Transcript Economics—The Dismal Science

Economics—The Dismal Science
• Economics is NOT a stranger. Why Dismal? (See p.551)
• People have NEEDS and WANTS. Very few people are satisfied
with what they have—you need a place to live, but you WANT
a mansion
• Fundamental problem: Scarcity--the condition that results when
we don’t have enough resources to produce all the things
people want.
• EX: Not everyone can have a fur coat…or can they? Depends
on allocation (distribution)
• Shortages occur when producers will not or cannot offer goods
or services at current prices
• Economics is the study of how people make choices in order to
try to satisfy seemingly unlimited wants through the careful use
of selected resources.
Hypothesis for this Class:
• “Social cooperation develops
spontaneously in societies that protect
private property rights and allow people
to exchange freely.”
Two types of Economics
• Macroeconomics: Examines behavior of entire
economies (US, China, Europe, the World).
Should we build more highways, explore space, expand the military, or
build more low-income housing?
• Will prices rise or fall with a tax cut? How do we stimulate a weak
economy?
•
• Microeconomics: Studies choices made by economic
actors such as households and companies.
•
•
Is a family saving enough for its future needs?
Should Chrysler introduce the Challenger?
• Do not confuse “Micro” and “Macro”-- studying GM is
a microeconomic topic
Why Study Economics?
• It helps us know how the economy works on a
daily basis, brings macro-concepts to microlevel.
• EX: Your decision to buy Pepsi instead of Coke, combined with the decisions
of others, may cause Coke to lower prices
• EX: Should we explore for oil fields in the United States, import foreign oil,
or use our resources to develop hydrogen as a fuel source?
• Helps us understand a free-market economy
• Helps us make political decisions
• Helps us understand global affairs
“There is no such thing as a free lunch”
(TINSTAAFL)
• Resources are limited, but sometimes consumers
receive resources without apparent cost. EX: Free
lunch at school is complementary, not FREE.
• Someone ALWAYS pays, however.
• Businesses/governments/corporations recover costs
• 1) Profit margin on other items
• 2) Overcharging for the first item in a “buy one, get
one free” scheme
• 3) Perhaps they didn’t pay full price for the product in
the first place (supplier or producer dumping
product—in that case they absorb the loss)
• 4) Passing cost along to others (taxes)
Examining Opportunity Costs
• “Snickers or Nickels”
Opportunity Costs
• Everything in life costs SOMETHING, even if it is not figured in
monetary terms. Choosing is refusing!
• Eliminate the phrase “I don’t have the time!”
• EX: I could have chosen to play football in college, chose instead to
graduate earlier. Sacrifices are economic trade-offs. The next-best
choice which is given up is the opportunity cost.
• EX: To date someone, you give up the next best alternative!
• EX: MDOT chooses to build M-6 in Grand Rapids—So it can’t spend as
much money to repair M-15. As a result of making this decision,
taxpayers have less discretionary income (more is taken in taxes to
pay for the new expressway, even from those who do not benefit)
• Law of Diminishing Returns: Eventually, the cost is no longer worth
the benefit, and producers will stop producing.
• EX: Picking strawberries: eventually you get full and decide the next
strawberry isn’t worth it. Your time is better spent resting than
eating.
Marginalism
• Economics frequently deals with issues at the margin. In other
words, how much more would it cost to produce one more unit
of something?
• Marginalism deals w/ sunk costs—unavoidable costs
• EX: Plane with an empty seat—marginal cost to transport one
additional passenger is essentially zero. Airlines frequently
“upgrade” passengers if first-class is not full—makes you more
satisfied and more likely to return. Whether you sit in coach or
first class, sunk costs are fixed.
• EX2: I can produce 400 cars/day. If I make workers work
overtime, I can make 450. Beyond that, I have to hire new
workers, and pay costly health insurance. I also have to buy
ONE extra load of steel, which will cost more.
• The 451st car costs too much money to make (profit margin is
negative)
The 4 Factors of Production
• Land—society’s limited natural resources or inputs—
landforms, minerals, vegetation, animal life, climate,
energy.
• Labor—workers who apply efforts, abilities, and skills
• Capital—money (financial capital), tools, equipment,
machinery, resources, human capital (can be
enhanced/improved by government investing in
health care, education)
• Entrepreneurs--risk-takers who combine the land,
labor, and capital into products. Includes managerial
ability. Entrepreneurs are crucial because the can
start new business and introduce new products—
which strengthens the economy
Resource Distribution and
Trade
• Each country of the world possesses different types
and quantities of land, labor, and capital resources.
• By specializing in the production of certain goods
and services, nations can use their resources more
efficiently.
• Specialization and trade can benefit all nations.
David Ricardo & Comparative Advantage
• David Ricardo (1772-1823) was a Classical Economist who
opposed England’s Corn Laws. The Corn Laws, in force
between 1815 and 1846, were import tariffs ostensibly
designed to "protect" British farmers and landowners against
competition from cheap foreign grain imports.
• They were repealed by PM Robert Peel after the Irish potato
famine (went against his own Conservative Party). This
sparked the concept of free trade.
• A person or nation has an absolute advantage when it can
produce a particular good at a lower cost than another person
or nation. Korea has absolute advantage in producing cars.
• Comparative advantage is the ability of one person or
nation to produce a good at a lower opportunity cost than
that of another person or nation. South Korea can make cars &
t-shirts cheaper than the U.S., but it is more productive at cars.
• The law of comparative advantage states that nations are
better off when they produce goods and services for which they
have a comparative advantage in supplying.
Key Assumptions of Ricardo
• There are no transport costs.
• Costs are constant and there are no economies of
scale.
• There are only two economies producing two goods.
• The theory assumes that traded goods are
homogeneous (ie identical).
• Factors of production are assumed to be perfectly
mobile.
• There are no tariffs or other trade barriers.
• There is perfect knowledge, so that all buyers and
sellers know where the cheapest goods can be found
internationally.
Section 1 Review
1. What is the difference between a shortage and scarcity?
– (a) A shortage can be temporary or long-term, but scarcity always
exists.
– (b) A shortage results from rising prices; a scarcity results from
falling prices
– (c) A shortage is a lack of all goods and services; a scarcity
concerns a single item.
– (d) There is no real difference between a shortage and a scarcity.
2. Opportunity cost is
– (a) any alternative we sacrifice when we make a decision.
– (b) all of the alternatives we sacrifice when we make a decision.
– (c) the most desirable alternative given up as a result of a
decision.
– (d) the least desirable alternative given up as a result of a
decision.
3 Basic Questions of Economics
• What to produce? Society chooses based on need.
• How to produce? Society chooses based on resources
• For whom to produce? Society chooses based on population
and other available markets where the good/service can be
sold. EX: Computers from US sold all around world**
• Goods= tangible material object. Can be durable (intended to
last, like washing machines) or nondurable (seasonal fruit)
• Service=actions/activities performed for a fee
• Problem: Can’t have both “guns” and “butter.” Lyndon Johnson
learned this the hard way.
• Highly effective, but also frustrating in short-term (gasoline on
9/11)
The Scope of Economics
• Describes events, situations.
• EX: Gross Domestic Product—dollar value of all goods
and services produced within a country’s borders
within year, Interest rates, unemployment rates,
Consumer Price Index (impacts union contracts)
• Analysis—is the current allocation of resources
effective? If not, how can it be improved?
• Explanation—Greenspan was able to “fix” recession
• Prediction—know consequences of alternatives (Will
Bush tax cut hurt Medicare drug coverage?)
Economic Methodologies
• Positive Economics—attempts to understand
economics without making value judgements
• Normative Economics—looks at the outcomes of
economic behavior, determines whether they are good
or bad, and whether they can be made better.
Opinionated statements. EX: “Cutting taxes on the rich
is a bad idea.”
• Descriptive Economics—graphs,charts tables like you’d
find in an almanac
• Empirical Economics—using data to test hypotheses
• All methodologies use the concept of ceteris paribus
(assuming all other things equal)
Economic/Logical Fallacies
• Post hoc, ergo propter hoc: “After this, therefore because of
this”
• EX: I watched the game, therefore the Duke Blue Devils lost.
• Causation/Correlation: Correlation does NOT imply causation.
• EX: New York City has more car accidents than Brown City.
NYC drivers must be worse.
• Fallacy of composition: Theories that seem to work well when
applied to individuals often break down when they are applied
to the whole.
• EX: Ranchers share grazing land…one rancher buys more cattle
to make more money, overgrazing destroys everyone
Discussion Questions:
Macroeconomics
• How might the economic decisions of Canada
and the United States differ on the concept of
waste removal and storage?
• Garbage debate; Canada unwilling to spoil
pristine wilderness, yet could certainly afford
to. US entrepreneurs looking to make a buck
off trash favor the status quo.
• Should you have the “right to pollute” your
own land?
Value, Utility, and Wealth
• Value is expressed in money; scarcity is not enough to
create value—MUST have utility
• Utility is a good’s or service’s capacity to provide
satisfaction, which varies with the wants and needs of
each person
• Some people like to show off assets. (Thorstein
Veblen and “Conspicuous consumption” of the
nouveau riche)
• Wealth is the accumulation of goods that are tangible,
scarce, useful, and transferable. Wealth does NOT
include services.
Net worth= Assets - Liabilities
“The Wealth of Nations”
Adam Smith, 1776
• In the late 18th and early 19th Century, the
Industrial Revolution comes to Europe
• The UK experiences it first, hence Smith is perfectly
placed to see the phenomenon first. Smith is the
acknowledged “Father of Economics.”
• In the book, Smith tried to make sense of why
factories were being built and why lives were
changing.
• Smith explained that a favorable balance of trade,
facilitated by mercantilism, was the key to wealth.
Countries needed to have gold and silver. Domestic
markets need to be kept open to foreign
competition. Favored laissez-fair approach
Discussion Question
• Why might a wealthy society not have
as much economic staying power as
another wealthy society with a highlyskilled work force?
• Wealth usually based on limited natural
resources; labor can produce more
goods and services
The Circular Flow Model
• Markets are locations or mechanisms for buyers and
sellers to trade. Markets can be local, regional,
national, and global
• People earn their income in the factor market.
Entrepreneurs buy labor for wages and salaries**
• Entrepreneurs also acquire financial capital for interest
and acquire land in return for rent
• After individuals receive income, they spend it in
product markets
The Free Market Economy
In a free market economy, households and business firms use
markets to exchange money and products. Households own
the factors of production and consume goods and services
Households pay
firms for goods
and services.
Product market
Firms supply
households with
goods and services.
Households supply
firms with land, labor,
and capital.
Factor market
Firms pay
households for land,
labor, and capital.
The Market’s Self-Regulating Nature
• In every transaction, the buyer and seller consider only their
self-interest, or their own personal gain. Self-interest is the
motivating force in the free market.
• Producers in a free market struggle for the dollars of
consumers. This is known as competition, and is the regulating
force of the free market.
• The interaction of buyers and sellers, motivated by self-interest
and regulated by competition, all happens without a central
plan. This phenomenon is called “the invisible hand” of the
marketplace
• EX: Student studies to be a lawyer, decides few lawyer jobs are
available, sees high need for teachers, and chooses secure job
over earnings potential.
• EX: GM must pay you at least what DCX is willing to pay
Section 2 Review
1. Why do people need to buy and sell goods or services?
– (a) People need to buy and sell goods to make a profit.
– (b) People buy and sell to maintain a competitive society.
– (c) No one is self-sufficient.
– (d) People need to provide the market with goods and
services.
2. What factors create the phenomenon of the “invisible hand”?
– (a) incentives and efficiency
– (b) specialization and efficiency
– (c) competition between firms
– (d) competition and self-interest
Productivity and Economic Growth
• Productivity- a measure of the amount of output
produced by the amount of inputs within a certain
time
• More productivity=more efficient use of scarce
resources
• Specialization and Division of Labor usually improve
productivity, while increasing interdependence.
Portugal produces cork, United States produces cars.
• Investing in “human capital” often promotes
productivity because when people’s skills, abilities,
health, and motivation advance, production improves
Critical Thinking/Discussion Q:
• What are the advantages and disadvantages of
specialization and division of labor?
• Interdependence improves efficiency and
productivity. Why might it still be a bad thing?
• What might happen to a country that is severely
interdependent on others if a war breaks out?
• Productivity must be linked with quality. Is the old
saying, “Never buy a car made on Monday or
Friday” still true, or have initiatives like QS-9001
and Six Sigma improved the products of the
American worker? How does Asian quality
matchup?
Production Possibilities
• The production possibilities curve (frontier diagram)
illustrates the concept of opportunity cost. The line on
the graph represents the full potential when an
economy employs all of its resources
• When you identify possible alternatives, you can
determine how to best use resources
• An economy pays a high cost if any of its resources
are idle—it will NOT reach its frontier
• Economic growth or contraction because of a change
in he # of resources will cause the graph to shift
• Law of Increasing Costs: As production shifts from one
item to another, more and more resources are
necessary to increase production of the second item
• More consumer goods=less capital goods & vice versa
A production possibilities graph (also known as
“frontier”) shows alternative ways that an economy
can use its resources. The slope between 2 points is
known as the marginal rate of transformation
Production Possibilities Graph
Shoes
(millions of pairs)
25
0
15
20
8
14
14
12
18
9
20
5
21
0
Shoes (millions of pairs)
Watermelons
(millions of tons)
15
10
a (0,15)
b (8,14)
c (14,12)
d (18,9)
5
0
A production
possibilities frontier
e (20,5)
f (21,0)
5
10
15
20
Watermelons (millions of tons)
25
Efficiency
Production Possibilities Graph
25
Shoes (millions of pairs)
Def’n: 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.
• Points underneath the
curve signify
inefficiency.
• In the long run, the
economy can’t be
inefficient.
20
S
15
a (0,15)
b (8,14)
c (14,12)
10
g (5,8)
5
d (18,9)
e (20,5)
A point of
underutilization
0
5
10
f (21,0)
15
20
Watermelons (millions of tons)
25
Growth
Production Possibilities Graph
25
Future production
Possibilities frontier
T
Shoes (millions of pairs)
If more resources become
available, or if technology
improves (productivity),
an economy can increase
its level of output and
grow. When this
happens, the entire
production possibilities
curve “shifts to the right.”
20
S
15
a (0,15)
b (8,14)
c (14,12)
10
d (18,9)
5
e (20,5)
f (21,0)
0
5
10
15
20
Watermelons (millions of tons)
25
Cost
Production Possibilities Graph
25
Shoes
(millions of pairs)
0
15
8
14
14
12
18
9
20
5
21
0
Shoes (millions of pairs)
Watermelons (millions
of tons)
20
15
c (14,12)
10
d (18,9)
5
0
5
10
15
20
Watermelons (millions of tons)
25
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. Cost-benefit analysis is very
important to businesses—sometimes it does not pay to produce
more!
Critical Thinking Question:
• Why was mercantilism such a successful
scenario for mother countries?
• Added resources for next to nothing
• New markets for finished goods guaranteed
positive balance of trade
• Put idle resources in the mother country back
to work
• Also successful for developing countries, to
an extent
Exchange
• Producers and Consumers are engaged in continuous
VOLUNTARY EXCHANGE
• Walter Williams calls it “seduction.” If I want you to work in a
Siberian coal mine, I have to pay your opportunity cost (which
is higher if you already have a good job). I must “seduce you.”
• Consumers are sovereign and control what is produced.
• The mix of output is dictated by consumer’s tastes—hence
those breath strips by Listerine continue to be produced, while
Crystal Pepsi is gone.
• In the past, exchange was via barter
• Difficulties: Couldn’t find people to trade with (no one wants
brussels sprouts but anyone will trade for gold), couldn’t “make
change,” goods could spoil, etc.
• Money developed--Now: Checks, Credit Cards, Installment
System, Mortgages
The 6 Fundamental Theorems of Economics
• People choose. Kia Sedona or Chrysler Town & Country
Limited?
• All choices involve costs (Kia is $10,000 cheaper, but has a
weaker V-6, fewer options, smaller. Buy Kia, and you might be
able to get a house too)
• People respond to incentives in predictable ways (cash-back
incentives, electric cars may get help from Congress, Cash for
Clunkers). INCENTIVES MATTER!!!!!!!!!
• Economic systems influence individual choices and incentives
(In USSR, I would have had to wait ten years for a minicompact sedan—with no chrome wheels)
• Voluntary Trade creates WEALTH (Daimler-Chrysler chooses to
do business in the United States, profits)
• The consequences of choices lie in the future (can only afford a
smaller house, maybe I saved American jobs??)