Transcript Chapter 1 - Cloudfront.net

Chapter 1
Fundamental Economic
Concepts
The Economic Perspective
Economists view things from the
economic perspective and are
concerned with:
1. Scarcity and choice
2. Purposeful behavior
3. Marginal Analysis: Benefits/costs
Economics and Scarcity
• Economics is the study of how people make
choices to satisfy their needs and wants.
• Scarcity results from the fact that our
wants are unlimited and the resources
which must be used to satisfy them are
limited.
• Unlimited Wants + Limited Resources =
Scarcity
Scarcity v Shortage
Scarcity involves almost everything out
there. It is faced by everyone because
the resources used to produce the goods
and services are very limited while our
desire for these goods and services is
endless.
Shortage involves a very specific
situation where the quantity demanded
is greater than the quantity supplied.
Right now there is a huge demand for
gasoline while there is not enough oil
being pumped in order to produce all the
gasoline people wish to purchase –
therefore a shortage exists (that is why
the price keeps going up!)
Purposeful Behavior
Economics assumes that human behavior
reflects “rational self-interest” and that
individuals look for ways to increase their
“utility” or pleasure or satisfaction from
consuming a good or service. (Do not confuse this
with selfishness in which individuals increase personal
satisfaction, without regard to others).
Marginal Analysis:
Benefits and Costs
To an economist, “marginal” means
“extra,” “additional” or “a change in.”
Most choices in life involve either marginal benefits or
marginal costs. In our world of scarcity, the decision
to obtain the marginal benefit always involves some
marginal cost. Are you willing to pay the cost?
Thinking at the Margin
• When you decide how much more or less
to do, you are thinking at the margin.
Options
Benefit
Opportunity Cost
1st hour of extra
study time
Grade of C on
test
1 hour of
sleep
2nd hour of extra
study time
Grade of B on
test
2 hours of
sleep
3rd hour of extra
study time
Grade of B+ on
test
3 hours of
sleep
The Decision-Making Grid
• Economists encourage us to consider the
benefits andKaren’s
costsDecision-making
of ourAlternatives
decisions.
Grid
Sleep late
Wake up early to study
Benefits
• Enjoy more sleep
• Have more energy during the day
• Better grade on test
• Teacher and parental approval
• Personal satisfaction
Decision
• Sleep late
• Wake up early to study for test
Opportunity cost
• Extra study time
• Extra sleep time
Benefits forgone
• Better grade on test
• Teacher and parental approval
• Personal satisfaction
• Enjoy more sleep
• Have more energy during the day
Marginal benefits/costs
Allocative/production efficiency
Marginal benefit:
The benefit that a person receives
from consuming one more unit of a
good or service
Marginal cost:
The opportunity cost of producing one
more unit of a good or service
Allocative efficiency: When we produce the combination of
goods and services on the PPC/PPF that
we value most highly.
Production efficiency: A situation in which we cannot produce
more of one good without producing
less of some other good—production is on the
PPC/PPF.
Marginal benefit/cost
• All the combinations of goods on the
PPC/PPF achieve production efficiency. But
only one combination is the most highly
valued and this point is the allocative
efficient production point.
• The combination that is most highly valued
is the combination where the marginal
benefit equals the marginal cost.
Economists rely on Scientific
Methods
• Observation of real world behavior and
outcomes
• A hypothesis is developed from observations
• Continued testing may result in an
“economic principle”
• Always use ceteris paribus or “other-thingsequal assumption”
Macroeconomics and Microeconomics
Microeconomics
The part of economics concerned
with individual units such as a
person, household, firm or
industry. We look at decisionmaking by individual consumers,
workers, households and
business firms.
We examine the sand, rocks, and
shells…not the beach.
Macroeconomics
The part of economics
concerned with the economy as
a whole or its basic subdivisions
or aggregates (government,
household, and business
sectors). Such economic
measures as total output, total
employment, total income,
aggregate expenditures and
the general level of prices are
examined.
We examine the beach…not
the sand, rocks, and shells.
We have limited income and
unlimited wants
A Need is a requirement for
survival – 5 of them - Air,
Water, Food, Clothing and
Shelter
A Want is something desirable
but not required for survival
Trade-Offs
Trade-offs are when people choose one
thing in place of another. For example,
I may choose to sleep instead of going
running at 4am. Or I might be willing
to only run a mile and a half instead of
three miles so I could sleep a few more
minutes.
Opportunity Cost
Opportunity Cost is the cost of the loss
of the next best alternative use of a
resource. When you choose to use your
time to talk on the phone instead of
doing homework, the “cost” of that
decision is the homework which you have
given up.
Goods v. Services
Services are tasks which
are performed by someone.
Goods are tangible items
which are produced.
Free v. Scarce Goods
Free Goods are ones which
you can have without giving
up anything to get them.
Scarce goods are ones
for which you must
give up something in
order to get them.
Consumer v. Capital Goods
Consumer goods are final
goods which are used by
the purchaser for their
own personal use/benefit.
Capital Goods are
manmade goods which are
used to produce other
goods and services.
Factors of Production
(resource categories)
Land – Natural Resources
untouched by man.
Labor – Human Resources
performing a task.
Capital – Manmade goods used to
produce other goods and services –
typically tools and/or equipment.
Entrepreneurship – creative
combining of the other factors of
production to produce a good or
service.
Production Possibilities
Production Possibilities show the potential
combinations of how to use resources efficiently
The model assumes that you have:
• Full employment - economy is using all its available resources)
• Fixed resources - quantity an quality of factors of production
are fixed
• Fixed technology – state of technology is constant
• Two goods – consumer goods and capital goods
Production Possibilities
•
A production possibilities graph shows alternative ways that an economy can use its
resources.
The production possibilities frontier is the line that shows the maximum possible
output for that economy.
Production Possibilities Graph
25
Watermelons
Shoes
(millions of tons) (millions of pairs)
0
15
8
14
14
12
18
9
20
5
21
0
Shoes (millions of pairs)
•
20
15
a (0,15)
b (8,14)
c (14,12)
10
5
0
d (18,9)
A production
possibilities frontier
e (20,5)
f (21,0)
5
10
15
20
25
Watermelons (millions of tons)
Classic Guns and Butter
Law of increasing opportunity costs
(In the real world, most activities have increasing opportunity costs)
• The law of increasing opportunities costs is reflected in the
shape of the production possibilities curve. The curve is bowed
out from the origin of the graph. As the economy moves down
along the curve, it must give up successively larger amounts of
product. This is known as the slope of the production
possibilities curve, which becomes steeper.The economic
rationale is that resources are not completely adaptable to
alternative uses.
• When initially increasing the production of one good, resources
(highly-trained people, state of the art machinery, etc.) that are
well suited for its production are used. When still more of the
good is produced, resources that are less well suited must be
used (untrained temporary workers, machines that are breaking
down, etc.) Because the resources are ill suited, more are
necessary to increase production of the first good, and the
foregone amount of the other good increases. Constant costs are
represented by a straight curve.
Cost
Cost A production possibilities graph shows the cost of producing more of
one item. To move from point c to point d on this graph has a cost of 3
million pairs of shoes.
Production Possibilities Graph
25
Watermelons
Shoes
(millions of tons) (millions of pairs)
0
15
8
14
14
12
18
9
20
5
21
0
Shoes (millions of pairs)
•
20
15
c (14,12)
d
10
5
0
5
10
15
20
25
Watermelons (millions of tons)
Efficiency
Production Possibilities Graph
25
Shoes (millions of pairs)
• Efficiency means using
resources in such a way
as to maximize the
production of goods and
services. An economy
producing output levels on
the production possibilities
frontier is operating
efficiently.
20
S
15
a (0,15)
b (8,14)
c (14,12)
10
d (18,9)
g (5,8)
5
• Any point (see “g”) inside
the curve represents
situations of a failure to
achieve “full employment”
of resources
e (20,5)
A point of
underutilization
0
5
f (21,0)
10
15
20
Watermelons (millions of tons)
25
Remember…
• Moving ALONG the PPC illustrates tradeoffs
because in order to produce more of
something you have to produce less of
something.
• Moving from INSIDE THE PPC TO A POINT
ON THE PPC, more of some goods and
services can be produced without producing
less of others—a free lunch.
What is Economic Growth?
• It is the sustained expansion of
production possibilities. If more capital
is accumulated, production
possibilities increase and the PPC
shifts outward.
What is the benefit of
economic growth?
• The benefit from economic growth is
increased consumption per person in the
future after the production possibilities
have expanded. That is, AFTER the PPC
has shifted outward.
Growth
Production Possibilities
Graph
Future production
Possibilities frontier
25
T
20
Shoes (millions of
pairs)
• Growth If more resources
become available, or if
technology improves, an
economy can increase its
level of output and grow.
When this happens, the
entire production
possibilities curve “shifts to
the right.”
15
S
a (0,15)
b (8,14)
c (14,12)
d (18,9)
10
e (20,5)
5
f (21,0)
0
5
10
15
20
Watermelons (millions of tons)
25
What is the cost of economic
growth?
Economic growth requires:
• developing new technologies
• accumulating more human capital
• accumulating more capital
All of the above avenues require resources, so the
opportunity cost of economic growth is the decrease
in the current production of goods and services.
Opportunity Cost is a Ratio
Along the PPC or PPF, the opportunity cost
of one good (A) equals the quantity of the
other good forgone or lost (B) divided by
the increase in the good (A).
Reworded
The opportunity cost per unit of Good “A,”
from gaining some of Good “A” while losing
some of Good “B,” equals:
Loss in Good B
Gain in Good A
Confused?
Of course you are…let’s look at an
examples together.
*Note to teacher—go to Checkpoint 3.2, pg. 32, 37