Scarcity, opportunity cost, choices Production Possibilities Curve Comparative/Absolute Advantage Supply and Demand Macro Issues

Economics defined: Study of choice How society deals with the problem of scarcity How scarce resources are used in the production, distribution and consumption of goods/services to maximize the satisfaction of human wants Economic interaction- how individuals choices affect others

TEN PRINCIPLES OF ECONOMICS 3 The most important determinant of living standards: productivity, the amount of goods and services produced per unit of labor. Productivity depends on the equipment, skills, and technology available to workers. Other factors (e.g., labor unions, competition from abroad) have far less impact on living standards. Principle #1: A country’s standard of living depends on its ability to produce goods & services. Economic Growth Economic Growth [Increase in Real GDP or per capita GDP] 3% 3% annual growth will increase our standard of living Per capita=$ 792$ per capita= $ 48, Per capita=$ 792 ; 1933-Per capita= $430 ; 2010-per capita= $ 48,000

TEN PRINCIPLES OF ECONOMICS 4 Huge variation in living standards across countries and over time: ▫Average income in rich countries is more than ten times average income in poor countries. ▫The U.S. standard of living today is about eight times larger than 100 years ago. Principle #1: A country’s standard of living depends on its ability to produce goods & services.

TEN PRINCIPLES OF ECONOMICS 5 In the short-run (1 – 2 years), many economic policies push inflation and unemployment in opposite directions. Other factors can make this tradeoff more or less favorable, but the tradeoff is always present. Full Employment % % Full Employment – about % employment is full employment. In 1982, unemployment was 10.8% [12 M unempl.] Principle #2: Society faces a short-run tradeoff between inflation and unemployment

“Doing the best with what we have.” Economic Efficiency 3. Economic Efficiency – “obtaining the maximum output from available resources” or “maximum benefits at minimum cost from our limited resources.”

. 4. Price Level Stability 4. Price Level Stability – sizable inflation or deflation should be avoided. We had over 10% in 73, 79, & 80. Inflation 2% in the 1950s, 2.3% in 1960s 7.4% in 80s. was 2% in the 1950s, 2.3% in 1960s and 7.4% in 80s. A person making $25,000 a year at age 30 would need (with average inflation of 5%) $125,000 a year at age 65 to have the same standard of living ; ; In 1945, $1.50 bought what $1.00 did in Today, it takes $11 to buy what $1 bought in It took $2.31 in 1982 to buy what $1 bought in It took $2.31 in 1982 to buy what $1 bought in In 2009, it took $2.23 to buy what $1 bought in Reasonable inflation, 1-2% is OK.

TEN PRINCIPLES OF ECONOMICS 8 Inflation: increases in the general level of prices. In the long run, inflation is almost always caused by excessive growth in the quantity of money, which causes the value of money to fall. The faster the govt creates money, the greater the inflation rate. Principle #4: Prices rise when the government prints too much money.

A n Equitable Distribution of Income 5. A n Equitable Distribution of Income. One group shouldn’t have extreme luxury while another is in stark poverty.

You are free to make your own economic decisions: –Choose your job –Choose where and when you work –Work for yourself or someone else –Leave your job and to move to another job –Free to buy what we want Businesses are free to: –Choose which workers they want –Figure out how much business they want to do –Businesses are free to sell what they want

TEN PRINCIPLES OF ECONOMICS 11 Rational people ▫systematically and purposefully do the best they can to achieve their objectives. ▫make decisions by evaluating costs and benefits of marginal changes – incremental adjustments to an existing plan. Principle #6: Rational People Think at the Margin

TEN PRINCIPLES OF ECONOMICS 12 Examples: When a student considers whether to go to college for an additional year, he compares the fees & foregone wages to the extra income he could earn with the extra year of education. When a manager considers whether to increase output, she compares the cost of the needed labor and materials to the extra revenue. Principle #6: Rational People Think at the Margin

. Economic Security 7. Economic Security – provision should be made for those not able to take care of themselves – handicapped, disabled, old age, chronically ill, orphans. Protection from lay-offs [unemployment insurance]. Also no discrimination. 43 million Americans have some type of disability. A. Hearing impaired: 22 million (including 2 million deaf) B. Totally blind: 120,000 (Legally blind: 60,000) C. Epileptic: 2 million D. Paralyzed: 1.2 million D. Paralyzed: 1.2 million E. Developmentally disabled; 9.2 million F. Speech impaired: 2.1 million G. Mentally retarded: up to 2.5 million H. HIV infected: 900,000 Balance of Trade $400 billion a year complementary economic growth F.E. ] conflict F.E.price level stability 8. Balance of Trade. O ver $400 billion a year the last few years. Some of these goals are complementary [ economic growth & F.E. ] and some conflict [F.E. and price level stability].

TEN PRINCIPLES OF ECONOMICS 14 Rather than being self-sufficient, people can specialize in producing one good or service and exchange it for other goods. Countries also benefit from trade & specialization: ▫Get a better price abroad for goods they produce ▫Buy other goods more cheaply from abroad than could be produced at home Trade Can Make Everyone Better Off

scarcity “The first lesson of economics is scarcity: There is never enough of anything to satisfy all those who want it. disregard the first lesson of economics The first lesson of politics is to disregard the first lesson of economics”. --Thomas Sowell

Unlimited ____________ vs. Limited _______________ You cannot have everything you want. Therefore: CHOICES must be made

What satisfies economic wants? Are tangible items that satisfy our wants. Such as: cars, TVs, computers, clothes, etc. Are goods for immediate consumption that satisfy our wants directly. Examples? Are goods that satisfy our wants indirectly; goods used to produce other goods. Examples?

What else satisfies our wants? Intangible items such as: Legal advice/representation Medical and dental work Tax preparation Painting and repair work House cleaning

Resources a.k.a. The Factors of Production Economists classify resources into 4 categories 1.Land  Natural resources, acreage, ports, oil, minerals, rivers - coal, oil, water, fossil fuels, etc. - vegetation and water – sun, wind, and rain  The payment for Land is RENT 2.Labor  Human resources (physical and intellectual)  The payment for Labor is WAGES

3. Capital (a product of Investment) All manufactured goods & services used in producing consumer goods. Examples: Tools, machinery, equipment, trucks to carry goods, airplanes, etc. Real (can produce something directly) and financial (money, stocks, bonds) The payment for Capital is INTEREST 4. Entrepreneurship The special ability of risk-takers to combine land labor and capital in new ways in order to make profit Someone who takes the initiative in using or combining land, labor & capital to produce a good or service. Someone who is innovative, a risk taker, and makes basic business decisions. The payment for Entrepreneurship is PROFIT

Distinguishing: The study of the economy as a whole – national trends related to income, output and the price level. The study of the individual economic units or parts of the economy – pricing and output decisions in a particular industry or part of the economy.

Distinguishing Positive and Normative Analysis/Statements What is? What was? What will be? What should be? What ought to be? How are these questions different? Type of analysis? Type of statement? Speaking as?

Three Basic Economic Systems: both Government Supply and Demand Supply and Demand Supply and Demand

Scarcity is the problem of using _?_ resources to fulfill people’s _?_ wants. A.limited; unlimited B.unlimited; unlimited C.unlimited; limited D.limited; limited E.None of the above

Once a resource or factor of production has been put to productive use an opportunity cost is incurred. (if you choose one, you give up another) Opportunity cost is the next best alternative use for a resource. ▫Ex. If the 3 cups of flour are used to bake bread, then the opportunity cost is the cake that could also have been baked with the 3 cups of flour. No matter what we do with our time or resources, we always incur opportunity cost. (price and everything else that must be given up)

When a small amount of the good is produced, opp. cost is low because society needs to use only those resources that are especially suited for its production

Assume that Matt and Kyle each have a yard to rake/bag leaves and a 10 page term paper to type. If it takes Matt 2 hours to rake/bag a lawn and 4 hours to type a paper and it takes Kyle 4 hours to rake/bag a lawn and 2 hours to type a paper, how long would it take each guy to complete both tasks? Is there a more efficient way to accomplish both tasks? Explain why? 6 hours Yes. Matt rakes/bags both lawns and Kyle types both papers. It would take each one 4 hours.

A C T I V E L E A R N I N G 1 Applying the principles You are selling your 1996 Mustang. You have already spent $1000 on repairs. At the last minute, the transmission dies. You can pay $600 to have it repaired, or sell the car “as is.” In each of the following scenarios, should you have the transmission repaired? Explain. A.Blue book value is $6500 if transmission works, $5700 if it doesn’t B.Blue book value is $6000 if transmission works, $5500 if it doesn’t 30

A C T I V E L E A R N I N G 1 Answers Cost of fixing transmission = $600 A. Blue book value is $6500 if transmission works, $5700 if it doesn’t Benefit of fixing the transmission = $800 ($6500 – 5700). It’s worthwhile to have the transmission fixed. B. Blue book value is $6000 if transmission works, $5500 if it doesn’t Benefit of fixing the transmission is only $500. Paying $600 to fix transmission is not worthwhile. 31

Production Possibilities Curves Notes A B C D E F GUNSGUNS BUTTER

Full and Efficient Production Productive Efficiency: getting the most produced from your scarce resource Allocative efficiency: getting the most of what people want from the scarce resources (allocating resources to the goods and services people want) How are these different?

Marginal benefit – the benefit derived from producing an additional unit(s) of product Marginal cost – the cost derived from producing an additional unit(s) of product Produce as long as MB MC to maximize satisfaction of wants. Marginal Analysis If MC >MB, production has exceeded society’s desire for the good (allocative inefficiency – overallocation of resources) If MC < MB, underallocation of resources exists. =

What is a production possibilities curves (PPC)? A diagram that shows all the possible combinations of 2 goods and services that a country/society/economy can produce. Illustrates the concept of opportunity cost and tradeoffs

Assumptions of a PPC Only two products can be produced All resources are fixed ▫ Resources are land, labor, capital and entrepreneurship All technology is fixed All resources are used fully and efficiently Ceteris paribus ▫ all else remains equal

Points of the PPC On the curve-On the curve ▫means full and efficient use of resources ▫we are using everything we have and not wasting anything Under the curve-Under the curve –Inefficient use of resources- called unemployment of resources –We are wasting resources- there can be unemployment of any resource not just labor. Above the curve-Above the curve –Not possible given the resources available –The only way to reach the point above the curve is to shift the curve outward to reach the point – ↑ technology, ↑ LLCE

Points of the PPC A B C E F GUNSGUNS BUTTER D

The Production Possibilities Frontier Quantity of Computers Produced Quantity of Cars Produced 3, ,000 2, , A B 2, C D

4,000 The Production Possibilities Frontier Quantity of Computers Produced Quantity of Cars Produced 3,000 2,000 A ,000 E 2, An outward shift in the production possibilities frontier

Increase and Decrease The PPC can shift to the right or left. Shift right when we discover new resources or technology ▫This will move the curve closer to point E Shift left when resources are destroyed or technology decreases A B C E F GUNSGUNS BUTTER

Cost… What kind of cost does the PPC have? A B C E F GUNSGUNS BUTTER If we move from point D to point C what is the opportunity cost? If we move from point C to point B? If we move from point B to point A? D

Cost… What would a PPC look like if it had constant cost? Hamburgers Hotdogs $ A B C D E F G H We call this a budget line.

Which is better? Which is better to have a point below the curve or to shift to the left? When there is a point below the curve, the resources are still available, but not being used. When we shift to the left (below) the PPC, the resources have been destroyed. If you are below the curve you lost your job, when you shift to the left you have died. Which is better?

fully employing 1. An economy that is fully employing all its productive less to investment than resources but allocating less to investment than to consumption to consumption will be at which of the following positions on the PPC to the right? a. A b. B c. C d. D e. E 2. Which of the following best explains the shape of the two-commodity PPC for the two-commodity economy shown above? a. Opportunity cost of producing another unit of each stays the same. decreases b. Opportunity cost of producing another unit of each decreases. increases c. Opportunity cost of producing another unit of each increases. true of the PPC 3. Which of the following is true of the PPC on the right? a. Point Q is attainable but undesirable. b. Point R is unattainable but undesirable. c. A technological improvement of watches would move the economy from T to P. d. There is unemployment at point T because workers e. The opportunity cost of moving from S to T is the # of watches given up. B to C 4. If we move from B to C on the graph (right), opportunity cost the opportunity cost is? a. AH units of good Y b. OG units of good Y c. EF units of good X d. HG units of good Y B C AHGO

5. Which of the following would cause the PPC shown (right) to shift outward? a. Reopening steel plants that had been closed b. Rehiring laid-off workers c. Using machinery for missile production instead of steel production d. Using machinery for steel production instead of missile production e. Developing a more efficient steelmaking process 6. Base on the graph (right), which statements are true? I. The opportunity cost of moving from P to R is 10 units of Y. II. The opportunity cost of moving from R to P is 8 units of X. III. The opportunity cost of moving from Q to R is 0 units. a. I only b. III only c. I & II only d. I, II, & III Steel Missiles X Y

Consumption Goods unemployment recession 41. At what letter is there unemployment [ recession ]? resources being used in their 42. What letters represent resources being used in their most productive manner most productive manner ? [full employment, full production, and best available technology] improvement in technology 43. What letter represents an improvement in technology, new PPC therefore a new PPC frontier line? “law of increasing cost”? 44. The (straight line/curve) illustrates the “law of increasing cost”? “law of constant cost.” 45. The (straight line/curve) illustrates the “law of constant cost.” most economic growth inthe 46. At what letter would there be the most economic growth in the future producing there now future if a country were producing there now? opportunity cost“C” to “B”; What is the opportunity cost when moving from “C” to “B”; A to C when moving from A to C; do we have to give anything upmoving fromD to B and do we have to give anything up when moving from D to B? D A, B, or C E A Consumption Capital no D A B C Capital Goods E More or better resources or better technology

inputshourssmaller numberabsolute And with inputs (hours), the smaller number indicates absolute advantagemore efficient advantage; that country is more efficient because it can produce absolutely fasterthan the other a good absolutely faster than the other with the same inputs. Absolute Advantage [Outputs v. Inputs] outputsquantitylarger number absolute advantage absolutelymoremore efficient Absolute Advantage [Outputs v. Inputs] Remember that with outputs or quantity, the larger number indicates absolute advantage; that country can produce absolutely more with the same inputs, and is more efficient.ProductMarket ResourceMarket

Assume that nation X can produce either 40 notepads or 80 pens; nation Y can produce either 10 notepads or 40 pens. Absolute Advantage? NPPens X4080 Y1040

Assume that nation X can produce either 40 notepads or 80 pens; nation Y can produce either 10 notepads or 40 pens. Which statement is true? The OC of producing 1 NP in X is 2 pens. The OC of producing 1 Pen in Y is 1/4 NP. All of the above. NPPens X40 1 (2)80 2 (1/2) Y10 1 (4)40 4 (1/4)

specialization and trade is more efficient than self sufficiency Most economists would agree that specialization and trade is more efficient than self sufficiency even when one country has an absolute advantage in the production of both products. To efficiently utilize resources and make gains from trade, nations should specialize in the products for which they have a comparative advantage or the least comparative disadvantage To efficiently utilize resources and make gains from trade, nations should specialize in the products for which they have a comparative advantage or the least comparative disadvantage.

comparative advantage receives a With comparative advantage, a nation receives a higher relative price for the goods it exports higher relative price for the goods it exports, and pays a lower relative price for the goods it imports pays a lower relative price for the goods it imports.

Assumptions: 8 hour work day (all work done) the services of a lawyer and a secretary cannot be done simultaneously Suppose that a lawyer makes $100 per hour and types twice as fast as her secretary. The secretary makes $10 per hour. Ceteris paribus, should the lawyer fire the secretary and do the typing (secretarial work) herself? Even though the lawyer has an absolute advantage in both tasks, she should NOT fire the secretary. If the lawyer spent half of her day typing, she would give up $400. If she pays a secretary to type, the lawyer only gives up $80.

Coffee Wheat Absolute Advantage? Should the U.S. and Brazil specialize and trade?

Step 1: Set up the problem Step 2:Identify Production Maximums Coffee Wheat U.S. Brazil Step 3: Reduce Ratios Step 4:Identify Opportunity Cost Step 5:Compare Costs --- lowest has CA Coffee: Wheat: 30 Brazil U.S (1W)(1C) (1/2 W)(2C)

Coffee Wheat Absolute Advantage? Should the U.S. and Brazil specialize and trade?

Step 1: Set up the problem Step 2: Identify production prior to specialization Step 3: Total production in each product prior to specialization Step 4: Identify maximum possible production of each product with specialization according to comparative advantage Step 5: Compare output before/after specialization and trade Coffee Wheat U.S. Brazil Before After Gain

Step 1: Identify original reduced ratios for each country Step 2: Make one of the two products both equal 1 Step 3: Terms of trade fall between the product that does not equal 1 U.S. 1 C = 1 W Brazil 2C = 1 W Possible Term of Trade 1.5C = 1W

Distinguishing input from output problems. An OUTPUT problem presents the data as products produced given a set of resources. (ex. Number of pens produced) An INPUT problem presents the data as amount of resources needed to produce a fixed amount of output. (ex. Number of labor hours to produce 1 bushel) Input problems change the scenario from who can produce the most to who can produce a given output with the least amount of resources.

Which type of problem? Acres to produce one unit of each. Input problem Output problem ApplesPears Tom105 Sam62

Absolute Advantage? Acres to produce one unit of each. Absolute advantage in apples and pears? Tom Sam ApplesPears Tom105 Sam62

Which type of problem? Number caught per day. Input problem Output problem TroutBass Tom46 Sam2412

Absolute Advantage? Number caught per day. Which guy has the absolute advantage in the production of each product? Tom Sam TroutBass Tom46 Sam2412

Which type of problem? Days to produce one unit of each. Input problem Output problem CarsPlanes XYZ Corp.810 QKFX Corp.1512

Absolute Disadvantage? Days to produce one unit of each. Which corporation has an absolute disadvantage in the production of both products? XYZ QKFX CarsPlanes XYZ Corp.810 QKFX Corp.1512

Which type of problem? To produce the following from one ton of olives. Input problem Output problem Canned OlivesOlive Oil Zaire6010 Colombia248

Absolute Advantage? To produce the following from one ton of olives. Which nation has the absolute advantage in both products? Zaire Colombia Canned OlivesOlive Oil Zaire6010 Colombia248

Calculating comparative advantage in an INPUT problem? Acres to produce one unit of each. This procedure requires an extra step after determining the problem is an input problem: convert the problem to an output problem and solve for comparative advantage. ApplesPears Tom105 Sam62

Calculating comparative advantage in an INPUT problem: Acres to produce one unit of each. To convert, look for the lowest common denominator (i.e., 30 for 10, 5, 6 and 2). Assume you have 30 acres and convert the numbers to output produced in 30 acres. See chart on right for conversion. Then solve problem as an output problem. ApplesPears Tom Sam ApplesPears Tom3 1 (2)6 2 (1/2) Sam5 1 (3)15 3(1/3)

Shortcut Method for Input Problems: Acres to produce one unit of each. Shortcut procedure: swap data per product per country. Reduce ratio and solve as output problem. See next screen for example. 2 6Sam 510Tom PearsApples 62Sam 105Tom PearsApples

Comparative Advantage? Days to produce one unit of each. Work this problem on your own paper to determine which corporation should specialize in cars and which in planes. Click the mouse upon completion of your work. CarsPlanes XYZ Corp.810 QKFX Corp.1512

CarsPlanes XYZ Corp.810 QKFX Corp.1512 Comparative Advantage? Days to produce one unit of each. Converted:CarsPlanes XYZ Corp.10 5 (4/5) 8 4 (5/4) QKFX Corp.12 4 (5/4)15 5 (4/5) Unconverted:

Comparative Advantage? Click the true statement based on the data: XYZ has an absolute disadvantage in cars and a comparative advantage in planes XYZ has an absolute disadvantage in cars and planes but a comparative advantage in cars. QKFX has an absolute advantage in cars and planes but a comparative advantage in cars (4/5)12 4 (5/4)QKFX Corp. 8 4 (5/4)10 5 (4/5)XYZ Corp. PlanesCarsConverted: