Slide 1

Unit 1: Basic ConceptsScarcity, opportunity cost, choicesProduction Possibilities CurveComparative/Absolute AdvantageSupply and DemandMacro IssuesEconomics defined:Study of choiceHow society deals with the problem of scarcityHow scarce resources are used in the production, distribution and consumption of goods/services to maximize the satisfaction of human wantsEconomic interaction- how individuals choices affect othersTEN PRINCIPLES OF ECONOMICS3The most important determinant of living standards: productivity, the amount of goods and services produced per unit of labor. Productivity depends on the equipment, skills, and technology available to workers.Other factors (e.g., labor unions, competition from abroad) have far less impact on living standards.Principle #1: A countrys standard of living depends on its ability to produce goods & services. Economic Growth [Increase in Real GDP or per capita GDP] 3% annual growth will increase our standard of living.1929-Per capita=$792; 1933-Per capita=$430; 2010-per capita= $48,00033TEN PRINCIPLES OF ECONOMICS4Huge variation in living standards across countries and over time:Average income in rich countries is more than ten times average income in poor countries. The U.S. standard of living today is about eight times larger than 100 years ago.Principle #1: A countrys standard of living depends on its ability to produce goods & services. 44Rich countries refers to countries like the U.S., Japan, and Germany. Poor countries refers to countries like India, Indonesia, and Nigeria. TEN PRINCIPLES OF ECONOMICS5In the short-run (1 2 years), many economic policies push inflation and unemployment in opposite directions. Other factors can make this tradeoff more or less favorable, but the tradeoff is always present. Full Employment about 95-96% employment is full employment. In 1982, unemployment was 10.8% [12 M unempl.]

Principle #2: Society faces a short-run tradeoff between inflation and unemployment55While the long-run effect of increasing the quantity of money is inflation, the short-run effects are more complicated - and controversial. However, most mainstream economists believe the following: An increase in the quantity of money causes spending to rise, which causes prices to rise, which induces firms to produce more goods and services, which requires that they hire more workers. Hence, in the short-run, increasing the quantity of money causes inflation to rise, but unemployment to fall. Of course, REDUCING the quantity of money would have the opposite effects (inflation would fall, while unemployment would rise) in the short run. Keep in mind, though, the lesson from Principle #9: In the long run, changing the quantity of money only affects inflation. We will learn in a later chapter what determines the rate of unemployment in the long run, and we will see that it has nothing to do with the quantity of money.

The second bullet addresses the following point: In some decades, due to factors outside of the control of policymakers, inflation and unemployment are both high (e.g. 1970s) or low (e.g. 1990s). Yet, given these other factors, policymakers can always reduce unemployment temporarily by creating more inflation, or vice versa.

Doing the best with what we have.3. Economic Efficiency obtaining the maximum output from available resources or maximum benefits at minimum cost from our limited resources. .

4. Price Level Stability sizable inflation or deflation should be avoided. We had over 10% in 73, 79, & 80. Inflationwas 2% in the 1950s, 2.3% in 1960s and 7.4% in 80s.A person making $25,000 a year at age 30 would need (withaverage inflation of 5%) $125,000 a year at age 65 to have the same standard of living. 1972 --------82; 1982-------2010In 1945, $1.50 bought what $1.00 did in 1860.Today, it takes $11 to buy what $1 bought in 1945.

It took $2.31 in 1982 to buy what $1 bought in 1972.In 2009, it took $2.23 to buy what $1 bought in 1982.Reasonable inflation, 1-2% is OK.7TEN PRINCIPLES OF ECONOMICS8Inflation: increases in the general level of prices. In the long run, inflation is almost always caused by excessive growth in the quantity of money, which causes the value of money to fall. The faster the govt creates money, the greater the inflation rate. Principle #4: Prices rise when the government prints too much money.885. An Equitable Distribution of Income. One group shouldnt have extreme luxury while another is in stark poverty.

6. Economic FreedomYou are free to make your own economic decisions:Choose your jobChoose where and when you workWork for yourself or someone elseLeave your job and to move to another jobFree to buy what we wantBusinesses are free to:Choose which workers they wantFigure out how much business they want to doBusinesses are free to sell what they wantTEN PRINCIPLES OF ECONOMICS11Rational people systematically and purposefully do the best they can to achieve their objectives.make decisions by evaluating costs and benefits of marginal changes incremental adjustments to an existing plan. Principle #6: Rational People Think at the Margin1111TEN PRINCIPLES OF ECONOMICS12Examples:When a student considers whether to go to college for an additional year, he compares the fees & foregone wages to the extra income he could earn with the extra year of education.When a manager considers whether to increase output, she compares the cost of the needed labor and materials to the extra revenue. Principle #6: Rational People Think at the Margin1212See the textbook for two classic examples:

1. The diamond-water paradox: water is essential for life but virtually free; diamonds are inessential but expensive. 2. The near-zero marginal cost of an airline taking an extra passenger when the flight isnt full.. 7. Economic Security provision should be made for those not able to take care of themselves handicapped, disabled, old age, chronically ill, orphans. Protection from lay-offs [unemployment insurance]. Also no discrimination. 43 million Americans have some type of disability.A. Hearing impaired: 22 million (including 2 million deaf)B. Totally blind: 120,000 (Legally blind: 60,000)C. Epileptic: 2 million D. Paralyzed: 1.2 millionE. Developmentally disabled; 9.2 millionF. Speech impaired: 2.1 millionG. Mentally retarded: up to 2.5 millionH. HIV infected: 900,0008. Balance of Trade. Over $400 billion a year the last few years. Some of these goals are complementary [economic growth & F.E.] and some conflict [F.E. and price level stability].

TEN PRINCIPLES OF ECONOMICS14Rather than being self-sufficient, people can specialize in producing one good or service and exchange it for other goods. Countries also benefit from trade & specialization:Get a better price abroad for goods they produceBuy other goods more cheaply from abroad than could be produced at homeTrade Can Make Everyone Better Off1414If each person had to grow his own food, make his own clothes, cut his own hair, we would have a world full of skinny, unfashionable poor people having bad hair days every day of the week.

Its far more efficient for each person to specialize in producing a good or service, and then exchanging it with other people for the things they produce.

The statement trade can make everyone better off should not be hard to understand, if you think about it for a moment: Each of two parties would not voluntarily enter into an exchange if it made either of them worse off, now would they?

The same principles apply at the national and international level: International trade allows countries to sell their exports abroad and get a higher price, and to buy things from abroad more cheaply than they could produce at home.

In addition, trade gives a countrys consumers access to a greater variety of goods including goods they might not be able to get at all. For example, U.S. consumers enjoy a variety of fresh produce year-round. This would not be possible without international trade. The first lesson of economics is scarcity: There is never enough of anything to satisfy all those who want it. ScarcityThe first lesson of politics is to disregard the first lesson of economics. --Thomas Sowell15Unlimited ____________ vs. Limited _______________GoodsServicesFactors of ProductionresourceswantsYou cannot have everything you want. Therefore: CHOICES must be madeWhat satisfies economic wants?GoodsAre tangible items that satisfy our wants. Such as: cars, TVs, computers, clothes, etc.Are goods for immediate consumption that satisfy our wants directly.Examples?Consumer GoodsCapital GoodsAre goods that satisfy our wantsindirectly; goods used to produceother goods. Examples?What else satisfies our wants?ServicesIntangible items such as:

Legal advice/representationMedical and dental workTax preparationPainting and repair workHouse cleaning

Resources a.k.a. The Factors of ProductionEconomists classify resources into 4 categoriesLandNatural resources, acreage, ports, oil, minerals, rivers - coal, oil, water, fossil fuels, etc.- vegetation and water sun, wind, and rainThe payment for Land is RENTLaborHuman resources (physical and intellectual)The payment for Labor is WAGES

3. Capital (a product of Investment)All manufactured goods & services used in producing consumer goods. Examples: Tools, machinery, equipment, trucks to carry goods, airplanes, etc.Real (can produce something directly) and financial (money, stocks, bonds)The payment for Capital is INTEREST4. EntrepreneurshipThe special ability of risk-takers to combine land labor and capital in new ways in order to make profitSomeone who takes the initiative in using or combining land, labor & capital to produce a good or service.Someone who is innovative, a risk taker, and makes basic business decisions.The payment for Entrepreneurship is PROFIT

Distinguishing:

The study of the economy as a whole national trends related to income, output and the price level. The study of the individual economic units or parts of the economy pricing and output decisions in a particular industry or part of the economy.MicroeconomicsMacroeconomicsmacromicro

Distinguishing Positive and Normative Analysis/StatementsWhat is?What was?What will be?What should be?What ought to be?How are these questions different?facts - can be verifiedvalue judgments - cannot be verifiedType of analysis?Type of statement?PositiveNormativePositiveNormativeSpeaking as?ScientistsNonscientists

Three Basic Economic Systems:mixedcommandmarketwhat?how?for whom?bothbothbothGovernmentGovernmentGovernmentSupply andDemandSupply andDemandSupply andDemandScarcity is the problem of using _?_ resources to fulfill peoples _?_ wants. limited; unlimitedunlimited; unlimitedunlimited; limitedlimited; limitedNone of the aboveOnce a resource or factor of production has been put to productive use an opportunity cost is incurred. (if you choose one, you give up another)Opportunity cost is the next best alternative use for a resource.Ex. If the 3 cups of flour are used to bake bread, then the opportunity cost is the cake that could also have been baked with the 3 cups of flour.No matter what we do with our time or resources, we always incur opportunity cost. (price and everything else that must be given up)Opportunity CostWhen a small amount of the good is produced, opp. cost is low because society needs to use only those resources that are especially suited for its productionAssume that Matt and Kyle each have a yard to rake/bag leaves and a 10 page term paper to type. If it takes Matt 2 hours to rake/bag a lawn and 4 hours to type a paper and it takes Kyle 4 hours to rake/bag a lawn and 2 hours to type a paper, how long would it take each guy to complete both tasks?

Problem AIs there a more efficient way to accomplish both tasks? Explain why?

6 hoursYes. Matt rakes/bags both lawns and Kyle types both papers. It would take each one 4 hours.A C T I V E L E A R N I N G 1 Applying the principlesYou are selling your 1996 Mustang. You have already spent $1000 on repairs. At the last minute, the transmission dies. You can pay $600 to have it repaired, or sell the car as is. In each of the following scenarios, should you have the transmission repaired? Explain.A.Blue book value is $6500 if transmission works, $5700 if it doesntB.Blue book value is $6000 if transmission works, $5500 if it doesnt3030Most of these PowerPoint chapters have two or three Active Learning activities. They break up the lecture with a short in-class activity for immediate reinforcement, application, or assessment of the material in the preceding slides. A good idea is to give students time to formulate their answers before asking for volunteers to share their answers with the class. When the questions or exercises are more complex, consider having them work in pairs. Digression on class participation: In general, its not a good idea to try to solicit participation by saying Now who can tell me the answer to.. The invariable result is regular participation by very few students the quick thinkers who have the confidence to answer spontaneously in front of the class while most students remain silent.When students have a bit of time to think through their answers, they are more likely to be comfortable sharing their answers with you and the class. Even better: try a simple, time-tested activity called THINK-PAIR-SHARE. Pair students up. Pose a question or problem. Have students work on the problem individually for a couple minutes. Then, allow a couple minutes to work in pairs: each student tries to explain to the other why his or her answer is correct, and the other offers feedback. In many cases, they come up with better answers by working together. Finally, ask for volunteers. Students are much more likely to participate since they have had the opportunity to test their answers on a classmate. And those who do not participate will at least have had the chance to share their answer with, and get feedback from, one other student. Activities like these are useful to break up a lecture every 20 minutes or so. They help maintain students attention spans, and increase their comprehension of the material you cover. These activities are also useful for quick, informal assessment often, they will alert you to problems (such as students not getting what you think theyre getting) which you can then correct before moving on to cover additional material. End of digression.

A C T I V E L E A R N I N G 1 AnswersCost of fixing transmission = $600A.Blue book value is $6500 if transmission works, $5700 if it doesntBenefit of fixing the transmission = $800($6500 5700). Its worthwhile to have the transmission fixed. B.Blue book value is $6000 if transmission works, $5500 if it doesntBenefit of fixing the transmission is only $500.Paying $600 to fix transmission is not worthwhile.3131Production Possibilities Curves Notes3213210ABCDEFGUNSBUTTERFull and Efficient ProductionProductive Efficiency: getting the most produced from your scarce resource

Allocative efficiency: getting the most of what people want from the scarce resources (allocating resources to the goods and services people want)How are these different?Marginal benefit the benefit derived from producing an additional unit(s) of productMarginal cost the cost derived from producing an additional unit(s) of product

Produce as long as MB MC to maximize satisfaction of wants.

Marginal AnalysisIf MC >MB, production has exceeded societys desire for the good (allocative inefficiency overallocation of resources)

If MC < MB, underallocation of resources exists.=What is a production possibilities curves (PPC)?A diagram that shows all the possible combinations of 2 goods and services that a country/society/economy can produce.Illustrates the concept of opportunity cost and tradeoffs

Assumptions of a PPCOnly two products can be producedAll resources are fixedResources are land, labor, capital and entrepreneurshipAll technology is fixedAll resources are used fully and efficientlyCeteris paribusall else remains equal

Points of the PPCOn the curve- means full and efficient use of resourceswe are using everything we have and not wasting anythingUnder the curve-Inefficient use of resources- called unemployment of resourcesWe are wasting resources- there can be unemployment of any resource not just labor.Above the curve-Not possible given the resources availableThe only way to reach the point above the curve is to shift the curve outward to reach the point technology, LLCE

Points of the PPC3213210ABCEFGUNSBUTTERDThe Production Possibilities FrontierQuantity ofComputersProducedQuantity ofCars Produced3,00001,0002,0007001,000300AB2,200600CD154,000The Production Possibilities FrontierQuantity of ComputersProducedQuantity ofCars Produced3,0002,000A70001,000E2,100750An outward shift in the production possibilities frontier15Increase and DecreaseThe PPC can shift to the right or left.Shift right when we discover new resources or technologyThis will move the curve closer to point EShift left when resources are destroyed or technology decreases3213210ABCEFGUNSBUTTERCostWhat kind of cost does the PPC have?3213210ABCEFGUNSBUTTERIf we move from point D to point C what is the opportunity cost?If we move from point C to point B?If we move from point B to point A?DCostWhat would a PPC look like if it had constant cost?HamburgersHotdogs$54321$5 4 3 21ABCDEFGHWe call this a budget line.Which is better?Which is better to have a point below the curve or to shift to the left?When there is a point below the curve, the resources are still available, but not being used.When we shift to the left (below) the PPC, the resources have been destroyed.If you are below the curve you lost your job, when you shift to the left you have died. Which is better?

1. An economy that is fully employing all its productive resources but allocating less to investment than to consumption will be at which of the following positions on the PPC to the right? a. A b. B c. C d. D e. E

2. Which of the following best explains the shape of the PPC for the two-commodity economy shown above? a. Opportunity cost of producing another unit of each stays the same. b. Opportunity cost of producing another unit of each decreases. c. Opportunity cost of producing another unit of each increases.

3. Which of the following is true of the PPC on the right? a. Point Q is attainable but undesirable. b. Point R is unattainable but undesirable. c. A technological improvement of watches would move the economy from T to P. d. There is unemployment at point T because workers e. The opportunity cost of moving from S to T is the # of watches given up.

4. If we move from B to C on the graph (right), the opportunity cost is? a. AH units of good Y b. OG units of good Y c. EF units of good X d. HG units of good Y

BC

A

H

G

OPPC Questions From Previous AP Exams45

5. Which of the following would cause the PPC shown (right) to shift outward? a. Reopening steel plants that had been closed b. Rehiring laid-off workers c. Using machinery for missile production instead of steel production d. Using machinery for steel production instead of missile production e. Developing a more efficient steelmaking process

6. Base on the graph (right), which statements are true? I. The opportunity cost of moving from P to R is 10 units of Y. II. The opportunity cost of moving from R to P is 8 units of X. III. The opportunity cost of moving from Q to R is 0 units. a. I only b. III only c. I & II only d. I, II, & III SteelMissiles

X

PPC AP QuestionsY46Consumption Goods41. At what letter is there unemployment [recession]?42. What letters represent resources being used in their most productive manner? [full employment, full production, and best available technology]43. What letter represents an improvement in technology, therefore a new PPC frontier line?44. The (straight line/curve) illustrates the law of increasing cost?45. The (straight line/curve) illustrates the law of constant cost.46. At what letter would there be the most economic growth in the future if a country were producing there now? What is the opportunity cost when moving from C to B; when moving from A to C; and do we have to give anything up when moving from D to B?DA, B, or CEAConsumptionCapitalno

DABCCapital Goods

EMore or better resources or better technologyPPC

Comparative Advantage can produce a product at a "lower opportunity cost".(giving up less) than another can produce the product.Absolute Advantage[outputs] can produce "absolutely more" with the same inputs. (can produce more of a product than another)[Inputs are constant as outputs vary]Absolute Advantage[inputs] can produce "absolutely faster" the same output. (can produce the same amount with less resources) [Outputs are constant as inputs vary]And with inputs (hours), the smaller number indicates absolute advantage; that country is more efficient because it can produce a good absolutely faster than the other with the same inputs. Absolute Advantage [Outputs v. Inputs]

Remember that with outputs or quantity, the larger number indicates absolute advantage; that country can produce absolutely more with the same inputs, and is more efficient.

ProductMarketResourceMarketAssume that nation X can produce either 40 notepads or 80 pens; nation Y can produce either 10 notepads or 40 pens. Absolute Advantage?NPPens X40 80 Y10 40Assume that nation X can produce either 40 notepads or 80 pens; nation Y can produce either 10 notepads or 40 pens.Which statement is true?The OC of producing 1 NP in X is 2 pens.The OC of producing 1 Pen in Y is 1/4 NP.All of the above.NPPens X40 1 (2)80 2 (1/2) Y10 1 (4)40 4 (1/4)Most economists would agree that specialization and trade is more efficient than self sufficiency even when one country has an absolute advantage in the production of both products. To efficiently utilize resources and make gains from trade, nations should specialize in the products for which they have a comparative advantage or the least comparative disadvantage.

With comparative advantage, a nation receives a higher relative price for the goods it exports,

and

pays a lower relative price for the goods it imports.Why Export What You Have A Comparative Advantage In?Assumptions: 8 hour work day (all work done) the services of a lawyer and a secretary cannot be done simultaneously

Problem CSuppose that a lawyer makes $100 per hour and types twice as fast as her secretary. The secretary makes $10 per hour. Ceteris paribus, should the lawyer fire the secretary and do the typing (secretarial work) herself?

Even though the lawyer has an absolute advantage in both tasks, she should NOT fire the secretary. If the lawyer spent half of her day typing, she would give up $400. If she pays a secretary to type, the lawyer only gives up $80.

30301218201084CoffeeCoffeeWheatWheatU.S.BrazilAbsolute Advantage? Should the U.S. and Brazil specialize and trade?Determine Comparative AdvantageStep 1: Set up the problemStep 2:Identify Production Maximums Coffee WheatU.S.

BrazilStep 3: Reduce RatiosStep 4:Identify Opportunity CostStep 5:Compare Costs --- lowest has CACoffee: Wheat:30BrazilU.S.3020101121(1W)(1C)(1/2 W)(2C)30301218201084CoffeeCoffeeWheatWheatU.S.BrazilAbsolute Advantage? Should the U.S. and Brazil specialize and trade?Gains From Trade:Step 1: Set up the problemStep 2: Identify production prior to specializationStep 3: Total production in each product prior to specializationStep 4: Identify maximum possible production of each product with specialization according to comparative advantageStep 5: Compare output before/after specialization and trade Coffee WheatU.S. BrazilBeforeAfterGain12188420222030+8Terms of Trade(Trading Possibilities)Step 1: Identify original reduced ratios for each countryStep 2: Make one of the two products both equal 1 Step 3: Terms of trade fall between the product that does not equal 1Terms are mutually beneficialU.S. 1 C = 1 WBrazil 2C = 1 WPossibleTerm ofTrade1.5C = 1WDistinguishing input from output problems.An OUTPUT problem presents the data as products produced given a set of resources. (ex. Number of pens produced) An INPUT problem presents the data as amount of resources needed to produce a fixed amount of output. (ex. Number of labor hours to produce 1 bushel)Input problems change the scenario from who can produce the most to who can produce a given output with the least amount of resources.Which type of problem?Acres to produce one unit of each.

Input problemOutput problemApplesPearsTom105Sam62Absolute Advantage?Acres to produce one unit of each.

Absolute advantage in apples and pears?TomSamApplesPearsTom105Sam62Which type of problem?Number caught per day.

Input problemOutput problemTroutBassTom46Sam2412Absolute Advantage?Number caught per day.

Which guy has the absolute advantage in the production of each product?Tom SamTroutBassTom46Sam2412Which type of problem?Days to produce one unit of each.

Input problemOutput problemCarsPlanesXYZ Corp.810QKFX Corp.1512Absolute Disadvantage?Days to produce one unit of each.

Which corporation has an absolute disadvantage in the production of both products?XYZ QKFXCarsPlanesXYZ Corp.810QKFX Corp.1512Which type of problem?To produce the following from one ton of olives.

Input problemOutput problemCanned OlivesOlive OilZaire6010Colombia248Absolute Advantage?To produce the following from one ton of olives.

Which nation has the absolute advantage in both products?Zaire ColombiaCanned OlivesOlive OilZaire6010Colombia248Calculating comparative advantage in an INPUT problem?Acres to produce one unit of each.

This procedure requires an extra step after determining the problem is an input problem: convert the problem to an output problem and solve for comparative advantage.ApplesPearsTom105Sam62Calculating comparative advantage in an INPUT problem:Acres to produce one unit of each.

To convert, look for the lowest common denominator (i.e., 30 for 10, 5, 6 and 2). Assume you have 30 acres and convert the numbers to output produced in 30 acres. See chart on right for conversion. Then solve problem as an output problem.ApplesPearsTom10 25 1Sam 6 32 1ApplesPearsTom3 1 (2)6 2 (1/2)Sam5 1 (3)15 3(1/3)Shortcut Method for Input Problems:Acres to produce one unit of each.

Shortcut procedure: swap data per product per country. Reduce ratio and solve as output problem. See next screen for example.2 6Sam510TomPearsApples 62Sam105TomPearsApplesComparative Advantage?Days to produce one unit of each.

Work this problem on your own paper to determine which corporation should specialize in cars and which in planes.Click the mouse upon completion of your work.CarsPlanesXYZ Corp.810QKFX Corp.1512CarsPlanesXYZ Corp.810QKFX Corp.1512Comparative Advantage?Days to produce one unit of each.

Converted:CarsPlanesXYZ Corp.10 5 (4/5) 8 4 (5/4)QKFX Corp.12 4 (5/4)15 5 (4/5)Unconverted:Comparative Advantage?Click the true statement based on the data:XYZ has an absolute disadvantage in cars and a comparative advantage in planesXYZ has an absolute disadvantage in cars and planes but a comparative advantage in cars.QKFX has an absolute advantage in cars and planes but a comparative advantage in cars.

15 5 (4/5)12 4 (5/4)QKFX Corp. 8 4 (5/4)10 5 (4/5)XYZ Corp.PlanesCarsConverted: