Copyright © 2004 South-Western/Thomson Learning Principle #3: The Cost of Something Is What You Give Up to Get It. The opportunity cost of an item is what you give up to obtain that item—the value of the next best alternative “Opportunity Cost = Opportunity Lost” “Choosing is refusing” Subjectivity of opportunity costs: Sometimes a $ amount Often—maybe always—a cost in time Sometimes more subjective

Copyright © 2004 South-Western/Thomson Learning Re-visiting Opportunity Cost Examples— Wild Kingdom Friday night Prom College Chauffeurs Celebrities An AP caveat about Opp Cost!

Copyright © 2004 South-Western/Thomson Learning The Road Not Taken

Copyright © 2004 South-Western/Thomson Learning MAJOR PRINCIPLES OF ECONOMICS The next 3 principles deal with how people interact with each other. 4.Trade can make everyone better off. 5.Markets are usually a good way to organize economic activity. 6.Governments can sometimes improve economic outcomes.

Copyright © 2004 South-Western/Thomson Learning Principle #4: Trade Can Make Everyone Better Off. Voluntary Trade creates wealth People only trade if both parties feel they benefit from the exchange By trade, we mean exchange of goods and services MM Simulation—an example of voluntary trade

Copyright © 2004 South-Western/Thomson Learning Debriefing the MM Simulation Examine the data Discuss the Principles Opportunity Cost As measured in “satisfaction points” Incomplete Information Voluntary Trade A Market economy

Copyright © 2004 South-Western/Thomson Learning Principle #5: Markets Are Usually a Good Way to Organize Economic Activity. Remember the Basic Questions in an Economy? We said: Because Goods are Scarce, society has to decide: What to produce? How to produce it? How much to produce? Who gets the goods of production? Markets are providing the answer to these questions in a particular way.

Copyright © 2004 South-Western/Thomson Learning Principle #5: Markets Are Usually a Good Way to Organize Economic Activity. A market economy is an economy that allocates resources through the decentralized decisions of many firms and households as they interact in markets for goods and services. Households decide what to buy and who to work for. Firms decide who to hire and what to produce.

Copyright © 2004 South-Western/Thomson Learning A new Question: Could we allocate goods in a different way? Markets are a way to allocate goods Could we organize the “rationing” or “allocation” process” differently? YES! Demonstration

Copyright © 2004 South-Western/Thomson Learning A new Question: Could we organize economies as a whole in another way? The free market system is a way we organize our economy. Could we organize our economy—could we solve our scarcity issues—differently? YES! Traditional Economy Command Economy Market Economy

Copyright © 2004 South-Western/Thomson Learning Traditional vs Command vs Market Economies Traditional Economy Command Economy Market Economy Decisions based on past, earlier practice, custom, etc. Decisions made by an authority, central planner, government, etc. Decisions made by individuals and firms through interchange of trade Family business “How it’s always been done” Passing on a family tradition Central Planning “5-year plan” Nationalized industries “From each according to his ability; to each according to his needs” Private property “invisible hand” Supply and demand Profit motive

Copyright © 2004 South-Western/Thomson Learning Principle #5: Markets Are Usually a Good Way to Organize Economic Activity. Father of Modern EconomicsAdam Smith (Father of Modern Economics) Writer of The Wealth of Nations (1776) Observed that households and firms interacting in markets act as if guided by an “invisible hand”