Econ 160 The Economic System of Competition Gains from Specialization & Trade

Review: Definitions Good Good : is anything that an individual wants to have more of, at zero price. Resource: Anything that can be used to produce goods. Scarcity: A good is scarce if the amount desired at zero price is more than the amount available at zero price.

Review:Assumptions Humankind has unlimited wants Our resources are limited ScarcityScarcity : Individually, and as a Society, we do not have enough resources to produce all the things we want.

Review:Implications of Scarcity ChoiceChoice: people must choose which goods to acquire. Economic CostEconomic Cost: The Cost of any action, is the personal value of the next highest valued alternative given-up. CompetitionCompetition: We are in a state of competition for the use of resources

Forms of Competition in Society Violence,Violence, or Threat of Violence Social/PoliticalSocial/Political : competition on the basis of some limited behavior or characteristic Economic/MarketEconomic/Market: competition based on offering the highest value in exchange.

Scarcity  Society Choices What to produce? Goal find the mixture of outputs that maximizes society’s value. How to produce? Goal: find the optimal mix of inputs to maximize technical output. For whom to produce? Who will get to consume the goods produced.

What Economics Is About Microeconomics: decisions of individuals and firms: what to buy and what to produce. Macroeconomics: the whole economic system and the role of government.

Mechanisms of Choice Political: our representatives make choices Economic/market: individuals and firms make choices based on relative prices about what to produce

Ten Principles of Economics Individual decision making How people interact The economy as a whole

Individual Decision Making People Face Trade-offs: Choice Opportunity Cost Rational people think at the margins People respond to incentives

How People Interact Trade Makes everyone better off The market system organizes production efficiently Markets outcomes can sometimes be improved upon by Government

The Economic/Market Form of Competition

Product Markets FIRMSHOUSEHOLDS Resource Markets $'s$'s Revenue $'s Income $'s Goods & Services Goods & Services Resources Inputs Circular Flow Diagram of the Exchange Economy

Economic Agents & Decision-making HouseholdsHouseholds: Decisions: What to sell? What to buy? Assume Maximize Utility FirmsFirms: Decisions: What inputs to use? What to produce? Assume Maximize Profits. MarketsMarkets: Factor Markets, Product Markets Role of Money Role of Money: The medium of exchange

Definition of Money Currency in Circulation: Currency outside of Banks in the hands of households,or firms Checkable deposits in Banks, Savings & Loans, Credit Unions

Interdependence & the Gains from Trade (Chapter 3)

Gains from Specialization &Trade Production Possibilities Resource FishCoconuts Crusoe: 8or 8 Friday:10or 20

Opportunity Cost in Production Crusoe: 8 F = 8 C 1 F = 1C and 1C = 1F Friday: 10 F = 20 C 1 F = 2C and 1C = ½ F Thus Crusoe has a comparative advantage in the production of fish ( 1F = 1C) and Friday has a comparative advantage in the production of Coconuts ( 1C = ½ F)

Separate Production Possibilities Crusoe Friday Fish Coco

Pre-Specialization Production ResourceFishCoconuts Crusoe: 4 and 4 Friday: 5 and 10 Total Output: 9 and 14

Output with Specialization Resource FishCoconuts Crusoe: 8 and 0 Friday: 1 and 18 Total Output: 9 and 18

Results of Specialization No increase in Resources No increase in effort Increased output by 4 coconuts Increased output will be shared by the two people or countries so as to make both better off

Apply Reasoning to more than two Resources Analyze production decisions using several resources with different relative abilities How to organize production to maximize output The graphical technique

Graph: Production Possibilities Function Assumptions: 1. Fixed resources: 10 acres in rows. 2. Fixed technology: current knowledge of how to produce. 3. Resources vary in relative productive ability.

Resources and Potential Outputs Row Corn10 Wheat

Resources and Opportunity Cost Row Corn10 Wheat Cost of 1 corn Cost of 1 wheat

Graph Mechanics The curve divides the space: interior points possible; Points beyond impossible SlopeSlope: Rise/ Run: The slope reflects the relationship: Negative, more corn means less wheat, more wheat means less corn ShapeShape: The concave shape reflects increasing cost of production for either good.

Changing assumptions Shifts the Curve An Increase in resources –Shifts the curve outward An increase in technology of Wheat production: Effects on Cost –Lowers cost of producing Wheat –Raises the cost of producing corn