CHAPTER 1

The Central Idea

CHAPTER OVERVIEW
This chapter introduces the important economic concepts of scarcity, choice, and opportunity cost. It is
shown that all individuals, whether consumers or producers, must make decisions because their
resources are limited. Trade is introduced as a means by which all individuals can be made better off.
Specialization, the division of labor, and comparative advantage are discussed, as is the role of money
in reducing the transaction costs of trading. The concepts of scarcity and cost are formalized in the
presentation of the production possibilities curve, which is used to describe the choices facing an
economy. Finally, a market-based economy is compared to a command economy.

TEACHING OBJECTIVES
1. Introduce the concepts of scarcity, choice, and opportunity costs.
2. Show that all consumers and producers must make decisions. Choice is an inevitable component
of economics.
3. Argue that trade between individuals benefits all parties involved. Trade leads to a better
allocation of products between consumers and greater production among producers. Discuss the
division of labor, specialization, and comparative advantage.
4. Explain the construction of the production possibilities curve. Describe various points on, inside,
and beyond the curve. Relate its shape to increasing opportunity costs.
5. Use the production possibilities curve to depict economic growth.
6. Compare a market economy with a command economy. Show that prices and markets permeate
the framework of a free market economy. Discuss prices as signals and how they provide
incentives.

KEY TERMS
economics
scarcity
choice
economic interaction
market
opportunity cost
gains from trade
division of labor
comparative advantage
international trade

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2 Chapter 1: The Central Idea

production possibilities
increasing opportunity cost
production possibilities curve
market economy
command economy
freely determined prices
property rights
incentive
market failure
government failure

TEACHING TAYLOR AND WEERAPANAS ECONOMICS

The overriding economic themes of scarcity, choice, and opportunity cost are first introduced for the
individual and then for the economy as a whole through the production possibilities curve. This chapter
initiates the idea that people, as consumers and producers, benefit from free exchange.

LECTURE OUTLINE AND TEACHING TIPS

I. Scarcity and Choice for Individuals
A. All individuals, whether consumers or producers, must make choices. Because the resources
used to satisfy wants are limited, all choices have opportunity coststhe next best
alternative given up.
B. In a world of scarcity, trade can make everyone better off. An example is shown in Figure 1.
By reallocating goods, trade benefits all parties; trade is not a zero-sum game.
C. Trade also permits producers to specialize and take advantage of the division of labor. This
can been seen in the concept of comparative advantage; people specialize in the things in
which they have a relative advantage. This allows opportunity costs to be minimized.
Teaching Tip
Discuss trade within a household. A family member may withdraw from the labor force in order to rear
a child. Could this decision be based on comparative advantage?
D. International trade recognizes that exchange between people takes place across borders and
among many people. The gains from international trade are the same as the gains from trade
within a countrys own borders.
II. Scarcity and Choice for the Economy as a Whole
A. Scarcity, choice, and opportunity cost may be viewed from the perspective of an entire
economy. This is done with a production possibilities curve. The data in Table 1 are used to
construct Figure 2.
B. The shape of the production possibilities curve is determined by the ease with which
resources may be switched between the two goods listed on the axes. The curve bows
outward because resources are not equally productive in all uses. This is called increasing
opportunity costs.
Teaching Tip
You may wish to discuss briefly the link between increasing costs and diminishing returns that will be
covered in Chapter 6.

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 Chapter 1: The Central Idea 3

C.Identify efficient, inefficient, and impossible points on the production possibilities curve.
The curve may be shifted to depict growth and to make impossible points possible.
Teaching Tip
Make one axis of a graph consumer goods and the other capital goods. To produce more capital, the
economy must give up consumer goods. The production of capital is called investment, and that which
was given up may be called savings. In this way, the importance of savings to economic growth can be
shown.
III. Market Economies and the Price System
A. All economies must answer three essential questions: what is to be produced, how these
goods are to be produced, and for whom the goods are to be produced.
Teaching Tip
Stress that these questions exist because of scarcity. They do not occur because one type of economy is
selected over an alternative type. Thus, economic theory is useful across economies.
B.Two general types of economies are seen in the world today, market economies and
command economies. Command economies have not been very successful in addressing the
three essential questions. Many have started a transition from command to market. The
Chinese command economy has evolved into one referred to as market socialism.
C. A market economy has some key features.
1. Prices are freely determined in a market economy.
2. Individuals own property in a market economy. Private property rights are protected
and provide incentives.
3. A market economy does not restrict the ability of individuals to trade in domestic and
foreign markets.
4. There is a role for government in a market economy. This may be appropriate in areas
of market failure. Yet, government failure is also possible.
5. Many other organizations outside of markets make decisions in a market economy.
Corporations usually make decisions out of a command structure but also have internal
incentives.
D. Prices play a central role in market economies. They send signals, provide incentives, and
affect the distribution of income. In a sense, a market is a messenger and price is the
message.
E. Markets do not have to have face-to-face transactions. Market transactions can also be over
the Internet (eBay) or over the radio (Tradio).
Teaching Tip
Make sure that students see that opportunity costs are behind prices. It may be the case that a movie
costs $5.50, but what is important is that $5.50 of something else must be given up.

DISCUSSION TOPICS
1. Have students draw a production possibilities curve using grades and student government
activities as the production possibilities. What determines where the curve hits the axes? Can the
curve shift?
2. Discuss the role of labor market activity and wages of women in determining the number of
children in a family. Are wages of women a measure of the opportunity cost of children? Why do
some households employ nannies?

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4 Chapter 1: The Central Idea

3. Many formerly command economies are moving toward more market-based systems. Explain this
movement in terms of the three questions economies must answer. Does this evolution relate to
the ability to answer the questions?
4. Discuss the idea that private property rights may be a way to protect the environment. Does
making a redwood forest someones private property mean that others can be excluded by the
owner?
5. Ask how many students have used the Internet for trade. What was their experience? Did they get
what they expected compared to what they get from transactions that are made face-to-face?

SOLUTIONS TO END-OF-CHAPTER PROBLEMS

1. The limited budget for guest speakers means that you have to make some choices. You can bring
in Stephen Colbert for one lecture or bring in both Will Ferrell and Jon Stewart or have ten
lectures by former economic advisers to the president. You can't bring in Stephen Colbert and Jon
Stewart or Stephen Colbert and an economic adviser, even though you would really like to hear
both of them speak. In making your decision you have to consider the opportunity cost of bringing
a big name speaker to campus, which is the opportunity to hear another, slightly less interesting
speaker.
2. Your opportunity cost, like Ms Wie's is the income you could have earned if you had worked
instead of going to school. Of course the money you could have earned at your job would
probably be much less than what Michelle Wie or Tiger Woods would have earned at their job.
3. The opportunity cost of any choice is the next-best or second-best alternative given up. Allisons
opportunity cost of ranking the consulting job first is not being able to attend a local community
college. The third alternative involving world travel has nothing to do with the opportunity cost of
consulting. An opportunity cost is the next-best alternative given up.
4. Assuming that people like chocolate and milk, both of us are better off if we trade chocolate and
milk. We both gain from a better allocation. There is no production going on in the question. We
both lose if trade is prevented.
5.
a. Tina is producing 30 brownies and Julia is producing 15 poems. Total production is 45
brownies and 4 poems.
b. Gains from trade are possible because they have different comparative advantages. This is to
say, they have different relative efficiencies in the production of brownies and poems.
c. Total production will be 5 poems and 50 brownies.

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 Chapter 1: The Central Idea 5

6.
a. Figure 1.1 shows the tradeoff between grades in math and grades in English.
English
Grade
100
90
80
70
60
50
40
30
20
10
0
0 20 40 60 80 100
Math Grade

Figure 1.1
b. The opportunity cost of increasing the time spent on math from 80 to 100 percent is 50
points on the English paper, a decrease in the English grade from 50 points to 0 points. The
opportunity cost of increasing the time spent on math from 60 to 80 percent is 20 points on
the English paper, a decrease in the papers grade from 70 to 50 points.
c. There are increasing opportunity costs from spending more time studying math. This is
because additional time spent on one subject takes away from the time available for the other
subject, and time taken away from that subject becomes increasingly valuable when less
time is available for that subject.
d. Given the figures in the chart, your would tell your parents that there is no distribution of
time between English and math that will create a grade of 92 on both. Therefore, the tradeoff
curve needs to shift to the right. You might use this opportunity to have them buy you a new
computer!

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6 Chapter 1: The Central Idea

7.
a. Figure 1.2 depicts the production possibilities curve between cars and cakes.

150
Cars
125

100

75

50

25

0
0 100 200 300

Cakes

Figure 1.2
b. PPF shifts out mainly in the production of cars.
8. First, if Huey is not very efficient (inside his PPF) at either studying or having fun, Tracy may
help with both by helping Huey be more efficient at having fun and studying. Huey would move
toward his PPF. Second, if Huey is efficient (on his PPF), Tracy may know something new about
how to study and how to have fun. Here, Hueys PPF shifts outward. In either case, Huey is not
being efficient.
Figure 1.3 shows how Hueys economics grade could be increased without affecting his grade in
mathematics starting from an inefficient situation.

Figure 1.3

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 Chapter 1: The Central Idea 7

9. Oil is bought and sold on a world market. A higher price tells U.S. producers that their oil is more
valuable and encourages them to increase production. The higher price redistributes income away
from consumers of oil toward producers of oil.
10. Nearly any good or service can be put into the sentence to produce a true statement. The statement
will not work, however, in the case of some public goods (for example, national defense), goods
that involve externalities (such as clean air), services in which the transport costs are prohibitive
(haircuts), goods and services that are explicitly illegal (illicit drugs), or human beings themselves
(that is, slavery is illegal).

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