The Central Concepts of Economics

The Age of Chiualry is gone; that of sophisters, economists, and

calculators has succeeded.

F,dmrrnd Rrrrke

A. WHY STUDY ECONOMICST

As you open this textbook, you may be rvondering, \{hy should I study economics? Let us count the ways. Many study economics to help them get a good
.iob. Some people feel they should understand more deeply what lies behind reports on inflation and

Choosing your life's occupation is the most important economic decision you will make. Your future depends not only on your own abilities but
also on how national and regional economic forces

affect your wages. Also, your knowledge of econom-

unemployment. Or people want to understand what kinds of policies might slow global warming or what it means to say an iPod is "made in China."

ics can help you make wise decisions about how to buy a home, pay for your children's education, and set aside a nest egg for retirement. Of course, studying economics will not make you a genius. But without economics the dice of life are loaded
against you.

ForWhom the BellTolls

All these reasons, and many more, make good sense. Still, as we have come to reaTize, there is one overriding reason to learn the basic lessons of economics: All your life-fiom cradle to grave and beyond-you will run up against the brutal truths of economics. As a voter, yor.r will make decisions on issues that cannot be understood until you have mastered the rudiments of this subject. Without studying economics, you cannot be fully informed about international trade, tax policy, or the causes ofrecessions and high unemployment.

There is no need to belabor the point. We in addition to being useful, economics is even a fascinating field. Generations of students, often to their surprise, hal,e discovered how stimulating it is to look beneath the surface and understand the fundamental laws of economics.
hope you will find that,

SCARCITY AND EFFICIENCY:THE TWIN THEMES OF ECONOMICS Definitions of Economics

Let us begin with a definition of economics. Over the last half-centur1,, the study of economics has expanded to include a vast range of topics. Here are

CHAPTER I

. THE CENTI{AI,

CONCEPTS OT ECONO\'{I(]S

solne of the major subjects that are covered

book:r

in this

fl-et over the cost of labor or health care; governrlents

o
o

.
o

Ecrnomics explorcs thc behavior of the frnancial rnarkets, including interest rates, exchange rates, ard stock prices. The subject examines the reasons r,vhy some people or countries have high incones r,vhile others are poor; it goes on to analyze wavs that poverty can be reduced lvithout harming the econornyr It studies br,rsiness cycles-the fluctuations in credit, unernployment, and inflation-along u,ith policies to rnoderate thern. Economics studies international trade and finance

nould not need to struggle o\er taxes or spending or pollution because nobody \'vould care. N{oreove
sincc al1 of us could have as much as u,e pleased, no one rvoulcl be concerned about the distribution of incomcs among difl'erent people or classes. In such an Eden of rflluence, all goods would be fiee, like sand in the descrt or seawater at the beach.

Al1 prices u,ould be zero, and markets wruld be unnecessar)r. Indeed, economics rvculd no longer be
a usefirl subject.

and the impacts of globalization, and it particularl,v cxarnines thc thorny issues involr,ed in openinu r-rp borders to frcc trade. It asks hor'v govcrnmcnt policies can be used to
pursue important goals such as rapicl economic grorvth, efficicnt use of resources, full ernplo,r..

But lro societ\'' has rcachcd a utopia of limitless possibilities. Ours is a r'r,.orld of scarcity, firll of economic goods. A situation of scarcitv is one in $,hich soods are limited rclativc to desires. An objectir,e observer \,vould hare to agree that, e\ren after two

ment, pricc stabilitl,, and a fair distribution of

income. This is a lons list, but we could cxtend it manl' tinrcs. Florl,eler, il'r.r,e boil down all thcsc definitions, rr'e frnd one comnlon therne: Economics is the study of how societies use scarce resources to produce rraluable goods and services and

distribute them amons different individuals.

centuries of rapid econornic grou/th, production in the United States is sirnply not hish enough to meet e\er,vonc's desires. If ,vou add up all the wants, you quickl,v find th:rt there are simply not elrouc.h goods and serr,ices to satisfy e\,en a srnall liaction of el,ervone's consumption dcsires. Our national output n,or-rld have to be many timcs largcr before the aterage American could live at thc lcvel of the a\,erage doctor or major-league bascball pla,ver. tr{oreor,er, or-rtside the United States, particularly in Africa, hundreds of millions of people suffer from hunger and material deprivation. Given unlimited lvants, it is importanl that an econonty rnake the best use of its limited l'esources.

Scorcity ond Efficiency

If

r,le think about the definitions, r,r,c find tlvo kcy ideas that run through all of economics: that goods arc scarce and that socien'must use its resotrrces efficie ntl1,. Inrleed, the conccrns oJ'et:onornit:s uill not go aua)
because 0l the

fitct

oJ

scnrcitl and

tl'e d,esire

Crnsider a r.r,orld r,vithout scarciq,. I

fbr efJtti,,nr' infinite quan-

tities of every good could bc produccd or if human dcsires ltere fully satisfied, lvhat r,l.ould be thc consequences? People nould not $'orrv about stretching or-rt their limited incornes because they could har,e er,erything they i,r,'antcd; businesses u,ould not nced tcr

That brings us to the critical notion of'efficienct. Efficiency denotes the most effective use of a soci ety's resources in satisfl.ing pe ople's wants alrd neecls. By contrast, consider an economv rvith unchecked monopolies or unhealthy pollution or eo\erlltlent corruption. Such an economy may procluce Iess than r,vould be possible nithout these factors, or it mav produce a distorted bundle of goods that lear,cs consumers worse off than the], other,vise could be-either situation is an inef'ficient allocation of resources.
Economic efficiency requires that an economy produce the highest combination of quantity and qr.rality of soods and selvices given its techrtology ancl scarce resources. An economy is producing efficiently when no indidual's economic welfre can be improved unless someone else is made worse off. The essence of economics is to acknorvledge the realitl,of scarcity and thcn fisure out how to organize

'l'his list contains several specialized terrns that -vou rvill need to unrlerstand. If r.ou arc not lamiliar lvith a particular r.orcl or phrase, 1,ou should consult the Gkrssar',v :rt the back of this book. The (ilossarl' contains rnost of thc lnajor technical econornic terrns used in this book. AII terrls printcd in boldlace :rre dellncd in tl'rc Cllossarr'.

THE LO(}IC OI' ECONON,{I(]S

society in a way which produces the most efficient use of resources. That is where economics rnakes its

economic science and of this text is to unclerstand this complex undertaking. How do economists go
about their task? Economists use the scientifi,c approach to understand economic life. This involves obsening economic affairs and drawine upon statistics and the historical record. For complex phenomena like the impacts of budget deficits or the causes of inflation, historical research has provided a rich mine of insights. Often, economics relies upon analyses and theories. Theoretical approaches allor,r, cconomists to rnake broad generalizations, such as those concerning the advantages of international trade and specialization or the disadvantases of tarifl.i and quotas. In addition, economists have developed a specialized technique knolvn as econometricq which applies the tools of statistics to economic problerns. Using

unique contribution.

Mi croe conomics a nd Mo croecononics

Economics is today dir-ided into two major subfields, microeconomics and macroeconornics. Adam Srnith is usuall1, considered the founder ofmicroeconomics, the branch of economics lthich today is concerned u,ith the behar.,ior of indir,idual entities such as rnarkets, frrnrs, and households. In Tl'c Weolth of l{atiott.s (1776), Smith considered holv individual prices are

set, studied the dctermination of' prices of lancl, labor, and capital, and inquired into the strengths and lveaknesses of the market mechanism. Most irnportzrnt, he identifred the remarkable efficiency properties of markets and explained hon the selfinterest of individuals r'vorking through the cornpetitive market can procluce a societal econornic benefit. Microeconomics today has moved be,vond the early concerns to include the study of monopoly,, the role

of international trade, finance, and many other vital

subjects.

The other major branch of our subject is macroeconomics, which is concerned r,r,'ith the overall performance of the cconom),. Macroeconomics did not even exist in its rnodern fbrm until 1936, whenJohn Nlaynard Keyncs published his revolutionary ()en,era,l Theorl of Emplolment, Intercst and Monq. At the time, England and the United States rvere still stuck in the Great Depression of the 1930s, with over one-quarter of the American labor force unemployed. In his nerv theory Keynes developed an analysis of what causes business cycle s, with alternating spells of high ullemployment and high inflation. Toda macroeconomics examine s a wide variety of areas, such as how total invcstment and consumption are detennined,
hor,r,'

economctrics, economists can sift thlough moru-rtrins of data to extract simple relationships. Budding economists must also be alert to common fallacies in econornic reasoning. Because economic relationships are ofien complex, involving many diff'erent variables, it is easy to become confused about the exact reason behind events or the irnpact of policies on the economy. The following are sorne of the common fallacics encountered in economic reasoning:

irrference of causality. The post h,oc fallacy occurs when we as.sume that, because one eaent occ'uned
bejbre another euent, th,e Jirst euent caused the second eaent.2 Art example of this syndrome occurred in

Tlrc post hoc fallacy.

The first fllacy involves the

the Great Depression of the 1930s in the United States. Some people had observed that periods of
business expansion were preceded

or accompa-

central banks manage money and interest rates, what causes international financial criscs, ancl why some nations grow rapidly while others stagnate. Althoush rnacroeconomics has prouressed far since his first insights, the issues addressed by Keynes still define the stud1, of macroeconomics today,.

nied by rising prices. From this, they concluded that the appropriate remedy for depression \\-as to raise wases and prices. This iclea led to a host of legislation and resulations to prop up wages and prices in an inefficient manner. Did these measures promote economic recovery? Almost surely not. Indeed, the1, probably slolved reco\'ery., which did not occur until total spending began to rise as the govelnment increased military spending in preparation for \\'orld War II.
2 "Post lroc" is shortliand or po.st hoc, ?rgo propLer hlc. Tianslated fr,m thc T.atin. tlre [ull erplession means "after this. therefore necessarily because of this."

THE LOGIC OF ECONOMICS Economic life is an enormously complicated

hive

of activity, u,ith people buvins, selling, bargaininu, investing, and persuading. The ultimate purpose of

CHAPTER

T}

IE

(]I.],

N]' IIAI, C]ON(]EPTS OF I,C]ONOI,IICS

Failure to hol,d otlrcr things corL.stan,t. A second pitfall is failure to hold other thinss constant when thinkins abolrt an issue. For example, we might want to knorv whether raising tax rates r,vill laise or lorver tax re\enues. Some people have plrt

indivicluals. Often the irchavior of the agurcgate looks very different fi-orn the behavior o[ individu1l pcople.
\,\,'e mention these fallacics only briefly in this introduction. Later, as wc introdr.rce the tools of cconomics, l've r,vill proltde examples of horv inattention to the losic of econornics can lead to false ancl sometirnes costlv errors. When y,ou reach the end of

forth thc seductive argument that r,ve calt eat our fiscai cake and have it too. They argue thar cuttins tax rates will at the sarne time raise gor..
ernment re\enlres and lor'r,er the budget deficit. They pciint to the KennedyJohnson tax cuts of 1964, lr,hich lowercd tax rates sharply and were follor'vecl by urn increase in gover-nment relenlles in 1965. Flence, they argue, lo,er tax rates produr e higher rc\cnues. \Vhy is this reasonins fallacious? Thc argument assumcs that other things $,erc constalttoverlo<kcd the growth in the ovcrall econom) frorn 1964 to 1965. Because people's incomes gren, cluring thirt period, total tax revenlles gre\\' erren though tit"x rates were lower. Careful econometric stuclies indicate thirt total tirx re\enues rvor.rld har.e been euen higher t 1965 if tax rates had been hcld at the san're level as in 1964. Flencc, this anal,vsis fails to holcl other things constant in makins the calculations.
Ifernembet to hold other thirtgs constctnt when you are ana\zin4 tlwimpu,r:t of a uoriable on. the er:orutit
s)stem.

this book, you can look back to see whl,e ach of these paradorit al example. is true.

Positive Economics versus Normative

Economics

When considering economic issues,

we

in particula it

must carefully distinguish questions of fact from questions of fairness. Positive economics describes

the facts of an econom while normative economics

involves value judgments.

Positive economics deals with questions such as: Why do doctors earn more than janitorsl Did the North
American Free Trade Agreement (NAFTA) raise or lower

the incomes of mostAmericans? Do higher interest rates

slow the economy and lower inflationlAlthough these may be difficult questions to answer, they can all be resolved by reference to analysis and empirical evidence.That puts them in the realm of positive economics.

Tlte

that r,r,'hat holds true for part of a system also holds true for thc whole. In econornics, honcver. ne often find that the nhole is differelrt frcim the sum of the parts. When yott ttssunte tha.t uthat is Lt,ue
for
the por,rt i,s also true
the

fallacy of composion. Sometimes \\e assume

for

the whole,

)ou

are cotnnLit-

ting

Flere are son)e trlre sta-telnetrts that misht surprise vou if you ignored the fallacv of composition: (l) If one frmer has r bumper crop, she has a higher income; if all rmers procluce a recorcl crop, frrn incomes will hll. (2) If one person receives a qreat cleal rnore mone),, that person will
bc better olI; if cveryone receive s a great deal rnore mone), the sociery is likely to be .worse ofI. (3) Il a high tariffis put on a procluct such as shoes or stccl, the producers in that industry are likely to profiU if high tariffb arer put otr all producls, the economic welfare of the nation is likel,v to be tvorse off. 'Ihese examples contain no tricks or magic. Rather, they are the results of systerns of interactinc

fttllacl ol cornpo.siti,on.

Normative economics involves ethical precepts and norms of fairness. Should unemployment be raised to ensure that price inflation does not become too rapid? Should the United States negotiate further agreements to lower tariffs on importsl Has the distribution of income in the United States become too unequal? There are no right or wrong answers to these questions because they
involve ethics and values rather than facts.While economic analysis can inform these debates by examining the lil<ely consequences of alternative policies, the answers can be resolved only by discussions and debates over society's fundamental values.

COOL HEADS ATTHE SERVICE OF WARM HEARTS

oter the iast centur\,, grolr,n lionl a tiny rcorn into r rniuhry oak. Under its spreacling branches rre fincl expl:rnations of the gains fiom internation:rl trade. aclvice on holv to rcduce
Ecorromics has,

(]OOL HEADS AT THE SERVICE OF \'\AR}I HE.\R'TS

unemployment and inflation, formulas for investins your retirement fnds, and proposals to auction limited carbon dioxide emissions permits to help slorv global rvarming. Throughout the world, economists are laboring to collect data and improve our understanding of economic trends.
You mightu,ell ask, What is the purpose of this arrny of economists measuring, anal,vzing, and calculating? ultimate goal of economic science is to'itnfoue tlrc Liuit'tg oJ peoNtle in their eueryclay llu.s. Increasing the gross domestic product is not jr-rst a numbers game.
T-he

maintain a healthy econom\', governments mlrst preserve incentir,es fbr people to tvork and to save. Societies can support the unemployed for a while,

condition,s

but when unemployment insurance.Pays too much for too long, people rna\ corne to depend upon the go\,ernment ancl stop looking fbr work. If they beein to believe that the government owes them a living, this may dull the cutting edge of enterprise. .Just because governrnent programs pursue lofty goals cannot exempt them from carefirl scrutiny and efficient management.
Socie.must strivc to conbinc the cliscipline o1'the mar:ketplace r,r,ith the compassion of social Pl:ograllls. Bv using cro1 ireacls to inforrn warm he2trts, ecolotlric science cin clo its part in linding the approprial.e brlirnce for an cflicient, pr-osperous, anci.jrrst societr'.

Hisher incomes mean good fbod, narm houses, and hot rvater. They mean safe drinking water and inoculations against the perennial plagues of humanitl'. Hisher incomes produce morc than food and shelter. Rich countries have the resources to build schools so that yoru)g people can learn to read and develop the skills necessary to Lrse modern machinery and computers. As incomes rise further, rtatiolrs can affbrd scientific research to determine agricultural techniques appropriate for a country's climate
and soils or to develop vaccines against local diseases.

B. THE THREE PROBLEMS OF ECONOMIC ORGANZATION

Every human socieq,-lvhether it is an advanced industrial nation, a centrally planned econonly, or an isolated tribal nation-must confront and resolve three fundamental economic problems. Evcry society must havc a way of determining ru/l commodities are produced, how these goods are made, and.for
uthorn they are produced.

With the resources fi-eed up by economic gror'vth, people have free time fbr artistic pursuits, such as poetryr and music, and the population has the leisr.rrc time to read, to listen, and to perform. Nthough there is no single pattern of economic development, and cultures differ around the world, freedom fiom hunger, disease, and the elements is a universal human goal. But centuries of human history also show that lvarm hearts alone r'vill not feecl the hungry or heal the sick. A free and efficient market will n<t necessarily produce a clistribution of income that is socially acceptable. Determining the best route to economic prosress or An equitable distribution of societv's output requires cool heads that objectivel,v weigh the costs and benefits of diff'erent approaches, tr,vins as hard as hr-rmanly possible to keep the analysis fiee from the taint of wishful thinking. Sometimes, economic progress will require shutting down an outrnoded factory. Sometimes, as u,'hen centrallv planned countries adopted market principles, things get worse befbre they get better. Choices are particularly difficult in the field of health care, where lirnited resources literally invoh,e life and death. You may have heard the saying, "From each according to his abiliql to each accordins to his need." Governments have learned that no society can long operate solely on this utopian principle. To

Indeed, these three firndamental questions of

ecorromic rrganization-what, hou, alnd for uthomare as crucial today as theywere at the dawn of human civilization. Let's look more closely at them:

o \\hat

commodities are produced and in what quantities? A society must cletermine how much of each of the many possible goods and serces it r'vill make and when they will be produced. Will we produce pizzas or shirts today? A few highquality shirts or rnany cheap shirts? Will we use scarce resources to produce many consumption goods (like pizz.as)? Or will we produce fewer consumption goods and more investment soods (like pizza-making machines), which will boost production and consurnption tomorrow? Hozu are goods produced? A socieq, must deter-

rnine who will clo the production, with what resources, and nhat procluction techniques they
will
use. \{rho farms and n ho teaches? Is

electricitv

CHAPTER I

. THE ( I-\TR\I- (,O\(]EP'fS O}- E(]ONOMT']S

senerated from oil, fiom coal, or from the sun? \\ill factories be run bv people or robots? o lior whont are goocls procluced? Who sets to eat the fruit of economic activity? Is the clistribution of income and 'w'ealth fair and cquitable? Hor,v is the national product diridecl alnong diflercnt hor.rseholds? Are rnanv people poor and a ferv rich? Do high incomes go to teachcrs rr athletes or autor,vorkers ()r venture capitalists? Will society pro\ide minimal c()nsumption to the poor, or mlrst people rvork if the,v lrre to eat?

such as the one u-hich operatecl in the So'n,iet Union during rnost of the trventieth centurt,, the gorernlnent o\,vns most of thc means of production (land and capital); it also orvns and directs the'opcrations ol entetprises in most industries; it is the ernplover

MARKEI, COMMAND, AND MIXED ECONOMIES

\{rhat arc the clifferent \\ays that a societv can ans\,ver the questions of whaL, hout, and fi toho.m? Different socie ties rre organized through alLnttatiue ecunomit. ,.1tems, and economics studies the various mechanisms that a society can use to allocate its scuce resources. \\re generally distinsuish fivo fundamentallv diflerent Ways of'organizing an econont\,. At one extreme, governnient makes most econornic decisions, with thosc on top of the hierarchv giving econornic cornrnands to those further dou,n the ladder. At the other extrcme, decisions arc made in markets. u,here indir.iduals or: enterprises r,oluntarilv agree to exchange goocls and sen.ices, usually thror.rgh payrnents of mone\,. Let's briefly erxaminc erch of these trvo forms of econonric orglnizatiolr. In the United States, and increasinul,v arouncl the worlcl, rnost economic questions are settled bv the market mechanism. Hence their ecolromic systerns are callcd market econornies. A market economy is one in lthich inclividuals alrd prirrate firnis rnrke the rnajor decisions about production and consumption. A svstern of prices, of markets, of profits and losses, of inccntives ancl rervards detennines uthat, ltozu, ancl Jor zuhorn.Firnts produce rhe commoclities that yielcl the lrighest profrts (the uthat) bv rhe rerchniques of production that are least costl1, (the ozrr). Consurnption is deterrninecl by indir.icluals' decisions rbout horv to spencl the r,vages and plopeltl- incomes gcnerated bv
Ther extrcme case of'a rnarkert econom),, in rvhich the

of most rvorkers and tells thern horv to clo their jobs; and it cle cides ho'w thc or.rtput of thc societv is to be cliviclecl amorlg diflrcnt soods urd services. In shorr, in a commarrcl economl,', the government ansr,r,ers the major economic questions thror.rgh its o.lvncrship of resorrrces and its po\\'er to enforce decisions. No contemporar\. societr. falls cornpleteh, into either of these polar categories. Rathe all societics are mixed economies" rvith elerner-rts of matket and comrnand.
Economic life is organizcd either through hierarchical command or decentrrlizecl voluntary markcts. Tcrclay most decisions in the Ur-rited States ancl other high-income econornies are rnade in the rnarket-

placc. But the government pla,vs an important role in overseeing the functionins o{'the rnarket; eo\/er.nments pass latr,s that regulate econornic life, produce cducational and police services, ancl control pollution. Mcst societies toclay operatc mixed economies.

C. SOCETY'S TECHNOTOGICAL POSSI BI LITI ES

Euery gu'n that
eaer)
theJt
T

ocket,

mnde, euer) uarship launched, Jired signif,es, in the ftna,l sense, a

i.s

from

those utho hun,ger ttn(J o,re noL fed.

President Dlvight D. Eisenliorvcr

Each economy has a stock cif iimited resourceslabor, technical krtou,ledge, lrctories and tools, land, energl'. In cleciding iuhaL ad /zozrr things should bc: produced, the economv is in rcaliq.decidins horv to allocate its resorrrces alnong the thor.rsancls of different possiblc commodities and sen,ices. Hou. rnuch lancl u,ill go into grou,ing u,'heat? Or into ironsing the population? Hou, rnauv factcrics will produce cor-nputers? IIorv manv r,vill rnrkc pizt-as? I{on,mau}, chilrlren r,r,ill e-ro\{ up to plav professitnal sports or to be: professionzrl econornists or to prograrn compr_rters? l-aced rvith the uncleniable fact that goods zrre scafce relrtir.e to \\-ants, in econolnY mlrst cleciclc

their labor and propertv or,r,nership (thc Jbr

uthornl

governmeut keeps its hands off'econornic clccisious,

is calied a laissez-faire econolnv.
B,v

contrast, a command economy is one in

lhich

the governrnent makes all important clecisions about production and distribution. In a cc.rnmand ccorrornr,.

THE PRODUCTION-POSSIBILITY FRO\TIER

how to cope with limited resources.

It mnst choose among different potential bundles of goocls (the uhat) , selectfrom different techniqr-res of prodlrction (the how), and decide in the end r,r,ho l'ill consume
the goods (the Jbr uhom).

Restating the three eccir-ronric problen-rs in these ternls, society must decide (l) ithot olltpnts to produce, and in rvhat quantin.; (2) lto1,, or u,ith u,hat irrputs and techniques, to prodr-rce th desired outprrts; and (3) for uthom fhe outputs shorrld be procluccd and distributed.

INPUTSAND OUTPUTS
To answer these three questions, every society must make choices about the economy's inputs and outputs. Inputs are commodities or services that are used to produce goods and services. An econorny uses its existing technology to combine irrputs to produce outpr.rts. Outputs are the various useful goods or senices that result fiom the production process and are either consumed or employed in further production. Consider the "production" of pizza. We say that the eggs, flouq heat, pizza or,en, and chef's skilled labor are the inputs. The tasty pizzais the output. In education, the inputs are the time of the faculty and students, the laboratories and classrooms, the textbooks, and so on, r,vhile the outputs are inforrned, productive, and well-paid citizens. Another term for inputs is factors of production. These can be classified into three broacl categories: Iand, labor, and capital.

THE PRODUCTION.POSSIBILITY
FRONTIER
in lif'e that we can't have everything. 'You can have chocolate or vanilla ice cream. No, not both," we might hear. Similarly, the consumption opportr.rnities of countries are limited by the resollrces and the technologies availabie to them. The need to choose among limited opportunities is dramatizecl during wartime. In debating lvhether the United States should invade Iraq in 2003, people wanted to know how much the war lvould cost. The administration said it rvould cost onl,v $50 billion, while some economists said it might cost as much as $2000 billion. These are not just mountains of dollar bills. These numbers represent resources direrted fiom other purchases. As the numbers began tc-r climb, people naturally asked, Wry are rve policing Baghdacl rather than Neu, York, or repairing the electrical system in the Middle East rather than in the U.S. Midwest? People understand, as did former general and president Eisenhowe that rvhen output is der,oted to military tasks, there is less available fbr civilian consumption and investment. Let us drarnatize this choice bv considcring an economy which produces only trvo economic goods, guns ancl br-itter. The gr,rns, of course, represent military spending, and the butter stands for civilian spending. Suppose that our econom),decicles to throrv all its enerplv- into producins the civilian good, butter. There is a rnaximum amolrnt of br.rtter that can be produced per year. The maximal amount of butter depends on the quantity and quality of the economl,'s resources and the prodr-rctive efficiencv rvith lthich they are used. Suppose 5 million pounds of butter is the maximum amount that can be producecl with the existing technology and resources. At the other extreme, imagine that all resources are instead devoted to the production of guns. Again,
We learn early
because of rescurce lim itations, the economy can pro-

o Lan,d-or, more generally, naturirl resourcesrepresents the gifi of nature to our societies. It
consists of the land used for farming or for under-

pinning houses, factories, and roads; the enerw resources that fuel our cars and heat our homes: and the nonenergy resources like copper ar-rd iron ore and sand. In today's congested world, \,\.e must broaden the scope of natural resources to include our environmental resources. such :rs clean air and drinkable rvater. o Labrr consists of the human time spent in procluction-rvorking in ar.rtomobile facLories, u,riting softn''are, teaching school, or baking pizzas. Thousands of occupations and tasks, at all skill levels, are performed b,v labor. It is at once the most familiar and the most crucial input for an adtanced industrial cconomrv. o Ca,?ita,l resources form the durable ;oods of an econom)', prodr.rced in order to produce yet other
goocls. Capital goods include machines, roads, corn-

puters, softuare, trucks, steel mills, autornobiles, nashing machines, and buildings. As r,vc will see
Iater, the accumulation of specialized capital goods is essential to the task of economic der,elopment.

duce only a limited quantiq' of gr.rns. For this cxanrple, assume that the econom\r can produce 15,000 suns of a ce rtain kincl if no butter is produced.

t0

CHAPTER I

' THE CENTRAL CONC]EPTS

O}- ECONOMICS

Alternative Prod uction Possibilities

Possibilities A
B
C

(millions of
0
1

Butter pounds)

Guns (thousands)

l5
14
L2

D
E F

3 4
5

I
5

TABLE l-

l.

Limitation of Scarce Resources Implies the

Guns-Butter Tradeoff
Scarce inputs rnd technologl imply t.hat the production of suns and butter is limited. As rve so fiom A to B . . . to F, wc are transferrine labor, rnachines, ancl lrnd from the gun industrv to butter anrl can thereby increase buttcr ff:,ffiilffi,-,r*,*,.i*d.,ri.,rii*ri*.,i.i,,!r
irili,:$F.niifii4r,\ffiiritiffi*ririlii.r.
firrli1i,lirrnr

012345
Butter (millions of pounds)

FGURE l-

l.

The Production Possibilities in a Graph

This figure

disp1a1,s

the alternativc combiuations of pro1-1.

duction pairs from Table

These are two extreme possibilities. In between are many others. Ifrve are willing to give up some butter, we can have some guns. If rve are willins to gir.e up still more butter, we can have still ntore guns.

combinations of guns and blrtter, we ha\e the continuous green clrr\re shorvn as the ltrod,uctiontto.ssibility
fron.tie or PPlt, in Figure 1-2.

A schedtrlc of possibilities is gir,en in Table 1-1. Combination F shor,vs the extreme, 'lvhere all butter and no guns are produced, nhile A depicts the opposite extreme, lr,here all resources go into guns. In betlveen-at E, D, C, and B-increasing am()unts of butter are gir,en up in return fbr more guns. Horv, you might tr,ell ask, can a nation turn butter into suns? Rutter is transfbrrnecl into guns not physicalll'but by the alchem,v of divertins the economy's resorlrces from one use to the other. Ie can represent our economy's production possibilities more vividlv in the diasram shown in Figure i-1. This diagram lneasures butter along the horizontal axis and suns along the vertical one. (If you are unsure about the different kinds of uraphs or about holv to turn a table into a uraph, cons-rlt the appendix to this chapter.) \{re plot point Fin Figure 1-1 from the data in Tablc 1-1 by countins over 5 butter Lrnits to the risht on the horizontal axis and goinu up 0 gr-rn r"rnits on the vertical axis; similarll,, I is obtained b,v uoinu 4 butter units to thc right and goinu up 5 gun trnits; and finall),, we set A bv going over 0 butter r.rnits and up 15 gun units. If rve fill in all intermediate positions tvith neu' g-reen-colored points representinu all the diff'erent

The production-possibility frontier (or PPF ) shows the maximum quantity of goods that can be elliciently

produced by an econornv, siven its technological

knowledge and the quantity o1'available inputs.

Applying the PPF to Society's Choices

The PPF is the menu of choices that an economv has to choose from. Figure 1-2 shol,r,s a choice betrveen suns and butter, but this concept can be applied to a broad range of economic choices. Thus the more resources the government uses to spend on public highrvays, the less lvill be left to produce private goods like houses; the rnore r'r,e choose to consume of fbocl,

the less we can conslrlne of clothing; the more an

economy consllmes toda the less can bc its production of capital soods to turn out rrore consumption goods in the lture.

The graphs in Figures l-3 to 1-5 present solne important applications of PPFs. Figure 1-3 shor,r,s the effect of economic gror'vth on a country's production possibilities. An increase in inputs, or improved technologicai knowledge, enables a country to procluce rnore of all goods and services, thus shifting

rHf, PRODUCTION-POSSIBILITY FRONTIER

il
FIGURE l-2. A Smooth Curve Connects the Plotted Points of the Nrmerical Production Possibilities
This frontier shows the schedule along which society can choose to substitute guns for butter. It assumes a given siate of technology and a given quantity of inputs. Points outside the frontier (such as point 1) are infeasible or unattainable. Any point inside the curve, such as U, indicates that the economy has not attained productive efficiency, as is the case, for instance, when unem-

The Production-Possibility Frontier

G

6 E c

ployment is high during severe business cycles.

f
E

(a) Poor Nation

(b) High-lncome Naton

-t
g;

1
!;

o o o
a !;
(

o o
a
(

u;

o
f

o
f x f J

x 5

FIGURE l-3. Economic Growth Shifts the PPP Outward

(a) Before development, the nation is poor. It must devote almost all its resources to food and enjoys few comforts. (b) Growth of inputs and technological change shift out t},:re PPF. With economic growth, a nation moves from A to B, expanding its food consumption little compared with its increased consumption of luxuries. It can increase its consumption of both goods iIit desires.

t2

CHAPTER

THE CENTR,A.L CONCEPTS OF ECONOMICS

(a) Frontier Society

(b) Urban Society

.j '(

'-:
f
(d

o) .9
-o

o o o E o o

c (

o
o
a E

o o

o-)

= o_

.o -o f
o_

Private goods (food, . .

.)

Pr Private goods (food, . . .)

FIGURE l-4. Economies Must Choose between Public Goods and Private Goods
(a) A poor frontier society lives from harrd to mouth, r,r,ith little left over for public eoods like clean air or public health. (b) A modern urbanized economl is rnore prosperous and chooses to spend more of its higher incrme on public goods and go\erl)ment services (roads, enronmental protection, and education).

(a) Today's Choices

(b) Future Consequences

c
c)

E
.E

o
E

o
0)

a
.= .=

0)

= (

oC

(Current consumpton

Future consumpton

FIGURE l-5. Investment for Fuflrre Consumption Requires Sacrificing Current Consumption
A nation can produce either current-consumption goods (pizzas and concerts) or investment goods (pizza ovens and concert halls). (a) Three countries start out eyen. They have the same PPfl shorvn in the panel on the left, but they have different investrncnt rates. (lountry/ 1 does not invest for the future and remains at A, (merely replacine machines).

Country 2 abstains modestly from consumption and invests at 4,. Country 3 sacrifices a great deal of current consumption and inr,ests hear.ily (b) In the follorving 1'ears, countries that invest more heavily forge ahead. Thus thrifqv Country 3 has shifted its PPF far out, while Country 1 's PPI has nct moved at all. Countries that invest healy can haye both higher investment and consumption in the lirture.

THE PRODUCTION.POSSIBILITY FRONTIER

t3

ollt the PPF. The figure also illustrates rhat poor countries must devote most of their resources to fbod production while rich countries can af1brd
r.nore luxuries as productive potential increases.

Figure 1-4 depicts the choice berw,een private goods (bought at a price) and public goods (paid for by taxes). Poor countries can afford little of public goods like public health and primary education. But nith economic growth, public goods as well as envir-onmental quality take a larger share of output. Figure 1-5 portrays an economy's choice between (a) current-consumption goods and () investrnent in capital goods (machines, factories, etc.). 81, sac-

rificing current consumption and producing more capital goods, a nation's economy can grow more rapidl making possible more of or eoods (consumption and investment) in the fture.

you decide whether to study economics, buy a car, or go to college, you will gilrc something up-there will be a forgone opportuniq,. The next-best good that is forgone represents the opportunity cost of a decision. The concept of opportunity cost can be illustrated usins tlne PPF Examine the frontier in Figure 1-2, which shons the tradeoff between guns and butter. Suppose the country decides to increase its gurr purchases from 9000 gr.rns at D to 12,000 units at C. \\hat is the opportunity cost of this decision? You might calculate the cost in dollar terms. But in economics we always need to "pierce the veil" of money to examine the real impacts of alternative decisions. On the most fndamental level, the opportunity cost

of moving from I) to C is the butter that must be given up to produce the extra guns. In this example, the opportunity cost of the 3000 exrra guns is 1 million pounds of butter forsone. Or consider the real-world example of the cost of
opening a golcl mine near Yellowstone National Park. The developer argues that the mine will have but a small cost because Yello'l,lstone's re\enues r,vill hardly be affected. But an economist would answer that the dollar receipts are too narro\v a measure of cost. We should ask whether the unique and precious qualities of Yellowstone misht be degraded if a gold mine rvere to operate, with the accompanng noise, water and air pollution, and decline in ameniq, values for sitors. \,Vhile the dollar cost mieht be small, the opportuniry cost in lost wilderness values mieht be larse indeed.

Be NotTime's Fool

The great American poet Carl Sandburg wrote, "Time is the coin of your life. lt is the only coin you have, and only you can
determine how it will be spent. Be careful lest you let other people spend it for you." This emphasizes that one of the

most important decisions that people confront is how to use their time. We can illustrate this choice using the productionpossibility frontier. For example, as a student, you might have l0 hours to study for upcoming tests in both economics and history. lf you study only history, you will get a high grade there and do poorly in economics, and vice

two tests as the "output" of your studying, sketch out the PPF for grades, given your limited time resources. Alternativel if the two student commodities are "grades" and "fun," how would you draw
versa.Treating the grades on the

In a world of scarciry choosing one thing means ging up something else. The opportunity cost of a decision is the value of the good or service forgone.

Efficiency
Economists devote much of their study to exploring the efficiency of difl-erent kinds of market structures, incentives, and taxes. Remember that efficiency means that the economy's resources are being used as effectively as possible to satisfy people's desires. One important aspect of overall economic efficiency is productir,e efficienc1,, which is easily pic_tured in terms of the PPfl Efficiency means that the economy

this PPF?Where are you on this frontierlWhere are your

lazy friendsl

Recentl the United States collected data on how Americans use their time. Keep a diary of your time use for two or three days.Then go to www.bls.govltuslhome.htm and compare how you spend your time with the results for other people.

Opportunity Costs
\A,lhen Robert Frost wrote

is on the fiontier rather than insitle the productionpossibility frontier. Productive efficiency occurs when an economy cannot produce more of one good without producing less of another eood; rhis implies that the economy is on its prodr-rctionpossibility frontier.

of the road not taken, he pointed to one of the deepest concepts of economics, opl1ouniQ ost. Because our resources are limited, we
must decide how to allocate our incomes or time. When

t4

CHAPTER I

" TH[, C]ENTRAL C]ON(]EPTS

O}- ECONOMIT]S

Let's see u,hy productive efficiency requires beine on the PP1,l Start in the sitr.ration shor,vn by point,D in Figure 1-2. Say the rnarket crlls for another million pouncls of' buttcr. If we isnorccl the constraiut shor,r,rr b,v the PPF, we might think it possible to produce rnore butter without reducing gun production, sayi b1, mo\ing to point { to the risht of point D. Brrt point 1is outside the frontier, in the "infeasible" region. Startins fiom D, we cannot get ntore blrtter lvithout uiving up some guns. Hence point D displal,s productive cfficienc1,, u,hile point 1is infeasible. One further point about productive efficiency crn be illustrated usins the PPfl'Beins on the PPF lneans that producing rnorc of one good inevitably requires sacrificins tther goods. \\hen lve produce more guns, \\re are sllbstituting guns fbr butter. Sttbstilulion. is the larv of lif'e in zr. full-emplo,vnle nt econont),, and the production-possibilitv frontier depicts the menLl of'societv's choices.

not suciclenly declined dr-rrir-rg those years. Rather, reduced overall spendinu pushecl the economy tempcrraril,v inside its PPFfor that pcriod.

clifferent kind of inefficiency ocurs rvhen

Woste from Business Cycles ond Environmental Degrodotion Economies sufl'er from inefficient use of resourccs for many reasons. \Arhen there are unemploverl resollrces, the economv is not on its production-possibilitv fiontier at ali but, rather, scrmewhere insi,deit. In Fisure 1-2, point [/represcnts a poirrt inside the PPF; at U, socie ty is proclucinu onl,v 2 units of butter and 6 units of guns. Some resources ar-e unemployecl, arrcl by puttinu them to r,vork, rve can increase orlr output of all soods; the econorny crrn rno\e fi-orn [r to l), proclucing nore butter ancl nlorc guns, thus improving the economr,'s efficiency. rc can har,e our guns and eat rnore butter too. Ilistoricalll., one source of inefficiency occlrrs durins ltusincss c,vcles. From 1929 to 1933, in ther (-).reat Deprcssion, the totll ()Lltput produced in thc
American economv declincd b1.25 percent. The econornv dicl not suIlr from an inu,ard shift of fhe PPF bccause of technological fcrrsettine. Rather, panics. bank failures, bankruptcies, irncl reducecl spendine nror,ed tlre economy /rtsidcits PPF. Aclecade later, the militar-v expeuditures for \{rcrld \\rar II expandecl dernand, and outptrt sre\{ rapidl), as the econom\J puslred back to the PPI|

markets are failing to reflect tme scarcities, as with eu.ironmental degradation. Suppose that an ul)regulated business decides to clurnp chemicals in a riler; killing fish ancl ruining recreational opportunitics. The finn is not nccessarily doing this because it has evil intent. Rathe the prices in the marketplace do not reflect true social priorities-the price on polluting in an unregulated environment is zero rather than the true opportunity cost in terms of lost fish and recreation. Environrnental degraclation can also push the econom,v inside its PPlt The situation is illustrated in Fisure 1-4(b). Because businesses do not face correct priccs, thc economv mo\ies fiom point B to point '. Private soods are increased, but public goocls (like clean air and water) are decreased. Efficient resulation of the environment could mo\e northeast back to the dashed efficient fiontier.
As we close this introductory chapte let us return briefly to olrr opening themc, Whv study economics? Perhaps the best ans\\er to the question is a fmous orre given by Keynes in the final lines of The General

l'heor1

oJ

Ernpktyrnent, Interest an.d Mon,e1:

Sirnilar situations occur pcriodicrlh. cluring

business-cvcle rcccssions. The latest grorvth slolt dol,r.n

The ideas of economist.s and political philosophers, both rvhen thev are rieht ancl rvhen they are \\Toltg, are rrrore ponerful than is cornrnon]r,unclersloocl. Indeed the u.orld is nrlecl b-v little else. Plactical rnen, tho bclier,e themselves to be quite exempt from any intellecttral influences, are usually the slar,es of srme rlefirnct ccorronist. Madmen in authoritl,, r,ho hear r,oices in the ai rrc distillirrc their frenzl, from sorne acaclernic scribbler of a ferr, r,errs back. I am strre thzrt the porver of vestcd intercsts is vastlv exaguerzrtecl c<npared r.ith the gradrLal cncrorchment of ideas. Not, irrdeecl. irumediat.eh', but after a certrin interval; lbr in the field <f ecrnomic ancl political pl'rilosopl'n, thcrc are n<t rrranv rvho are influencccl bv ncrr, thcorics aflcr thel are fiven.five or thirtv vears of lrgc. s,, that tl-re iclcas rvhich civil sen,arts arrcl politicians ancl even :rqilators appl1'to clrrrent events arc ltot 1ikel),t.) be the nervcst. But, soon or lirte, it is irlcrs, not \,ested interests, rvhich are dangelous for eood or evil.

occurred in 2007-2008 rrhen problems in housing aud creclit rnarkcts spread through the entire cconornri The econcmv's r-rnderlying procluctivity had

To rurrlerstand

hor,r,

the powerfirl icieas of econorl-

ics apph tc thc central issues of'human sociedesrLltinrateh, this is ,l,hy 'l,r,e stud,v economics.

f.,O\CEPTS FOR REVIEW

t5

SUMMARY
A. Why Study Economics? 1. \Vhat is economics? Economics is the study of horv )ocicties choose lo use \carce pr.Udrrctive aaro,,aa".
that have alternative uses, to produce cornm<tdities of. various kinds, and to distribute thern among different groups. We study economics to understancl not onlv the tvorld we live in br-tt also the many potentiai $orlds that refbrmers are constantly proposing to us. 2. Goods are scarce because people desire much rnore than the econorny can produce. Economic goods are scarce, uot free, and society must choose rmong thc limiterl goods that can bc produced rvith its availablc resoulces. 3. Microeconomics is concernecl rvith the behar.ior of individual entities such as rnarkets, firms, ancl house_ holds. Macroeconornics vielvs the pcrformance of the econon)v as a r,hole. Through all economics, bcr.arc of the fallacy of cornposition and the post hoc fallao,, and rcmember to keep other things corlstallt. combinations of command and market: all societies
are mixed econrmies.

C. Society's Technological possibilities 6. Ulith given resources and tcchnoloe.y. the production
choices behvecn trvo goods such as butter and guns can be sumnrarize d tn the prod,uction-po.ssibiti\ fiontier (ppF ) . -fhe PP-F shorvs horv the pr.odtrctior-r of onc eood (such as guns) is traded offagainst the production ofanother

sood (such as butrer). In a rvorld of scarciry choosing one thing mcans givine up something else. The r.aluc

7. Productive efficiencl, occrtrs when production of

of the rood or serl.ice forgone is its opportuniry cost.

one

8.

B. TheThree Problems of Economic Organization

{.

5.

Er.erv societv must ans$er three fundamental ques_ tions: uhat, h,out, and for zLth,om? What kincls ancl quinti_ tics are produced among the wide ranse of all possible goods and services? floatare resources used in prorlucring these goods? And for ul'rrnare the goods produced (that is, u,hat is the distribution of income ancl con_ sumption arnons diflrent individuals ancl classes)? Societies ans\\rer these questions in different \,\,.a\.s. The n]ost important fbrms of economic orgarrization toda,v
an:e commctnd and m.a,rhet. The comrnand econornl is directcd by centralized q.o\ernment control: a market economy is guided b1, an inltrrnral stst.tm of prices and profits in ivhich most decisions irre macle by pri_ vate individuals and firrns. A1l societies have clifferenr

and odrer necessities as it clcvelops. [rorr, a counl.ry

chooses bcfiveen pri\ate goods and public goocls, ancl holv societies choose bet.ryeen consurnption goods anci capital soods that enhalrce future consunrption.

tion of another good. This is illustrated bv the p1,L Whcn an economy is o its ppfl it can p.r,,.. ,rro.. of one good onl1, by producing iess of another grocl. Production-possibilit,v fronl.iers illustrate many basic economic processes: how economic grorvth pushes out the frontie hol, a natiiin chooses relatir.ely less foocl

goocl cannot be increased u,ithout curtailing produc_

9. Societies zrre sometimes inside their

procluction_ possibility frontier because of rnacroeconomic business ct,cles or microeconorlic rnarkct failures. \Arhen creclit conditions are tight or spending sudclenl_v dcclines, a society moves inside its ppI in r-ecessions; this occurs
because of rnacroeconomic rigidities, not because

technclosical forgetting. A societl,can also be insidc tts l'PF if markets fail because prices clo lrot reflect social priorities, such as .r,l.ith environmental cleerada_ tion fiorn air and rvater pollution.

of

CONCEPTS FOR REVIEW

Fundamentat Concepts
scarcity and efficiency fiee goods vs. economic goods I nJCl oeconom ics a r n' ;ar."cotrolnic\

Key Problems of Economic

Organization
ohut,
h.ow,

Choice among Production Possibilities

inputs ancl outlllrts

nornraliUc r.. po.itivc economicr fallacy of cimposition, post hoc fallacv "keep othcr t.hinss conitarrt"

altelnatit'e econornic systcms: cll11 vr. markrt

laissez-faire mixecl econornies

and Jitr zohom

prodrrctionlossibility frontier (ppp

procluctile efficiencv zrnd inelflciency opportunin-cost

t6

CHAPTER

IHE

C]ENTRAI, C]ONCEPTS OF ECONO\{ICS

FURTHER READING AND INTERNET IYEBSITES

Further Reading Robert Heilbroner, The Wodl l,ltiktsophers, 7th
f<runcl at.
ed. index.ltlttt[.
atutut.
b ib

Lio tn a,ni, a.. t o rn

/ N o nlrit:t

io n

/,\

tn

i Lh,

We

alth

(Touchstone Books, 1999), provides a livell,bioeraphy of the greal. ccorromists along rvith their ideas and irnpact. The rut.horitrtir.e n-ork on the historv of cccnorlic anah,sis i s.|ose ph Sclru m pe te Il is t or o E t: o n. o m c A rLal.v.s ( Mc Ci.rau. f
i.

Log on to one of the Internet ref-etcrrce sites for ec()nontics

srrclr as Ptesourr:e.s Jor Etonotnist.s o'n. the Intern,el (uutzu..rfe.org). Brorvsc through somc of the sections to frmiliarizc l,ourself

Hili, Nel,York,
Websites

litl-r the sitc. Ytru might tant to look up jvour college or

ttniretritr. look trl tecenl nC\\s in a nc\vsptperor magazirre. or check somc ec()n()rnic data.
T\vo sites lcr exccllent irnalyses of public policv issues irr econonrics are thosc of the Brookings Institutic>n (utzrzLt. took.edu) and of the Arnerican Entcrprise Institute (z.rrzrrzr. aei.org). Each of these publishcs borks and has polio, bricli online-

195,+).

()nc of thc greatest books of all economics is Aclarn Smith, Tlrc Wealth of Nations (rnan,v publishers, 1776).
Every ec<rromics stuclent shotrld read a ferv pages to set the flavor of lris rvritine. The \Yealth of Nuti.ons can be

QUESTTONS FOR DTSCUSSION

l. The grcat En{rlish economist Alfrecl Mrrshall (18421924) invented man,v <f thc tools of modern L-cononrics, but he l,as most concerned rvith the applicat.ion of thcse tools to the problems of sociei In his inzrugural Iecttrre. Marshall .lvrote:

3. l)cfine 4.

each of the follorvine temrs carcfirllv ancl give exarnples: PPfl scarci,, plocluctive effi ciclc_r., inputs.
olrtPuts.

lill be lnl nlost chcrishecl :urbition to incr.eirse the numbers who Camtrridsc Universitv sends orrl into the ruorld 'nith cool heads but u.arm hearts, r,villing to rirc sornc of their best porvers to grapplino with the social suffeliug- :rrouncl tht:nt; r'esolr,ed not to rest colltent till tlter. h:l,e opcnecl up to ;rll the rnatcrial rneans of a refined rncl noble lif. ll,lernorinl.s olAlfrud l[arslnll, A. (]. Pisou, ecl. (Macrnillan and Co., Lorrdon, 1925), p. 174, rvirh l,-inor
It
e

on timc use (p. I3). Then do the exercise in t.he last paragraph. Constnrct a tablc that. cornpares r,our tirne use r,r,ith that of the at,cragc
Reacl the special scctiori

American. (For a graphical analvsis, see quest.ion i) of' the appendix to this chaptcr.) 5. Assume that Ecrnrland produces haircuts and shirts lith inputs of labor. Eccnolrnd has 1000 hotrrs of lalror rvailable. A haircut. requires 1l hour o.l labo rvl'ri1c a shirt requires 5 hours of lrlor. Clonstrtrct Econolancl's
procluction-possibilin, fron
ti cr.

clits. I

6. Assunle that scientific inventions have doubled the

producti\it\. of societr,'s res()urccs in butter procluction
r,r,iIhorLt llterine the ploductir,ilv of srr mafact,r'c. Rech'aw societl"s ploduction-possibilitv Iirntier Fi s-

Explain horv the cool heacl might proviclc the essenl.ial positive econimic :rnal1'sis to irnltlement the normative r,:rluc jurlgments o{ the tr,atm heart. Do y()u agrcc rvith Ntlarshall's r.iei,v of the rolc of the te:rcher? L)o r.ou
acrcept his challengc?

il

7.

2. The

la1.c

George Stielcl, un ernilcnt corrsr.rratir,e Chi-

cag() econolr)ist, r\rotc as follor,r,s:

No thoroughh, egalitarialr socie tl h:rs ever bccn able tc corrstruct ol rnaintrin an efllcicnt an<l proar.essive ecrr nol]ric system. It has bcen unitcrsal expericnce tht sonrc: sr-stem ol diffel'ential rcrr,:rrcls is ne cessar.l to stimulate rurrrkcrs. fTh.c T heor rf Price, 3d ed. (N1acrnillan, Neir, York, I9tl6), p. I9.l

Are these st?rternents positive or normative ecoltonticsr I)iscuss Stiglcr's vie.rv in li3*hr of ,,Ufied \,Iarshall's qrrote in qtrestion 1. Is there a crnflict?

8.

to illustratc thc neu, tlacleoff. Sornc scientists belicvc that \\e arc rapidly clepleting our nal.rrral 1es()rlrces. Asstrme that there are onlv tr,r,ct inputs (labor and natlrral resources) plochrcirg tuo goods (conccl'ts arlcl gasolinc) rvith no inrpror,crnent in societt,'s technologv r>r,er til'nc. Shor. r,r,l'rat r,r,oulcl happcn to t.l-re PPTrover tine as natural resr)llrces are crhausted. Hol, l,ould inr.ention and technological irnprovernent nlodih'1rr ztnsler? On the brsis of this cx:rrnple, explairr wh),it is said that "econornic gl'owdl is r race betlyccn clepletion atrd invention." Srv thrt Diligent has 10 horLrs t() studv fbr upcortriuq tcsts ili economics arrd hist.oly. Dra.w. a PPF l<':'r rlades, givcn Diliuent.'s lirnitecl timc resonrces. If Dilient
1-2

ure

QUESTIONS FOR DISCUSSION

l7
to loud music
and b.

studies inefficiently by listening

your discussion with a carerllv drarr"n

-PPF

for

chatting with friends, where will Diligent's grade "output" be relative to the PPF? \44rat will happen to the grade PPf if Diligent increases study inputs from

9.

10 hours to 15 hours? Consider the PPFfor clean air and automobile travel. a. Explain why unregulated air pollution in automobiles would push a country inside its PPI Illustrate

these two goods. Next explain how putting a pce on harmfirl autc mobile emissions would increase bo goods and move the country to its PPE Illustrate bn-shoning how correcting the "market failure- r-ould change

the final outcome.