Chapter 18Chapter 18

What is economics?What is economics?– The study of how we make decisions in The study of how we make decisions in

a world where resources are limited.a world where resources are limited.

Bell StarterBell Starter

Economics Economics NeedsNeeds WantsWants ScarcityScarcity Economic modelEconomic model Trade-offTrade-off Opportunity costOpportunity cost Marginal benefitMarginal benefit

Cost-benefit Cost-benefit analysisanalysis

Market economyMarket economy CapitalismCapitalism Free enterpriseFree enterprise IncentiveIncentive Rational choiceRational choice

Why Study Economics?Why Study Economics?Read the following examples of possible newspaper Read the following examples of possible newspaper

headlines and describe how these headline headlines and describe how these headline events could effect you.events could effect you.

1.1. War in the Middle East Threatens Oil SupplyWar in the Middle East Threatens Oil Supply2.2. Cost of College Education continues to RiseCost of College Education continues to Rise3.3. Government Indicators warn of Possible Government Indicators warn of Possible

RecessionRecession4.4. New Law Prevents Teens from Working more New Law Prevents Teens from Working more

than Two days a Weekthan Two days a Week5.5. Computer Related Industries experience Great Computer Related Industries experience Great

Shortage in WorkersShortage in Workers6.6. Cost of Health Care continues to Spiral UpwardCost of Health Care continues to Spiral Upward7.7. Unions report that Many Jobs being Lost to Unions report that Many Jobs being Lost to

Oversees WorkersOversees Workers

Fundamental Fundamental EconomicsEconomics

Economic ChoicesEconomic Choices EconomicsEconomics is the study of how we is the study of how we

make decisions in a world where make decisions in a world where resources are limited. It is resources are limited. It is sometimes called the science of sometimes called the science of decision making.decision making.

MICRO: SMALL MICRO: SMALL MACRO: LARGEMACRO: LARGE

NeedsNeeds are things we need for are things we need for survival, such as food, survival, such as food, clothing, & shelter. clothing, & shelter. WantsWants are things we would are things we would like to have.like to have.

WANTS VS NEEDS: WANTS VS NEEDS: WHAT IS THE DIFFERENCE?WHAT IS THE DIFFERENCE?

NEED: REQUIRED TO SURVIVENEED: REQUIRED TO SURVIVE WATERWATER FOODFOOD CLOTHINGCLOTHING SHELTERSHELTER

WANT: THING WE WOULD LIKE TO HAVE WANT: THING WE WOULD LIKE TO HAVE BUT DO NOT NEED TO SURVIVEBUT DO NOT NEED TO SURVIVE

PEPSIPEPSI CAVIAR CAVIAR FUR COATFUR COAT BEACH HOUSEBEACH HOUSE

Needs and WantsNeeds and Wants

Divide a sheet of paper in halfDivide a sheet of paper in half On one side write Needs. On the On one side write Needs. On the

other write Wantsother write Wants On the next slide is a list of products. On the next slide is a list of products.

Place the product in the correct Place the product in the correct category (need or want)category (need or want)

No discussion!No discussion! Place according to Place according to definition given in class.definition given in class.

toothpastetoothpaste SoapSoap BedBed Chewing Chewing gumgum

WristwatchWristwatch CoatCoat JeansJeans Air Air conditionerconditioner

SocksSocks glassesglasses MP3 playerMP3 player FruitFruit

TelevisionTelevision HaircutHaircut WaterWater PedicurePedicure

DeodorantDeodorant MoviesMovies ComputerComputer Cell phoneCell phone

Hair sprayHair spray PizzaPizza Microwave Microwave ovenoven

JewelryJewelry

vegetablesvegetables electricityelectricity RefrigeratorRefrigerator Porsche Porsche 911 (car)911 (car)

Economic Choices (con’t)Economic Choices (con’t)

The fundamental economic problem The fundamental economic problem is is scarcityscarcity-we do not have enough -we do not have enough resources to produce all the things resources to produce all the things we would like to have. Because of we would like to have. Because of scarcity, we must make choices scarcity, we must make choices among alternatives.among alternatives.

Three Decisions Society must make: Three Decisions Society must make: What to produce? How to produce? What to produce? How to produce? For whom to produce?For whom to produce?

Using Economic ModelsUsing Economic Models

The economy includes all the activity in The economy includes all the activity in a nation that together affects the a nation that together affects the production, distribution, & use of goods production, distribution, & use of goods & services& services

Economic ModelsEconomic Models-representations of -representations of the real world, based on economic the real world, based on economic theories.theories.1. Business & government often base 1. Business & government often base decisions decisions on the model’s responses to on the model’s responses to tests.tests.2. Model’s based on assumptions.2. Model’s based on assumptions.3. Economists use models to predict 3. Economists use models to predict future of economy.future of economy.

Trade-OffsTrade-Offs

Economic choices involve Economic choices involve trade-trade-offsoffs, or exchanging one thing for the , or exchanging one thing for the use of another. use of another.

(For example, when you by a product, you (For example, when you by a product, you exchange money for the right to own that exchange money for the right to own that product rather that something else you product rather that something else you could buy for the same price.)could buy for the same price.)

Trade-Off (con’t)Trade-Off (con’t)

People, businesses, & societies People, businesses, & societies make trade-offs every time they make trade-offs every time they chose to use their resources in one chose to use their resources in one way & not in another. More money way & not in another. More money for education means less money to for education means less money to spend on medical research or spend on medical research or national defense.national defense.

Opportunity CostOpportunity Cost

is what you cannot buy or do when you is what you cannot buy or do when you choose to do or buy one thing rather than choose to do or buy one thing rather than another. another.

IT IS THE NEXT BEST ALTERNATIVE THAT IT IS THE NEXT BEST ALTERNATIVE THAT YOU HAD TO GIVE UP FOR THE CHOICE YOU YOU HAD TO GIVE UP FOR THE CHOICE YOU MADE. MADE.

(example: the opportunity cost of cleaning (example: the opportunity cost of cleaning the house includes not only the price of the house includes not only the price of cleaning products, but also the time you cleaning products, but also the time you spent cleaning instead of doing something spent cleaning instead of doing something else, like listening to music.)else, like listening to music.)

TRADE OFFS VS OPPORTUNITY COSTTRADE OFFS VS OPPORTUNITY COST

TRADE OFFSTRADE OFFS ALTERNATIVE YOU ALTERNATIVE YOU

FACE IF YOU DECIDE FACE IF YOU DECIDE TO DO ONE THING TO DO ONE THING RATHER THAN RATHER THAN ANOTHERANOTHER– CHOICE YOU HAVE CHOICE YOU HAVE

BETWEEN TWO BETWEEN TWO THINGSTHINGS

OPPORTUNITY COSTOPPORTUNITY COST IS THE COST OF THE IS THE COST OF THE

NEXT BEST USE OF NEXT BEST USE OF YOUR TIME & MONEY YOUR TIME & MONEY WHEN YOU CHOOSE WHEN YOU CHOOSE TO DO ONE THING TO DO ONE THING OVER ANOTHEROVER ANOTHER– MONEYMONEY– DISCOMFORTSDISCOMFORTS– INCONVIENCESINCONVIENCES

Measure of CostsMeasure of CostsBusinessBusiness

All business have fixed & variable costs. All business have fixed & variable costs. Fixed costsFixed costs are expenses that are the are expenses that are the

same no matter how many units of a same no matter how many units of a good are produced. good are produced.

– Rent, mortgages, property taxesRent, mortgages, property taxes

Variable costsVariable costs are expenses that are expenses that change with the number of products change with the number of products produced. If a business produces more, produced. If a business produces more, variable costs like raw materials & variable costs like raw materials & wages will increase.wages will increase.

– Wages, raw materials, gas for transportWages, raw materials, gas for transport

Business Costs (continued)Business Costs (continued) Fixed costs plus variable costs equal Fixed costs plus variable costs equal

total coststotal costs.. Marginal costMarginal cost is the extra cost of is the extra cost of

producing one additional unit of output. producing one additional unit of output. If it costs an extra $50 to produce one If it costs an extra $50 to produce one more bicycle helmet, the marginal cost more bicycle helmet, the marginal cost is $50.is $50.

Total revenueTotal revenue equals the # of units equals the # of units sold times the average price per unit. sold times the average price per unit.

Marginal revenueMarginal revenue is the additional is the additional benefit associated with an action.benefit associated with an action.

MEASURES OF COST: MEASURES OF COST: PROBLEMS OF PRODUCTIONPROBLEMS OF PRODUCTION

SURPLUS: SURPLUS: – ANYTHING ABOVE ANYTHING ABOVE

WHAT PEOPLE ARE WHAT PEOPLE ARE WILLING TO BUYWILLING TO BUY

– IF YOU PRODUCE TOO IF YOU PRODUCE TOO MUCH THIS IS THE MUCH THIS IS THE PROBLEM YOU HAVEPROBLEM YOU HAVE

– PRODUCTS LEFT ON PRODUCTS LEFT ON SHELFSHELF

– LOWER PRICES LOWER PRICES BECAUSE SUPPLY IS BECAUSE SUPPLY IS GREAT: SALESGREAT: SALES

SHORTAGES:SHORTAGES:– ANYTHING BELOW ANYTHING BELOW

WHAT PEOPLE ARE WHAT PEOPLE ARE WILLING TO BUYWILLING TO BUY

– IF YOU PRODUCE TOO IF YOU PRODUCE TOO LITTLE THIS IS THE LITTLE THIS IS THE PROBLEM YOU HAVEPROBLEM YOU HAVE

– PRODUCTS ARE NOT PRODUCTS ARE NOT THERETHERE

– PRICES GO UP: SUPPLY PRICES GO UP: SUPPLY IS LOWIS LOW

MARGINAL: ONE EXTRAMARGINAL: ONE EXTRAMARGINAL COST: COST OF MAKING ONE EXTRA PRODUCTMARGINAL COST: COST OF MAKING ONE EXTRA PRODUCT

COST 1500 TO MAKE 10 PRODUCTSCOST 1500 TO MAKE 10 PRODUCTS COST 1550 TO MAKE 1 MORE COST 1550 TO MAKE 1 MORE WHAT IS MARGINAL COST TO MAKE WHAT IS MARGINAL COST TO MAKE

ONE MORE ITEM? ______ONE MORE ITEM? ______ COST 1400 TO MAKE 1 PRODUCTCOST 1400 TO MAKE 1 PRODUCT COST 1900 TO MAKE JUST ONE MORE COST 1900 TO MAKE JUST ONE MORE WHAT IS MARGINAL COST TO MAKE WHAT IS MARGINAL COST TO MAKE

ONE MORE ITEM? _______ONE MORE ITEM? _______

MARGINAL COSTMARGINAL COST REVENUE: AMOUNT YOU BRING IN OR MAKE REVENUE: AMOUNT YOU BRING IN OR MAKE

FROM SELLING A PRODUCTFROM SELLING A PRODUCT– TOTAL REVENUE: # OF UNITS SOLD X AVERAGE TOTAL REVENUE: # OF UNITS SOLD X AVERAGE

PRICE/UNITPRICE/UNIT– MARGINAL REVENUE: CHANGE IN TOTAL REVENUE MARGINAL REVENUE: CHANGE IN TOTAL REVENUE

(EXTRA REVENUE FROM SELLING JUST ONE MORE UNIT (EXTRA REVENUE FROM SELLING JUST ONE MORE UNIT OF OUTPUTOF OUTPUT

MARGINAL BENEFIT: THE ADDITIONAL OR EXTRA MARGINAL BENEFIT: THE ADDITIONAL OR EXTRA BENEFIT ASSOCIATED WITH AN ACTIONBENEFIT ASSOCIATED WITH AN ACTION

COST-BENEFIT ANALYSIS: ECONOMIC MODEL COST-BENEFIT ANALYSIS: ECONOMIC MODEL USED BY BUSINESSES TO SEE IF COST OUTWEIGH USED BY BUSINESSES TO SEE IF COST OUTWEIGH BENEFITS OR IF BENEFITS OUTWEIGH COSTBENEFITS OR IF BENEFITS OUTWEIGH COST

Cost-benefit analysisCost-benefit analysis

is an economic model used to compare is an economic model used to compare marginal costs & marginal benefits of a marginal costs & marginal benefits of a decision. decision.

You should choose an action when the You should choose an action when the benefits are greater than the costs. If benefits are greater than the costs. If the costs outweigh benefits, you should the costs outweigh benefits, you should reject the option. reject the option.

Cost-benefit analysis could be used to Cost-benefit analysis could be used to help determine help determine whatwhat to produce & to produce & for for whomwhom to produce. to produce.