1.4 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 1.7. 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.
Figure 1.7 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 basic idea is that people make purposeful choices with scarce resources and interact with other people when they make these choices. Every society faces trade-offs described by production possibilities curves. There is an opportunity cost every time a choice is made. People gain from trade through a better allocation of goods and through comparative advantage. 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 government and private organizations, provide answers to the fundamental questions. Economic interactions typically take place in a market. Prices provide incentives for buyers and sellers in the market, send signals about changing tastes and technologies, and affect the distribution of income.
You will see this central idea again and again as you continue to study economics.
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 production possibilities curve summarizes the trade-offs in the whole economy because of scarcity.
Economic production is efficient if the economy is on the production possibilities curve. Production is inefficient if the economy is inside the production possibilities curve.
Points outside the production possibilities curve currently are impossible. More investment, more workers, or better technology can shift the production possibilities curve out and make the impossible possible.
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?
What is the principle of increasing opportunity costs?
Why is the production of a combination of goods that is located inside the production possibilities curve considered to be inefficient?
What are the key ingredients of a market economy?
What are the key differences between a market economy and a command economy?
What are the three basic questions that any economic system must address?
What roles do prices play in a market economy?
What role does the price system play during a national disaster?
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. Jimmy Fallon 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?
In 2020, Jalen Green, a teenage basketball prodigy, turned down scholarship offers from Arizona and USC to sign a one-year $600,000 offer with the NBA Developmental G-League and then signed a contract with the Houston Rockets in 2021 that guaranteed $10 million a year in pay for the next three years. What was his opportunity cost of four years of college? How does it compare to your opportunity cost of four years 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 two gallons of milk. Explain how you can both gain from a trade. Is this a gain from a trade through better allocation or greater production?
Suppose Tina and Julia can produce brownies and romantic poems (which can be combined to make a lovely gift) in the following combinations in a given week:
| Tina | Julia | ||
|---|---|---|---|
| Brownies | Poems | Brownies | Poems |
| 50 | 0 | 25 | 0 |
| 40 | 1 | 20 | 1 |
| 30 | 2 | 15 | 2 |
| 20 | 3 | 10 | 3 |
| 10 | 4 | 5 | 4 |
| 0 | 5 | 0 | 5 |
If Tina and Julia are each currently producing two poems per week, how many brownies are they producing? What is the total production of brownies and poems between them?
Is there a possibility for increasing production? Why or why not?
Suppose Julia completely specializes in producing poems and Tina completely specializes in producing brownies. What will be their total production of brownies and poems?
Suppose you must divide your time between studying for your math final and writing a final paper for your English class. The fraction of time that you spend studying math and its relation to your grade in the two classes given in the table below.
| Fraction of Time Spent on Math | Math Grade | English Grade |
|---|---|---|
| 0 | 0 | 97 |
| 20 | 45 | 92 |
| 40 | 65 | 85 |
| 60 | 75 | 70 |
| 80 | 82 | 50 |
| 100 | 88 | 0 |
Draw a trade-off curve for the math grade versus the English grade.
What is the opportunity cost of increasing the time spent on math from 80 to 100 percent? What is the opportunity cost of increasing the time spent on math from 60 to 80 percent?
Are there increasing opportunity costs from spending more time on math? Explain.
Suppose your parents want you to get a 92 percent in both subjects. What would you tell them?
A small country produces only two goods, cars and cakes. Given its limited resources, this country has the following production possibilities:
| Cars | Cakes |
|---|---|
| 0 | 200 |
| 25 | 180 |
| 50 | 130 |
| 75 | 70 |
| 100 | 0 |
Draw the production possibilities curve.
Suppose car production uses mainly machines and cake production uses mainly labor. Show what happens to the curve when the number of machines increases, but the amount of labor remains unchanged.
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? If Huey is taking just two courses and he can improve his economics grade without hurting his math grade, how could you represent this situation graphically?
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.