Chapter 2- The Economizing Problem 2/21/2019 Chapter 2- The Economizing Problem Objective – Students will be able to answer questions regarding how economists solve economic problems. SECTION 1 © 2001 by Prentice Hall, Inc.

Key Assumptions in Economics People are rationally self-interested They seek to maximize their utility (happy points) People generally make decisions at the margin They weigh the marginal benefit against the marginal cost of a decision Ceteris Paribus Economists hold factors constant, except for what’s being considered

Resources a.k.a. The Factors of Production Economists classify resources into 4 categories 1. Land Natural resources The payment for Land is RENT 2. Labor Human resources The payment for Labor is WAGES

Resources a.k.a. The Factors of Production 3. Capital (a product of Investment) Tools, machines, factories The payment for Capital is INTEREST 4. Entrepreneurship The special ability of risk-takers to combine land, labor and capital in new ways in order to make profit The payment for Entrepreneurship is PROFIT

The Fundamental Problem of Economics: Scarcity People have unlimited wants but the resources to satisfy those wants are scarce. Therefore, we must make choices about how to use our scarce resources. We face trade-offs when it comes to using available resources. Ex. Assume flour is a scarce resource: 3 cups of flour can be used to make a loaf of bread or a cake, but the 3 cups cannot be used to make both.

Opportunity Cost Once a resource or factor of production has been put to productive use an opportunity cost is incurred. Opportunity cost is the next best alternative use for a resource. Ex. If the 3 cups of flour are used to bake bread, then the opportunity cost is the cake that could also have been baked with the 3 cups of flour. No matter what we do with our time or resources, we always incur opportunity cost.

The PPC The PPC = The Production Possibilities Curve The PPC = a graph showing all of the possible combinations of output for an economy fully employing all of its resources in producing 2 goods.

Introduction The Production Possibilities Frontier (PPF) is a graph that shows all possible combinations of two goods when an economy is producing at full potential. It does not actually show reality, since it assumes only two goods are produced. It is a simplification that shows what sort of trade-offs would be made in reality. It only shows what can be produced – not what would be consumed.

Production Possibilities A production possibilities graph shows alternative ways that an economy can use its resources. Watermelons (millions of tons) Shoes (millions of pairs) 25 20 15 10 5 Production Possibilities Graph a (0,15) 15 8 14 b (8,14) 14 18 20 21 12 9 5 A production possibilities frontier c (14,12) d (18,9) e (20,5) f (21,0)

PPF for the Country ALPHA The frontier shows the limit of what can be produced – all possible combinations when all resources are fully utilized. Guns Butter

PPF for the Country ALPHA All resources are being used to produce guns. 1500 Guns Butter

PPF for the Country ALPHA All resources are being used to produce butter. 1500 Guns 2000 Butter

PPF for the Country ALPHA 1100 Guns 1500 Butter

PPF for the Country ALPHA At point A (and at any point on the frontier), production is EFFICIENT. A Guns Butter

PPF for the Country ALPHA At point B (and at any point inside the frontier), production is INEFFICIENT. B Guns Butter

PPF for the Country ALPHA A and B represent tradeoffs. A produces more guns, B produces more butter. A B Guns Butter

PPF for the Country ALPHA The opportunity cost of A equals the decrease in butter: 1100 units. A 1400 B Guns 800 600 1700 Butter

PPF for the Country ALPHA The opportunity cost of B equals the decrease in guns: 600 units. A 1400 B Guns 800 600 1700 Butter

Five Variables that Shift the PP Outward (to the right): Increase the productive labor force (productivity). Increase the quantity and quality of natural resources. 3. Increase the quantity and quality of capital. 4. Increase health and education. 5. Increase technology.

PPF for the Country ALPHA Growth Guns Butter

Section 1 Assessment Describe a trade off you have made in the past. What was the opportunity cost of that trade off? 2. Describe a factor that would shift the production possibilities curve to the left. Graph the original and shifted curve.

Summary: In a paragraph, describe what you have learned today.