontier. Eventually, a d though, Alpha will have to settle on a sin- 70 gle combination such as point a, b, or any other point on or inside the curve, because e b Cars 40 its resources are limited. Fully Employed Resources c All points on the curve such as a, b, and c 0 300 400 represent maximum combinations of output Clothing that are possible if all resources are fully employed. To illustrate, suppose that Alpha is producing at point a, and the people The production possibilities frontier shows the different combinations would like to move to point d, which rep- of two products that can be produced if all resources are fully resents the same amount of cars, but more employed. clothing. As long as all resources are fully Economic Analysis Why can production take place on or employed at point a, there are no extra inside the frontier? CHAPTER 1 What Is Economics? 21  Opportunity Cost Figure 1.7 Opportunity Cost Suppose that Alpha was producing at point a and that it wanted to move to point b. This is clearly possible as long O PPORTUNITY C OST as point b is not outside the production possibilities frontier. However, Alpha will have to give something up in return. As a 70 shown in Figure 1.7, the opportunity cost of producing the 100 additional units of b clothing is the 30 units of cars given up. Cars 40 As you can see, opportunity cost applies to almost all activities, and it is not always measured in terms of dollars c and cents. For example, you need to bal- 0 300 400 ance the time you spend doing home- Clothing work and the time you spend with your friends. If you decide to spend extra When the production for one item increases, the production of other hours on your homework, the opportu- items decreases. In the example shown, the opportunity cost for pro- nity cost of this action is the time that you ducing and additional 10 units of clothing is the 30 cars given up. cannot spend with your friends. You nor- Economic Analysis If Alpha decided to produce units of mally have a number of trade-offs avail- clothing at point c, what would be the opportunity cost in cars? able whenever you make a decision, and the opportunity cost of the choice you make is the value of the next best alterna- tive that you give up. Figure 1.8 Economic Growth Economic Growth The production possibilities frontier represents potential output at a given point in time. Eventually, however, E CONOMIC G ROWTH changes may cause the production possi- bilities frontier to expand. The popula- tion may grow, the stock of capital may a d expand, technology may improve, or pro- ductivity may increase. If any of these Cars b changes occur, then Alpha will be able to produce more in the future. The effect of economic growth is shown c in Figure 1.8. Economic growth, made pos- sible by having more resources or Clothing increased productivity, causes the pro- duction possibilities frontier to move outward. Economic growth will eventu- The only way to expand the production possibilities frontier is to attain ally allow Alpha to produce at point d, economic growth. which it could not do earlier. Economic Analysis What factors make it possible for the Reading Check Synthesizing How can the economy to grow? production possibilities frontier be used to illustrate economic growth? Thinking Like an for example, we assumed that only two economic model simplified version of goods could be produced. This made the Economist model easier to illustrate and still allowed a complex concept or behavior expressed us to discuss the concepts of trade-offs and in the form of an MAIN Idea Economists use a strategy called opportunity costs. equation, graph, cost-benefit analysis to evaluate choices. or illustration It is also important to keep in mind that Economics & You When you work a models can be revised to make them better. complicated math problem, do you ever look at a If an economic model helps us to make a simplified example to better understand the process? prediction that turns out to be right, the Read on to learn how economists use models to model can be used again. If the prediction understand complex economic activities. is wrong, the model might be changed to Because economists study how people make better predictions the next time. satisfy seemingly unlimited and competing wants through the careful use of scarce resources, they are concerned with strate- gies that will help people make the best CAREERS choices. Two strategies are building models and preparing a cost-benefit analysis. Economist The Work Build Simple Models * Collect and analyze data, One of the most important strategies is to observe economic trends build economic models. An economic model is a simplified equation, graph, or figure * Advise businesses and other organizations on such topics as showing how something works. Simple energy costs, inflation, imports, models can often reduce complex situa- and employment levels tions to their most basic elements. To illus- trate, the production possibility frontiers in * Study economic conditions in the United States or in other this section and the circular flow diagram countries to estimate the economic effects of new legislation or in Figure 1.3 on page 15 are examples of public policies how complex economic activity can be explained by a simple model. Qualifications Another basic model is the production * Strong computer and quantitative skills possibilities frontier that is illustrated in Figure 1.6 on page 21. Realistically, of * Ability to conduct complex research, write reports, and prepare statistical data course, economies are able to produce more than two goods or services, but the con- * Bachelor’s degree, with a focus on economics and statistics, cepts of trade-offs and opportunity costs accounting, or calculus are easier to illustrate if only two products * Master’s degree required for most economists in the private are examined. As a result, simple models sector such as these are sometimes all that econo- mists need to analyze or describe an actual Earnings situation. * Median annual earnings: $72,780 It is important to realize that models are based on assumptions, or things we think Job Growth Outlook are true. In general, the quality of a model is no better than the assumptions on which * Slower than average it is based, but a model with simple assump- Source: Occupational Outlook Handbook, 2006–2007 Edition tions is usually easier to understand. In the case of the production possibilities frontier, CHAPTER 1 What Is Economics? 23 Image Source/Getty Images  Cost-Benefit Analysis Before The Road Ahead