fundamental economic concepts. i won the lottery! i’ll give you anything you want other than...
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Fundamental Economic Concepts
I WON THE LOTTERY!
I’ll give you anything you want other than
money. What do you want? Would your list ever
end? Why not?
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What is Economics?- The study of mankind’s
unlimited desires in a world of limited resources.
-Economics is the science of scarcity
-Since we are unable to have everything we desire, we must make CHOICES on how we will use our resources.
In economics we study the choices of individuals, firms, and governments
Microeconomics deals with individual decisions, Macroeconomics looks at the economy as a whole
Positive vs. Normative Positive Statements- Based on facts. Avoids value judgements (what is).Normative Statements- Includes value judgements (what ought to be).
How is Economics used? • Economists use the scientific method
to make generalizations and abstractions to develop theories. This is called theoretical economics. • These theories are then applied to fix problems or meet economic goals. This is called policy economics.
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5 Key Economic Assumptions1. Society has unlimited wants and limited resources (scarcity). 2. Due to scarcity, choices must be made. Every choice has a cost (a trade-off).3. Everyone’s goal is to make choices that maximize their satisfaction. Everyone acts in their own “self-interest.”4. Everyone makes decisions by comparing the marginal costs and marginal benefits of every choice.5. Real-life situations can be explained and analyzed through simplified models and graphs.
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What is the Economy?
Why Do We Study It?
1. Description
2. Analysis
3. Explanation
4. Prediction
What? or How Much?
How? or Why?
When?
OR…
Why do we study Economics?
Sowe
don’t get
screwed.
Book AuctionWhat economic concepts were
demonstrated by the book auction?◦Scarcity◦Value◦Choices◦Rationing◦Equity vs. Efficiency
Which was the sealed auction?
◦Consumer surplus
}Stay Tuned
!
ScarcitySituation that occurs when wants are greater than available resources.Scarcity is the fundamental problem in economics.
In this classroom, is/are _________ scarce?Desks?Water?Books?Gasoline?Jolly Ranchers?…
Good looking economics instructors?
But not in the hallway…
Wants are satisfied by available resources
No want for it in classroom, but outside… yes
Wants exceed available resources
Good looking economics instructors?
We always assume….People make decisions based
upon RATIONAL SELF-INTEREST
We must consider…
Examples: Shelter is a need, a mansion is a want.
Food is a need, a large pizza is a want.
UtilityThe satisfaction that
consumption of a good or service provides
DIMINISHING MARGINAL UTILITY
As you consume additional units of a good, at some point each additional unit will begin providing less utility than the one before it.
Cost – Benefit Analysis
Question? :
What do you want RIGHT NOW?
Cost – Benefit Analysis
Follow up question? :
Why don’t you go get it?
Cost – Benefit Analysis
• We all make decisions in our own self-interest
• All decisions come with certain trade-offs and alternatives
• THERE IS NO SUCH THING AS A FREE LUNCH!!!Seinfeld example
• Opportunity Cost: the next-best alternative given up when making a choice
Opportunity Cost
VS.
VS. VS.
Marginal Cost
Marginal = Additional, next
Additional cost vs. additional benefit
We constantly engage in marginal analysis
Would you see the movie three times?
Notice that the total benefit is more than the total cost but you
would NOT watch the movie the 3rd time.
Thinking at the Margin
# Times Watching Movie
Benefit Cost
1st $30 $10
2nd $15 $10
3rd $5 $10
Total $50 $30
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Marginal AnalysisMarginal analysis (aka: thinking on the margin) making decisions based on incrementsExample:• When you decide to go to the mall you consider the
additional benefit and the additional cost (your opportunity cost).
• Once you get to the mall, you continue to use marginal analysis when you shop, buy food, and talk to friends.
• Since your marginal benefits and costs can quickly change your analyzing them every second.
• What if your ex-girlfriend shows up? The Point: You will continue to do something as long as the marginal benefit is greater than the marginal costCopyright
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Turn to a partner and share a recent example of marginal thinking in your life.
Economic Terminology
Utility =Marginal =
Satisfaction!Additional!
Allocate = Distribute!
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Paradox of ValueWater vs. DiamondsMonetary Value
◦Must be scarce◦Must give utility
Are diamonds scarce?Do they give utility?
Conspicuous consumption◦Examples?
Scarcity forces us to ask the following questions…
WHAT to produce?
HOW to produce?
FOR WHOM to produce?
Imagine a scenario where…
…we take an all-expenses-paid class trip to…
Australia!
Our plane is forced to make a “water landing,” and we are able to swim to an uncharted island.
You are in charge. Prioritize 3-5 things we’ll have to do to survive and how (and with who) we should accomplish these tasks.
Specialization
• Allocating resources toward production for which they are best suited.
FACTORS OF PRODUCTION• Land – all gifts of nature• Labor – human efforts and abilities• Capital – tools, equipment, space• Entrepreneurship – risk taking, ideas
– **The “spark” or driving force of the economy**
EXAMPLES:
Durable vs. Nondurable goodsDurable – lasts more than 3 yearsNondurable – lasts less than 3 years
Adam Smith“Wealth of Nations”
◦1776Invisible hand
◦ Meat◦ Bread◦ Candles◦ How do we decide to provide these?
CIRCULAR FLOW
But Remember...
5 Key Economic Assumptions1. Society has unlimited wants and
limited resources (scarcity). 2. Due to scarcity, choices must be made. Every choice has a cost (a trade-off).3. Everyone’s goal is to make choices that maximize their satisfaction. Everyone acts in their own “self-interest.”4. Everyone makes decisions by comparing the marginal costs and marginal benefits of every choice.5. Real-life situations can be explained and analyzed through simplified models and graphs.
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Production Possibilities ModelIllustrate production choices
Assumptions:◦Full employment◦Fixed resources◦Fixed technology◦Two goods
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Production Possibilities FrontierGuns (thousands)
807560300
Butter (tons)
0150300400450
All possible combinations of two products that can be produced when employing 100% of available resources.
Production Possibilities Frontier
Type of Product
Pizzas (in hundred thousands)
Industrial Robots (in thousands)
Production Alternatives
A B C D E
10 9 7 4 0
0 1 2 3 4
Plot Points to Create Graph…
Production Possibilities Table
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Production Possibilities Curve
Pizzas
Ind
ust
rial
Ro
bo
ts
Attainable
0 1 2 3 4 5 6 7 8 9
14
13
12
11
10
9
8
7
6
5
4
3
2
1
Unattainable
AB
C
D
E
EconomicGrowth
Now Attainable
A’
B’
C’
D’
E’
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Production Possibilities Curve
Pizzas
Ind
ust
rial
Ro
bo
ts
Attainable
0 1 2 3 4 5 6 7 8 9
14
13
12
11
10
9
8
7
6
5
4
3
2
1
Unattainable
AB
C
D
E
Law of IncreasingOpportunity Cost
A’
B’
C’
D’
E’
Shape of the Curve
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Quick QuizWhy is the PPF bowed out
from the origin?◦Law of increasing opportunity
costs…◦…due to specialization of
resourcesWhat is the marginal
opportunity cost of the 2nd unit of pizza?◦2 thousand robots
Which point(s) on the curve represent full employment of resources?◦All points ON the curve
The Future Economy
Consequences of unemployment
Economic growth◦More resources ◦Better quality resources◦Technological advances
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Future Possibilities
Goods for the Present
Goo
ds f
or t
he F
utur
e
Goo
ds f
or t
he F
utur
eGoods for the Present
P
F
CurrentCurve
CurrentCurve
FutureCurve
FutureCurve
Compare Two Hypothetical Economies
Presentville Futureville
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Why do people trade?1. Assume people didn’t trade. What things would
you have to go without? Everything you don’t produce yourself!
(Clothes, car, cell phone, bananas, heath care, etc)The Point: Everyone specializes in the production
of goods and services and trades it to others 2. What would life be like if cities couldn’t trade
with cities or states couldn’t trade with states?Limiting trade would reduce people’s choices and
make people worse off. The Point: More access to trade means more
choices and a higher standard of living. 57Copyright
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Economic Basis for Trade
• Nations have different resource endowments
• Labor-intensive goods
• Land-intensive goods
• Capital-intensive goods
LO2
Absolute and Comparative Advantage
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Let’s Simplify…
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Specialization benefits both sides
Shift resources to export industry
Achieve higher overall output and income
Absolute advantage◦Higher output per worker for a good
Comparative advantage◦Lower domestic opportunity cost for a good
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Comparative Advantage
Product A B C D E
Avocados 0 20 24 40 60Soybeans 15 10 9 5 0
**Optimal domestic production occurs at point C
Mexico’s Production Possibilities Table (in Tons)
Production Alternatives
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Comparative Advantage
Avocados 0 30 33 60 90Soybeans 30 20 19 10 0
**Optimal domestic production occurs at point C
Product A B C D E
U.S.’s Production Possibilities Table (in Tons)
Production Alternatives
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Comparative Advantage
Product A B C D E
Avocados 0 20 24 40 60Soybeans 15 10 9 5 0
**Optimal domestic production occurs at point C
Mexico’s Production Possibilities Table (in Tons)
Production Alternatives
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Comparative Advantage
Avocados 0 30 33 60 90Soybeans 30 20 19 10 0
**Optimal domestic production occurs at point C
Product A B C D E
U.S.’s Production Possibilities Table (in Tons)
Production Alternatives
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Comparative Advantage
Mexico will produce avocados
U.S. will produce soybeansU.S. gives up 3 A for 1 SMexico gives up 4 A for 1 S
Terms of trade◦3.5 A for 1 S◦Both countries benefit
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Comparative AdvantageGains from tradeMexico starts at C (24 A and 9S)◦Move to E (60 A and 0 S)◦Trade 35 A for 10 S
U.S. starts at T (33 A and 19 S)◦Move to R (0 A and 30 S)◦Trade 10 S for 35 A
Overall gains?5-67
Comparative Advantage (pg. 98)Terms of Trade – 1s : 3.5a
Trade: 10 tons soybeans for 35 tons avocados