The Study of Economics & the PPF

Positive versus Normative Statements Example; Imagine that you are an economic advisor to the Premier of Ontario. What kinds of questions might the Premier ask you to answer? Question 1: How much would the revenue of Harmonized Sales Tax (HST) increase if the tax were raised by 1%? Question 2: Should the government increase the tax? There is a difference between the above two questions The first question is about facts The second question is a matter of opinion. Two people who agree on the effects of higher HST could still disagree about whether raising the tax is a good idea

The above example highlights a key distinction between two roles of economic analysis Analysis that tries to answer questions about the way the world works, is known as positive economics Positive Statements: are statements about what is. It is an expression that can be verified by observation. Example; The unemployment rate is 10%. Analysis that involves saying how the world should work is known as normative economics Normative Statements: are statements about what ought to be. It is an expression of opinion that cannot be verified by observation. Example; We should abolish the minimum wage.

Positive or Normative? Economics is a Social Sciences discipline. Economics should be made a compulsory credit for graduation of high school. Provinces to the east of Quebec have lower provincial income tax rates than those to the west of Quebec. The federal government should be made to balance its budget. The inflation rate is 2%. If the interest rate goes up, history has shown it is likely that the value of the Canadian dollar will increase.

Economic Choice Recall, economists study how people allocate their limited resources to satisfy their unlimited wants Because of limited resources, economic agents (individuals/households and firms) must continually make choices These choices are made according to the following four principles: Self-interest motive: economists assume that individuals pursue their own self-interest and are primarily concerned with their own welfare Economic agents will compare an actions costs and benefits when making choices Profit maximization: firms and producers supply consumers to maximize their own profit

Utility maximization: economists assume that whenever you make an economic choice, you are trying to maximize your own utility Note: Utility is subjective and differs for each individual and therefore it is difficult to quantify. It is not measured in practice Opportunity cost: the cost of any activity measured in terms of the best alternative activity that is forgone. That is, it is the cost of not choosing the best possible alternative Policy-makers must keep in mind the opportunity cost of each alternative Economic good: goods that are scarce Free good: are abundant (their production does not involve an opportunity cost) Question: What is the opportunity cost of going to university?

The Production Possibilities Frontier The production possibilities model illustrates the tradeoffs that society faces in using its scarce resources Each country or economy has a finite amount of the factors of production. The production possibility frontier (PPF) is a graph that compares the production rates of two commodities that share the same factors of production. The production possibilities model is based on three assumptions 1) An economy make only two products 2) Resources and technology are fixed 3) All resources are employed to their greatest capacity

The economy can produce at any point along the curve (A, B, C, D) Example; Assume an economy can produce two products, hamburgers and computers. The following is the production possibilities schedule, a table that shows the possible output combinations for an economy The economy can produce at any point along the curve (A, B, C, D) Points in the interior of the curve (F) are also possible combinations but some resources are not being used Points outside the PPF curve (E) are impossible to produce with this level of fixed resources. There are not enough resources Quantity of Hamburgers produced Quantity of Computers produced 1000 900 1 600 2 3

Over time the economy could increase its resources or productivity of these resources and shift the PPF curve outward. This is called economic growth

Law of Increasing Opportunity Costs The law of increasing opportunity costs exists because economic resources are not completely adaptable to alternative uses. As we increase hamburger production, resources which are less and less adaptable to making hamburgers must be induced, or "pushed" into hamburger production. The law of increasing opportunity costs gives the PPC a bowed out shape. Constant opportunity costs result in a linear PPC.

As the quantity of computers rises, so does the opportunity cost Example; As the quantity of computers rises, so does the opportunity cost Quantity of Hamburgers produced Quantity of Computers produced Opportunity cost of Computers 1000 900 1 100 600 2 300 3

The Science of Economics Science of economics: the application of the knowledge learned in positive economics to achieve the goals determined in normative economics. Economic goals include the following policy objectives Price stability Satisfactory rate of economic growth Sustainable growth Correct distribution of income/equity Efficient allocation of resources