What is Economics?!

Scarcity Limited Resources Also called Factors of Production Unlimited Wants Goods and services Can change over time Limited Resources Also called Factors of Production

Scarcity and Choice Resources can only be used for one purpose at a time. Choices must be made! The cost of any good, service or activity is the value of what must be given up to obtain it. There is no such thing as a free lunch!

For Example… Joe has the choice of purchasing two shirts. If both shirts are essentially the same, and he doesn’t really have a preference, which shirt will he choose? Shirt A $15 Shirt B $20

Joe will choose A!! But why?

But, opportunity cost does not always refer to money… The value of something can be subjective The value of that item may not be measurable!

Rational Behavior Human Behavior reflects “rational self interest” We tend to pursue opportunities that increase our utility. Rational decision making is different for everyone and in different situations. Not the same as being selfish!

Ceteris Paribus “Other things equal” – In order to judge the effect of one variable it is necessary to hold other contributing factors constant.

Specific economic units. products and resources ECONOMICS MACRO The economy as a whole. *Total Output *Employment *Income/Wealth Distribution *Aggregate Expenditures *General Price Level MICRO Specific economic units. *Individual industry firm or household *Prices of specific products and resources

Problems! Biases or preconceptions Loaded Terminology Definitions Fallacy of Composition – what is true for one is true for all Post Hoc Fallacy – “after this, because of this” Correlation vs. Causation – Events may be related without a causal relationship. (Income and education)

Factors of Production Land – Natural resources, “Gifts from nature” Labor – physical and mental talents of individuals

Factors of Production Capital – tools, machinery, and equipment used to make goods and services NOT MONEY! Consumer goods – intended for final use by consumers Investment – purchasing capital Entrepreneurship – someone who starts their own business, invents a product, or changes a production process

Full Employment VS Full Production Full employment requires all resources are employed. Must be willing and able. Full production uses all resources efficiently (max output). The right goods in the right way.

Two types of efficiency Productive – production of goods and services in the least costly way. Allocative – goods and service most wanted by society. (bathing suits in Alaska vs. ski equipment in Florida) a. Requires productive efficiency

Production Possibilities Curve Illustrates scarcity and helps to determine opportunity cost. A graphical representation of all possible combinations of quantities of goods and services that can be produced using existing resources.

We must assume: Full employment and productive efficiency 2. Fixed resources. 3. Fixed technology 4. Two goods only

Production Possibilities Curve Computers A All computers, no globes E Not possible with the current amount of resources B Some computers and some globes D Possible, but some resources are unemployed All globes, no computers C Globes

Law of increasing opportunity cost Increased production of one product results in a decreased production of the other, at an increasing rate.

Shift vs. Movement Movement – from one point to another. Caused by increasing production of one good and giving up another Movement – from one point to another.

Shift vs. Movement A complete relocation of the curve. Shift – complete relocation of the entire curve.

Causes Shifts of the PPC Change in the amount or capability of the resources Change in the amount or size/capacity of capital goods. New or obsolete technology

Absolute and Comparative Advantage

Why do countries trade? Lack of goods Need for raw materials Specialization Produce the things they do the best Exports vs. imports Exotic products Profit

Is there a way to operate outside the curve without increasing resources?

YES!! Specialization allows countries to make one product and trade with another. How do we decide who makes what? Absolute advantage OR Comparative advantage

Absolute Advantage Who can absolutely make more with their available resources? United States Great Britain Who can make more Guns? Who can make more Butter? GUNS BUTTER 1 million 700,000 30,000 500,000 GUNS BUTTER 80,000 40,000

But is that what they should make? Not necessarily… Comparative Advantage – Who can produce the item with the least opportunity cost? Which is better?

COMPARATIVE ADVANTAGE!

Calculating Comparative Advantage United States Great Britain Set up ratios of the two end points. Reduce ratios to 1: X Identify who has the lowest “cost” to make one unit. GUNS BUTTER 1 million 700,000 30,000 500,000 GUNS BUTTER 80,000 40,000

Comparative Advantage? Who should produce Guns? United States! Why? Who should produce Butter? Great Britain!

Why shouldn’t both produce Guns and Butter? Because that is STUPID! Specialization and trade allows for more of everything to be produced.

What makes trade better??? # Produced Traded Able to Keep Has if no trade # Gained from trade US – 1 m -100,000 900,000 700,000 200,000 US – 0 +35,000 35,000 30,000 5,000 GB – 0 +100,000 100,000 40,000 60,000 GB – 80K -35,000 45,000

Sources of Comparative Advantage Investments in Technology Availability of key inputs Government services/regulations Public education Transportation and communication infrastructure Safety laws and environmental standards.

Practice Problem Cheese Bread Germany 3 12 France 2 4 Who has absolute advantage in cheese? Who has absolute advantage in bread? Who has comparative advantage in cheese? Who has comparative advantage in bread?

Input vs. Output Problems Output problems involve determining how much can be produced with a set amount of resources. Input problems require you to examine how many units of an resource is required to make one unit of output.

Example of an input problem Mow a Lawn Trim a Bush Ty 60 min 30 min Jess 45 min 90 min Remember that having absolute and comparative advantage requires that you be able to do more, better and/or faster.

Example, continued: Mow a Lawn Trim a Bush Ty 60 min 30 min Jess Who has absolute advantage in mowing? Who has absolute advantage in trimming? Ty Ty But how to we find comparative advantage when the bigger numbers are actually bad?

How to solve output problems: Mow a Lawn Trim a Bush Ty 60 min 30 min Jess 45 min 90 min Method 1: Unit Conversion Examine the numbers in the table to find a common multiple or time period. For our example we can use 180 minutes.

Mow a Lawn Trim a Bush Ty 60 min 30 min Jess 45 min 90 min Now we convert the inputs to outputs. How many lawns can Ty mow in 180 minutes if it taken him 60 min to mow one? 3 You convert the rest!

Now our table looks like this… Mow a Lawn Trim a Bush Ty 3 6 Jess 4 2 Now solve it they way you learned last class. Jess – 4:2 1:1/2 Should make… Ty = 3:6 1:2 Should make…

So… Who has absolute advantage in mowing? Jess Who has absolute advantage in trimming? Ty Who has comparative advantage in mowing? Who has comparative advantage in trimming?

In conclusion… Specialization and trade can lead to more goods being produced and less waste in the production process.