It is Fun to Learn Economics http://www.youtube.com/results?search=ben&sort=video_view_count Or http://www0.gsb.columbia.edu/students/organizations/follies/media/EveryBreath.wmv

Economics: The Core Issues Chapter 1

In This Chapter… What is Economics about? The Core Issues in Economics Key (Basic) Concepts in Economics Why Study Economics?

1. What is Economics?

1. What is Economics? Definition: Why are you here? Why am I here? Why should I teach you? Why should you have to register for my class?

1. What is Economics? Definition: Economics is the study of how best to allocate scarce resources among competing uses.

1. What is Economics? In general we have relentless quest for more and better This relentless quest for more arises from Necessity Increased income Development and growth

1. What is Economics? We have unlimited wants (desire)—It either grows or changes, but…. But the RESOURCES from which we produce goods and services that satisfy our needs (wants) are limited. Resources are Limited in Supply. That is, Resources are Scarce!!!

1. What is Economics? Although resources are scarce, they have alternative (multiple) uses To get the best out of the scarce resources we have, we choose between the alternative uses Scarcity entails Choice, and choice involves Making Decisions

1. What is Economics? Summary Economics is the study of how best to allocate scarce resources among competing uses….. Economics is the study of how the society chooses to allocate its scarce resources among alternative uses The study of resource allocation The science of choice

2. The Core Issues in Economics

2. Three Core Issues of Economics WHAT to produce with our limited resources. HOW to produce the goods and services we select. FOR WHOM goods and services are produced; that is, who should get them.

2. Three Core Issues of Economics Fact! All societies, Individuals, Economies face these Core Economic problems (Decisions) Why?

3. Key (Basic) Concepts in Economics

3. Basic Concepts 3.1. Scarcity (What is scarcity)? Scarcity is the lack of enough resources to satisfy all desired uses of those resources. That is, we can’t have everything we want because relative to our wants, Economic Resources are limited in supply (availability). Thus it is the foundation of economics

3. Basic Concepts 3.2. What are Resources? Are factors of production that are used to produce goods and services with which we satisfy our needs. Inputs that are needed to produce outputs

3. Basic Concepts Four Basic Factors of Production

3. Basic Concepts Land Labor refers to all natural resources such as crude oil, water, air, and minerals. Labor refers to the skills and abilities to produce goods and services.

Factors of Production Capital Entrepreneurship: Goods produced for use in the production of other goods, e.g., equipment, structures. Entrepreneurship: is the assembling of resources to produce new or improved products and technologies. (know how, managerial capacity)

3. Basic Concepts 3.3. What is the economy? The economy is an abstraction that refers to the sum of all our individual production and consumption activities. The economy is us — the aggregation of all of our supply and demand decisions.

3. Basic Concepts So far…. Implication-1? What Resources are (Factors of Production) What the Economy is ( an abstraction of us and our actions) Scarcity of Resources (Limitation) and Insatiable Wants (desires) Implication-1? There is a limit to the output we produce!

3. Basic Concepts Example: Colonization of the Moon and Exploration of Mars http://msnbc.msn.com/id/%204008805/ or http://cndyorks.gn.apc.org/yspace/articles/spaced_out_invaders.htm

3. Basic Concepts No matter how an economy is organized there is a limit to how fast it can grow. Recall: We can’t have everything we want because relative to our wants, Economic Resources are limited in supply (availability)…. The most evident limit is the amount of resources available for producing goods and services.

3. Basic Concepts Scarcity — thus is the result of the imbalance between our desires and available resources Implication-2? —forces us to make economic choices. What, how and how much to produce? Choice between alternative uses ….Definition of economics?

3. Basic Concepts Studying how the society allocates its scarce resources Requires… The knowledge of alternative combination of outputs that could be produced from the mix of the available resource(s) and The Production Possibilities The Costs of Making Choices… …. Opportunity Cost

Basic Concepts 3.4. Opportunity Costs It is what is given up in order to get something else. (The best alternative forgone) Opportunity cost is the most desired goods or services that are forgone in order to obtain something else. The cost of allocating scarce resources for one use rather than the other use

3. Basic Concepts 3.5. Production Possibilities Curve (Frontier)—PPC (PPF) A graphic representation of production possibilities Production possibilities are the maximum alternative combination of goods and services that could be produced in a given period of time with all the available resources and technology.

The Production Possibilities Curve (PPC)

The Production Possibilities Curve (PPC)

The Production Possibilities Curve A B C D E F OUTPUT OF TRUCKS 5 4 3 2 1 OUTPUT OF TANKS

The Production Possibilities Curve Each point on the production possibilities curve depicts an alternative mix of output. A(5 trucks, 0 Tanks) B(4 trucks, 2 Tanks) . F(0 trucks, 5 Tanks)

Production Possibilities Curve (PPC) also Illustrates Several Essential Principles and Core Issues Scarce resources – there’s a limit to the amount we can produce in a given time period with available resources and technology.

A X 5 Currently not attainable B 4 C 3 OUTPUT OF TRUCKS 2 1 1 2 3 4 5 OUTPUT OF TANKS

2. Opportunity Costs – we can obtain additional quantities of any desired good only by reducing the potential production of another good. Thus movement along the PPC represent opportunity cost How much we give up in the production of one output to get more of the other output)--tradeoffs

Opportunity Costs A B C D E F Step 1: give up one truck 5 4 Step 3: give up another truck Step 2: get two tanks C 3 OUTPUT OF TRUCKS Step 4: get one more tank D 2 E 1 F 1 2 3 4 5 OUTPUT OF TANKS

It shows the Law of Increasing Opportunity Costs Increasing quantities of any good can be obtained only by sacrificing ever-increasing quantities of other goods…? Resources do not transfer perfectly from the production of one good to another.

Increasing Opportunity Costs Step 1: give up one truck 5 B 4 Step 3: give up another truck Step 2: get two tanks C 3 OUTPUT OF TRUCKS Step 4: get one more tank D 2 E 1 F 1 2 3 4 5 OUTPUT OF TANKS

Some Real Life Examples The Cost of North Korea’s Military North Korea’s inability to feed itself is due in part to its large army. Resources used for the military aren’t available for producing food.

The Cost of North Korea’s Military P G Reduced food output N C FOOD OUTPUT Military buildup O H D B MILITARY OUTPUT

The Military Share of Output 0.5 0.9 1.0 1.2 2.7 2.8 3.4 3.8 4.1 12.0 16.3 Jamaica Mexico Japan Canada Germany India S. Korea USA Bosnia China Saudi Arabia N. Korea 1.5 Percent of Output Allocated to Military

3.6. Efficiency and Inefficiency PPC also shows whether outcomes (of allocation decision) are Efficient or Inefficient. Efficiency means getting the maximum output of a good from the resources used in production. Every point on a production possibilities curves is efficient.

Inefficiency Recall that a production possibilities curves shows potential output, not necessarily actual output. Thus if we are inefficient, actual output will be less than the potential output. Any point inside the PPC represent inefficient outcomes ?????

Countries may end up inside their production possibilities curve if all available resources are not used. ……Unemployment

A 5 B 4 Y C 3 OUTPUT OF TRUCKS Unemployment 2 1 1 2 3 4 5 OUTPUT OF TANKS

3. Basic Concepts 3.7. Economic Growth Economic growth is an increase in output (real GDP) — an expansion of production possibilities. PPC also shows Economic Growth or Decline A point outside the production possibilities curve suggests that we could get more goods than we are capable of producing!

Recall- Currently Unattainable Levels X 5 Currently not attainable B 4 C 3 OUTPUT OF TRUCKS 2 1 1 2 3 4 5 OUTPUT OF TANKS

with more resources or better technology, production possibilities curve may shift outward. Such a shift represents Economic Growth

Economic Growth PP2 PP1 OUTPUT OF TRUCKS OUTPUT OF TANKS

Back to the Core Issues in Economics

Basic Decisions Production possibilities define the output choices confronting a nation (the three core issues in economics): WHAT to produce HOW to produce FOR WHOM to produce

WHAT There are millions of points along a production possibilities curve, and each one represents a specific mix of output. We can choose only one of these points at any time.

HOW There are lots of different ways of producing goods and services. Someone has to make a decision about which production methods to use.

FOR WHOM Who is going to get the output produced?

Three type of economies An economy is largely defined by how it answers the WHAT, HOW and FOR WHOM questions. Three type of economies Free Market Economy Centrally Planned (Command) Economy Mixed Economy

Market Economy: is a system that is based on market mechanism (the use of market prices and sales to signal desired outputs (or resource allocations). I.e., the market decides the mix of output in an economy.

The Invisible Hand of a Market Economy Laissez faire policy--the doctrine of leave it alone — of nonintervention by government in the market mechanism. The Invisible Hand of a Market Economy

Centrally Planned (Command Economy) Karl Marx argued that the government not only had to intervene but had to own all the means of production. Markets permit capitalists to enrich themselves while the proletariat toil long hours for subsistence wages.

A Mixed Economy: ….is one that uses both market signals and government directives to allocate goods and resources. Most economies use a combination of market signals and government directives to select economic outcomes.

Failures Markets Fail Governments Fail too

Market Failure A market failure is an imperfection in the market mechanism that prevents optimal outcomes. If the market signals don’t give the best possible answers, we say that the market mechanism has failed. Example: Environmental Pollution (Over Production of goods with harmful effects (negative externalities), Underproduction of goods with positive effects (positive externalities)

Government Failure Government intervention (Regulation) may move us closer to our economic goals. The government may also fail. A government failure is government intervention that fails to improve economic outcomes. Example: The cost of regulation may outweigh the benefits

Why Study Economics?

Seeking Balance The challenge for society is to minimize failures by selecting the appropriate balance of market signals and government directives. …and the basic purpose of studying economics is thus to understand how the economy functions. How an economy is organized, how it behaves, and how successfully it achieves it basic objectives.

Why Study Economics? How to best achieve a goal with the available resources. Helps us make the right decisions

Macro Versus Micro Macroeconomics is the study of aggregate economic behavior, of the economy as a whole. Microeconomics is the study of individual behavior in the economy, of the components of the larger economy.

The economy is much too vast and complex to describe and explain in one course (or one lifetime). Economists use theories, or models, of economic behavior to evaluate and design economic policy and analyze the behavior of economics agents (individuals and businesses) One such a model and the demand and supply