1. AP Micro- /Macroeconomics Unit I Basic Economic Concepts

2. The Economic Way of Thinking AP Microeconomics Unit I – Basic Economic Concepts

3. What does the saying “There’s no such thing as a free lunch” mean?

4. Objectives Define opportunity cost Define economic way of thinking Apply scarcity concepts to variety of economic and noneconomic situations.

5. Introduction A.P. Economics has thousand of details that can sometimes be confusing. This lesson will acquaints you with some basic economic concepts and methodology.

6. What is Economics? Comes from Greek words oikos (“house”) and nomos (“custom” or “law”), thus “rules of the house” What are we managing? Unlimited wants and needs How do we know they’re unlimited?

7. What is Economics? Society and Scarce Resources We use resources to meet wants and needs, but resources are limited Factors of production: land, labor, capital, entrepreneurship/ideas Scarcity – society has limited resources, cannot produce all the goods and services people wish to have Economics is the study of scarcity How does society allocate scarce resources to meet unlimited wants and needs?

8. The Economic Way of Thinking Everything has a cost. “there is no such thing as a free lunch” every action costs someone time, effort or lost opportunities to do something else. Opportunity cost is the real cost of an item, including what must be given up to obtain it people incur costs when making decisions, even when people appear to pay nothing.

9. People choose for good reasons.  People always face choices, however, if people have different values, they may make different choices.  Most of AP Economics concerns business and government decision making. (Remember, these decisions are made by people.)  Normative economics “makes prescriptive statements about how the economy should work” (Krugman G-7)  Positive economics “describes the way the economy actually works” (Krugman G-7)

10. Incentives matter.  Many believe economics is all about incentives.  Supply and demand is about incentives  Theory of the firm and factor markets are about incentives.  Government decision making is about incentives  Incentives change, people’s behavior changes in predictable ways.

11. People create economic systems to influence choices and incentives. Cooperation among people is governed by written and unwritten rules that are the core of an economic system. As rules change, incentives and behavior change. The success of market systems and the failure of communism are rooted in incentives.

12. People gain from voluntary trade. People will trade when they believe the trade makes them better off. Always remember throughout this course that it is people, not countries, that trade and make decisions. Economics is all about trade.

13. Economic thinking is marginal thinking. Marginal choices involve the effects of additions and subtractions from current conditions. A great deal of this course is about marginal costs and benefits and will be discussed in every unit.

14. The value of a good or service is affected by people’s choices. o Goods and services do not have intrinsic value; their value is determine by the preferences of buyers and sellers. o Intrinsic Value is the “value of a company or an asset based on an underlying perception of the value.” (“Intrinsic Value”) o Because of this, trading moves goods and services to higher-valued uses. This is why trading is so important. o The price of a good or service is set by supply and demand.

15. Economic actions create secondary effects. Good economics involves analyzing secondary effects. Example: rent controls make apartments more affordable to some consumers. Controls also make it less profitable to build and maintain apartments. The secondary effect is a shortage of apartments and houses for rent.

16. The test of a theory is its ability to predict correctly.  You will discuss many theories in AP Economics – all of these theories have simplifying assumptions  If the theory correctly predicts the consequences of actions, it is a good theory.  Nothing is “good in theory but bad in practice.”

17. Do Activity 1 – Do You Think Like an Economist? 1. Because it is desirable, sunshine is scarce. TF Sunshine isn’t scarce because it isn’t limited; it is a free good. 2. Because it is limited, polio is scarce. TF TF Polio isn’t scarce because it isn’t desirable.

18. 3. Because water covers three-fourths of the earth surface and is renewable, it cannot be considered scarce. TF Scarcity is a relative, not an absolute, concept. Because resources are scarce and wants are unlimited, almost everything to scarce. If you pay an opportunity cost to use a good or service, it is scarce. If you pay a positive price for a good or service, it is scarce. Water may cover three-fourths of the earth but we pay an opportunity cost and a positive price for clean water everywhere. Of course, water may be scarce in the desert than in the wetlands. Only a government can actually make water cheaper in a desert.

19. 4. The main cost of going to college is tuition, room, and board. TF An important opportunity cost of going to college is lost earnings. If you could earn $20,000 a year by working, you will sacrifice $80,000 during four years of college.

20. 5. If mass transportation fares are raised, almost everyone will take the trains anyway.TF It is false because, if all other things are equal, less mass transportation will be purchased if the price is higher. The price could be increased in terms of dollars, inconvenient schedules, crime and filthy cars. The demand curve for transportation would have to be perfectly inelastic, or vertical, for the answer to this question to be True. (We will discuss this issue later in the semester.)

21. 6. You get what you pay for. TF The price of something depends on supply and demand, not on usefulness or on some criterion of quality. Water is more useful than diamonds, but it has a lower price. What you pay for a good or service depends on the market price determined by supply and demand.

22. Both Q-5 & Q-6 deal with the law of supply and demand. People tend to buy more of something when the price is lower and less when the price is higher. Price includes money as well as such things as time, aggravation, inconvenience and moral guilt. Sellers will try to sell more of something if the price is higher and less of it if the price is lower. This conflict resolved through the market.

23. 7. If someone makes an economic gain, someone else loses.T F 8. If one nation produces everything better than another nation, there is no economic reason for these two nations to trade. TF

24. Both Q-7 and Q-8 concern gains from trade. When people trade voluntarily, both parties expect to gain, or they wouldn’t trade. One reason for this gain is the law of comparative advantage if one person does legal work better than another and if a second person word-processes documents better than the first, they would gain by trade. But would a lawyer who is the fastest word processor in town hire a secretary? Yes, because of comparative advantage: Each person would specialize in what he or she does comparatively better. An hour spent word processing would is an hour not spent in legal work, and the opportunity cost for the lawyer would be very high. The lawyer will specialize in legal work and the secretary in word processing. The total output of goods and services will increase. This concept can also be applied to countries.

25. 9. A nonregulated monopoly tends to charge the highest possible price.TF A monopoly charges a higher price than a competitive market price, but the monopolist cannot repeal the law of demand. If the price is too high, the monopolist might sell nothing. A monopolist will try to establish a price at a point that will make the greatest profit. This price is higher than a competitive price and will result in less production.

26. 10. A business owner’s decision to show more care for consumers is a decision to accept lower levels of profits.T F Profits are an incentive for business to succeed. A business that doesn’t care about its customers will not make high profits. As Adam Smith (1723-1790) said, “It is not from the benevolence of the butcher, the brewer or the baker that we expect our dinner, but from their regard for their own interest. We address ourselves not to their humanity but to their self-love, and never talk to them of our own necessities but of their advantages.”

27. The Production Possibilities Curve: Scarcity, Trade-offs, and Opportunity Costs AP Microeconomics Unit I – Basic Economic Concepts

28. Warm-up Is there any limit to what the United States can produce? Is there any limit to what you can buy?

29. Today’s Objectives 1. Define scarcity, opportunity cost, and trade-offs. 2. Identify the conditions that give rise to the economic problem of scarcity. 3. Identify the opportunity costs of various recent decisions made by your school or your community. 4. Construct PPCs from sets of hypothetical data. 5. Apply the concept of opportunity cost to a PPC. 6. Analyze the significance of different locations on, above, and below a PPC. 7. Identify the three questions every economic system must answer.

30. When faced with SCARCITY of resources, decisions have to be made about how to use those resources Trade-offs Opportunity costs

31. Trade-offs This is the decision making process that is occurring in your mind right now! Am I going to pay attention to what Mr. White is saying, or am I going to daydream? Am I going to come to class or go buy a lottery ticket? Am I going to stay in school or go find a full time job? Each and every decision you make has a cost!!! Not necessarily a cost in dollar terms, but a cost in that you must give up something in order to get more of something else.

32. Opportunity Cost The “price you pay” for each decision you make is called the OPPORTUNITY COST. Opportunity cost is vital to the understanding of economics. “The amount of a product or service that must be forgone (given up) in order to obtain more of the next best alternative product or service”

33. Production Possibilities curve (sometimes referred to as a production possibilities frontier) Used to illustrate: Productive Capacity Opportunity Costs Efficiency Productive Allocative Economic Growth/Decline Vital Link to Aggregate Supply (short/long run)

34. Production Possibilities Curve

35. The type of land resource suitable for growing Wheat is DIFFERENT than the land resource for growing Rice. If a society wants MORE Rice, then as you convert land suitable for growing Wheat (arable, relatively dry) so that you can grow Rice (wet, swampy) it will become MORE costly to do that, in terms of Wheat production We have INCREASING OPPORTUNITY COSTS of producing Rice in terms of Wheat

36. Production Possibilities Curve Economies produce MORE that just Wheat and Rice. We produce LOTS of goods of many different types. We can broadly categorize goods into TWO categories Capital Goods Consumer Goods

37. The best way to illustrate Trade-Offs and Opportunity Costs is to use a Production Possibilities Curve The PPC shows the relationship between two goods: 1. Capital Goods (Investment Goods): Goods that satisfy our wants INDIRECTLY and promote future growth or “happiness” – Delayed gratification. 2. Consumer Goods: Goods that satisfy our wants DIRECTLY. Instant Gratification

38. Production Possibilities Curve

39. The reason the PPC is bowed is because of INCREASING OPPORTUNITY COSTS. At Point A the economy gives up 10 capital goods in order to get 400 consumer goods. 400 Consumer goods = 10 Capital goods 1 Consumer good = 10 Capital goods/400 1 Consumer good =.025 Capital good

40. Production Possibilities Curve The reason the PPC is bowed is because of INCREASING OPPORTUNITY COSTS. At Point B the economy gives up 10 Capital goods in order to get 200 more Consumer goods. 200 Consumer goods = 10 Capital goods 1 Consumer good = 10 Capital goods/200 1 Consumer good =.05 Capital good

41. Production Possibilities Curve The reason the PPC is bowed is because of INCREASING OPPORTUNITY COSTS. Not all resources are adaptable to alternative uses. Resources used for Capital Goods may not be suitable to make Consumer Goods (and Vice Versa) Marsh land suitable for growing rice could not easily be converted for use as a an airport. It would be much more costly than using farmland in Kansas.

42. Production Possibilities Curve Let’s take a closer look at the PPC What do the different points on the PPC represent?

43. Production Possibilities Curve Each point represents Productive Efficiency This means that this economy is allocating ALL of it productive resources in the least costly way

44. Production Possibilities Curve There are an infinite number of points on the PPC. Where a society decides to produce is called Allocative Efficiency. This represents the combination of Capital and Consumer Goods most desired by the society

45. Production Possibilities Curve The whole PPC represents FULL PRODUCTION Productive efficiency Full employment of resources

46. Production Possibilities Curve Do economies always produce on the PPC? NO! Point E represents a point inside the PPC. The area between point E and the PPC represents underutilization of resources or under-employment of resources or unemployment. The economy is being inefficient.

47. Production Possibilities Curve Do economies always produce on the PPC? NO! Point F represents a point outside the PPC. The area between point F and the PPC represents overutilization of resources It represents a combination of Capital and Consumer Goods that is currently not possible with this economy’s resources

48. Scarcity is the fundamental economic problem In order to solve the dilemma of scarce resources being needed to fulfill unlimited wants, we must be answer the 3 fundamental economic questions What to produce? How to produce? For whom to produce?

49. Do activity 1-2

50. Absolute Advantage and Comparative Advantage, Specialization and Trade AP Microeconomics Unit I – Basic Economic Concepts

51. Objectives Define comparative advantage and absolute advantage. Describe and give examples of the law of comparative advantage. Explain how both parties in a trade gain from voluntary exchange. Define specialization and exchange. Use data to determine absolute and comparative advantage.

52. Introduction Activity 1-3 introduces absolute advantage and comparative advantage. Concepts will be covered in more detail in the international-trade unit. People trade because both parties stand to benefit when they engage in voluntary exchanges.

53. Absolute Advantage and Comparative Advantage What would life be like, if every person had to be totally self-sufficient and could not specialize and trade. You always have to remember that individuals, not nations, trade. However, specialization and trade can be accomplished both domestically and internationally. The more we trade, the better off we all are.

54. Absolute Advantage and Comparative Advantage ABSOLUTE ADVANTAGE One nation can produce more output with the same resources as the other. COMPARATIVE ADVANTAGE One nation can produce a good at a lower opportunity cost than the other. EXAMPLES OF COMPARATIVE ADVANTAGE Lawyer and secretary Doctor and nurse

55. Comparative advantage is a powerful concept that helps explain how mutual benefits can occur from exchange. A nation and an individual have a comparative advantage when they can make one or more products at a lower opportunity cost than another nation or individual. When producers specialize in the lower-cost product, they can make additional goods. Which they can trade to other producers for goods that would have been more costly to make. To determine a comparative advantage, costs must be measured in terms of what other products must be forgone to make particular product. This relative measure is a subtle, difficult and very important idea to understand. A nation’s or an individual’s comparative advantage will change as the opportunity costs of products made available by different trading partners change.

56. Absolute Advantage and Comparative Advantage We discussed earlier the idea of a lawyer hiring a secretary in the field of word processing. Remember we stated that the opportunity cost of the lawyer’s time spent as a secretary is very high, perhaps $100 or more. The lawyer could even hire more than one secretary for this amount and still come out ahead. The doctor/nurse situation is the same as the lawyer/secretary situation.

57. Determining Comparative Advantage (Output Method) 1. Which nation has an absolute advantage in producing CDs? 2. Which nation has an absolute advantage in producing beef? 3. Which nation has a comparative advantage in producing CDs? 4. Which nation has a comparative advantage in producing beef? 5. Should Japan specialize in CDs or beef? 6. Should Canada specialize in CDs or beef? Neither country Canada Japan Canada CD’s Beef

58. Determining Comparative Advantage (Input Method) 1. Which nation has an absolute advantage in producing CDs? 2. Which nation has an absolute advantage in producing beef? 3. Which nation has a comparative advantage in producing CDs? 4. Which nation has a comparative advantage in producing beef? 5. Which country should specialize in CD production? 6. Which country should specialize in producing beef? Mexico Japan Mexico Japan Mexico

59. Activity 1-3 You will be doing an activity that illustrates the same concept as it relates to comparative advantage using inputs (minutes or hours to produce a good) and outputs (number of goods produced per hour or per minute). The key is that if one party trades the good for which it has the lower opportunity cost for the good for which the other party has the lower opportunity cost, both parties gain.

60. Productivity AP Microeconomics Unit I – Basic Economic Concepts

61. Productivity Ratio of the amount of goods and services produced (output) per unit of productive resources used (input). As a ratio, productivity can be increased by: producing more goods and services with the same amount of resources OR by producing the same amount of goods and services with fewer resources.

62. Productivity Personal and national standards of living are directly related to labor productivity. The greater an individual’s labor productivity, the higher wage that individual can command. People must produce more per person if they are to receive more per person. Individual workers can increase productivity by investing in education and training (human capital).

63. PIZZA PARTY!!! Participate in a simulation that will demonstrate: How productivity is calculated The factors that can increase productivity Work in teams of four to produce pizzas (made of paper).

64. How to make a pizza: Trace the template (a small paper plate) on a piece of 8.5″ x 11″ paper. Cut out the circle. Draw 10 pepperoni pieces, about 1″ in diameter, on the pizza, using the red marker. Draw 15 black olive slices, ½″ to ¾″ in diameter, on the pizza, using the black marker.

65. PIZZA PARTY!!! Each round will be three minutes long. At the end of each round, quality control experts will determine if pizzas meet standards. Complete the data chart (Activity 8.1). Round 1: Each employee will work alone. Employees must complete one pizza before moving on to the next.

66. Thoughts on how to improve productivity? Round 2: Assign each employee a different task. You may work on more than one pizza at a time. You are limited to the same resources as in Round 1.

67. Thoughts on how to improve productivity? Round 3: Each team may acquire a capital good: a machine that pre-cuts pizza dough (paper plates). Machine rental is $2.50 per round. Reorganize the factory.

68. How was productivity calculated? Labor productivity = output per worker over a set time What happened to productivity between Round 1 and Round 2, and between Round 2 and Round 3? Why did this occur? What happened to quality between Round 2 and Round 3? What effect did investing in capital goods (the pizza-cutting machine) have on productivity? What effect did increased productivity have on average costs (row 10, Activity 8.1)? Why is this important?

69. What effect will increased productivity in the pizza factory have on wages? What happens if labor productivity increases in the overall economy? What costs were incurred by attempts to increase productivity? What are the advantages and disadvantages of specialization and division of labor? What else could the pizza factory do to increase productivity? What should a company consider before investing in capital, such as the pizza-cutting machine?

70. Factors That Increased Productivity Specialization/division of labor Assigning small, repeatable tasks at which workers gain expertise, as in Round 2 Results in more output per unit of labor Increase in human capital Acquired through education/training, displayed in all three rounds Investment in capital goods Tools/machines/factories as in Round 3 Technology

71. The Laws of Demand and Supply AP Microeconomics Unit I – Basic Economic Concepts

72. Markets and Competition A market is a group of buyers and sellers of a particular good or service. The terms supply and demand refer to the behavior of people... as they interact with one another in markets.

73. Markets and Competition Buyers (consumers) determine demand Sellers (producers) determine supply

74. DEMAND Quantity demanded is the amount of a good that buyers are willing and able to purchase. Law of Demand The law of demand states that, other things equal (ceteris paribus), the quantity demanded of a good falls when the price of the good rises. Substitution Effect Consumers have an incentive to substitute what is now a less expensive product for similar products that are now relatively more expensive Income Effect Lower price raises real income, enabling buyers to buy more of the product

75. The Demand Curve: The Relationship between Price and Quantity Demanded Demand Schedule The demand schedule is a table that shows the relationship between the price of the good and the quantity demanded.

76. Catherine’s Demand Schedule

77. The Demand Curve: The Relationship between Price and Quantity Demanded Demand Curve The demand curve is a graph of the relationship between the price of a good and the quantity demanded.

78. Catherine’s Demand Schedule and Demand Curve

79. Market Demand versus Individual Demand Market demand refers to the sum of all individual demands for a particular good or service. Graphically, individual demand curves are summed horizontally to obtain the market demand curve.

80. Shifts in the Demand Curve Change in Quantity Demanded Movement along the demand curve. Caused by a change in the price of the product.

81. Changes in Quantity Demanded

82. Shifts in the Demand Curve Change in Demand A shift in the demand curve, either to the left or right. Caused by any change that alters the quantity demanded at every price.

83. Shifts in the Demand Curve Determinants of Demand – a change in any of the following causes a change in demand and will shift the curve: Number of consumers Income of consumers Complement price Expectations Substitute price Tastes and preferences

84. Shifts in the Demand Curve

85. Shifts and Changes in Demand (cont.) A closer look at changes in income: Normal Good (or Luxury Good) Consumers demand more when their income increases Inferior Good Consumers demand less when their income increases

86. Consumer Income Normal Good

87. Consumer Income Inferior Good

88. Diminishing Marginal Utility Principle of Diminishing Marginal Returns: general tendency for marginal utility to decrease as the quantity of a good consumed increases Can be used to determine one’s individual demand curve for a product Measured in units of utility

89. Consumer Surplus Consumer Surplus = marginal benefit from a good minus the price paid for that good, summed over the quantity consumed How to calculate consumer surplus… How to calculate consumer surplus…

90. SUPPLY Quantity supplied is the amount of a good that sellers are willing and able to sell. Law of Supply The law of supply states that, other things equal (ceteris paribus), the quantity supplied of a good rises when the price of the good rises.

91. The Supply Curve: The Relationship between Price and Quantity Supplied Supply Schedule The supply schedule is a table that shows the relationship between the price of the good and the quantity supplied.

92. Ben’s Supply Schedule Price of Ice Cream ConesQuantity of Cones Supplied $0.000 0.500 1.001 1.502 2.003 2.504 3.005

93. The Supply Curve: The Relationship between Price and Quantity Supplied Supply Curve The supply curve is the graph of the relationship between the price of a good and the quantity supplied.

94. Ben’s Supply Schedule and Supply Curve

95. Market Supply versus Individual Supply Market supply refers to the sum of all individual supplies for all sellers of a particular good or service. Graphically, individual supply curves are summed horizontally to obtain the market supply curve.

96. Shifts in the Supply Curve Determinants of Supply– a change in any of the following causes a change in supply and will shift the curve: Resource prices Expectations Number of producers (level of) Technology Government actions (taxes, subsidies, regulations) Other (related) goods prices

97. Shifts in the Supply Curve Change in Quantity Supplied Movement along the supply curve. Caused by a change in the price of the product.

98. Change in Quantity Supplied

99. Shifts in the Supply Curve Change in Supply A shift in the supply curve, either to the left or right. Caused by a change in a determinant other than price.

100. Shifts in the Supply Curve

101. Producer Surplus Producer Surplus: amount seller is paid minus the seller’s cost Also the area under the equilibrium price and above the supply curve How to calculate producer surplus… (HINT: Same way as consumer surplus…)

102. SUPPLY AND DEMAND TOGETHER Equilibrium refers to a situation in which the price has reached the level where quantity supplied equals quantity demanded. Equilibrium Price and Quantity On the graph, it is where supply and demand intersect

103. SUPPLY AND DEMAND TOGETHER Demand Schedule Price of Ice Cream ConeQuantity Demanded $0.0019 0.5016 1.0013 1.5010 2.007 2.504 3.001 Supply Schedule Price of Ice Cream ConeQuantity Supplied $0.000 0.500 1.001 1.504 2.007 2.5010 3.0013

104. The Equilibrium of Supply and Demand

105. Disequilibrium Surplus When price > equilibrium price, then quantity supplied > quantity demanded. There is excess supply or a surplus. Suppliers will lower the price to increase sales, thereby moving toward equilibrium.

106. Markets Not in Equilibrium

107. Disequilibrium Shortage When price the quantity supplied. There is excess demand or a shortage. Suppliers will raise the price due to too many buyers chasing too few goods, thereby moving toward equilibrium.

108. Markets Not in Equilibrium

109. Equilibrium Law of Supply and Demand The price of any good adjusts to bring the quantity supplied and the quantity demanded for that good into balance.

110. How an Increase in Demand Affects the Equilibrium

111. How a Decrease in Supply Affects the Equilibrium

112. Economic Systems How do we answer the 3 main economic questions?

113. 3 questions faced by every society What to produce? How to produce ? For whom to produce?

114. 3 Types of economies

115. Command Economy All economic decisions made solely by the government Gov’t owns or controls most resources Planners decide what to produce, how to produce, and for whom to produce. Command decisions can be democratic or authoritarian. Citizens living under the command economy have NO freedom of choice.

116. Command Economy (cont.) Some examples of command economy include China and U.S.S.R Under the command economy, the U.S.S.R collapsed, leading us to question whether or not the command economy can succeed.

117. Pure Market Economy All economic decisions are made by people engaged in voluntary exchange. Consumers determine what to produce while producers determine how to produce. All resources are privately owned. Government’s role limited to providing laws protecting property rights.

118. Pure Market Economy Income depends on the productive resources a person has to sell. Market prices are signals that affect consumption and production. Sometimes called free enterprise system or capitalism

119. Traditional Economy Economic decisions repeat those made in earlier times. Economic decisions heavily influenced by religion and culture Traditional economy is often found in underdeveloped, agricultural parts of South America, Asia and Africa.

120. Mixed Economy Mixed economy incorporates aspects from all of the different systems of economy. The United States is an example of a mixed economy.We have a diverse mix of freedoms and regulations that is constantly changing in our economy.

121. Marginal Analysis How much of something should we do?

122. Will you do all you can to get an A on your test Monday? Why do you want an A? What’s the benefit of an A over a B or C? What will you give up to study the amount of time needed to get an A?

123. Marginal analysis What it is: the tool economists use to make these allocation decisions It’s simple! If the marginal benefit from another unit of some activity exceeds the marginal cost of that unit, you should undertake that extra unit of the activity. If the marginal benefit of the extra unit is less than the extra cost of that unit, do not take on the extra unit.

124. MC-MB Graph

125. So… Given the marginal cost of each extra hour devoted to studying for your exam, compared to the marginal benefit of receiving an A rather than a B or a C, how many hours are you really willing to devote to your exam???