CHAPTER 1

THE FOUNDATIONS
OF ECONOMICS

Vo Thi Xuan Hanh

What Economics Is All About

▪ Human wants:
▪ Wants are things that we would like to have
but which are not necessary for our
immediate physical survival, such as
televisions/mobile phones
▪ Human wants are infinite

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What Economics Is All About
Factors of production
▪ Land : includes all natural resources
▪ Labour : is human factor. It is physical and mental
contribution of the existing workforce to production.
▪ Capital : is the factor of production that comes from
investment in physical capital and human capital
▪ Management (entrepreneurship) : is the organizing
and risk-talking factor of production. Entrepreneurs
organize the other factors of production - land,
labour and capital - to produce goods and services
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What Economics Is All About
▪ Scarcity: the limited nature of society’s
resources
▪ cannot produce all the goods and services people
wish to have.
▪ each member of a household cannot get everything
she wants
▪ each individual in a society cannot attain the highest
standard of living to which she might aspire

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What Economics Is All About
▪ Economics: the study of how society manages
its scarce resources allocated to fulfill the infinite
wants of human.
▪ It is a study of rationing systems.
▪ how people decide what to buy,
how much to work, save, and spend
▪ how firms decide how much to produce,
how many workers to hire
▪ how society decides how to divide its resources
between national defense, consumer goods,
protecting the environment, and other needs
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Three basic economic problem

▪ What should be produced and in what

quantities?
▪ How should things be produced?
▪ Who should things be produced for?

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PRINCIPLE #1:
People Face Tradeoffs
All decisions involve tradeoffs. Examples:
▪ Going to a party the night before your midterm
leaves less time for studying.
▪ Having more money to buy stuff requires
working longer hours, which leaves less time
for leisure.
▪ Protecting the environment requires resources
that could otherwise be used to produce
consumer goods.

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PRINCIPLE #2:
The Cost of Something Is
What You Give Up to Get It
▪ Making decisions requires comparing the costs
and benefits of alternative choices.
▪ The opportunity cost of any item is
whatever must be given up to obtain it.
▪ It is the relevant cost for decision making.

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PRINCIPLE #2:
The Cost of Something Is
What You Give Up to Get It
Examples:
The opportunity cost of…
…going to college for a year is not just the tuition,
books, and fees, but also the foregone wages.
…seeing a movie is not just the price of the ticket,
but the value of the time you spend in the theater.

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Our Second Model:
The Production Possibilities Frontier
▪ The Production Possibilities Frontier (PPF):
a graph that shows the combinations of
two goods the economy can possibly produce
given the available resources and the available
technology.
▪ Example:
▪ Two goods: computers and wheat
▪ One resource: labor (measured in hours)
▪ Economy has 50,000 labor hours per month
available for production.

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 PPF Example
▪ Producing one computer requires 100 hours labor.
▪ Producing one ton of wheat requires 10 hours labor.

Employment of
Production
labor hours
Computers Wheat Computers Wheat
A 50,000 0
B 40,000 10,000
C 25,000 25,000
D 10,000 40,000
E 0 50,000
 PPF Example

Wheat
Point Production
(tons)
on Com- 6,000
graph puters Wheat
5,000
A 500 0
4,000
B 400 1,000
3,000
C 250 2,500
2,000
D 100 4,000
1,000
E 0 5,000
0
0 100 200 300 400 500 600
Computers
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 ACTIVE LEARNING 1
Points off the PPF
A. On the graph, find the point that represents
(100 computers, 3000 tons of wheat), label it F.
Would it be possible for the economy to produce
this combination of the two goods?
Why or why not?
B. Next, find the point that represents
(300 computers, 3500 tons of wheat), label it G.
Would it be possible for the economy to produce
this combination of the two goods?

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The PPF: What We Know So Far
Points on the PPF (like A – E)
▪ possible
▪ efficient: all resources are fully utilized
Points under the PPF (like F)
▪ possible
▪ not efficient: some resources underutilized
(e.g., workers unemployed, factories idle)
Points above the PPF (like G)
▪ not possible

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The PPF and Opportunity Cost
▪ The opportunity cost of an item is what must
be given up to obtain that item.
▪ Moving along a PPF involves shifting resources
(e.g., labor) from the production of one good to
the other.
▪ Society faces a tradeoff: Getting more of one
good requires sacrificing some of the other.
▪ The slope of the PPF tells you the opportunity
cost of one good in terms of the other.

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Microeconomics and Macroeconomics
▪ Microeconomics is the study of how
households and firms make decisions and how
they interact in markets.
▪ Macroeconomics is the study of economy-wide
phenomena, including inflation, unemployment,
and economic growth.
▪ These two branches of economics are closely
intertwined, yet distinct—they address different
questions.

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The Economist as Policy Advisor
▪ As scientists, economists make
positive statements,
which attempt to describe the world as it is.
▪ As policy advisors, economists make
normative statements,
which attempt to prescribe how the world should be.
▪ Positive statements can be confirmed or refuted,
normative statements cannot.
▪ Govt employs many economists for policy advice.
E.g., the U.S. President has a Council of Economic
Advisors, which the author of this textbook chaired
from 2003 to 2005.
 ACTIVE LEARNING 3
Identifying positive vs. normative
Which of these statements are “positive” and which
are “normative”? How can you tell the difference?
a. Prices rise when the government increases the
quantity of money.
b. The government should print less money.
c. A tax cut is needed to stimulate the economy.
d. An increase in the price of burritos will cause an
increase in consumer demand for music
downloads.

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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Rationing systems

▪ Planned economies: centrally planned

economy or a command economy
▪ In a planned economy, the government
decide to what to produce, how to produce,
and who to produce for.
▪ In a planned economy, all resources are
collectively owned. Government bodies
arrange all production, set wages, set
prices through central planning in their best
interests, in theory.
Rationing systems
▪ Free market economies: private enterprise
economy)
▪ In the free market economy, three basic problems
are solved by prices, government does not
interfere with the economy.
▪ The mixed economy: an economic model which
combines free market economy and planned
economy.
▪ In the mixed economy, three basic problems are
solved by prices and government decisions to
minimize the negative effects of free market
economy
 SU MMA RY

• As scientists, economists try to explain the world

using models with appropriate assumptions.
• Microeconomics studies the behavior of
consumers and firms, and their interactions in
markets. Macroeconomics studies the economy
as a whole.
• As policy advisers, economists offer advice on how
to improve the world.

© 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.