Economics, Scarcity, and Choice

This is Unit One of Principles of Macroeconomics, part one of two: what economics studies, and the ideas the rest of the course is built on. Carry one idea through this lecture. Scarcity forces choosing, and the real cost of a choice is what it gives up rather than what it costs at the till. That idea is named early, made computable near the end of this part, and then bounded by a cost that should be left out of the decision altogether. By the end you will be able to say what scarcity is and why it is not poverty. To state the opportunity cost of a choice and tell it from a purchase price. To explain why dividing work raises output, and why it pays only if there is a way to trade. To trace a payment to the right market in the circular flow. And to work an opportunity cost out of two prices.

Three entries on the problem the subject begins with: what economics studies, the condition that forces choosing, and what a choice costs.

What the subject studies.

MAC 0001 What Economics Studies

Economics studies how people choose when they cannot have everything, and individuals, households, firms and governments all face that problem. A student picks courses, a firm picks products, a government picks a budget. It is a set of questions and tools rather than a list of facts: it lights up the choices without dictating the answer.

The condition that forces choosing.

MAC 0002 Scarcity and the Three Questions

Scarcity means wants exceed the resources available, so every society must answer three questions: what to produce, how to produce it, and for whom. Time is the sharpest case, since everyone gets twenty-four hours a day and no more. Scarcity is not poverty: a wealthy person cannot buy every good, and must still choose how to spend an hour.

What a choice costs.

MAC 0003 Opportunity Cost

The opportunity cost of a choice is the value of the best alternative given up, and every choice has one. A year at college costs tuition and the earnings given up while studying. It is not the purchase price: time given up can cost more than money spent, and it never appears on the receipt.

Four entries on the first answer to scarcity: dividing the work, why that raises output, what it depends on, and the resources an economy produces with.

The first answer to scarcity.

MAC 0004 Division of Labor

Adam Smith described the division of labor in seventeen seventy-six: split production into separate tasks and give each to a different worker. His pin factory split the work into eighteen tasks, and ten specialized workers far outproduced ten working alone. This is the first answer to scarcity, because the same resources yield more output when the work is divided.

Why dividing the work produces more.

MAC 0005 Why Specialization Raises Output

Specialization raises output for three reasons: workers do what suits them best, they improve with practice, and larger scale lowers the average cost per unit. A factory building fifty thousand cars a year pays less per car than one building a hundred. The first reason previews comparative advantage; the third is called economies of scale, and it returns in unit seventeen.

What specialization depends on.

MAC 0006 Specialization Requires Trade

A specialist produces one thing and needs everything else, so specialization works only if there is a way to trade, and markets provide it. A software developer sells code and buys food, clothing and shelter from others who specialize. The gain from specializing is inseparable from the gain from trade, which is why unit seventeen treats them together.

The resources an economy produces with.

MAC 0007 Factors of Production

The factors of production are labor, capital and natural resources. Capital is anything produced in order to produce something else, and human capital is skill gained from education and experience. A hammer, a road and a software program are capital. Money is not: a firm cannot produce with money directly, only buy capital with it, so money is financial capital instead.

Three entries that set the frame: the two halves of the subject, what macroeconomics aims at, and the two instruments governments hold.

The two halves of the subject.

MAC 0008 Microeconomics and Macroeconomics

Microeconomics studies individual agents: households, workers and firms. Macroeconomics studies the economy whole: production, unemployment, inflation, deficits, exports and imports. One biologist studies a single fish species; another studies the whole lake. They are not rivals, because firms hire more when the whole economy grows, and the macroeconomy is the sum of millions of micro decisions.

What macroeconomics aims at.

MAC 0009 The Three Macroeconomic Goals

Macroeconomics is organized around three goals: growth in the standard of living, low unemployment, and low inflation. Every model in this course speaks to at least one of them, and units four, five and six take the three one at a time. A fourth goal, a sustainable balance of trade, is added once the open economy arrives in unit seven.

The two instruments governments hold.

MAC 0010 Monetary Policy and Fiscal Policy

Monetary policy is set by the central bank and works through interest rates and bank lending. Fiscal policy is government spending and taxation, set by the legislature and the executive. The Federal Reserve runs monetary policy; Congress and the President set fiscal policy. Both are named here and taught later, monetary policy in unit twelve and fiscal policy in unit fourteen.

Three entries on how economists reason: what a model is, the first model in the course, and how to follow a single payment around it.

How economists reason about this.

MAC 0011 Theories, Models and Ceteris Paribus

A theory is a simplified representation of how variables interact, and ceteris paribus means all other things unchanged, the assumption that isolates one effect from the rest. A map omits most of the landscape and is more useful for it. In the world everything changes at once, so the assumption is never literally met, and every economic test must work around it.

The first model in the course.

MAC 0012 The Circular Flow

The circular flow puts households and firms in two markets. In the goods market firms sell and households buy; in the factor market households sell labor and receive wages. Goods travel one way around the circle and payments travel the other. This version has two sectors only, and unit three adds government and the rest of the world.

Following one payment around it.

MAC 0013 Tracing a Payment Around the Circular Flow

To trace a payment, ask who is paying whom and what moves the other way. Households sell the factors of production to firms in the factor market and receive wages, rent, interest and profit. Firms sell goods and services to households in the goods market. Money flows from firms to households as factor income and back again as spending, while goods and factor services travel the opposite way. A worker earning two thousand dollars a month at a bakery and spending four hundred of it on bread makes both trips. The usual slip is the wrong market, so ask what is being bought: a factor of production, or a finished good.

Three entries on how economies are organized, how to place a real one among them, and how economies connect across borders.

Who makes these decisions.

MAC 0014 Three Ways to Organize an Economy

Economies are organized three ways: traditional, where occupations pass down through families; command, where a government decides what is produced and at what price; and market, where decisions are decentralized. Ancient Egypt and the medieval manor are the standard command examples. No real economy is pure, and every market economy still needs rules that protect property and enforce contracts.

Placing a real economy among them.

MAC 0015 Placing an Economy on the Spectrum

To place an economy, ask three questions. Who owns the resources and the businesses, private individuals or the state? Who decides what is produced and at what price, buyers and sellers or an authority? And how far does government regulate what private owners may do? Private ownership with decentralized decisions sits at the market end, state ownership with central direction at the command end, and heavy regulation of private firms between the two, which is where most economies are. Two cautions: regulation alone does not make a command economy, since rules such as enforcing contracts exist in every market economy and are what make trade possible; and an economy moves along the range over time, so a placement describes a moment.

The connections between economies.

MAC 0016 Globalization, Exports and Imports

Globalization is the widening of economic connections across borders. Exports are produced at home and sold abroad; imports are produced abroad and sold at home. Containers, air cargo and telecommunications drove much of it. Large economies trade a smaller share of their output than small ones, because a big economy keeps more of its division of labor inside its own borders.

Four entries on choosing with a fixed budget: what one person can afford, reading a cost off that line, deciding at the margin, and the cost to leave out.

What one person can afford.

MAC 0017 The Budget Constraint

A budget constraint shows every combination of two goods a person can buy when all income is spent at given prices, and its slope is the ratio of the two prices. Points on or inside it are affordable; points outside are not. The line is straight because prices do not change with the quantity bought, which is what distinguishes it from the frontier.

Reading a cost off that line.

MAC 0018 Opportunity Cost from Two Prices

When income is fixed and two goods have fixed prices, the opportunity cost of one good is its price divided by the price of the other. Find the endpoints: income divided by each price gives the most of that good you could buy alone. The slope joining them reads as a sentence, one unit of this costs so many units of that. With sixty dollars a month, sandwiches at four dollars and bus rides at one, sixty dollars buys fifteen sandwiches or sixty rides, so one sandwich costs four rides. Double the budget and the endpoints double, but a sandwich still costs four rides. The two costs are reciprocals, and income moves the line without changing its slope.

How much more, rather than all.

MAC 0019 Marginal Analysis and Diminishing Utility

Marginal analysis compares the benefit and cost of a little more or a little less, rather than all or nothing, and utility is the satisfaction a good gives. Nobody decides whether to use water, but whether to take a shorter shower. That is the law of diminishing marginal utility: a buyer keeps buying only while the next unit is worth its cost.

The cost to leave out.

MAC 0020 Sunk Costs

A sunk cost is money or effort already spent that cannot be recovered, so it should not affect a current decision. Walking out of a bad film does not waste the ticket, which is spent either way. Opportunity cost looks forward at what a choice gives up; sunk cost looks back at what is already gone.

Look at what you can now do. You can say what scarcity is, wants exceeding the resources available, and why it is not poverty: a wealthy person still cannot buy every good. You can state the opportunity cost of a choice as the value of the best alternative given up, and tell it from a purchase price that appears on a receipt. You can explain why dividing work raises output, through suitability, practice and scale, and why a specialist needs a market to trade in. You can trace a payment to the right market by asking what is being bought, a factor of production or a finished good. And you can work an opportunity cost out of two prices, finding the endpoints and reading the slope as a sentence. Part two turns to the production possibilities frontier, where a whole society faces the same tradeoff, and to comparative advantage.