Transcript Opportunity Cost.

Introduction to Economics
Mr. Bordelon
AP Economics
What is Economics?
• Economics. Social science concerned with the
efficient use of limited or scarce resources to
achieve maximum satisfaction of human
economic wants.
– Scarcity and choice—these are your economic
friends.
– Every economic issue involves individual choice.
– Why do we have to choose?
Market and Command Economies
• Market Economy. Production and
consumption are the result of decentralized
decisions by many firms and individuals.
• Command Economy. Industry is publicly
owned and there is a central authority making
production and consumption decisions.
• Most countries have adopted a market
economy. Command economies typically and
spectacularly fail miserably. Why?
Market and Command Economies
• Why do command economies fail?
– 1. Incentives. Prices make for a powerful
incentive.
• Stupid question: why?
– 2. Property rights. In command economies, the
government owns all resources and property.
• How is this a problem?
Factors of Production
• Land
• Labor
• Capital
– Physical capital
– Human capital
• Entrepreneurship
Scarcity
• Economic resources are limited/scarce, which
means that goods/services produced must be
limited.
– Scarcity requires choices to be made.
– Choices require that something must be given
up.
Opportunity Cost
• Opportunity cost. The opportunity cost is the
best alternative given up as a result of a
decision. The sacrifice you make when you
make a choice.
– When you make a choice, you are giving up the
opportunity to do something else.
Opportunity Cost
• Awesome. What about free stuff? Is it
actually free?
Opportunity Cost
• No. Think of this in terms of resources, not
marketing tactics.
• Resources were used to make these “free”
items (land, labor, capital) and because those
resources do not have alternative uses, society
gives up something else to produce the “free”
items you get at no cost.
Opportunity Cost and
Marginal Analysis
• Opportunity Cost. The real cost of something
is what you must give up to get it.
• Decisions are often made on an incremental
basis. Bit by bit, step by step.
– Video games vs. studying.
Opportunity Cost and
Marginal Analysis
• Marginal Analysis. If the person believes that
the additional benefits received from an
activity outweigh the additional costs
incurred, then the person will continue with
that activity.
– Marginal Benefits. The additional benefits.
– Marginal Costs. The additional costs.
• If MB ≥ MC, do it. If MB < MC, do not.
Micro- and Macroeconomics
• Microeconomics. The branch of economics
concerned with how individuals make decisions
and how these decisions interact.
Microeconomics focuses on choices made by
individuals, households, or firms.
• Macroeconomics. The branch of economics that
sutdies the overall ups and down of the economy.
Macro focuses on economic aggregates that
summarize data across many different localized
markets.
Positive and Normative Economics
• Positive Economics. Economic analysis used
to answer questions about how the world
actually works.
• Normative economics. Economic analysis
that involves saying how the world should
work.
Macroeconomics
• Macroeconomics. The branch of economics
that sutdies the overall ups and down of the
economy. Macro focuses on economic
aggregates that summarize data across many
different localized markets.
Business Cycle
• Business Cycle. Alternation between economic downturns
and upturns in the macroeconomy.
– Peak. Business activity reaches temporary maximum with
full employment and near capacity output.
Unemployment rate at lowest level.
– Recession. Decline in total output, income, employment,
and trade lasting six months or more. Unemployment rate
rising.
– Trough. Bottom of recession period. Unemployment at
highest level.
– Recovery. Output and employment expanding toward fullemployment. Unemployment rate falling.
– Cycle measured by time between peaks in the cycle.
Employment, Unemployment,
Business Cycle
• Measured by Bureau of Labor Statistics.
– Under 16 or institutionalized (military/jail) not
surveyed.
– Labor force = employed + unemployed
– Those not in labor force.
Employed and Unemployed
• Employed: those who work at a job with pay
for at least one hour or without pay for at
least 15 hours (family business/farm).
• Unemployed: no job, or temporarily laid off
but actively looking for work.
Labor Force and
Unemployment Rate
• LF = E + U
• UR% = 100 x (#U)/(#LF)
• Unemployment Rate. Percentage of labor
force not employed.
Aggregate Output and
the Business Cycle
• Aggregate Output. Economy’s total
production of g/s for a given time period,
usually a year.
• Relation to Unemployment
– Economy is strong, many g/s produced, firms need
to hire workers, employment is high,
unemployment rate is low.
– Economy is weak, fewer g/s produced firms need
to lay off workers, employment low,
unemployment rate is high.
Inflation, Deflation,
and Price Stability
• Inflation. A rise in the overall price level.
– Reduces ability to purchase g/s.
• Deflation. A fall in the overall price level.
– As prices fall, consumers hold onto money and
wait for lower and lower prices.
• Why could this be a problem?
Ceteris Paribus
• Ceteris Paribus. In order to figure out the
effect one variable has on another, we have to
hold other contributing factors constant. This
is the idea of ceteris paribus, or “other things
equal.”
Production Possibilities Curve
Production Possibilies Curve
• Efficient in production. All points along the
curve are efficient in production. Can not
increase production of one without giving up
production of the other.
• Efficient in allocation. What society wishes to
have more than anything else. If society
wants more of one thing than another, that
point in the PPC would be efficient in
production but not allocation.
Production Possibilities Curve
Production Possibilities Curve
• Opportunity cost. What is the opportunity cost
between pizza and bulldozers?
– Opportunity cost of the good graphed on x-axis is
ALWAYS slope of PPC.
– Opportunity cost of the good graphed on y-axis is
ALWAYS the inverse of the slope of PPC.
• Does it matter where you start out on the PPC in
determining the opportunity cost?
• The opportunity cost (slope) is constant. What does
this tell you about the substitutability of the
resources used to produce pizza and bulldozers?
Production Possibilities Curve
Law of
Increasing Opportunity Costs
• When switching from one item of production
to another, more and more resources are
necessary to incrase production of the
second item.
– 1. Amount of other products forgone to obtain
more of any given product is the opportunity cost.
– 2. More of a product produced, greater is its
(marginal) opportunity cost.
– 3. Slope of PPC becomes steeper, demonstrating
increasing opportunity cost (which gives curve its
concave look).
Law of
Increasing Opportunity Costs
• Why?
– Economic resources are not completely adaptable
to alternative uses.
– To get increasing amounts of bulldozers, resources
that are not particularly well suited for that
purpose must be used. Workers accustomed to
producing pizza may not be good bulldozer
builders. Gee, go figure.
– Pizza ovens are physical capital, and not very
adaptable to building bulldozers.
Economic Growth
• Economic growth means an expansion of the
economy’s production possibilities. The
economy can produce more of everything.
Shifts in PPC
Shifts in PPC
Shifts in PPC
Shifts in PPC
Summary PPC
• Efficiency. PPC represents combinations of
output that are possible, given economy’s
resources and tech.
• Scarcity. Given stock of resources and tech,
economy can produce only so much.
• Economic Growth. Rightward shift or rotation
of PPC.
• Choice.
Comparative Advantage and Trade
• Why do we trade?
• How do you think this might affect the PPC?
Comparative Advantage and Trade
• Milton Hershey is
famous for making
chocolate.
• And going bankrupt
twice.
• What does it take to
make chocolate?
– Land
– Labor
– Capital
Comparative Advantage and Trade
• How much chocolate do you think Hershey
personally produced?
Comparative Advantage and Trade
• Reality is if Hershey got his hands dirty at all, it
was with filthy stacks of obscene amounts of
cash.
• Why hire all these people to work for him
creating chocolate?
Comparative Advantage and Trade
• Specialization. Each person specializes in the
task that he or she is good at performing.
• Gains from trade. By diving tasks up and
trading, people can each get more of what
they want than they could get by being selfsufficient.
• Key: The economy can produce more when
each person specializes in a task and trades
with others.
Comparative Advantage
• Comparative Advantage. Individual has
comparative advantage in producing something if
hte opportunity cost of that production is lower
for that individual than for other people.
• Basic Idea: There are differing opportunity costs
of producing various g/s. Trading partners
benefit if they specialize and trade based upon
comparative advantage. There are gains from
trade even if one of traders isn’t particularly
specialized.
Tom and Hank
Reading the PPC
• According to PPC, Tom can catch 40 fish, but
only if no coconuts. He could get 30 coconuts,
but only if no fish.
• What’s the slope?
Reading the PPC: Tom
• According to PPC, Tom can catch 40 fish, but
only if no coconuts. He could get 30 coconuts,
but only if no fish.
• What’s the slope? -3/4
• Opportunity cost of 1 fish is ¾ of a coconut.
• What’s the opportunity cost of 1 coconut to
fish?
Reading the PPC: Hank
• Hank’s PPC has a slope of -2.
• Opportunity cost of 1 fish is 2 coconuts.
• What’s the opportunity cost of 1 coconut to
fish?
Opportunity Cost
Gains from Trade
Can Tom and Hank Make a Deal?
Gains from Trade
• Tom and Hank are better off when they
specialize in what they are good at and trade
for each other.
– Tom should catch fish. Why?
– Hank should get coconuts. Why?
Here’s the Deal
• Tom gives 10 fish to Hank.
– Tom consumes two more fish per week and one
more coconut per week.
• Hank gives 10 coconuts to Tom.
– Hank consumes four more fish per week and two
more coconuts per week.
Effect on Production Possibilities
Limits on Trade
• Why did Tom and Hank agree to a deal of 10
fish for 10 coconuts? Was there another deal
to be made?
– Hank will not accept a deal where he must give up
more than 2 coconuts per fish.
– Tom will not accept a deal where he must give up
more than 4/3 of a fish per coconut.
• Why?
Limits on Trade
• A trading partner engages in trade ONLY IF the
price of the good being obtained from the
trade is less than the opportunity cost of
producing the good himself.
Okay, so what?
• Specialization. By agreeing to specialize and
provide goods to each other, Tom and Hank
can produce more; both are better off than
being self-sufficient.
• Comparative Advantage. As long as people
have different opportunity costs, everyone has
a comparative advantage in something, and
everyone has a comparative disadvantage in
something.
Wait, wasn’t Tom better at
producing both fish and coconuts?
• Absolute Advantage. Individual has absolute
advantage in producing a good or service if he
can make more of it with a given amount of
time and resources.
– How is this different from comparative
advantage?
• FRQ Happy Points: Comparative advantage is
the basis for mutual gain, not absolute
advantage. Only the opportunity cost is what
matters ultimately.
A More Realistic Example
Oregon vs. Washington
State Apples Timber Opportunity
Cost of 1
Timber
OR
10
40
0.25 Apple
WA
40
10
4 Apple
Opportunity
Cost of 1 Apple
4 Timber
0.25 Timber
Who has comparative advantage? And in what?
Who has absolute advantage? And in what?
Draw Out the PPCs
• Assume that each state is producing and
consuming at the midpoint.
PPCs for Oregon and Washington
What can we gather form this info?
•
•
•
•
•
Oregon has 20 timber, 5 apples.
Washington has 20 apples, 5 timber.
Total timber production: 25
Total apple production: 25
Comparative advantage states that total
output will be greatest when each good is
produced by the state that has the lowest
opportunity cost.
• So who should specialize in what?
Oregon vs. Washington
• Washington has comparative advantage in
apple production and should specialize in
apples.
• Oregon has comparative advantage in timber
production and should specialize in timber.
• Why?
• Who is going to export what and to whom?
Oregon vs. Washington
• Limits of trade...how do we determine that?
Oregon vs. Washington
• Washington: 1 apple = 0.25 timber
– More than 0.25 timber for 1 apple.
• Oregon: 1 apple = 4 timber
– Less than 4 timber for 1 apple.
Go Back to Your PPCs
for OR and WA
• Assume Oregon and Washington negotiate a
deal for 20 timber and 20 apples.
• Show these points outside of both PPCs.
The Point
• Without trade, each state is constrained by
the PPC. With trade, they can go beyond the
PPC.
Test Content
• Modules 1-4
• 20 Questions, multiple choice