Barron’s Chapter 2

Discipline of Economics ► Absolute Advantage: The ability to produce something more efficiently ► Capital: Productive equipment or machinery ► Comparative Advantage: The ability to produce something with a lower opportunity cost ► Economics: A social science that studies how resources are used and is often concerned with how resources can be used to their fullest potential

Discipline of Economics ► Efficiency: Using resources to their maximum potential ► Labor: All human activity that is productive ► Land: All natural resources ► Law of Increasing Costs: Law that states that when more of a product is initially being produced, the higher the opportunity cost will be to produce still more ► Macroeconomics: Economic problems encountered by the nation as a whole

Discipline of Economics ► Microeconomics: Economic problems faced by individual units within the overall economy ► Opportunity cost: The amount of one good that must be sacrificed to obtain an alternative good  ΔY / ΔX ► Positive Economics: Economic analysis that draws conclusions based on logical deduction or induction. Value judgments are avoided.  Based on the scientific method ► Production Possibilities Frontier: The combinations of two goods that can be produced if the economy uses all of its resources fully and efficiently

Discipline of Economics ► Normative Economics: Economics involving value judgments  What should be done? ► Resource: Anything that can be used to produce a good or service

Discipline of Economics ► Opportunity Cost of Guns = ΔB / ΔG  5/3 = 1.67 Butter ► Opportunity Cost of Butter = ΔG / ΔB  3/5 =.6 Guns PointGunsButter A030 B325 C620 D915 E1210 F155 G180

Discipline of Economics All the way to left, all resources are devoted to guns All the way to right, all resources are devoted to butter All points on the line are efficient Any point inside the line are inefficient Any point outside the line are unattainable as of now

Discipline of Economics ► PPF CAN shift:  Changes in the amount of resources in the economy  Changes in technology and productivity ► Increases in these shift the PPF out ► Decreases in these shift the PPF in

Discipline of Economics ► As more of a product is produced, the opportunity cost increases ► The more guns we produce, the more expensive it will be to produce one more gun (in terms of butter) ► The opportunity cost of producing a good becomes greater as more resources are forced into industries where they are not as productive. Causes the PPF to be CONCAVE to the origin (bowed out).

Discipline of Economics ► Portugal has an absolute advantage in both ► OC:  Portugal: Wheat =.5 C Cloth = 2 W Cloth = 2 W  England: Wheat =.3 C Cloth = 3 W Cloth = 3 W Labor Hours Needed to Produce a Unit of: CountryWheatCloth Portugal1020 England2060

Economic Systems ► Allocative Efficiency: Term for resources being deployed to produce just the right amount of each product to satisfy society’s wants ► Capitalism: An economic system where supply and demand determine prices ► Circular Flow Diagram: Diagram that shows how households and firms are related y the exchange of resources and products ► Command Economy: Economy in which the central government dictates what will or will not be produced and who gets what

Economic Systems ► The Law of Demand: Law that states that when the price of a product increases, the quantity demanded decreases ► The Law of Supply: Law that states that when the price of a product increases, the quantity supplied increases ► Mixed Economy: A blend of government commands and capitalism

Economic Systems ► Command Economy: Government dictates production (Communism, Socialism)  Experiences inefficiency and doesn’t provide incentive ► Capitalism: Supply and demand determine prices  Free markets determine prices.  Allocative efficiency is achieved

Economic Systems ► Determinants of Demand (Shifts):  Income  Consumer Tastes  Price of substitutes  Price of complementary goods  Expected future prices ► Change in PRICE is just a different point on the same curve ► Change in QUANTITY DEMANDED is a different point on same curve; change in DEMAND is a shift in the demand curve

Economic Systems ► Determinants of Supply (Shifts):  Price of inputs  Technology and productivity  Expected future price ► Change in price is a different point on the same curve (QUANTITY SUPPLIED) ► Shift refers to a change in SUPPLY

Demand and Supply ► Market: Place where buyers and sellers meet to exchange goods and services ► Quantity Demanded: Has an inverse relationship with changes in the price of a particular good ► Quantity Supplied: Has a direct relationship with changes in the price of a particular good ► Change in Demand (Supply): Shift in demand (supply) due to non-price factors or determinants

Demand and Supply ► Equilibrium Price: Price at which quantity supplied equals quantity demanded ► Price Ceiling: Established below the equilibrium price ► Price Floor: Established above the equilibrium price

Demand and Supply ► No single firm can affect the price in a competitive market ► Equilibrium price  Does not change  Quantity demanded = Quantity supplied  There is no shortage or surplus

Demand and Supply ► Determinants of Demand  Number of consumers  Tastes and preferences of consumers  Prices of substitutes and complements  Consumers’ income  Price expectations

Demand and Supply ► Determinants of Supply  Number of sellers  Costs of resources or production  Price of substitute goods  Price expectations  Technology  Taxes/subsidies

Demand and Supply ► Price floor is always established above the equilibrium price. Always causes a surplus. ► Price ceiling is always established below the equilibrium price. Always causes a shortage.