1. 1 1 What Is Economics? Why does public discussion of economic policy so often show the abysmal ignorance of the participants? Whey do I so often want to cry at what public figures, the press, and television commentators say about economic affairs? Robert M. Solow What Is Economics? Why does public discussion of economic policy so often show the abysmal ignorance of the participants? Whey do I so often want to cry at what public figures, the press, and television commentators say about economic affairs? Robert M. Solow

2. ♦Introduction and Course Info ♦Ideas for Beyond the Final Exam ♦Scarcity and Choice ♦Introduction and Course Info ♦Ideas for Beyond the Final Exam ♦Scarcity and Choice Contents Copyright© 2006 South-Western/Thomson Learning. All rights reserved.

3. Introduction and Course Info

4. Copyright© 2006 South-Western/Thomson Learning. All rights reserved. Ideas for Beyond the Final Exam ●Idea 1: How Much Does It Really Cost? ♦Opportunity cost = value of the best forgone alternative to any decision ♦All actions  opportunity costs ♦Opportunity costs  true economic costs ●Idea 1: How Much Does It Really Cost? ♦Opportunity cost = value of the best forgone alternative to any decision ♦All actions  opportunity costs ♦Opportunity costs  true economic costs

5. Copyright© 2006 South-Western/Thomson Learning. All rights reserved. Ideas for Beyond the Final Exam ●Idea 2: The Market Strikes Back ♦Markets set prices. ♦Government may intervene. ♦Markets may “strike back.” ■Example: rent control reduces the supply of housing. ●Idea 2: The Market Strikes Back ♦Markets set prices. ♦Government may intervene. ♦Markets may “strike back.” ■Example: rent control reduces the supply of housing.

6. Copyright© 2006 South-Western/Thomson Learning. All rights reserved. Ideas for Beyond the Final Exam ●Idea 3: The Surprising Principle of Comparative Advantage ♦When two nations trade, both benefit. ♦Comparative advantage = the production of goods with the lowest opportunity cost ♦Comparative advantage  specialization ●Idea 3: The Surprising Principle of Comparative Advantage ♦When two nations trade, both benefit. ♦Comparative advantage = the production of goods with the lowest opportunity cost ♦Comparative advantage  specialization

7. Copyright© 2006 South-Western/Thomson Learning. All rights reserved. Ideas for Beyond the Final Exam ●Idea 4: Trade is a Win-Win Situation ♦Trade  benefits for both buyers & sellers ♦Restrictions on trade   benefits ♦Intervention into markets   costs ●Idea 4: Trade is a Win-Win Situation ♦Trade  benefits for both buyers & sellers ♦Restrictions on trade   benefits ♦Intervention into markets   costs

8. Copyright© 2006 South-Western/Thomson Learning. All rights reserved. Ideas for Beyond the Final Exam ●Idea 5: The Importance of Thinking at the Margin ♦Marginal = small change ♦Marginal costs = change in costs ♦Rational decisions = comparison of costs to benefits at the margin ●Idea 5: The Importance of Thinking at the Margin ♦Marginal = small change ♦Marginal costs = change in costs ♦Rational decisions = comparison of costs to benefits at the margin

9. Copyright© 2006 South-Western/Thomson Learning. All rights reserved. Ideas for Beyond the Final Exam ●Idea 6: Externalities: Shortcoming of the Market Cured by Market Methods ♦Externalities = effects of transactions on third parties ♦Externalities  social costs ♦Market failure  need for government intervention ●Idea 6: Externalities: Shortcoming of the Market Cured by Market Methods ♦Externalities = effects of transactions on third parties ♦Externalities  social costs ♦Market failure  need for government intervention

10. Copyright© 2006 South-Western/Thomson Learning. All rights reserved. Ideas for Beyond the Final Exam ●Idea 7: The Trade-off between Efficiency and Equality ♦More efficiency  more output & jobs ♦More equality  less efficiency ♦Labor markets distribute income efficiently, not equally. ●Idea 7: The Trade-off between Efficiency and Equality ♦More efficiency  more output & jobs ♦More equality  less efficiency ♦Labor markets distribute income efficiently, not equally.

11. Copyright© 2006 South-Western/Thomson Learning. All rights reserved. Inside the Economist’s Toolkit ●Economics as a Discipline ♦Economics is the most scientific of the social sciences. ♦Yet, it is much more social than the natural sciences. ●Economics as a Discipline ♦Economics is the most scientific of the social sciences. ♦Yet, it is much more social than the natural sciences.

12. Copyright© 2006 South-Western/Thomson Learning. All rights reserved. Inside the Economist’s Toolkit ●The Need for Abstraction ♦Real world complexity  simplification in economic theory ♦The “art” of economics: focus on the essential; ignore the trivial. ●The Need for Abstraction ♦Real world complexity  simplification in economic theory ♦The “art” of economics: focus on the essential; ignore the trivial.

13. Copyright© 2006 South-Western/Thomson Learning. All rights reserved. Inside the Economist’s Toolkit ●What Is an Economic Model? ♦Economic model = formal statement of economic theory ♦Usually expressed in mathematics, with equations and graphs ●What Is an Economic Model? ♦Economic model = formal statement of economic theory ♦Usually expressed in mathematics, with equations and graphs

14. Copyright© 2006 South-Western/Thomson Learning. All rights reserved. Map 1 - Detailed Road Map of Los Angeles

15. Copyright© 2006 South-Western/Thomson Learning. All rights reserved. Map 2 - Major Los Angeles Arteries and Freeways

16. Copyright© 2006 South-Western/Thomson Learning. All rights reserved. Map 3 - Greater Los Angeles Freeways

17. The Fundamental Economic Problem: Scarcity and Choice Our necessities are few but are wants are endless. INSCRIPTION ON A FORTUNE COOKIE The Fundamental Economic Problem: Scarcity and Choice Our necessities are few but are wants are endless. INSCRIPTION ON A FORTUNE COOKIE

18. Copyright© 2006 South-Western/Thomson Learning. All rights reserved. ●Scarcity, Choice, and Opportunity Cost ●The Concept of Efficiency ●Specialization Fosters Efficient Resource Allocation ●Specialization Leads to Exchange ●Markets, Prices, and the Three Coordination Tasks ●Scarcity, Choice, and Opportunity Cost ●The Concept of Efficiency ●Specialization Fosters Efficient Resource Allocation ●Specialization Leads to Exchange ●Markets, Prices, and the Three Coordination Tasks Contents Copyright© 2006 South-Western/Thomson Learning. All rights reserved.

19. Scarcity, Choice and Opportunity Cost ●Scarcity of resources  necessity of choices ●Opportunity cost = value of the best forgone alternative ♦True cost of a scarce resource ●Scarcity of resources  necessity of choices ●Opportunity cost = value of the best forgone alternative ♦True cost of a scarce resource

20. Copyright© 2006 South-Western/Thomson Learning. All rights reserved. ●Opportunity cost: Closely related to money cost if markets are well functioning ●No explicit prices for some valuable resources, e.g., time ●Total cost = money cost + opportunity cost ●Opportunity cost: Closely related to money cost if markets are well functioning ●No explicit prices for some valuable resources, e.g., time ●Total cost = money cost + opportunity cost Opportunity Cost and Money Cost Copyright© 2006 South-Western/Thomson Learning. All rights reserved.

21. ●Example of opportunity cost: a firm that produces two outputs with a fixed supply of inputs ●More of one output  less of the other output ●Example of opportunity cost: a firm that produces two outputs with a fixed supply of inputs ●More of one output  less of the other output Opportunity Cost and Money Cost Copyright© 2006 South-Western/Thomson Learning. All rights reserved.

22. Scarcity and Choice for a Single Firm ●Production Possibilities Frontier ♦Production possibilities frontier = a graph showing different combinations of output for a given amount of inputs ♦More of one good  less of another ♦Illustrates opportunity costs in production ●Production Possibilities Frontier ♦Production possibilities frontier = a graph showing different combinations of output for a given amount of inputs ♦More of one good  less of another ♦Illustrates opportunity costs in production

23. Copyright© 2006 South-Western/Thomson Learning. All rights reserved. TABLE 1 Production Possibilities Open to a Farmer Copyright© 2006 South-Western/Thomson Learning. All rights reserved.

24. ●Negatively sloped ●Slope = opportunity cost ●Illustrates the trade-off in the production of one good (or class of goods) against another ●Negatively sloped ●Slope = opportunity cost ●Illustrates the trade-off in the production of one good (or class of goods) against another The Production Possibilities Frontier Copyright© 2006 South-Western/Thomson Learning. All rights reserved.

25. FIGURE 1 PPF for Production by a Single Farmer Attainable region Soybeans Wheat E D C B A Unattainable region 60655238302010 0 20 30 40 Copyright© 2006 South-Western/Thomson Learning. All rights reserved.

26. ♦Shape: concave ♦Principle of increasing costs:  production of one good   opportunity cost of producing another unit ♦Reason: Inputs tend to be specialized. ♦Shape: concave ♦Principle of increasing costs:  production of one good   opportunity cost of producing another unit ♦Reason: Inputs tend to be specialized. The Principle of Increasing Costs Copyright© 2006 South-Western/Thomson Learning. All rights reserved.

27. FIGURE 2 PPF with No Specialized Resources D C B A Brown Shoes Black Shoes 50 40 30 20 10 0 5040302010 Copyright© 2006 South-Western/Thomson Learning. All rights reserved.

28. ●Productivity constant along a production possibilities frontier. ●  productivity  shift of the frontier ♦Skills ♦Technology ♦Capital stock ●Productivity constant along a production possibilities frontier. ●  productivity  shift of the frontier ♦Skills ♦Technology ♦Capital stock Production Productivity Copyright© 2006 South-Western/Thomson Learning. All rights reserved.

29. ●Resources are scarce for the entire society. ●Choices must be made: More of one good implies less of another. ●Production possibilities frontier applicable to the economy as a whole. ●Resources are scarce for the entire society. ●Choices must be made: More of one good implies less of another. ●Production possibilities frontier applicable to the economy as a whole. Scarcity and Choice for the Entire Society

30. Copyright© 2006 South-Western/Thomson Learning. All rights reserved. FIGURE 3 PPF for Entire Economy Thousands of Automobiles per Year Thousands of Everything Else C F E D B 500400300200100 0 200 300 400 500 600 700 G Copyright© 2006 South-Western/Thomson Learning. All rights reserved.

31. ●Problems of scarcity and choice are everywhere in the economy. ●Households, firms, and government must decide how to allocate their income. ●Problems of scarcity and choice are everywhere in the economy. ●Households, firms, and government must decide how to allocate their income. Scarcity and Choice Elsewhere in the Economy Copyright© 2006 South-Western/Thomson Learning. All rights reserved.

32. The Concept of Efficiency ●Efficiency = no waste ●All available resources are utilized. ●Sources of inefficiency ♦Assigning inputs to the wrong task ♦Unemployment ♦Discrimination ●Competition should eliminate inefficiency. ●Efficiency = no waste ●All available resources are utilized. ●Sources of inefficiency ♦Assigning inputs to the wrong task ♦Unemployment ♦Discrimination ●Competition should eliminate inefficiency.

33. Copyright© 2006 South-Western/Thomson Learning. All rights reserved. The Concept of Efficiency ●Efficiency and the production possibilities frontier ♦Every point on a production possibilities frontier is efficient. ♦Efficiency does not tell us which point is best. ♦Any point inside the frontier is inefficient. ●Efficiency and the production possibilities frontier ♦Every point on a production possibilities frontier is efficient. ♦Efficiency does not tell us which point is best. ♦Any point inside the frontier is inefficient.

34. Copyright© 2006 South-Western/Thomson Learning. All rights reserved. The Three Coordination Tasks of Any Economy ●How to utilize its resources efficiently. ●What combination of goods and services to produce. ●How much of each good to distribute to each person. ●How to utilize its resources efficiently. ●What combination of goods and services to produce. ●How much of each good to distribute to each person.

35. Copyright© 2006 South-Western/Thomson Learning. All rights reserved. ●The Wonders of the Division of Labor ♦Breaking a task into a set of smaller, more specialized tasks ♦Specialization  productivity growth ●The Wonders of the Division of Labor ♦Breaking a task into a set of smaller, more specialized tasks ♦Specialization  productivity growth Specialization Fosters Efficient Resource Allocation

36. Copyright© 2006 South-Western/Thomson Learning. All rights reserved. Specialization Fosters Efficient Resource Allocation ●The Amazing Principle of Comparative Advantage ♦Principle of comparative advantage = specialization in the production of the good with the lowest opportunity cost ♦Comparative advantage  specialization ●The Amazing Principle of Comparative Advantage ♦Principle of comparative advantage = specialization in the production of the good with the lowest opportunity cost ♦Comparative advantage  specialization

37. Copyright© 2006 South-Western/Thomson Learning. All rights reserved. Specialization Leads to Exchange ●Specialization requires exchange ●Trading   production because it permits specialization ●Specialization requires exchange ●Trading   production because it permits specialization

38. Copyright© 2006 South-Western/Thomson Learning. All rights reserved. Markets, Prices, and the Three Coordination Tasks ●Markets  solutions to the three coordination tasks ●Consumers are in control ●Sometimes the solutions are compatible with society’s goals, other times not. ●Markets  solutions to the three coordination tasks ●Consumers are in control ●Sometimes the solutions are compatible with society’s goals, other times not.

39. Copyright© 2006 South-Western/Thomson Learning. All rights reserved. The End ???