What’s in Economics for You? Scarcity, Opportunity Cost & Trade

LEARNING OBJECTIVES A.1 Explain scarcity and describe why you must make smart choices among your wants A.2 Define and describe opportunity cost A.3 Describe how comparative advantage, specialization, and trade make us all better off A.4 Explain how markets connect us all using the circular flow of economic life A.5 Illustrate and explain the Three Steps to Smart Choices

ARE YOU GETTING ENOUGH? SCARCITY AND CHOICE Because you can never satisfy all of your wants, making the most out of your life requires smart choices about what to go after, and what to give up.

SCARCITY AND CHOICE Economics how individuals, businesses, and governments make the best possible choices and how those choices interact in markets Problem of scarcity arises because of limited money, time, and energy

GIVE IT UP FOR OPPORTUNITY COST Opportunity cost is the single most important concept both in economics and for making smart choices in life.

OPPORTUNITY COST Every choice involves a trade-off, you have to give up something to get something else True cost of any choice is the opportunity cost, cost of best alternative given up For a smart choice, value of what you get must be greater than value of what you give up continued…

Incentives rewards and penalties for choices You are more likely to choose actions with rewards (positive incentives) avoid actions with penalties (negative incentives)

Economics is the social science that studies the choices that individuals, businesses, governments, and entire societies make as they cope with scarcity and the incentives that influence and reconcile those choices. Economics is the study of the use of scarce resources to satisfy unlimited human wants. No definition of economics can adequately capture the subject. For that reason, some teachers don’t like definitions and skip right over them. If you are one of these teachers, go ahead. Not much is lost. Other teachers regard a basic definition as essential, and the textbook takes this view. The definition in the text…“the social science that studies the choices that individuals, businesses, and governments, and entire societies make as they cope with scarcity,” is a modern language version of Lionel Robbins famous definition, “Economics is the science which studies human behavior as a relationship between ends and scarce means that have alternative uses.” Some teachers like to play with definitions a bit more elaborately. If you are one of these, here are four more, all of which add some useful insight and the last one a bit of fun: John Maynard Keynes: “The theory of economics does not furnish a body of settled conclusions immediately applicable to policy. It is a method rather than a doctrine, an apparatus of the mind, a technique of thinking, which helps it possessors to draw correct conclusions.” Alfred Marshall: “Economics is a study of mankind in the ordinary business of life; it examines that part of individual and social action which is most closely connected with the attainment and with the use of the material requisites of wellbeing.” Jacob Viner: “Economics is what economists do.” Jim Duesenberry: “Economics is all about how people make choices. Sociology is about why there isn’t any choice to be made.”

2 main areas of economics. Micro & Macro- economics Microeconomics is the study of choices that individuals and businesses make, the way those choices interact in markets, and the influence of governments.

Macroeconomics is the study of the performance of the national and global economies. analyzes performance of the whole Canadian economy and global economy

Back to Scarcity Possible solutions to allocating scarce resources First come first serve Rationing Lottery Producer/sellers preference (nepotism/favoritism) Social norms Markets

The Big Economic Question The basic question that summarize the scope of economics: How do choices end up determining what, how, and for whom goods and services get produced? (basic questions of economics)

A society’s resources are usually divided into land, labour, capital, and entrepreneurship. Economists refer to resources as factors of production. Outputs are goods (tangibles) or services (intangibles).

What, How, and For Whom? What? What we produce changes over time. E.g. what combination of civilian and military goods will be chosen?

How? Resource allocation determines the quantities of various goods that are produced What combination of labour & capital should be employed in the production of the good?

For Whom? Who gets the goods and services produced? Why do some people get a lot while others get only a little?. Answers to What, How and For Whom depends on the economic system

Types of Economic Systems: 4 Cs Co-operation, customs, capitalism, command There are Four pure types of economic systems: Traditional (Custom) Co-operation Command In practice, every economy is a mixed economy, in the sense that it combines significant elements of all systems. Free-Market

Prices and Value Value is subjective Scarcity determines Value Teachers, Doctors, and Athletes Water and Diamonds (Paradox of value) Different values lead to trade

Choosing at the Margin Price = marginal value or incremental value not total value Margin = additional (one at a time) Benefit that arises from an increase in an activity = marginal benefit Cost of an increase in activity = marginal cost Compare marginal benefit to marginal cost in decision making. Begin by encouraging the students to use the economic way of thinking to reflect on their own lives. Why are you here in college? Ask the students why they are pursuing a university degree. Most of them will say that they want a good paying job. Tell them about jobs such as postal workers, long haul truck drivers or grocery clerks that require relatively little training and offer up to $30,000 a year plus benefits. Ask the students to calculate the opportunity cost of being in school. Most students are shaken when they realize that the opportunity cost of a college degree approaches $150,000 to $200,000. Don’t leave them hanging here though. Mention that a college education does yield a high rate of return and suggest that they study Reading Between the Lines (pp. 46–47) when they get through Chapter 2.

The Economic Way of Thinking Choices and Tradeoffs The economic way of thinking places scarcity and its implication, choice, at center stage. You can think about every choice as a tradeoff—an exchange—giving up one thing to get something else. Begin by encouraging the students to use the economic way of thinking to reflect on their own lives. Why are you here in college? Ask the students why they are pursuing a university degree. Most of them will say that they want a good paying job. Tell them about jobs such as postal workers, long haul truck drivers or grocery clerks that require relatively little training and offer up to $30,000 a year plus benefits. Ask the students to calculate the opportunity cost of being in school. Most students are shaken when they realize that the opportunity cost of a college degree approaches $150,000 to $200,000. Don’t leave them hanging here though. Mention that a college education does yield a high rate of return and suggest that they study Reading Between the Lines (pp. 46–47) when they get through Chapter 2.

Scarcity implies the need for choice Every choice has an associated cost – - opportunity cost. Opportunity cost is defined as the benefit given up by not choosing the next best alternative.

•A   Combination A is unattainable. Unattainable Consider the choice that must be made by a child who has only 50 cents to spend. She wishes to spend it all on two types of candy. Bubble gums cost 5 cents each and lollipops cost 10 cents each. 10 Unattainable Quantity of Bubble Gums •A 8  6  4 Attainable Combination A is unattainable. 2 3 4 5 Quantity of Lollipops

•A Combination B is attainable. Quantity of Bubble Gums 10 Unattainable The negatively sloped line provides a boundary between attainable and unattainable combinations. 8 •A  6 B   4 The opportunity cost of getting 1 more lollipop is the 2 bubble gums that must be given up. Attainable 2 3 4 5 Quantity of Lollipops

The production possibilities boundary illustrates: scarcity choice opportunity cost Unattainable combinations Quantity of Civilian Goods • d Production possibilitiesboundary • a Point d illustrates scarcity; it is unattainable with current resources. • c • b Points a and b illustrate choice. They are both attainable, but which one will be chosen? Attainable combinations Quantity of Military Goods The negative slope illustrates opportunity cost.

4. Is Productive Capacity Growing? After growth Growth in productive capacity is shown by an outward shift of the production possibilities boundary. Quantity of Civilian Goods • d • a Point d was initially unattainable. But after sufficient growth, it becomes attainable. Before growth • b Quantity of Military Goods

WEIGH MARGINAL BENEFITS & COSTS Three Keys to Smart Choices 1 Choose only when additional benefits are greater than additional opportunity costs 2 Count only additional benefits and additional opportunity costs 3 Be sure to count all additional benefits and costs, including implicit costs and externalities continued…

Marginal benefits additional benefits from next choice Marginal opportunity costs additional opportunity costs from next choice Implicit costs opportunity costs of investing your money or time Negative (or positive) externalities costs (or benefits) that affect others external to a choice or a trade

SCARCITY & CHOICE In your own words define scarcity. What does the definition of economics have to do with scarcity? Social activists argue that materialism is one of the biggest problems with society: If we all wanted less, instead of always wanting more, there would be plenty to go around for everyone. What do you think of this argument?

OPPORTUNITY COST What is the opportunity cost of any choice? What is the biggest difference between the money cost of attending college and the opportunity cost? This weekend, your top choices are going camping with your friends or working extra hours at your part-time job. What facts (think rewards and penalties), if they changed, would influence your decision?

GAINS FROM TRADE If you spend the next hour working at Sears, you will earn $10. If you instead spend the next hour studying economics, your next test score will improve by 5 marks. Calculate the opportunity cost of studying in terms of dollars given up per mark. Calculate the opportunity cost of working in terms of marks given up per dollar. continued…

2. Highway 407 ETR in Toronto is a toll road that uses transponders to keep track of how many kilometres you drive, and then sends a monthly bill. Highway 401 runs parallel to Highway 407 and is free. Why do drivers voluntarily pay the tolls? (Use opportunity cost in your answer.) Suppose the government could estimate the cost per kilometre of the pollution damage from your driving, and send you a similar monthly bill. How would that additional cost affect your decision to drive?