Transcript Some Tools of the Economist

Chapter 2
Some Tools
of the Economist
Slides to Accompany “Economics: Public and Private Choice 9th ed.”
James Gwartney, Richard Stroup, and Russell Sobel
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1. What Shall
We Give Up?
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Opportunity Cost

Opportunity cost: The highest valued
activity sacrificed in making a choice.


Opportunity costs are subjective and
vary across individuals.
The opportunity cost of college:
Monetary cost: tuition, books.
 Non-monetary cost: forgone earnings.
 If opportunity cost of college rises
(e.g. tuition rises), then one will be
less likely to attend college.

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Trade

Mutual gain is the foundation of trade.


Value can be created by exchanges that
move goods to individuals who value
them more.
Transactions costs:
-- the time, effort, and other resources
needed to search out, negotiate, and
consummate an exchange.

Transactions costs reduce our ability to
produce gains from potential trades.
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Trade

Middleman:
-- a person who buys and sells, or
arranges trades.

Middleman reduce transactions costs.
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2. The Importance
of Property Rights
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Private Property Rights


Property rights:
-- the right to use, control, and obtain
benefits from a good or service.
Private property rights involve:
the right to exclusive use
 legal protection against invaders.
 the right to transfer to another.

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Private Property
and Incentives



Private owners can gain by employing
their resources in ways that are
beneficial to others.
The private owner has a strong
incentive to care for and properly
manage what he or she owns.
The private owner has an incentive to
conserve for the future if the
property’s value is expected to rise.
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Private Property
and Incentives

With private property rights, the
private owner is accountable for
damage to others through misuse of
the property.

Private ownership links responsibility
with the right of control.
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Questions for Thought:
1. It takes 1 hr. to travel from New York City to
D.C. by air, but it takes 5 hrs. by bus. If the air
fare is $55 and the bus fare is $35, which is
cheaper for someone whose opportunity cost of
travel time is $3 per hour? For someone whose
opportunity cost is $5 per hour? $7 per hour?
2. (a) Do private property rights allow owners to
use their property in any way that they
would like?
(b) Will private owners pay any attention to the
desires of others?
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3. Production
Possibilities Curve
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Production Possibilities Curve
for Susan’s Grades in English and Economics (10 Hrs of Study)
• Consider Susan, a student who only
has 10 hours of study to divide
between her economics and
english classes.
• If Susan spends most of her time
studying economics, she can earn an
A in economics . . . and a D in her
english class.
• If Susan splits her time between the
two, she can earn a B in economics
. . . and a B in her english class.
• If Susan spends most of her time
studying english, she can earn an
D in economics . . . and an A in her
english class.
• Mapping out all the possibilities of
how Susan can divide her time
(resources) between these activities
shows us her Production
Possibilities Curve (PPC).
Expected
Grades in
Economics
Production
Possibilities
Curve
A
B
C
D
F
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D
C
B
A
Expected
Grades in
English
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Production Possibilities Curve
for a Nation’s Economy (Given Limited Resources)
• Consider the economy of a nation which
has limited resources to divide between
the production of clothing and food.
• If the nation allocates all of its resources
toward the production of clothing, then
it can produce at point S.
• If the nation allocates all of its resources
toward the production of food, then it
can produce at point T.
• Mapping out all the possibilities of how
the nation can divide its resources
between these activities shows us the
nation’s Production Possibilities Curve.
• Output combinations A, B, and C are
all on the PPC are are therefore
efficient allocations of resources.
• Output combination D is within the
PPC and therefore represents an
inefficient allocation of resources.
Note that the nation could produce the
same level of clothing while producing
a greater quantity of food at point B.
Output
of
Clothing
Production
Possibilities
Curve
Only clothing
is produced
S
All output
possibilities
on the
frontier
curve are
efficient
A
B
D
- Inefficiency -
C
Only food
is produced
T
Output
of
Food
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Shifting the Production
Possibilities Curve Outward


An increase in the economy’s resource
base would expand our ability to
produce goods and services.
Advancements in technology can
expand the economy’s production
possibilities.
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Shifting the Production
Possibilities Curve Outward


An improvement in the rules (laws,
institutions, and policies) of the
economy can increase output.
By working harder and giving up
current leisure, we could increase our
production of goods and services.
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Investment and
Production Possibilities in the Future
• The long-term benefits of investment
include greater output in the future.
Therefore, decisions we make today
regarding how much to save
(investment goods) and how much
to consume (consumption goods)
determine the shape of the future
Production Possibilities Curve (PPC).
• If we choose to produce a mixture of
consumption and investment goods
which corresponds to bundle A . . .
then the future PPC might move out
to PPC 2005 (due to the new buildings,
equipment, training, and other forms
of investment goods that IA represents).
Investment
Goods
PPC 2005 with A
PPC 1995
A
IA
CA
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Consumption
Goods
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Investment and
Production Possibilities in the Future
PPC 2005 with B
Investment
Goods
PPC 2005 with A
• If, though, we choose to produce a
mixture of consumption and investment
goods which corresponds to bundle B,
where (CB < CA) fewer consumption
goods and (IB > IA) more investment
goods are chosen for production . . .
and so the future PPC might move out
to PPC 2005with B.
• The level of investment (savings) in an
economy is only one determinant of
the movement outward (or inward) of
the production possibilities curve.
PPC 1995
B
IB
A
IA
CB
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CA
Consumption
Goods
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4. Division of Labor,
Specialization,
and Production
Possibilities
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Division of Labor

Division of labor:
-- breaks down the production of a
commodity into a series of specific
tasks performed by different workers.
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Division of Labor

Specialization and division of labor
increase output for three reasons:
Specialization permits individuals to
take advantage of their existing skills.
 Specialized workers become more
skilled with time.
 Division of labor allows for the
adoption of mass-production
technology.

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Law of
Comparative Advantage

Law of comparative advantage:
-- proposition that the joint output of trading
partners will be greatest when each good is
produced by the low opportunity cost producer.
Implies that trading partners can gain by
specializing in the production of goods
they can produce at a relatively low cost
and trade for goods they could only
produce at a relatively high cost.
 The principle of comparative advantage is
universal as it applies across individuals,
firms, regions and countries.

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Voluntary Exchange

Voluntary exchange channels goods
toward those who value them most and
permits us to realize gains from
specialization, division of labor, mass
production, and cooperative effort
among individuals.

These elements underlie our modern
living standards.
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5. Economic
Organization
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Methods of
Economic Organization

Market organization:
-- A method or organization that allows
unregulated prices and the decentralized
decisions of private property owners to
resolve the basic economic problems.

Sometimes market organization is
called capitalism.
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Methods of
Economic Organization

Collective decision making:
-- Organizational method that relies on
public-sector decision making to resolve
basic economic issues.

An economic system in which the
government owns the income-producing
assets and directly determines what
goods they produce is called socialism.
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Exit and Voice

Individuals have two major methods
for sending messages.

Voice:
-- communicating complaints, desires, and
suggestions directly to decision makers.

Exit:
-- the ability to withdraw from an economic
relationship.
 Exit is easier to exercise in a market setting.
 Voice will be more effective if exit is also
available.
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Questions for Thought:
1. What does a production possibilities curve
demonstrate?
2. In many states, the resale of tickets to sporting
events at prices above the original purchase price
(“ticket scalping”) is prohibited. Is this a good
idea? Who is hurt and who is helped by the
prohibition?
3. (a) Suppose that grades in this class were going to
be determined by a random draw at the end of
the course. How would this influence your
study habits?
(b) Do you think the total output of goods in a
country would be influenced by whether there
was a close relationship between productive
contribution and individual reward?
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End
Chapter 2
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