Fundamental Economic Concepts

3 Basic Economic Questions What to produce How to produce it For whom to produce it Why do we need to answer these questions? Because wants often outweigh needs creating scarcity

Scarcity and Opportunity Cost Economics – social science studying the allocation of scarce resources and goods (firms/bus, indiv, govt) Resources – inputs such as labor, capital, entrepreneurship, and land-use by people to produce outputs Natural Resources – all of the raw materials which occur in nature and that are used to produce what humans want or need (ex: timber, water, crude oil, arable land)(can be renewable or nonrenewable) Goods – finished products created from resources

Four Factors of Production Land: incl. property on which a plant is built, but also other natural resources involved (timber, water, fish, etc. in an area) Labor: contribution of human workers, incl. mental efforts as well as physical ones (both skilled and unskilled) Capital: all of the structures and equipment involved in the manufacturing process (building, machinery, tools, lighting, nail guns, rags used at a car wash) Entrepreneurship: creative, managerial, and risk-taking capabilities involved in starting up or running a business (organizing, developing, raising funds; Bill Gates, Sam Walton)

Concepts cont. Scarcity – situation of having inadequate resources to obtain all of one’s wants (the more scarce an item, the more it costs) Government regulation (a means for dealing with scarcity) – price ceiling, price floor, rationing Want – everything you could get if there was no limit to resources (creates scarcity) Need – resources and goods that are necessary for people Allocate – to distribute according to some plan or system

Scarcity Means There Is Not Enough For Everyone Government must step in to help allocate (distribute) resources

Opportunity Cost Trade-Off – the act of giving up one thing of value to gain another thing of value Opp. Cost - is the value of the alternative option that is lost when an individual, business (firm), or government makes a decision. Example: Ashley wants tank tops and t-shirts for school. She doesn’t have enough $ for both . . . so she buys the t-shirts. The enjoyment of wearing the tank tops is her opportunity cost! Her trade-off is owning the tank tops

Opportunity Cost Ms. Kent owns an empty warehouse downtown that is about the size of a football field. She would like to build big cargo airplanes, but there is not enough space in the warehouse for this to be done. Therefore, building cargo airplanes is not one of her choices in the decision-making process. Instead, she currently has two choices. A company would like to lease the warehouse and use the space to store furniture, but Ms. Kent might use the space to build her own art gallery. If she decides to lease the space to the furniture company, what is her opportunity cost?

EOCT question Bill wants to buy a shirt for $45 and a hat for $20. However, he only has $50. If he buys the shirt, then his opportunity cost will be The cost of the shirt The cost of the hat The enjoyment he would have gotten from the hat How comfortable he will feel in the shirt

Cost-Benefit Analysis Whenever people decide whether the advantages of a particular action are likely to outweigh its drawbacks, they engage in a form of benefit-cost analysis. (Think: pros v. cons) – This also results in a rational decision! Marginal benefit: amt. of benefit received once the cost of the decision is considered Marginal cost: cost of the decision once it is weighed against the benefits Why do people recycle?

Supply and Demand and Scarcity Law of Supply – as price goes up, so does production (see supply curve) Law of Demand – as price goes up, demand goes down (see demand curve) Market Equilibrium – occurs when the quantity supplied and the quantity demanded are both equal at the same price (see supply and demand curve) Market Clearing Price – is the same as market equilibrium . . . The market is cleared of all products

Supply and Demand Curves

Surplus and Shortage Surplus - exists when the quantity supplied exceeds the quantity demanded at the price offered Incentive – when a producer offers coupons, rebates, or 2 for 1 deals to get customers Used to attract consumers and stimulate demand Shortage – exists when the quantity demanded exceeds the quantity supplied at the price offered Consumers develop a budget that lists needs and wants and the amount of $ to get them If a consumer does not have enough $, they will change the budget, finding substitute goods

Market Equilibrium/Shortage/Surplus

Substitute/Complementary Goods Substitute Goods – goods and services that serve the same purpose that can be used in place of each other Example: Butter and margarine, Coke and Pepsi, ? Complementary Goods – “An item that you would buy along with another item” Example: Peanut butter and Jelly, Hot dog and Buns, ?

Substitutes

Complements

Warm-up What is the number one problem in economics and how does the problem affect our buying habits? (use your new economic terms) Explain how it affects: Households When scarcity exists, people have to make choices (substitutes) Firms Businesses have to offer incentives to encourage people to but their products Governments Must regulate in some way (rationing, price floor, price ceiling)

Draw This PPC (Production Possibilities Curve)

Production Possibility Frontiers (Curve) Shows the different combinations of goods and services that can be produced with a given amount of resources No ‘ideal’ point on the curve – any point ON the curve is the most efficient Any point inside the curve – suggests resources are not being utilized efficiently Any point outside the curve – not attainable with the current level of resources, but with additional resources or technology it can be reached Useful to demonstrate economic growth and opportunity cost This slide introduces the key features about PPFs. The activity that accompanies this presentation seeks to apply PPFs in a slightly different way – focussing on using health resources. Going through the theory at this stage and then following it up with the activity will be useful in developing early understanding of the issues.

PPC If it devotes all resources to capital goods it could produce a maximum of Ym. If it devotes all its resources to consumer goods it could produce a maximum of Xm If the country is at point A on the PPF It can produce the combination of Yo capital goods and Xo consumer goods Assume a country can produce two types of goods with its resources – capital goods and consumer goods Capital Goods If it reallocates its resources (moving round the PPF from A to B) it can produce more consumer goods but only at the expense of fewer capital goods. The opportunity cost of producing an extra Xo – X1 consumer goods is Yo – Y1 capital goods. Ym A Yo These slides introduce the diagrams and then have animation to show how points on the PPF relate to different resource use and allocation. Moving from point A to point B involves sacrificing some capital goods to gain more consumer goods and thus demonstrates the opportunity cost involved. Students doing history can be reminded about the resource allocation decisions taken by Stalin during the 1930s and the subsequent decisions by successive Soviet premiers since the war about what resources are important for a nation like the USSR! (you might of course have to explain a little bit about what the USSR was!) B Y1 Xo X1 Xm Consumer Goods

Production Possibility Frontiers It can only produce at points outside the PPF if it finds a way of expanding its resources or improves the productivity of those resources it already has. This will push the PPF further outwards. Production inside the PPF – e.g. point B means the country is not using all its resources Capital Goods C Y1 A .B Yo The next slide allows the lecturer to demonstrate what happens when resources are not used efficiently and production takes place within the PPF. It then allows the expansion of the PPF and can be used to illustrate the issue of economic growth and where opportunity cost does not exist if the economy moves from point A to point C (in a simple context of course – there is always some form of sacrifice of using resources!). Xo X1 Consumer Goods

Specialization and Division of Labor To maximize profits, producers try to reduce costs of production To accomplish this, they must increase productivity (ability to turn input into output in certain amount of time) One way to accomplish this is through specialization (one worker focuses on one particular task) and division of labor (splitting up work into smaller and more specialized tasks)

Voluntary Exchange U.S. economy is based on voluntary exchange (individuals and businesses freely exchange goods, services, and resources for something of value $) Benefits: Increases productivity and efficiency Encourages inventions and innovations (change or improvement)