The Central Concepts of Economics: Economics 19E Paul Samuelson, William Nordhaus

Chapter 1
The Central Concepts of

Economics
Economics 19E
Paul Samuelson,
William Nordhaus
What is Economics?
Economics is the study of how societies use

scarce resources to produce valuable goods
and services and distribute them among
different individuals
*
We find two key ideas that run through all of economics:
1 2
Scarcity Efficiency
It means that society has limited resources Efficiency denotes the most effective
and therefore cannot produce all goods and use of a society’s resources in satisfying
services people wish to have people’s wants and needs.
 Goods are scarce and that society must use its resources efficiently.
 Given unlimited wants, it is important that an economy make the best use
of its limited resources.
 Economic efficiency requires that an economy produce the highest
combination of quantity and quality of goods and services given its
technology and scarce resources.
Essence of Economics
The essence of economics is to acknowledge

the reality of scarcity and then figure out how
to organize society in a way which produces
the most efficient use of resources.
*
Positive Economics versus Normative Economics
When considering economic issues, we must

carefully distinguish questions of fact from
questions of fairness. Positive economics
describes the facts of an economy, while
normative economics involves value judgments.
 Positive economics deals with  Normative economics involves

questions that can be resolved by ethical precepts and norms of fairness.
reference to analysis and empirical There are no right or wrong answers to
evidence. That puts them in the these questions because they involve
realm of positive economics. ethics and values rather than facts.
Three fundamental questions of
economic organization— what, how, and for whom —
 Every society must have a way of determining what commodities are

produced, how these goods are made, and for whom they are produced.
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 economy uses its existing technology to combine inputs to produce outputs.
 Outputs are the various useful goods or services that result from the production
process and are either consumed or employed in further production.
Factors of Production
Another term for inputs is factors of production . These can be

classified into three broad categories: land, labor, and capital.
 Land —or, more generally, natural resources— represents the gift of

nature to our societies
 Labor consists of the human time spent in production—working in
automobile factories, writing software, teaching school, etc.
 Capital resources form the durable goods of an economy, produced in
order to produce yet other goods.
Production-possibility frontier (or PPF)
The production-possibility frontier (or PPF) shows the maximum

quantity of goods that can be efficiently produced by an economy,
given its technological knowledge and the quantity of available
inputs.
This frontier shows the schedule along which society can
choose to substitute guns for butter. It assumes a given state
of technology and a given quantity of inputs.
 Points outside the frontier, such as point I, 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 unemployment is high during
severe business cycles.
Economic Growth Shifts the PPF 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 the 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 if it
desires.
Economies Must Choose between Public Goods and Private Goods

(a) A poor frontier society lives from hand to mouth, with little left over for public goods like clean air
or public health.
(b) A modern urbanized economy is more prosperous and chooses to spend more of its higher
income on public goods and government services (roads, environmental protection, and
education).
Investment for Future 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 even. They have the same PPF,
shown in the panel on the left, but they have different investment
rates. Country 1 does not invest for the future and remains at A1
(merely replacing machines). Country 2 abstains modestly from
consumption and invests at A2. Country 3 sacrifices a great deal
of current consumption and invests heavily.
(b) In the following years, countries that invest more heavily forge
ahead. Thus thrifty Country 3 has shifted its PPF far out, while
Country 1’s PPF has not moved at all. Countries that invest
heavily can have both higher investment and consumption in the
future
Opportunity Cost
 One of the deepest concepts of economics, opportunity cost. Because our resources are
limited, we must decide how to allocate our incomes or time.
 The concept of opportunity cost can be illustrated using the PPF.
In a world of scarcity, choosing one thing

means giving up something else. The
opportunity cost of a decision is the
value of the good or service forgone
 Example: Guns and Butter

Efficiency
 Economists devote much of their study to exploring the efficiency of different

kinds of market structures, incentives, and taxes.
 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 productive efficiency,
which is easily pictured in terms of the PPF.
 Efficiency means that the economy is on the frontier rather than inside the
production possibility frontier.
 Productive efficiency occurs when an economy cannot produce more of one

good without producing less of another good; this implies that the economy is on
its production-possibility frontier.
MARKET, COMMAND, AND MIXED ECONOMIES
A market economy is one in which individuals and private firms

make the major decisions about production and consumption.
 A command economy is one in which the government makes all

important decisions about production and distribution.
Mixed economy is the combination of market economy and

command economy

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The Central Concepts of Economics: Economics 19E Paul Samuelson, William Nordhaus

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Chapter 1

The Central Concepts of

Economics is the study of how societies use

The essence of economics is to acknowledge

When considering economic issues, we must

 Positive economics deals with  Normative economics involves

 Every society must have a way of determining what commodities are

Another term for inputs is factors of production . These can be

 Land —or, more generally, natural resources— represents the gift of

The production-possibility frontier (or PPF) shows the maximum

 Points outside the frontier, such as point I, are infeasible

 Any point inside the curve, such as U, indicates that the

Economic Growth Shifts the PPF Outward

Economies Must Choose between Public Goods and Private Goods

 The concept of opportunity cost can be illustrated using the PPF.

In a world of scarcity, choosing one thing

 Example: Guns and Butter

 Economists devote much of their study to exploring the efficiency of different

 Productive efficiency occurs when an economy cannot produce more of one

A market economy is one in which individuals and private firms

 A command economy is one in which the government makes all

Mixed economy is the combination of market economy and

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