The document provides an overview of key concepts in economics. It discusses:
1) Economics is the study of choice under conditions of scarcity. Scarcity means that resources are insufficient to satisfy all wants and needs.
2) Scarcity applies at both the individual and societal level and forces trade-offs in how resources are allocated. Economists study how individuals and societies make choices.
3) There are different methods for allocating scarce resources in an economy, including traditional, command, and market-based approaches.
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Understanding Opportunity Cost and Production Possibilities
1. What is Economics?
Two important terms:
1. Choice
2. Scarcity
Study of choice under conditions of scarcity
Scarcity
Situation in which the amount of something
available is insufficient to satisfy the desire for it
2. Scarcity and Individual Choice
There are an unlimited variety of scarcities,
however they are all based on two basic
limitations
Scarce time
Scarce spending power
Limitations
force each of us to make choices
Economists study
choices we make as individuals, and consequences
of those choices
more subtle and indirect effects of individual choice
on our society
3. Scarcity and Social Choice
Resources in our society —land, labor, and capital—are limited
Scarcity of Labor
Time human beings spend producing goods and services
Scarcity of Capital
Something produced that is long-lasting, and used to make other
things that we value
Human capital
Capital stock
Scarcity of land/natural resources
Physical space on which production occurs, and the natural
resources that come with it
Scarcity of entrepreneurship
Ability and willingness to combine the other resources into a
productive enterprise
4. Agents and Scarcity in Economics
Who are involved in resource allocation?
Households allocate limited income / time among
goods and services
Business firms choices of what to produce and how
much are limited by costs of production
Government agencies work with limited budgets and
must carefully choose which goals to pursue
Economists study these decisions to
Explainhow our economic system works
Forecast the future of our economy
Suggest ways to make that future even better
5. Microeconomics vs Macroeconomics
Micro
Microcomes from Greek word mikros,
meaning “small”
Microeconomics
Study of behavior of individual households,
firms, and governments
Choices they make
Interaction in specific markets
Focuses
on individual parts of an
economy, rather than the whole
6. Microeconomics vs Macroeconomics
Macro
Macro comes from Greek word, makros,
meaning “large”
Macroeconomics
Study of the economy as a whole
Focuses on big picture and ignores fine
details
7. Microeconomics
Scarcity, opportunity cost
Price determination -- theory of Supply and
Demand
Elasticities
Consumer Choice
Production and cost, Producer Choice
Perfect competition and imperfect competition
Labor market and Economic Inequality
Capital and investment
Economic Efficiency
8. Positive Economics v.s. Normative Economics
Positive economics
tudy
S of how economy works
ccessing the expected, objective
A
outcomes
o matter whether they are true or not
N
ccuracy of positive statements can be
A
tested by looking at the facts—and just the
facts
9. Positive Economics v.s. Normative Economics
Normative Economics
Study of what should be
Used to make value judgments, identify
problems, and prescribe solutions
Statements that suggest what we should do
about economic facts, are normative
statements
Based on values
Normative statements cannot be proved or
disproved by the facts alone
10. Why Study Economics
To understand the world better
You’llbegin to understand the cause of many of the things that
affect your life
To gain self-confidence
You’ll
lose that feeling that mysterious, inexplicable forces are
shaping your life for you
To achieve social change
understand origins of social problems and design more effective
solutions
To help prepare for other careers
You’ll
discover that a wide range of careers deal with economic
issues on many levels
11. The Methods of Economics
Modeling
Model: Abstractrepresentation of reality
Economic theories must have a well-
constructed model
While most models are physical constructs
Economists use words, diagrams, and
mathematical statements
12. Assumptions
Assumptions are very important for modeling
Types of assumptions in an economic model
Simplifying assumptions
Way of making a model simpler without affecting any of its
important conclusions
Critical assumptions
Affect conclusions of a model in important ways
If critical assumptions are wrong model will be wrong
All
economic models have one or more critical
assumptions
13. Questions
1. What are the opportunity costs of the choices you
make?
2. How does a production possibility frontier (PPF)
illustrate opportunity cost, specialization of resources,
inefficiency, and economic growth?
3. What are the differences between command
economies, free market economies, and mixed
economies in terms of the ways they address the 3
basic economic questions?
4. Why do we observe specialization in production and
trade?
14. Opportunity Cost - Concept
Remember that scarcity in time and money
results in choice making in real world
Definition: Opportunity cost of any choice
What we forego when we make that choice
Most accurate and complete concept of cost we
should use when making decisions
An Example:
in one hour, George can fix 4 flat tires or type 200
words. What is his opportunity cost of fixing a flat
tire? What is his opportunity cost of typing 100
words?
15. Opportunity Cost - Components
Direct money cost of a choice may only be a part of
opportunity cost of that choice
Opportunity cost of a choice
= explicit costs + implicit costs
Explicit cost—money actually paid out for a
choice
Accounting cost
Implicit cost—value of something sacrificed when
no direct payment is made
16. Opportunity Cost - Examples
Opportunity cost of investing on education
Explicit cost: tuition and fees
Implicit cost: time or forgone income
Opportunity cost of a typical firm
Explicit cost Implicit cost
Rent paid out Owner’s rent forgone
Manager’s salaries Owner’s return from investment
Worker’s wages Owner’s labor income forgone
Cost of raw material
Interest on loans
17. Opportunity Cost and Society
Resources in whole society are limited.
All production carries an opportunity cost
o produce more of one thing
T
Must
shift resources away from producing
something else
There is no such thing as a free lunch!
18. Increasing Opportunity Cost
According to law of increasing
opportunity cost
he
T more of something we produce
The
greater the opportunity cost of
producing even more of it
This principle applies to all of
society’s production choices
19. Production Possibilities Frontiers
ProductionPossibilities Frontiers (PPF)
shows the combinations of two goods that
can be produced with resources and
technology available
20. Figure 1: (PPF)
cars At point A, all
resources are used
for ”biofuels."
A Moving from point A to point B
1,000,000 B
950,000 requires shifting resources out of
850,000 C biofuels and into grains/ food.
D
700,000
500,000 At point F. all
W E resources are used
400,000
for grains/food
F
100,000 200,000 300,000 400,000 500,000 grains
21. Characteristics of PPF
The points on the curve show the maximum number
of goods capable to be produced
Unit in the horizontal and vertical axis is quantity (not
price) of the two different goods
The points inside the curve show the possible other
combinations of goods possible to be produced
Inefficient production
The shape of the curve is concave toward the origin
in most cases
The law of increasing opportunity cost
The points outside the curve show the impossible
combinations of goods
Society’s choices are limited to points on or inside the
PPF
22. Productive Inefficiency
Productive Inefficiency
More of at least one good can be produced
Without
pulling resources from the production of
any other good
Reasons
Wasteof sources
Recession (economic slump)
23. Recessions
A slowdownin overall economic activity
when resources are idle
Widespread unemployment
Factories shut down
Land and capital are not being used
An end to the recession would move the
economy from a point inside its PPF to a point
on its PPF
Using idle resources to produce more goods and
services without sacrificing anything
Can help us understand an otherwise confusing episode in
economic history
24. The Case of Production and
Unemployment in the US
1. Before WWII the United States
Military Goods operated inside its PPF . . .
per Period
2. then moved to the PPF
B during the war. Both
military and civilian
production increased.
A
Civilian Goods per Period
25. Economic Growth
If economy is already operating on its PPF
Cannot exploit opportunity to have more of everything by moving to it
But what if the PPF itself were to change? Couldn’t we then
produce more of everything?
This happens when an economy’s productive capacity grows
Many factors contribute to economic growth, but they can be
divided into two categories
Quantities of available resources—especially capital—can increase
An increase in physical capital enables economy to produce more of
everything that uses these tools
More factories, office buildings, tractors, or high-tech medical equipment
Same is true for an increase in human capital
Skills of doctors, engineers, construction workers, software writers, etc.
Technological change enables us to produce more from a given
quantity of resources
Capital and technological change usually go hand in hand
26. Economic Growth
Increases in capital and technological change often go
hand in hand
For instance, PET body scanners will enable us to save
even more lives than our current set of resources
Moving horizontal intercept of PPF rightward, from F to F‘
Impact of PET scanners stretches PPF outward along horizontal
axis
How can a technological change in lifesaving enable us
to produce more goods in other areas of the economy?
Society can choose to use some of increased lifesaving potential
to shift other resources out of medical care and into production
of other things
Because of technological advance and new capital, we can shift
resources without sacrificing lives
27. Figure 3: The Effect of a New Medical
Technology
Quantity of All
2. But not its vertical
Other Goods 4. or more lives saved and greater
intercept.
per Period production of other goods.
A
1,000,000
3. The economy can end
J up with more lives
H saved and un-changed
700,000
production of other
D
goods . . .
1. A technological advance in
saving lives increases this
PPF's horizontal intercept . . .
F F'
300,000 500,000 600,000
Number of Lives Saved per Period
28. Economic Growth
If we can produce more of the things that we value,
without having to produce less of anything else, have we
escaped from paying an opportunity cost?
Yes . . . and no
Figure 3 tells only part of story
Leaves out steps needed to create this shift in the PPF
For example, technological innovation doesn’t just “happen”—
resources must be used to create it
Mostlyby research and development (R&D) departments of large
corporations
In order to produce more goods and services in the
future, we must shift resources toward R&D and capital
production
Away from production of things we’d enjoy right now
29. Specialization and Exchange
self sufficiency
Specialization
Method of production in which each person concentrates on a
limited number of activities
Example: Adam Smith observed that
10 men produce 200 pins a day working separately
10 men produce 48,000 pins a day through specialization!
Exchange
- Practice of trading with others to obtain what we want
Allows for
Greater production
Higher living standards than otherwise possible
All economics exhibit high degrees of specialization and
exchange
30. Resource Allocation
Problem of resource allocation
Which goods and services should be produced with
society’s resources?
Where on the PPF should economy operate?
How should they be produced?
Labor or Capital intensive
No capital at all
Small amount of capital
More capital
Who should get them?
How do we distribute these products among the
different groups and individuals in our society?
31. The Three Methods of Resources
Allocation
Traditional Economy
Resources are allocated according to long-
lived practices from the past
Command Economy (Centrally-Planned)
Resources are allocated according to explicit
instructions from a central authority
Market Economy
Resources are allocated through individual
decision making
Dominant method
32. The Nature of Markets
A market is a group of buyers and
sellers with the potential to trade with
each other
lobal
G markets
Buyers and sellers spread across the globe
ocal
L markets
Buyersand sellers within a narrowly
defined area
33. The Importance of Prices
A price is the amount of money that must
be paid to a seller to obtain a good or
service
When people pay for resources allocated
by the market
They must consider opportunity cost to
society of their individual actions
Marketscan create a sensible allocation of
resources
34. Resource Allocation
Various levels of government collect about one-
third of our incomes as taxes
Enables government to allocate resources by
command
Government uses regulations of various types to
impose constraints on our individual choice
The market is the dominant method of resource
allocation
However, it is not a pure market
35. Resource Ownership
Communism
Most resources are owned in common
Socialism
Most resources are owned by state
Capitalism
Most resources are owned privately
36. Types of Economic Systems
Aneconomic system is composed of
two features
echanism
M for allocating resources
Market
Command
ode
M of resource ownership
Private
State
37. Figure 4: Types of Economic Systems
Resource Allocation
Market Command
Centrally
Market
Private Planned
Capitalism
Capitalism
Resource
Ownership
Centrally
Market
State Planned
Socialism
Socialism
38. Summaries
Opportunity cost Specialization and
vsaccounting cost Exchange
PPF
Recession/inefficiency
Economic system
Economic growth /
Technological Change 4 types
Law of increasing
opportunity cost
Other Characteristics