An Exercise in Connecting the Dots Today, over 1 billion people in the world go hungry while over 1 billion people are overweight. How do you explain this?

Connecting more dots How do you explain the relationship between the previous problem and the 3 features of the economic way of thinking: Scarcity and Choice Rational behavior Marginal analysis

The Economizing Problem part 1 Learning Objectives: Students will thoroughly and completely explain: The 4 basic input factors of production, The individual’s economizing problem, Society’s economizing problem. The basic types of economic systems, The circular flow model.

The Foundations of Economics SOCIETY HAS VIRTUALLY UNLIMITED WANTS... The economic wants of citizens, firms, and governments

BUT LIMITED OR SCARCE PRODUCTIVE RESOURCES! SOCIETY HAS VIRTUALLY UNLIMITED WANTS... The Foundations of Economics The means of producing goods and services

Goods & Services Provide... UTILITY A measure of satisfaction or pleasure.

Individuals want luxuries – goods and services Goods & Services Provide… UTILITY

Goods & Services Provide... UTILITY As well as necessities The objective of all economic activity Is to fulfill wants.

PROPERTY RESOURCES LAND - including ecosystem services Scarce Resources Types of Economic Resources

Property Resources - LAND - CAPITAL Scarce Resources Economic Resources Real Capital: Equipment, tools, machinery, buildings - Used to produce final goods! Financial Capital: Funds available for acquiring real capital!

Property Resources LAND CAPITAL HUMAN RESOURCES Scarce Resources Economic Resources

PROPERTY RESOURCES LAND CAPITAL HUMAN RESOURCES - LABOR – physical & Mental talents of individuals, Available and useable in the production of goods and services SCARCE RESOURCES ECONOMIC RESOURCES

Entrepreneurial Ability The Entrepreneur: – Takes the Initiative in combining resources – Makes Strategic Business Decisions that set the course of the business – Is an Innovator – The Risk Bearer – success is not guaranteed

PROPERTY RESOURCES LAND CAPITAL HUMAN RESOURCES LABOR ENTREPRENEURIAL ABILITY SCARCE RESOURCES ECONOMIC RESOURCES Also known as the Input Factors of Production

Resource Payments RENTAL INCOME INTEREST INCOME WAGES PROFIT & LOSS PROPERTY RESOURCES LAND CAPITAL HUMAN RESOURCES LABOR ENTREPRENEUR

The Individual’s Economizing Problem Characteristics: Limited income Unlimited wants A budget line – aka budget constraint Tradeoffs & opportunity costs Make best choice possible What happens when there is a change in income?

Budget Line (constraint) for the Individual DVDs $20 Books $ $120 Budget Income = $120 P dvd = $20 = 6 Income = $120 P b = $10 = 12 Attainable Unattainable Quantity of Paperback Books Quantity of DVDs 1-17

Society’s Economizing Problem Introducing the Production Possibility Model. A Production Possibilities Model illustrates the tradeoffs and output that are possible given a limited amount of input. It is important to understand because it can help display which options might allow a country to use their resources in the most efficient way possible.

Key Point: Make sure you understand this: To realize the best use of scarce resources, A society must achieve both full employment and full production! What does this mean?

Key Concepts of the model Full Employment – the use of all available resources Full production – all employed resources are used so they provide the maximum satisfaction of our economic wants. This implies two kinds of efficiency. Productive Efficiency – Production of any particular mix of goods and services in the least cost way. Allocative Efficiency – least cost production of the 1 set of outputs that society wants most.

The Production Possibilities model Assumptions 1.Full Employment and Full Production 2.Fixed resources – in both quantity and quality 3.Fixed technology 4.Two Goods – a consumer good and a capital good

Production Possibilities Assumes... Full Employment and Productive Efficiency Fixed Resources Fixed Technology Two Goods for example... PIZZA A Consumer Good

Two Goods Fixed Resources Fixed Technology Assumes... Full Employment and Productive Efficiency Production Possibilities for example... Robots A Capital Good

Using all of our resources, to get some more pizza, we must give up some more robots! for example... What if we could only produce... 10,000 Robots or 400,000 Pizzas Production Possibilities

PIZZA01234 (in hundred thousands) ROBOTS (in thousands) in table form Production Possibilities

PIZZA01234 (in hundred thousands) ROBOTS (in thousands) in table form graphical form Robots (thousands) Pizzas (hundred thousands) Production Possibilities

PIZZA01234 (in hundred thousands) ROBOTS (in thousands) in table form graphical form Robots (thousands) Pizzas (hundred thousands) Production Possibilities

PIZZA01234 (in hundred thousands) ROBOTS (in thousands) in table form graphical form Robots (thousands) Pizzas (hundred thousands) Production Possibilities

PIZZA01234 (in hundred thousands) ROBOTS (in thousands) in table form graphical form Robots (thousands) Pizzas (hundred thousands) Production Possibilities

PIZZA01234 (in hundred thousands) ROBOTS (in thousands) in table form graphical form Robots (thousands) Pizzas (hundred thousands) Production Possibilities

PIZZA01234 (in hundred thousands) ROBOTS (in thousands) in table form graphical form Robots (thousands) Pizzas (hundred thousands) Production Possibilities

At any point in time, a full-employment, full- production economy must sacrifice some of product X to obtain more of product Y. Limited Resources means a limited output... Production Possibilities

Q Q Robots (thousands) Pizzas (hundred thousands) A B C D E W Attainable but Inefficient Unattainable Attainable & Efficient Note: Every point on the curve represents productive efficiency Production Possibilities

The amount of other products that must be forgone or sacrificed to obtain 1 unit of a specific product is called the opportunity cost of that good. The Law of Increasing Opportunity Costs says: that in order to produce more of one good, more of some other good must be sacrificed. Law of Increasing Opportunity Costs

Q Q Robots (thousands) Pizzas (hundred thousands) A B C D E Attainable but Inefficient Explain the Law of Increasing Opportunity Costs using the PPC. Production Possibilities *

To find the point of allocative efficiency, you can use Marginal analysis, which involves: Comparing marginal benefits and marginal costs Here’s how to think about marginal analysis: 1.Any economic activity should be expanded as long as Marginal benefits exceed Marginal costs. 2.The optimal amount of activity occurs at MB=MC 3.No resources beyond the MB=MC point should be allocated to the production of that good. In fact, you should reduce the use of resources until you get back to MB=MC.

Q Q Robots (thousands) Pizzas (hundred thousands) A B C D E Attainable but Inefficient Where on the curve will the Point of Allocative Efficiency be found? Production Possibilities * Here’s How to Figure it out! Two Step Process: 1. Find the allocatively efficient quantity of Pizzas. 2. Then find the quantity of Robots that correspond to that quantity of Pizzas. Note: every point on the PPC consists of pizza – robot pairs!

P Q Marginal Benefit & Cost Quantity of Pizzas $ Production Possibilities MC MB Allocative Efficiency: MB=MC MB=MC Two Step Process Step One! 1.Find the allocatively efficient quantity of Pizzas. You are looking at the MB and MC associated with the production of different quantities of pizzas. The quantity of pizzas where MB=MC is the allocatively efficient quantity of pizzas. 200,000!

Q Q Robots (thousands) Pizzas (hundred thousands) A B C D E Production Possibilities Point of Allocative Efficiency Step Two! 2. Then find the quantity of Robots that correspond to that quantity of Pizzas (200,000). At 200,000, go up to the PPC, then go left, horizontally to the Robot axis. The point on the PPC where the vertical and horizontal lines intersect identifies the one point of allocative efficiency. Allocative efficiency means – 200,000 pizzas and 9000 robots will maximize the satisfaction of the society. But we must be able to product that combo at least cost!

Q Q Robots (thousands) Pizzas (hundred thousands) U Unemployment & Underemployment Shown by Point U Sort of like today! More of either or both is possible Production Possibilities

The ability to produce a larger total output - a rightward shift of the Production Possibilities curve caused by... 1 – Increase in resource supplies 2 – Better resource quality 3 – Technological advances Economic Growth This is a BIG Deal!

Economic Growth Q Q Robots (thousands) Pizzas (hundred thousands) A’ B’ C’ D’ E’ Production Possibilities

Two Examples of Economic Growth And the importance of today’s decisions on our future! Presentville - FAVORS PRESENT GOODS Goods for the Present Goods for the Future CURRENT CURVE FUTURE CURVE CONSUMPTION Production Possibilities Presentville

Two Examples of Economic Growth And the importance of today’s decisions on our future! Presentville - FAVORS PRESENT GOODS Futureville- FAVORS FUTURE GOODS Goods for the Present Goods for the Future CURRENT CURVE FUTURE CURVE CONSUMPTION Goods for the Present Goods for the Future FUTURE CURVE CONSUMPTION CURRENT CURVE Production Possibilities Presentville Futureville

Applications... Unemployment and Productive inefficiency Production Possibilities The Great Depression of the 1930’s Nations experiencing significant unemployment and unused / under used production capacity. Economies that allow discrimination of any kind

Applications... Unemployment and Productive Inefficiency Tradeoffs and Opportunity Costs Production Possibilities Should land be used for oil production or preserved as wilderness? Farming or waste disposal, Should corn be used for fuel or food? Should society devote more resources to homeland security or education?

Applications... Unemployment and Productive Inefficiency Tradeoffs and Opportunity Costs Shifts in the Production Possibilities Curves Production Possibilities More resources – increase in number of women in the workforce. Better quality resources – women becoming better educated and professionally trained. New technologies.

Practice constructing answers Please thoroughly and completely explain The Production Possibility Model Step 1 – write down the key points to include, in outline format Step 2 – add detail to each of the key points Step 3 – construct your response based on this outline

You should at least have these items Description of the model Assumptions of the model – list and explain! – full production and full employment – fixed resources – fixed technology – two goods – capital and consumer goods Key concepts – list and explain! – productive efficiency, define, relate to the curve – allocative efficiency - define, how to find and tool to use – Economic Growth What’s it mean, 3 prereqs, the futureville / presentville case, how to represent graphically. – Law of increasing opportunity cost Draw picture of the model