Ch2 Microeconomics ECO
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Transcript of Ch2 Microeconomics ECO
2PART I INTRODUCTION TO ECONOMICS
The EconomicProblem:
Scarcityand Choice Scarcity, Choice, and
Opportunity CostScarcity and Choice in a One-Person EconomyScarcity and Choice in an Economy of Two or MoreThe Production Possibility FrontierThe Economic Problem
Economic SystemsCommand EconomiesLaissez-Faire Economies:
The Free MarketMixed Systems, Markets, and Governments
CHAPTER OUTLINE
The Economic Problem: Scarcity And Choice
FIGURE 2.1 The Three Basic Questions
Every society has some system or process that transforms its scarce resources into useful goods and services. In doing so, it must decide what gets produced, how it is produced, and to whom it is distributed. The primary resources that must be allocated are land, labor, and capital.
The Economic Problem: Scarcity And Choice
The term resources is very broad. Some resources are the products of nature: land, fertile soil, minerals, wind...
In addition, the resources available to an economy include things such as buildings and equipment that have been produced in the past but are now being used to produce other things.
Also: the human workforce forms part of the resources.
The Economic Problem: Scarcity And Choice
Things that are produced and then used in the production of other goods and services are called capital.
The basic resources available to a society are often referred to as factors of production (or factors).
The Economic Problem: Scarcity And Choice
The process that transforms scarce resources into useful goods and services is called production.
The three key factors of production are land, labor, and capital.
Resources or factors of production, that is, anything provided by nature or previous generations that can be used directly or indirectly to satisfy human wants, are the inputs into the process of production; goods and services of value to households are the outputs of the process of production..
Scarcity, Choice, And Opportunity Cost
Scarcity and Choice in a One-Person Economy
Nearly all the same basic decisions that characterize complex economies must also be made in a simple economy.
The individual has to decide what s/he wants to produce; s/he must look at the possibilities he has.
Given the resources are limited, the individual has to decide how to best use them to satisfy his/her wants.
The concepts of constrained choice and scarcity are central to the discipline of economics.
Given the scarcity of time and resources, there will be a trade-off of doing one activity rather than another.
Opportunity Cost
Scarcity, Choice, And Opportunity Cost
opportunity costs The best alternative that we give up, or forgo, when we make a choice or decision.
Scarcity and Choice in a One-Person Economy
Using a day at the beach as an example, what is the opportunity cost of leisure?
a. Leisure is free. For example, you don’t have to pay for the benefit of enjoying the sun or relaxing at the beach.
b. Leisure has an opportunity cost only if there is a cost associated with it. For example, entering the beach may require you to pay a fee.
c. The opportunity cost of leisure at the beach is the value of the things that you could have produced during the time you were at the beach. For example, you could have used the time to work and earn some money.
d. According to economists, leisure activities are the only activities that do not carry an opportunity cost.
Scarcity, Choice, And Opportunity Cost
Scarcity and Choice in a One-Person Economy
The growth of the frozen food market in the last 50 years is a good example of the role of opportunity costs in our lives.
Opportunity Cost
Frozen Foods andOpportunity Costs
Specialization, Exchange, and Comparative Advantage
Scarcity, Choice, And Opportunity Cost
theory of comparative advantage Ricardo’s theory that specialization and free trade will benefit all trading parties, even those that may be “absolutely” more efficient producers.
SIMPLE EXAMPLE: Suppose that Bill and Colleen have only 2 tasks: gathering food to eat and cutting logs to burn.
If Colleen could cut more logs than Bill in 1 days and Bill could gather more food than Colleen could, specialization would clearly lead to more total production.
However, specialization would also work even if Colleen is better in both tasks:
Scarcity and Choice in an Economy of Two or More
Scarcity, Choice, And Opportunity CostScarcity and Choice in an Economy of Two or More
FIGURE 2.2 Comparative Advantage and the Gains from Trade
Scarcity, Choice, And Opportunity Cost
absolute advantage A producer has an absolute advantage over another in the production of a good or service if he or she can produce that product using fewer resources. (In the previous example Colleen has an absolute advantage in the production of both goods)
comparative advantage A producer has a comparative advantage over another in the production of a good or service if he or she can produce that product at a lower opportunity cost.
In the previous example, Bill has a comparative advantage over Colleen in the production of food because he gives up only 4 logs for an additional 8 bushels, whereas Colleen gives up 8 logs. On the other hand, Colleen has comparative advantage in the production of wood.
Specialization, Exchange, and Comparative Advantage
Scarcity and Choice in an Economy of Two or More
Scarcity, Choice, And Opportunity Cost
FIGURE 2.3a Production Possibilities with No Trade
A Graphical Presentation of Comparative Advantage and Gains from Trade
Scarcity and Choice in an Economy of Two or More
Scarcity, Choice, And Opportunity Cost
FIGURE 2.3b Production Possibilities with No Trade
A Graphical Presentation of Comparative Advantage and Gains from Trade
Scarcity and Choice in an Economy of Two or More
Scarcity, Choice, And Opportunity Cost
Before we saw that both could be better off :
Colleen:3 days food / 27 days logs.Bill: all his time on food.
Colleen trades 100 logs to Bill in exchange for 140 bushels of food.
So, after trade:
Colleen: 170, 170
Bill: 100, 100
Graphically:
Scarcity, Choice, And Opportunity Cost
FIGURE 2.4 Colleen and Bill Gain from Trade
Scarcity and Choice in an Economy of Two or More
Scarcity, Choice, And Opportunity Cost
Weighing Present and Expected Future Costs and Benefits
Very often we find ourselves weighing benefits available today against benefits available tomorrow.
A simple example of trading present for future benefits is the act of saving. When you put aside income today for use in the future, you give up some things that you could have had today in exchange for something tomorrow.
Scarcity and Choice in an Economy of Two or More
Scarcity, Choice, And Opportunity Cost
Capital Goods and Consumer Goods
A society trades present for expected future benefits when it devotes a portion of its resources to research and development or to investment in capital. Capital is anything that has already been produced that will be used to produce other valuable goods or services over time.
In a modern society, resources used to produced capital goods could have been used to produce consumer goods, that is, goods produced for present consumption.
Capital is not necessarily tangible: human capital = investment in education. This capital will continue to exist and yield benefits to you for years to come.
Scarcity and Choice in an Economy of Two or More
Scarcity, Choice, And Opportunity Cost
Capital Goods and Consumer Goods
The process of using resources to produce new capital is called investment.
A wise investment in capital is one that yields future benefits that are more valuable than the present cost.
Because resources are scarce, the opportunity cost of every investment in capital is forgone present consumption.
Scarcity and Choice in an Economy of Two or More
Scarcity, Choice, And Opportunity Cost
production possibility frontier (ppf) A graph that shows all the combinations of goods and services that can be produced if all of society’s resources are used efficiently.
It illustrates the principles of constrained choice, opportunity cost, and scarcity.
The Production Possibility Frontier
Scarcity, Choice, And Opportunity Cost
The Production Possibility Frontier
All points below and to the left of the curve (the shaded area) represent combinations of capital and consumer goods that are possible for the society given the resources available and existing technology.
Points above and to the right of the curve, such as point G, represent combinations that cannot be reached.If an economy were to end up at point A on the graph, it would be producing no consumer goods at all; all resources would be used for the production of capital.
Scarcity, Choice, And Opportunity Cost
The Production Possibility Frontier
Points that are actually on the ppf are points of both full resource employment and production efficiency.
Resources are not unused, and there is no waste.
Scarcity, Choice, And Opportunity Cost
The Production Possibility Frontier
Although an economy may be operating with full employment of its land, labor, and capital resources, it may still be operating inside its ppf, at a point such as D. The economy would be using those resources inefficiently.Periods of unemployment also correspond to points inside the ppf, such as point D Moving onto the frontier from a point such as D means achieving full employment of resources.
Scarcity, Choice, And Opportunity Cost
The Production Possibility Frontier
To be efficient, an economy must produce what people want. This means that in addition to operating on the ppf, the economy must be operating at the right point on the ppf.
This is referred to as output efficiency, in contrast to production efficiency.
Scarcity, Choice, And Opportunity Cost
The Production Possibility Frontier
Negative Slope and Opportunity Cost
When the resources are fully and efficiently employed, a society can produce more capital goods only by reducing the production of consumer goods.
The opportunity cost of the additional capital is the forgone production of consumer goods. (see next figure)
The slope of the ppf is negative
The slope of the production possibility frontier (ppf) is called the marginal rate of transformation (MRT).
Scarcity, Choice, And Opportunity Cost
FIGURE 2.5 Production Possibility Frontier
The Production Possibility Frontier
Scarcity, Choice, And Opportunity Cost
TABLE 2.1 Production Possibility Schedule for Total Corn and Wheat Production in Ohio and Kansas
Point on ppf
Total Corn Production
(Millions of Bushels Per Year)
TotalWheat Production
(Millions of Bushels Per Year)
A 700 100
B 650 200
C 510 380
D 400 500
E 300 550
The Law of Increasing Opportunity Cost
The Production Possibility Frontier
FIGURE 2.7 Corn and Wheat Production in Ohio and Kansas
Consider the figure below. As this country moves from point D to point B along the production possibility frontier AE,
a. the opportunity cost of building more consumer goods rises.
b. the opportunity cost of building more capital goods rises.
c. the opportunity cost is not affected because the curve does not shift.
d. the opportunity cost of producing more of either consumer goods or capital goods rises.
Refer to the figure. A 10-ton increase in the production of agricultural goods requires a sacrifice of manufactured goods that is:
a. greater between points b and c than between points e and f.
b. greater between points e and f than between points b and c.
c. proportionally the same between any two points.
d. less and less as you move downward along the curve.
Scarcity, Choice, And Opportunity Cost
Economic Growth
economic growth An increase in the total output of an economy. It occurs when a society acquires new resources or when it learns to produce more using existing resources.
New resources may mean a larger labor force or an increased capital stock. The production and use of new machinery and equipment (capital) increase workers’ productivity.
Improved productivity also comes from technological change and innovation, the discovery and application of new, more efficient production techniques.
The Production Possibility Frontier
Scarcity, Choice, And Opportunity Cost
TABLE 2.2 Increasing Productivity in Corn and Wheat Productionin the United States, 1935–2007
CORN WHEAT
Yield Per Acre (Bushels)
Labor Hours Per 100 Bushels
Yield Per Acre (Bushels)
Labor HoursPer 100 Bushels
1935–19391945–19491955–19591965–19691975–19791981–19851985–19901990–19951998200120062007
26.136.148.778.595.3
107.2112.8120.6134.4138.2145.6152.8
1085320
743
NAa
NAa
NAa
NAa
NAa
NAa
13.216.922.327.531.336.938.038.143.243.542.340.6
67341711
97
NAa
NAa
NAa
NAa
NAa
NAa
a Data not available.
Economic Growth
The Production Possibility Frontier
Scarcity, Choice, And Opportunity Cost
FIGURE 2.8 Economic Growth Shifts the PPF Up and to the Right
Economic Growth
The Production Possibility Frontier
Scarcity, Choice, And Opportunity Cost
Sources of Growth and the Dilemma of Poor Countries
The Production Possibility Frontier
FIGURE 2.9 Capital Goods and Growth in Poor and Rich Countries
Scarcity, Choice, And Opportunity Cost
The Economic Problem
Recall the three basic questions facing all economic systems:
(1) What gets produced?
(2) How is it produced?
(3) Who gets it?
Given scarce resources, how do large, complex societies go about answering the three basic economic questions?
This is the economic problem, which is what this text is about.
Economic Systems
Command Economies
command economy An economy in which a central government through a combination of government ownership of state enterprises and central planning, either directly or indirectly sets output targets, incomes, and prices.
While the extremes of central planning have been rejected, so too has the idea that markets solve all problems.
One of the major themes of this book is that government involvement, in theory, may improve the efficiency and fairness of the allocation of a nation’s resources.
At the same time, a poorly functioning government can destroy incentives, lead to corruption, and result in the waste of a society’s resources.
Economic Systems
Laissez-faire Economies: The Free Market
At the opposite end of the spectrum from the command economy is the laissez-faire economy.
laissez-faire economy Literally from the French: “allow [them] to do.” An economy in which individual people and firms pursue their own self-interest without any central direction or regulation.
The central institution through which a laissez-faire system answers the basic questions is the market, a term that is used in economics to mean an institution through which buyers and sellers interact and engage in exchange.
Some markets are simple and others are complex, but they all involve buyers and sellers engaging in exchange. The behavior of buyers and sellers in a laissez-faire economy determines what gets produced, how it is produced, and who gets it.
Economic Systems
In a free market, goods and services are produced and sold only if the supplier can make a profit, i.e. if selling goods or services for more than it costs to produce them is possible.
It’s not possible to make profits unless someone wants the product that you are selling.
This logic leads to the notion of:
consumer sovereignty The idea that consumers ultimately dictate what will be produced (or not produced) by choosing what to purchase (and what not to purchase).
Consumer Sovereignty
Laissez-faire Economies: The Free Market
Economic Systems
Under a free market system, individual producers must also determine how to organize and coordinate the actual production of their products or services.
Often the market system is called a free enterprise system.
free enterprise The freedom of individuals to start and operate private businesses in search of profits.
Proponents of free market systems argue that free enterprise leads to more efficient production and better response to diverse and changing consumer preferences. In a free market economy competition forces producers to use efficient techniques of production. It is competition then that ultimately dictates how output is produced.
Individual Production Decisions: Free Enterprise
Laissez-faire Economies: The Free Market
Economic Systems
Distribution of Output
In a free market system the distribution of output –who gets what- is also determined in a decentralized way.
The amount that any one household gets depends on its income and wealth.
Income is the amount that a household earns each year. It comes in a number of forms: wages, salaries, interest, and the like.
Wealth is the amount that households have accumulated out of past income through saving or inheritance.
Laissez-faire Economies: The Free Market
Economic Systems
Price Theory
Laissez-faire Economies: The Free Market
The basic coordination mechanism in a free market system is price
A price is the amount that a product sells for per unit, and reflects what society is willing to pay.
Prices of inputs- labor, land, and capital – determine how much it costs to produce a product.
Prices of various kinds of labor, or wage rates, determine the rewards for working in different jobs and professions.
Economic Systems
Mixed Systems, Markets, And Governments
The differences between command economies and laissez-faire economies in their pure forms are enormous.
In fact, these pure forms do not exist in the world; all real systems are in some sense “mixed.”
That is, individual enterprise exists and independent choice is exercised even in economies in which the government plays a major role.
Conversely, no market economies exist without government involvement and government regulation.
Economic Systems
Mixed Systems, Markets, And Governments
Advocates of free market argue that such markets work best when left to themselves. The result is quality and variety. But market systems have problems too.
1) They do not always produce what people want at the lowest cost – there are inefficiencies
2) Rewards (income) may be unfairly distributed and some groups may be left out
3) Periods of unemployment and inflation recur with some regularity
Many people point to these problems as reasons for government involvement. Indeed for some problems government involvement may be the only solution. But governments may fail to improve matters as well.
A market exists primarily in what type of economic system?
a. A command economy.
b. A laissez-faire economy.
c. A democracy.
d. A dictatorship.
e. An economy in transition.
Exercise: Consider the following data for the harvest of crabs versus the harvest of fish off the coast of Virginia, US, in answering the following questions.
Graph the production possibilities frontier and calculate theaverage opportunity cost of any of the first fifteen crabs produced.