Basic Ideas of Economics
Study Questions
1. How do individuals make decisions? 2. Why does the existence of scarcity
force us to make decisions? 3. How are goods and services produced? 4. Why is there always a cost in making
decisions, even if no money changes hands?
Study Questions
5. What are the alternative organizing mechanisms a society can choose?
6. How do these alternative organizing mechanisms differ in answering vital economic questions?
7. What is the payoff when there is state protection of property rights?
Study Questions
8. What does the production possibilities curve show us?
9. Why do we want economic growth?
What do you think of when you think of
ECONOMICS?
Definition of EconomicsThe study of how people, both individually and in groups, deal with the
problem of scarcity.
Why is economics considered a social science?
Scarcity forces human beings to make choices
Why has there always been an economic problem?
man’s wants are virtually unlimited
scarcity of resources
*Have to prioritize
All resources regardless where they are located are scarce.
The scarcity causes most to have a cost because the demand does not go away…. Supply is limited
The scarcity of resources causes most things to have a cost.
Remember****
Society has virtually unlimited wants BUT limited resources
This means prioritization!When did you last have to prioritize?Companies? Are you seeing them prioritize? WhereWhat about government?
Principal Assumption
People act rationally.Plan ahead.Think things through.Gather information.Recall past experiences.
Economics is a Social Science
What does that mean?
Why Act Rationally?
People want to better themselves. Improve their net worth.Obtain satisfaction.Obtain happiness.
Satisfying Unfilled Wants and Needs Rational people set priorities.
Satisfy the highest priority first. What satisfies?
Goods things produced
Services actions produced
ResourcesWhat are the factors of production? Inputs into a production process.
LandLabor CapitalEntrepreneurship
Putting it together
Make sure you have the right mix
Resources Inputs Process
OUTPUT
Figure 1-1.Transformation Process
INPUTS PROCESS OUTPUTS
Resources
Goods and services
thatsatisfy wants
and needs
Technologycan improvethe process
or the capitalgoods
The Production Process
Inputs are processed into outputs. Inputs = resourcesOutputs = goods and servicesProcess = how the transformation is done
Efficiency
Defined:get the maximum salable output from the lowest possible cost of inputswhile minimizing the waste.
Technology
Defined: the application of knowledge to improve the process, or to improve the capital input
Scarcity
Unlimited wants and needs Limited resources
which leads to limited amount of satisfying goods and services
Anything is scarce if it is useful and there is a limited amount of it.
Economic vs non-economic wants
Decision Making
Since everyone’s wants and needs cannot be satisfied, decisions have to be made to determine which will be satisfied now
… and which will be put off until later … or never satisfied. ………………..Trade Off ………………………opportunity cost
Scarcity forces individuals and groups to do what?
All economies evolve around a basic conflict.. Want more than we can have.
What is a Trade-off
Giving up one thing to get something else.
Thing you give up is called “opportunity cost.”
So if resources are limited and wants are unlimited…. Makes for an interesting “trade-off.”
Reality of Trade-offsJust a few of the products getting a start
from a barrel of oil:Aspirin furniture not to mention gasolineCandles hair dryers carpetsCD players lipstick paintsClothing luggage fertilizerCompact discs perfumes oils of all kindsComputers photographsCredit cards piano keysDeodorant roller bladesDiapers shampooDinnerware soft contact lensesDVDs toothpasteEyeglass frames vitamin capsules
Decision Making
Cost-benefit analysis:weigh the value of what will be obtained (the
benefit) and …the value of what must be given up (the
cost), and…then decide whether or not to take the next
step.
Marginal Analysis
This cost-benefit analysis takes one step at a time:compare the marginal benefit (MB) to the
marginal cost (MC).use your unique valuation system to do this.keep the steps small, so a mistake won’t hurt
too much.
Decision Matrix
If MB > MC, taking the next step is worthwhile.do it! and your net worth goes up.
If MB < MC, taking the next step is not worthwhile.don’t do it! because, if you do, your net worth
goes down.
Opportunity Cost
When you commit a resource to satisfying one want or need, it is no longer available to be used for another want or need.You satisfy the most valued need first.The value you place on the foregone
alternative need (second best choice) is your opportunity cost of making the decision.
Trade-Off
You must always give up one thing to get another thing. This is the trade-off. If MB (what you get) > MC (what you give up),
then the trade-off is worth making. Included in MC above is the opportunity cost
of making the decision.
Basic Economic Questions
All societies must answer the following:What to produce?How to produce?For whom to produce?
Invisible Hand- apolitical Individuals rather than government
should answer the 3 basic questions.What to produceHow to produceFor Whom to produce
But not just carte’ blancheSmith distinguished between self-interest
and greed! It is in our self-interest to have Rule of Law
in place – (property rights, patents, copyright, protection of workers, regulations, etc.)
Three basic economies
Market capitalist (capitalism) Command dictatorship (communism) socialism
Traditional Society
What? – exactly what our ancestors produced
How? – in the time-honored, old-fashioned way
For whom? – in the way they always have been distributed
Rationing: distribution method
Not everyone can have a good (scarcity)The market society uses purchasing power to
ration out available goodsThe command society uses political favor to
ration out available goods Whatever the rationing device, people will
compete to obtain it.
Private Property Rights
Enlightened government should protect the rights of its citizens to earn, own, and keep private property.protect from government confiscationprovides incentive to accumulate goodsprovides incentive to improve their lot
People move out of poverty and into the “middle class”
Private and Public Property
Owners care for their own goods Owners put their own goods to their best use. Publicly owned property is abused and
overused. Most pollution problems deal with publicly owned
goods, not privately owned goods: the atmosphere the lakes and rivers the oceans
Adam Smith
Wrote “The Wealth of Nations” in 1776 The Wealth of a Nation is “not in the king’s
treasury, but in the capability of its people to create and produce.”
“Invisible hand” causes us to operate for the betterment of society (even when we do not intentionally intend to do so).
Two things that allow economies to progress
This is an Adam Smith concept:
Division of labor
Specialization of labor
Recipe For Success
Select the option that is best in your own self interest.Make a good that satisfies the customer.Pay enough to cover the seller’s costs.Both become better off.
Self interest (both become better off) is not selfish (just me becomes better off)
What is Standard of Living?How can you calculate it?
How well off people are!
How well off are you?
Divide total production by population…
If production is high and population is low…. “get more stuff.”
3rd world countries… high population/low production
Per capital income China = $8,500Per capita income U.S.= $41,663
Social Examples U.S. Households90% have microwave ovens
88% have television in living room
87% subscribe to cable or satellite TV
77% own personal computer
72% have flat screen TV
68% have broadband Internet service
68% have television in their bedrooms.
Market or Command?
Market -each individual: decides for himself owns and controls
resources and property
Command - the ruler: makes all decisions controls the use of
resources and property, no matter who owns them
PPC illustrates 4 concepts
1. Scarcity
2. Choice
3. Opportunity Cost
4. Law of Increasing cost
THE WAY EACH COUNTRY ANSWERS THESE 3 QUESTIONS… INDICATES THE TYPE OF ECONOMY THEY HAVE
Figure 1-2. PPC: data and graph
PRODUCTION POSSIBILITIES CURVE (PPC)
0
1
2
3
4
5
0 10 20 30 40 50 60 70 80 90 100
COOKIES
CA
KE
Data:Cake Cookies 3 0 2 30 1 50 0 60
Production Possibilities CurvePPC
A
B
C
D
E
F
OUT
PUT
OF
SHO
ES
5
4
3
2
1
0 1 2 3 4 5OUTPUT OF TELEVISIONS
Note Difference in Shape of Curve
Direct Correlation … Two items produced… 1 to 1 ratio. Can Relinquish one part of resources and not have to give upMore of another. No law of increasing cost.
Economics
English
Increasing Opportunity Costs
Step 1: give up one shoe
Step 2: get two TVs
Step 4: get one more TV
A
B
C
D
E
F
5
4
3
2
1
0 1 2 3 4 5OUTPUT OF TELEVISIONS
At any point in time, a full-employment, full-production economy must sacrifice some of product X to obtain more of product Y. Do you know why?
Limited Resources meansa limited output...
Production Possibility
Q
QQPizzas (hundred thousands)
1413121110 9 8 7 6 5 4 3 2 1
1 2 3 4 5 6 7 8
A B
C
D
E
W
Attainablebut
Inefficient
Unattainable
Law of Increasing Opportunity CostsThe amount of other products that must beforgone or sacrificed to obtain 1 unit of a specific
product is called the opportunity cost of that good.
A graph of the production possibilities curve will be CONCAVE - bowed out from the origin.
Economic resources arenot completely adapt-able to other uses. Crude Oil is not adaptable to
making bread.
Figure 1-3. PPC:Trade-Off
PRODUCTION POSSIBILITIES CURVE (PPC)
0
1
2
3
4
5
0 10 20 30 40 50 60 70 80 90 100
COOKIES
CA
KE
Data:Cake Cookies 3 0 2 30 1 50 0 60
-1
+30-1 +20-1 +10
The Trade Off Gets Worse
More and more cake must be given up to get another increase in cookies.Resources are usually specialized to do one
job better than another.Shifting them between jobs causes the trade
off to get worse.The PPC gets bowed outward because of
this.
Q
Q
Ro
bo
ts (t
ho
usa
nd
s)
Pizzas (hundred thousands)
1413121110 9 8 7 6 5 4 3 2 1
1 2 3 4 5 6 7 8
U
Unemployment &Underemployment Shown by Point U
More of either orboth is possible
Economic GrowthThe ability to produce
a larger total output - OR
a rightward shift of
the production
possibilities curve caused by... ????????
Figure 1-5. PPC: Economic Growth
PRODUCTION POSSIBILITIES CURVE (PPC)
0
1
2
3
4
5
0 10 20 30 40 50 60 70 80 90 100
COOKIES
CA
KE
z
PPF and Economic Growth
Research and Development R&D
1 – Increase in resource supplies2 - New Resources 3 – Better resource quality 4 – Technological
advances
Where does the impetus of this R & D come from? More from private or public?
PPC: Trade-Off
PRODUCTION POSSIBILITIES CURVE (PPC)
0
1
2
3
4
5
0 10 20 30 40 50 60 70 80 90 100
COOKIES
CA
KE
Data:Cake Cookies 3 0 2 30 1 50 0 60
-1
+30
PPC: Trade-Off
PRODUCTION POSSIBILITIES CURVE (PPC)
0
1
2
3
4
5
0 10 20 30 40 50 60 70 80 90 100
COOKIES
CA
KE
Data:Cake Cookies 3 0 2 30 1 50 0 60
-1
+30-1 +20
Inefficient, Efficient, and Unattainable Points Any point inside the PPC is inefficient.
Produce more by moving out to the PPC. Any point on the PPC is efficient.
All resources and technology are being used. Any point outside the PPC is unattainable.
Not enough resources and technology exist to make these combinations of goods.
Figure 1-5. PPC: Economic Growth
PRODUCTION POSSIBILITIES CURVE (PPC)
0
1
2
3
4
5
0 10 20 30 40 50 60 70 80 90 100
COOKIES
CA
KE
z
Any Questions?
Are you learning to think in Economic Terms?????
When you drive by a strip mall –
What do you see? What do you think? Does the economy
come to mind? How did McDonald’s get
so popular back in 60”s
QUESTIONS?