Unit 1: The Nature and Importance of Economics

Outline Review of Chapter 1 5 Key Principles of Economics Principle of Opportunity Cost Production Possiblities Marginal Principle Marginal Benefit vs Marginal Cost Remaining Principles Principle of Diminishing Returns Spillover Principle Reality Principle Class Activity

Review of Chapter 1 Economics = study of the choices made when there is a scarcity of resources. Choices: An economic decision always aims to answer one of the following Qs: What to produce? How to produce it? Who will consume this product?

Review of Chapter 1 Scarcity: when the availability of a resource is limited, we must make sacrifices One good/service for another Example: a city has a limited amount of land, and must decide whether to build more parks, or more apartments Resources: There are 5 categories of resources used to produce goods (Factors of Production): Natural Resources Labor Physical Capital Human Capital Entrepreneurship

Review of Chapter 1 Market = an arrangement that allows buyers and sellers to exchange things Trade what you have for what you want Most economic decisions (the 3 Qs) are made in, or are influenced by markets Marginal = a small amount marginal change is a change in one unit of a variable. marginal analysis is used to analyze how a change in one unit of a variable causes a change in another Example: If I keep my store open for 30 min more per day, how much more money will I make? What we will look at today: factors: will the benefits of being open for the extra time (i.e. income) outweigh the costs of staying open? (electricity, wages, etc)

5 Key Principles of Economics

Principle of Opportunity Cost No matter what decision we make, there is always a trade-off “No such thing as a free lunch” Any time we acquire something, we have used up a resource that could have been used to acquire something else Ex: listen to a sales pitch for a free sample. What has been sacrificed? Opportunity Cost = what you sacrifice in order to get something

Principle of Opportunity Cost When we make a decision, we are choosing something over an alternative To determine the opportunity cost, we look at the best alternative Ex. Studying for Economics exam instead of studying for History, or playing video games. What is the opportunity cost? Can we quantify it? Opportunity cost = if either history or video games is chosen, studying for economics exam is the opportunity costs - vise-versa: if economics is chosen, pleasure of video game is opport cost - If studying for history would increase grade by 4% on test, then opport cost of studying for economics is 4% lost on history test

Production Possibilities Curves Normal Production (100 Al, 180 W) Resource = electricity, provided by hydro dam (water) Normally  point i During drought  frontier (or curve) shifts inward due to reduced avail of resources (water) response of the community was to stop aluminum production, and use the avail electricity to produce wheat (more important)  therefore, point f  other possibilities? (point g) Why is it not a straight line? Production During Drought (0 Al, 150 W) OR (40 Al, 130 W)

Principle of Opportunity Cost Your turn: What could be the opportunity cost of a part-time job while attending University? There are many possibilities

Marginal Principle Helps make economic decisions easier Economists consider how a one-unit (marginal) change in one variable affects the value of another variable Ex: Should a store-owner keep his shop open one hour longer? We must compare the marginal benefit with the marginal cost Benefit = the extra bonus that results from the small change Cost = the additional costs associated with the small change

Marginal Principle Marginal principle = increase the level of an activity its its marginal benefit exceeds its marginal cost. If possible, choose a level of production where the marginal benefit equals the marginal cost. Marginal Benefit Marginal Cost

Key Principles of Economics Principle of Diminishing Returns When there are two or more inputs involved in producing something (output) If we continue to increase only one input, eventually a point is reached where the output increases by smaller, and smaller amounts

Key Principles of Economics Spillover Principle The costs or benefits of producing something, sometimes spill over to people or organizations that are not involved in producing or consuming them Reality Principle What matters to people is the real value of money or income. In other words, its purchasing power. How much can I get for the money I have? Example: chemical leak from an AC unit depletes the ozone layer and causes more skin cancer. Decision not to fix it based on cost of repair does not consider the spill over effect. Example: If the hourly wage you are being paid does not allow you to buy the things you need, you ask for a raise.

Critical Thinking Activity Read p. 31 in your textbook “ Why Are We Getting Bigger?” Imagine you are an organization hired by the national government to solve this issue. Propose a solution that makes use of the principle of opportunity cost and marginal principle.