The Economic Problem

1 2 Resources and Wants Our wants for goods and services exceed the productive capacity of the resources used to produce these goods and services.

1 3 Limited Resources The resources that are used to produce goods and services are: Labor Land Capital Entrepreneurship

1 4 Limited Resources Labor The time and effort that we devote to producing goods and services. Land The gifts of nature that we use to produce goods and services.

1 5 Limited Resources Capital The goods we use to produce other goods and services. Includes physical capital interstate highways, buildings, and dams and human capital the knowledge and skill that people obtain from education and on-the-job training

1 6 Limited Resources Entrepreneurship The resource that organizes labor, land, and capital.

1 7 Unlimited Wants Our wants are insatiable. Humans, by nature, would like to have more of those things they find desirable.

1 8 Resources and Wants We have limited resources. We have unlimited wants. This leads to scarcity. Scarcity exists when there are insufficient resources to satisfy people’s wants.

1 9 Economics Economics is the study of the choices people make to cope with scarcity.

1 10 Resources, Production Possibilities, and Opportunity Cost The production possibilities frontier is used to illustrate the maximum quantity of two goods that can be produced due to scarcity.

1 11 Tapes Soda (millions (millions of bottles Possibility per month) per month) Production Possibilities Frontier a 0and15 b1and14 c2and12 d3and 9 e4and 5 f5and 0

1 12 Attainable Production Possibility Frontier Soda (millions of bottles per month) Unattainable Tapes (millions per month) z a b d c f e

1 13 Opportunity Costs Production Efficiency Production efficiency is achieved if we cannot produce more of one good without producing less of some other good. Tradeoff Tradeoffs exist when we must give up something to get something else.

1 14 Opportunity Costs Opportunity Cost All tradeoffs involve a cost — an opportunity cost.

1 15 Opportunity Costs The opportunity cost of an action is the highest valued alternative foregone. Opportunity costs increase as we desire to produce more tapes. This explains the shape of the PPF — it is bowed outward.

1 16 Opportunity Costs Opportunity Cost Is a Ratio The decrease in the quantity produced of one good divided by the increase in the quantity of another good. Increasing Opportunity Cost Opportunity costs tend to increase because not all resources are equally productive in all activities.

1 17 Using Resources Efficiently Marginal cost The opportunity cost of producing one more unit of a good or service. The marginal cost of an additional tape is the quantity of soda that must be given up to get one more tape — the opportunity cost.

1 18 Opportunity Cost and Marginal Cost Tapes (millions per month) a b c d e f Soda (millions of bottles per month) Increasing opportunity cost of tapes...

1 19 Opportunity Cost and Marginal Cost Tapes (millions per month) Soda (millions of bottles per month) …means increasing marginal cost of tapes. MC

1 20 Marginal Benefit Marginal benefit The benefit that a person receives from consuming one more unit of a good or service. It is measured as the maximum amount that a person is willing to pay for one more unit. Decreasing Marginal Benefit The more we have of any one good or service, the smaller is our marginal benefit.

1 21 Marginal Benefit a0.55 b1.54 c2.53 d3.52 e4.51 Tapes Willingness to Pay Possibility (millions per month) (bottles per tape)

1 22 Marginal Benefit Tapes (millions per month) Soda (millions of bottles per month) MB Decreasing marginal benefit from tapes.

1 23 Efficient Use of Resources Efficiency Implies that we cannot produce any more of any good without giving up something that we value even more highly. We compare the marginal cost to the marginal benefit.

1 24 Efficient Use of Resources If the marginal benefit of the last unit of a good exceeds its marginal cost, we increase production of that good. If the marginal cost of the last unit of a good exceeds its marginal benefit, we decrease production of that good.

1 25 MC Efficient Use of Resources Marginal cost and willingness to pay (bottles of soda per tape) Tapes (millions per month) MB Bottles of soda that people are willing to forgo Bottles of soda that people must forgo Cost exceeds benefit Benefit exceeds cost

1 26 Economic Growth Economic growth is illustrated by an economy’s expansion in production over time.

1 27 Economic Growth The Cost of Economic Growth The development of new goods and better ways of producing goods and services is technological change. The growth of capital resources is capital accumulation. Does economic growth allow us to avoid opportunity costs?

1 28 PPF 1 Economic Growth Tape-making machines (per month) c Tapes (millions per month) b a PPF 0 If we produce 6 machines a month (b), then the PPF rotates. We will be able to produce more tapes in the future. b' a'

1 29 Economic Growth in the United States and Hong Kong Since 1960, Hong Kong has grown more rapidly than the United States. Hong Kong has devoted a bigger fraction of its resources to accumulating capital.

1 30 Economic Growth in the United States and Hong Kong Consumption goods (per person) Capital goods (per person) a a b Hong Kong in 1960 United States and Hong Kong in 1998 United States in 1960 c 0

1 31 Learning Objectives (cont.) Explain how economic growth expands production possibilities Explain how specialization and trade expand production possibilities

1 32 Gains from Trade Comparative Advantage A person or nation has a comparative advantage in an activity if one/it can perform an activity at a lower opportunity cost than others. Why is there a difference? Differences in abilities Differences in resource characteristics

1 33 Comparative Advantage Tom’s Factory Can produce 4,000 lengths of tape/hour or Can produce 1,333 cases/hour Opportunity Cost To produce 1 case, he must decrease tape production by 3 lengths — opportunity cost. To produce 1 length of tape, he must decrease case production by case — opportunity cost.

1 34 Comparative Advantage Nancy’s Factory Can produce 1,333 lengths of tape/hour or Can produce 4,000 cases/hour Opportunity Cost To produce 1 case, she must decrease tape production by lengths — opportunity cost. To produce 1 length of tape, she must decrease case production by 3 cases — opportunity cost.

1 35 Comparative Advantage Cases (thousands per hour) Nancy’s PPF 1 Tom’s PPF 4 b b' a Nancy’s opportunity cost: 1 tape costs 3 cases, and 1 case costs 1/3 tape Tom’s opportunity cost: 1 tape costs 1/3 case, and 1 case costs 3 tapes Trade line c Tape (thousands of lengths per hour)

1 36 Absolute Advantage An absolute advantage exists when a person or nation can produce more of a good than another. Individuals and nations can have absolute advantages in any or all goods. However, it is not possible to have a comparative advantage in everything.

1 37 Dynamic Comparative Advantage People or nations can become more productive simply by repetition --learning- by-doing. Dynamic Comparative Advantage results from learning-by-doing. Examples: Hong Kong, South Korea, Taiwan

1 38 The Market Economy Two key social institutions organize trade among nations. Property rights: Real Financial Intellectual

1 39 The Market Economy Two key social institutions organize trade among nations. Markets A market is any arrangement that enables buyers and sellers to get information and to do business with each other.

1 40 Circular Flows in the Market Economy

1 41 The Market Economy Coordinating Decisions Markets coordinate individual decisions through price adjustments.

1 42 NEXT A First Look at Macroeconomics