AP Econ Chapter 2

Work on Activity 1-1

The foundation of economics is the economizing problem: society’s material wants are unlimited while resources are limited or scarce. A. Unlimited wants (the first fundamental fact): 1. Economic wants are desires of people to use goods and services that provide utility, which means satisfaction. 2. Products are sometimes classified as luxuries or necessities, but division is subjective. 3. Services satisfy wants as well as goods. 4. Businesses and governments also have wants. 5. Over time, wants change and multiply.

Scarcity “The first lesson of economics is scarcity: There is never enough of anything to satisfy all those who want it. The first lesson of politics is to disregard the first lesson of economics”. --Thomas Sowell

Remember -- ALL THESE RESOURCES ARE IN LIMITED SUPPLY. Resources or “Factors of Production” Land – Natural Resources Acreage, rivers, lakes, ports, (oil, precious metals, minerals) Labor – Human Resources Physical and mental talents that produce goods and services Capital – “stuff used to make other stuff” All manufactured goods & services used in producing consumer goods. Examples: Tools, machinery, equipment, trucks to carry goods, airplanes, etc. Entrepreneurship – the “boss” 1. Someone who takes the initiative in using or combining land, labor & capital to produce a good or service. 2. Someone who is innovative, a risk taker, and makes basic business decisions. Remember -- ALL THESE RESOURCES ARE IN LIMITED SUPPLY. And who is the “World’s Best Boss”? They are scarce!!!

The Four Factors of Production Resources beget production, which beget income, which beget wealth. The Four Factors of Production . 1. Land [natural resources] – Nature’s items [“gifts of nature”] A. In the earth - coal, oil, water, fossil fuels, etc. B. On the earth – vegetation and water C. In the atmosphere – sun, wind, and rain [Land is the starting point of all production. “Stuff” from which everything is made. Water Wind Fossil fuels Sun

“Hired Help” 2. Labor [human resources] {“effort”} anyone who works [“paid work”] [Labor is the “brain-power” and “muscle-power” of human beings] A. Physical – pro athletes & lumberjacks B. Intellectual – ministers, doctors & lawyers . *Most important resource – 70% of input cost “Hired Help”

Real Capital v. Financial Capital [tools, machinery, & factories] Can produce something directly with these FINANCIAL CAPITAL [stocks, bonds, and money] Can’t produce anything directly with these

production process (tools, machinery, and physical plants). 3. Capital Resources – all “man-made inputs” used in the production process (tools, machinery, and physical plants). A. Capital goods – produced goods [machinery, buildings, & tools] used to produce other goods. [crane, Ford plant, hammer] [products meant for “future consumption”] [Satisfy our wants indirectly] B. Consumer goods – products meant for “immediate consumption”. A product can be both a consumer good and a capital good –depends on its use. Ex: Jet aircraft used by a movie star [like Jim Carey] to visit friends (consumer good). The same aircraft used by a business manager to serve customers [capital good]. Ex: F150 pick-up to deliver produce [capital good] or take family to church [consumer good] “man-made inputs”

Rent Wages Interest Profits Land Labor Capital Entrepreneur . 4. Entrepreneurship – starting a new business or introducing a new product. “Sparkplugs” who introduce the product or start the new business. He combines land, labor, & capital to produce products. Resource payments. The resource owners receive rent [for the use of their land; wages [for their labor]; interest [payment for financial capital], and profits [for their entrepreneurial ability].

Economics: Employment and Efficiency A. Basic definition: Economics is the social science concerned with the problem of using scarce resources to attain the greatest fulfillment of society’s unlimited wants. B. Economics is a science of efficiency in the use of scarce resources. Efficiency requires full employment of available resources and full production. 1. Full employment means all available resources should be employed. 2. Full production means that employed resources are providing maximum satisfaction of our economic wants. Underemployment occurs if this is not so. C. Full production implies two kinds of efficiency: 1. Allocative efficiency means that resources are used for producing the combination of goods and services most wanted by society—for example, producing compact discs instead of long-playing records with productive resources or computers with word processors rather than manual typewriters. 2. Productive efficiency means that least costly production techniques are used to produce wanted goods and services. D. Full production means producing the “right” goods (allocative efficiency) in the “right” way (productive efficiency).

Production Possibilities Table A. Assumptions: 1.Economy is operating efficiently (full employment and full production). 2.Available supply of resources is fixed in quantity and quality at this point in time. 3.Technology is constant during analysis. 4.Economy produces only two types of products. B. Choices will be necessary because resources and technology are fixed. A production possibilities table illustrates some of the possible choices (see Table 2-1). C.A production possibilities curve is a graphical representation of choices. 1.Points on the curve represent maximum possible combinations of robots and pizza given resources and technology. 2.Points inside the curve represent underemployment or unemployment. 3.Points outside the curve are unattainable at present.

Assumes... Full Employment and Productive Efficiency Fixed Resources PRODUCTION POSSIBILITIES Assumes... Full Employment and Productive Efficiency Fixed Resources Fixed Technology Two Goods for example...

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

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

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

in table form PRODUCTION POSSIBILITIES PIZZA 0 1 2 3 4 (in hundred thousands) ROBOTS 10 9 7 4 0 (in thousands)

in table form graphical form PRODUCTION POSSIBILITIES PIZZA 0 1 2 3 4 (in hundred thousands) ROBOTS 10 9 7 4 0 (in thousands) graphical form (thousands) Robots Pizzas (hundred thousands)

in table form graphical form PRODUCTION POSSIBILITIES PIZZA 0 1 2 3 4 (in hundred thousands) ROBOTS 10 9 7 4 0 (in thousands) graphical form (thousands) Robots Pizzas (hundred thousands)

in table form graphical form PRODUCTION POSSIBILITIES PIZZA 0 1 2 3 4 (in hundred thousands) ROBOTS 10 9 7 4 0 (in thousands) graphical form (thousands) Robots Pizzas (hundred thousands)

in table form graphical form PRODUCTION POSSIBILITIES PIZZA 0 1 2 3 4 (in hundred thousands) ROBOTS 10 9 7 4 0 (in thousands) graphical form (thousands) Robots Pizzas (hundred thousands)

in table form graphical form PRODUCTION POSSIBILITIES PIZZA 0 1 2 3 4 (in hundred thousands) ROBOTS 10 9 7 4 0 (in thousands) graphical form (thousands) Robots Pizzas (hundred thousands)

in table form graphical form PRODUCTION POSSIBILITIES PIZZA 0 1 2 3 4 (in hundred thousands) ROBOTS 10 9 7 4 0 (in thousands) graphical form (thousands) Robots Pizzas (hundred thousands)

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

PRODUCTION POSSIBILITIES Q 14 13 12 11 10 9 8 7 6 5 4 3 2 1 Unattainable A B C W Attainable & Efficient Robots (thousands) D Attainable but Inefficient E Q 1 2 3 4 5 6 7 8 Pizzas (hundred thousands)

PRODUCTION POSSIBILITIES Notes... 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. LAW OF INCREASING OPPORTUNITY COSTS Q 14 13 12 11 10 9 8 7 6 5 4 3 2 1 Unattainable A B C W Attainable & Efficient Robots (thousands) D Attainable but Inefficient E Q 1 2 3 4 5 6 7 8 Pizzas (hundred thousands)

PRODUCTION POSSIBILITIES Notes... LAW OF INCREASING OPPORTUNITY COSTS A graph of the production possibilities curve will be CONCAVE - bowed out from the origin. Economic resources are not completely adapt- able to other uses. Q 14 13 12 11 10 9 8 7 6 5 4 3 2 1 Unattainable A B C W Attainable & Efficient Robots (thousands) D Attainable but Inefficient E Q 1 2 3 4 5 6 7 8 Pizzas (hundred thousands)

Law of increasing opportunity costs: 1. The amount of other products that must be foregone to obtain more of any given product is called the opportunity cost. 2. Opportunity costs are measured in real terms rather than money (market prices are not part of the production possibilities model.) 3. The more of a product produced the greater is its (marginal) opportunity cost. 4. The slope of the production possibilities curve becomes steeper, demonstrating increasing opportunity cost. This makes the curve appear bowed out, concave from the origin. 5. Economic Rationale: a. Economic resources are not completely adaptable to alternative uses. b. To get increasing amounts of pizza, resources that are not particularly well suited for that purpose must be used. Workers that are accustomed to producing robots on an assembly line may not do well as kitchen help.

Work on Activity 1-2

Allocative Efficiency: MB=MC PRODUCTION POSSIBILITIES Allocative Efficiency: MB=MC P Q Marginal Benefit & Cost Quantity of Pizzas $15 10 5 1 2 3 MC MB=MC MB

Allocative efficiency revisited: 1. How does society decide its optimal point on the production possibilities curve? 2. Recall that society receives marginal benefits from each additional product consumed, and as long as this marginal benefit is more than the additional cost of the product, it is advantageous to have the additional product. 3. Conversely, if the additional (marginal) cost of obtaining an additional product is more than the additional benefit received, then it is not “worth” it to society to produce the extra unit. 4. Figure 2‑2 reminds us that marginal costs rise as more of a product is produced. 5. Marginal benefits decline as society consumes more and more pizzas. In Figure 2‑2 we can see that the optimal amount of pizza is 200,000 units, where marginal benefit just covers marginal cost. a. Beyond that, the added benefits would be less than the added cost. b. At less than 200,000, the added benefits will exceed the added costs, so it makes sense to produce more. 6. Generalization: The optimal production of any item is where its marginal benefit is equal to its marginal cost. In our example, for robots this must occur at 7,000 robots.

Production Possibilities Curve Economic Growth More/better resources Better technology A’ 14 13 12 11 10 9 8 7 6 5 4 3 2 1 B’ A B C’ Unattainable Industrial Robots C D’ D Now Attainable Attainable E E’ 0 1 2 3 4 5 6 7 8 9 Pizzas

Economic Growth Demonstrating "Economic Growth" on a PPC Graph d a e b - ability to produce a larger total output over time. Economic Growth d a e b Capital Goods [Robots] f C Consumer Goods [Pizza]

Production Possibilities Two Examples of Economic Growth FAVORING PRESENT GOODS FAVORING FUTURE GOODS CONSUMPTION CURRENT CURVE FUTURE CURVE FUTURE CURVE Goods for the Future Goods for the Future CURRENT CURVE CONSUMPTION Goods for the Present Goods for the Present

PPC Questions From Previous AP Exams 1. An economy that is fully employing all its productive resources but allocating less to investment than to consumption will be at which of the following positions on the PPC to the right? a. A b. B c. C d. D e. E 2. Which of the following best explains the shape of the PPC for the two-commodity economy shown above? a. Opportunity cost of producing another unit of each stays the same. b. Opportunity cost of producing another unit of each decreases. c. Opportunity cost of producing another unit of each increases. 3. Which of the following is true of the PPC on the right? a. Point Q is attainable but undesirable. b. Point R is unattainable but undesirable. c. A technological improvement of watches would move the economy from T to P. d. There is unemployment at point T because workers e. The opportunity cost of moving from S to T is the # of watches given up. 4. If we move from B to C on the graph (right), the opportunity cost is? a. AH units of good Y b. OG units of good Y c. EF units of good X d. HG units of good Y A H G O B C

PPC AP Questions 5. Which of the following would cause the PPC shown (right) to shift outward? a. Reopening steel plants that had been closed b. Rehiring laid-off workers c. Using machinery for missile production instead of steel production d. Using machinery for steel production instead of missile production e. Developing a more efficient steelmaking process 6. Base on the graph (right), which statements are true? I. The opportunity cost of moving from P to R is 10 units of Y. II. The opportunity cost of moving from R to P is 8 units of X. III. The opportunity cost of moving from Q to R is 0 units. a. I only b. III only c. I & II only d. I, II, & III Missiles Steel Y X

Economic Growth PRODUCTION POSSIBILITIES Q Robots (thousands) Q 14 13 12 11 10 9 8 7 6 5 4 3 2 1 Economic Growth B’ C’ Robots (thousands) D’ E’ Q 1 2 3 4 5 6 7 8 Pizzas (hundred thousands)

Two Examples of Economic Growth PRODUCTION POSSIBILITIES Two Examples of Economic Growth ALTA - FAVORS PRESENT GOODS CURRENT CURVE FUTURE CURVE Goods for the Future CONSUMPTION Goods for the Present Alta

Two Examples of Economic Growth PRODUCTION POSSIBILITIES Two Examples of Economic Growth Economic Growth More/better resources Better technology ALTA - FAVORS PRESENT GOODS ZORN - FAVORS FUTURE GOODS CURRENT CURVE CONSUMPTION FUTURE CURVE FUTURE CURVE Goods for the Future Goods for the Future CONSUMPTION CURRENT CURVE Goods for the Present Goods for the Present Alta Zorn

Economic systems differ in two important ways: Who owns the factors of production and the method used to coordinate economic activity. A. The market system: 1. There is private ownership of resources. 2. Markets and prices coordinate and direct economic activity. 3. Each participant acts in his or her own self-interest. 4. In pure capitalism the government plays a very limited role. Laissez-faire 5. In the U.S. version of capitalism, the government plays a substantial role. B. Command economy, socialism or communism: 1. There is public (state) ownership of resources. 2. Economic activity is coordinated by central planning.

The Circular Flow The Circular Flow is an abstract, oversimplified model, showing how economic transactions [resources, products (g/s), and money] take place. iFuzzy iWuzzy 1 Products [goods/services] 2 a. Goods and services[iFuzzy] b. Consumer expenditures c. Land, labor, cap., entrepreneur d. Rent, wages, interest, & profits 1 2 Householders Businesses 4 3 3 Resources [Land, labor, cap., ent.] 4

The Circular Flow Resources Products D S D S 3 4 2 1 Product Market [iFuzzy iWuzzy] Product Market Resource Market 1 Resources [Land, labor, cap., ent.] 2 a. Goods and services[iFuzzy] b. Consumer expenditures c. Land, labor, cap., entrepreneur d. Rent, wages, interest, & profits 3 4 Householders Businesses 2 1 [iFuzzy iWuzzy] 3 Products [goods/services] 4

Products [Goods/services] Consumer expenditures Hog CIRCULAR FLOW MODEL RESOURCE MARKET 1 2 Mechanic Products [Goods/services] Consumer expenditures Land, Labor, Capital, Entrepreneur Rent, Wages, Interest Profits 4 BUSINESSES HOUSEHOLDS 3 3 4 PRODUCT MARKET

Products [Goods/services] Consumer expenditures Hog CIRCULAR FLOW MODEL RESOURCE MARKET 1 2 Mechanic 4 Products [Goods/services] Consumer expenditures Land, Labor, Capital, Entrepreneur Rent, Wages, Interest Profits BUSINESSES HOUSEHOLDS 3 1 2 3 4 PRODUCT MARKET