Dolan, Economics Combined Version 4e, Ch. 1

EconomicsCombined version

Edwin G. DolanBest Value Textbooks

4th edition

Chapter 1The Economic

Wayof Thinking

EconomicsSocial Science

Studies choices made under scarcity

Scarcity: When not enough is available for free to

satisfy every desired use…

Are Oranges in Tulare County Scarce???Is your time scarce???

Micro vs. Macro• Microeconomics– Studies the economy at the level of individual consumers,

workers, firms, goods, and markets

• Macroeconomics– Studies the economy at the aggregate level, at the level of

the economy as a whole.– Examines total consumer behavior, total employment,

total production, total sales, etc.

Factors of Production

• Generally 3 Categories:– Natural Resources (old school Land….)

– Labor (physical and intellectual services of people + [skills called Human Capital]

– Capital (plant, machinery, equipment used in production)

Copyright (c) Houghton Mifflin Company. All rights reserved.

Opportunity Cost

• The opportunity cost of a good or service is its cost in terms of the forgone opportunity to pursue the one best possible alternative activity with the same time or resources

Copyright (c) Houghton Mifflin Company. All rights reserved.

6

Your Daily Econ MANTRA

• Opportunity cost is:

The value of The value of

the next best optionthe next best option..

Opportunity cost• Examples: Opportunity costs for

College

– The tuition you pay to your college.

– The money you could have earned if you spent your time working instead of studying is also part of the opportunity cost of a college education.

– The cost of meals that you eat while you are in college is not part of the opportunity cost of a college education, because you would have to eat whether you went to college or not.

Copyright (c) Houghton Mifflin Company. All rights reserved.

8

• Comparative Advantage: the ability to produce a good or service at a lower opportunity cost than someone else.

• 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.

Dolan, Economics combined version 4e, Ch. 1

Comparative Advantage• Comparative advantage is

the ability to do something at a relatively lower opportunity cost than someone else.

• Who has a comparative advantage in splitting, Kim or Lee?

• Who has a comparative advantage in stacking, Kim or Lee?

Example:• Kim can split a cord of

wood in 1 hour and stack a cord in 30 min.

• Lee can split a cord of wood in 2 hours or stack a cord in 30 min.

Copyright (c) Houghton Mifflin Company. All rights reserved.

10

Specialization• Economic actors will be better off if they choose to

produce those things for which they have the lowest opportunity costs, and trade for those with higher costs. – This is called specialization.

• Choices based on lowest opportunity costs involve giving up the least amount of other things.

Specialization is based on Comparative Advantage!

Chalk talk: Tom and Nancy… 40:120 (30)

David Ricardo• Established the Theory of

Comparative Advantage – Especially in foreign Trade.

• Expected eventual “steady state” with mass poverty.

• Paired with Thomas Malthus

• Economics as the “dismal science”

• Principles of Political Economy and Taxation, 1817

Copyright (c) Houghton Mifflin Company. All rights reserved.

12

Production Possibilities Frontier

Underutilized(Inefficient)

Nondefense Goods

B1

F1

C1

D1

Only nondefense goods produced

E1

Only defensegoods produced

A1

Efficient Combinations

Defense Goods

Impossible

200

175

150

125

100

75

07525 50

G1

100 125

Defense Non-defense

A1 200 0

B1 175 75

C1 130 125

D1 70 150

E1 0 160

F1 130 25

G1 200 75

150

Dolan, Economics combined version 4e, Ch. 1

Production Possibility Frontier• The slope of the

production possibility frontier is equal to the opportunity cost of one good (education) in terms of the other (cars)

Copyright (c) Houghton Mifflin Company. All rights reserved.

14

Marginal Opportunity Cost

• The marginal opportunity cost is the amount of one good or service that must be given up to obtain one additional unit of another good or service.

• The slope (absolute value) of the PPC is the opportunity cost of the good on the X axis.

• The inverse of the slope is the opportunity cost of the good on the Y axis.

Reminder: Slope = Rise/Run

Copyright (c) Houghton Mifflin Company. All rights reserved.

15

Marginal Opportunity Cost

• The PPC bows outward because there are ever-increasing marginal opportunity costs to the production of any good.

Copyright (c) Houghton Mifflin Company. All rights reserved.

16

Marginal Costs

To increase its production of nondefense goods, society must give up ever-increasing amounts of defense goods.

1. What is the Opportunity cost of making a Snowboard in Plant 1, Plant 2, and Plant 3?

2. What is the opportunity cost of making a pair of skis in Plant 2, Plant 2, and plant 3?

3. Who makes the cheapest Snowboards?4. Who makes the cheapest Skiis?

Jeff’s Efficiency Soapbox . . .

Growth can expand the PPF over time

• Economic Efficiency: – State of affairs where it is impossible to make any

change that improves satisfaction for one actor without harming the interests or satisfaction of another. • Can’t make anyone better off without harming

others• Can’t make more of one thing without

sacrificing some of something else

Key Terms:

• Positive Economics: Deals with facts and objective realities about relationships and economic realities

• Normative Economics: Deals with judgments about what choices, policies or options are better or worse – involves value judgments and preferences

Key Terms:

• Hierarchy: A way of achieving coordination guided by a central authority

• Spontaneous order: A way of achieving coordination through individuals acting in response to cues and incentives from the environment

Key Terms:

• Market: Any arrangement people have for trading with each other.

• Empirical: Based on experience or factual observations

Key Terms:

• Ceteris Paribus: Latin term used in Economics to mean “all other things held constant.

• Spontaneous order: A way of achieving coordination through individuals acting in response to cues and incentives from the environment

Basic Graphing for Economics:

Calculate the Slope