1.3 End-of-Chapter Material
Conclusion
One basic idea lies at the center of economics: People make purposeful choices with scarce resources, and interact with other people when they make these choices.
This introductory chapter illustrates this idea, starting with decisions by Elon Musk and Mark Zuckerberg about whether to leave school and continuing with simple examples of people making choices about what to consume or produce.
From this central idea, many other powerful ideas follow, as summarized visually in Figure 1.2. An opportunity cost exists every time a choice is made. People gain from trade, both through a better allocation of goods and through comparative advantage. Every society faces trade-offs described by production possibilities curves. Every society faces three fundamental questions: what, how, and for whom to produce. Market economies—characterized by freely determined prices, property rights, freedom to trade, and a role for both government and private organizations—provide answers to these three questions. The price system helps a market economy work by providing incentives, sending signals, and affecting the distribution of income.
You will see this central idea again and again as you continue to study economics.
Figure 1.2 From One Central Idea, Many Powerful Ideas Follow
As you study economics, you will see the same central idea again and again. This figure illustrates how many powerful economic ideas are connected to the one in the center.
Show long descriptionLong Description
The graphic shows a text box at the center which contains the central idea - that people make purposeful choices with scarce resources and interact with other people when they make these choices. Four arrows connect this box with four other ideas - that every society faces tradeoffs, that people gain from trade, that economic interactions take place in a market, and that every society has to choose what, how and for whom to produce. Two other boxes show that tradeoffs carry opportunity costs and that market economies provide answers to the what/how/for whom questions.
Key Points
Everyone faces a scarcity of something, usually time or resources.
Scarcity leads to choice, and choice leads to opportunity costs.
Trade leads to gains because it allows goods and services to be reallocated in a way that improves people’s well-being.
Trade also leads to gains because it permits people to specialize in what they are relatively good at.
The three basic questions that any economy must face are what, how, and for whom production should take place.
A well-functioning market system, involving freely determined prices, property rights, freedom to trade, and a role for government and private organizations, can answer these basic questions.
Prices transmit signals, provide incentives, and affect the distribution of income in a market economy. If prices are set at incorrect levels by government, waste and inefficiency—such as feeding bread to livestock—will result.
Questions for Review
What is the basic idea at the center of economics?
Why does scarcity imply a choice among alternatives?
What is the opportunity cost of making a choice?
How can gains be achieved from trade even when total production of goods and services does not change?
How can specialization lead to gains from trade?
How can financial crises cause inefficiencies?
What are the key ingredients of a market economy?
What are the three basic questions that any economic system must address?
What roles do prices play in a market economy?
Problems
Suppose that you are president of the student government, and you have to decide how to allocate a $20,000 fund for guest speakers for the year. Conan O’Brien and Will Ferrell each cost $10,000 per appearance, Stephen Colbert costs $20,000 per appearance, and former economic advisers to the government charge $1,000 per lecture. Explain the economic problem of choice and scarcity in this case. What issues would you consider in arriving at a decision?
Michelle Wie, a teenage golf prodigy who earned $16 million in endorsements and $4 million in prize money and appearance fees in 2006, announced that she would enroll as a student at Stanford University in the fall of 2007. What was her opportunity cost of a year of college? How does it compare to your opportunity cost of a year of college?
Allison will graduate from high school next June. She has ranked her three possible post-graduation plans in the following order: (1) work for two years at a consulting job in her hometown paying $20,000 per year, (2) attend a local community college for two years, spending $5,000 per year on tuition and expenses, and (3) travel around the world tutoring a rock star’s child for pay of $5,000 per year. What is the opportunity cost of her choice?
Suppose you have two boxes of chocolate chip cookies and a friend of yours has 2 gallons of milk. Explain how you can both gain from trade. Is this a gain from trade through better allocation or greater production?
Tracy tells Huey that he can improve his economics grade without sacrificing fun activities or his grades in other courses. Can you imagine ways in which this might be possible? What does that imply about the initial situation?
Suppose decreased production of oil in the Middle East causes the price of oil to rise around the world. Explain how this change in the price signals information to U.S. producers of various goods, provides incentives to U.S. producers of various goods, and affects the distribution of income.
When you look at the economies of the United States, Europe, or Japan, you see most of the ingredients of a market economy. For example, consider bicycles. Prices in the bicycle market are free to vary; people have property rights to the bicycles they buy; many people sell bicycles; many bicycles sold in the United States, Europe, and Japan come from other countries; the government regulates bicycle use (no bicycles on the freeways, for example); and bicycle production takes place within firms with many workers. Replace bicycles with another good or service of your choosing and comment on whether the statement is still true.