Scarcity, Choice and Opportunity Economics Scarcity, Choice and Opportunity

The Social Sciences An academic discipline that studies human activities, e.g. economics, political science, sociology, psychology Uses scientific method in quantitative and qualitative studies

Scientific Method Define the question Gather information and resources Form hypothesis Perform experiments and collect data Analyze data Interpret data and draw conclusions that serve as a starting point for new hypotheses Publish results

Scientific Method, cont. Hypothesis must be falsifiable – the logical possibility that an assertion can be shown false by an observation or a physical experiment. Studies must be empirical, or dependent on evidence or consequences that are observable by the senses.

Why is Economics Studied? Our wants exceed our resources Economics provides a framework for making acceptable choices Economic decisions are both objective and subjective

Resources (Factors of Production) and Scarcity Land – natural resources (renewable and non-renewable) Labor – human effort and skill Capital - stock of goods which are to be used in the production of other goods or services Entrepreneurship – the skill to detect a previously untapped opportunity to make profits Human Capital – The practical knowledge, acquired skills and learned abilities of an individual that make him or her potentially productive and thus equip him or her to earn income in exchange for labor.

The Three Basic Economic Questions What – given the resources available what will be done with them? How – how will resources be used to create goods or services? Who – who is going to benefit from what is produced?

Opportunity Cost Opportunity cost is the sacrifice made when selecting one product or service over another. The Opportunity cost can be graphically illustrated through the use of the Production Possibility Curve

Production Possibility Curve The Production Possibilities Curve is a graphical representation showing various maximum combinations of output an enterprise can produce with limited economic resources in a fixed time period.

Production Possibilities Curve Assumptions of the Production Possibilities Curve 1. Two goods are produced depicting choices and trade-offs for an enterprise. 2. Full employment and full production are achieved allowing for maximum utilization of resources. 3. Short-run is the time frame over which resources cannot be improved or increased. The output represented by the curve is limited

Production Possibility Curve Points A and B – all resources being used Point C – not all resources being used Point D – not enough resources available

Production Possibility Curve Malibu Entertainment produces VHS and audio cassettes. The material used to produce 1 VHS cassette equals 3 audio cassettes. Its maximum daily production run is 1000 VHS cassettes. If the firm produces no VHS cassettes, how many audio cassettes can it produce? Ans. 3000 If the firm produces 5 audio cassettes, what is its opportunity cost in terms of VHS cassettes? Ans. 2

Production Possibility Curve Malibu Entertainment

Sunk Costs Sunk costs are costs that have already been incurred and can’t be recovered Sunk cost dilemma - having to choose between continuing a project of uncertain prospects already involving spent costs or discontinuing it

Macroeconomics Macroeconomics – deals with the economy as a whole Why do economies grow (or decline)? What determines a nation’s savings, investments, consumption? What causes inflation (deflation)? Why does it generate high unemployment?

Microeconomics Microeconomics analyzes the behavior of individual households, firms and markets Why do firms produce what they do? How do they price goods and services? How do markets work? What is the difference between competitive and non-competitive markets What determines people’s demands?

Positive and Normative Economics Positive economics – analyzes the way the economy actually operates Normative economics – founded on value judgments and leading to assertions what ought to be

Econometrics Mathematical and statistical models which analyze economic data Used to predict economic trends so that firms and government have plans to deal with future events Analogous to weather forecasting Ceteris Paribus – ‘holding constant’, i.e. that no major changes occur to influence the analysis

Marginal Utility The change in total utility (satisfaction or enjoyment) a person derives from consuming an additional unit of a good The concept implies that the utility or benefit to a consumer of an additional unit of a product is inversely related to the number of units of that product he already owns.

Absolute vs. Comparative Advantage Developed by Adam Smith Absolute Advantage exists if one can produce an item (service) using fewer resources. Comparative Advantage exists if one can produce an item (service) at smaller opportunity cost. If one country has an absolute advantage in every type of output, the disadvantaged country can benefit from specializing in and exporting the product with the largest opportunity cost for the other country.

Example The standard example is 2 economies producing 2 items. Aruba: 1 employee can produce 2 tents or 700 shorts per week (opportunity cost: 1 tent = 350 shirts) Bermuda: 1 employee can produce 1 tent or 300 shorts (opportunity cost: 1 tent = 300 shorts). Aruba has an Absolute Advantage in tents and shorts. But Bermuda has a Comparative Advantage in tents since 1 tent = 300 shorts to them while 1 tent = 350 shorts in Country A. What should Bermuda produce – tents or shorts?

Determining Comparative Advantage 1. Which nation has an absolute advantage in producing CDs? 2. Which nation has an absolute advantage in producing beef? 3. Which nation has a comparative advantage in producing CDs? 4. Which nation has a comparative advantage in producing beef? 5. Should Japan specialize in CDs or beef? 6. Should Canada specialize in CDs or beef?

Production Possibility Frontier Related to Production Possibility Curve Used to illustrate shifts (increase or decrease) in resources (production capacity) Shifts caused by: productivity and efficiency and changes in factor resources (labor and capital) Allocative efficiency – producing goods that are in demand Productive efficiency – reduction of waste Distributive efficiency – getting goods to market

Production Possibility Frontier Shift