Economics

Scarcity, Choice and Opportunity

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The Social Sciences

An academic discipline that studies human activities, e.g. economics, political science, sociology, psychology

Uses scientific method in quantitative and qualitative studies

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Scientific Method

Define the question Gather information and resources Form hypothesis Perform experiments and collect data Analyze data Interpret data and draw conclusions that

serve as a starting point for new hypotheses Publish results

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Scientific Method, cont.

Hypothesis must be falsifiable – the logical possibility that an assertion can be shown false by an observation or a physical experiment.

Studies must be empirical, or dependent on evidence or consequences that are observable by the senses.

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Why is Economics Studied?

Our wants exceed our resources Economics provides a framework for making

acceptable choices Economic decisions are both objective and

subjective

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Resources (Factors of Production) and Scarcity Land – natural resources (renewable and non-

renewable) Labor – human effort and skill Capital - stock of goods which are to be used in the

production of other goods or services Entrepreneurship – the skill to detect a previously

untapped opportunity to make profits Human Capital – The practical knowledge, acquired

skills and learned abilities of an individual that make him or her potentially productive and thus equip him or her to earn income in exchange for labor.

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The Three Basic Economic Questions What – given the resources available what

will be done with them? How – how will resources be used to create

goods or services? Who – who is going to benefit from what is

produced?

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Opportunity Cost

Opportunity cost is the sacrifice made when selecting one product or service over another.

The Opportunity cost can be graphically illustrated through the use of the Production Possibility Curve

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Production Possibility Curve

The Production Possibilities Curve is a graphical representation showing various maximum combinations of output an enterprise can produce with limited economic resources in a fixed time period.

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Production Possibilities CurveAssumptions of the Production Possibilities Curve 1. Two goods are produced depicting choices and

trade-offs for an enterprise. 2. Full employment and full production are achieved

allowing for maximum utilization of resources. 3. Short-run is the time frame over which resources

cannot be improved or increased. The output represented by the curve is limited

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Production Possibility Curve

Points A and B – all resources being used

Point C – not all resources being used

Point D – not enough resources available

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Production Possibility Curve

Malibu Entertainment produces VHS and audio cassettes. The material used to produce 1 VHS cassette equals 3 audio cassettes. Its maximum daily production run is 1000 VHS cassettes.

If the firm produces no VHS cassettes, how many audio cassettes can it produce?

Ans. 3000 If the firm produces 5 audio cassettes, what is its

opportunity cost in terms of VHS cassettes? Ans. 2

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Production Possibility Curve Malibu Entertainment

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Sunk Costs

Sunk costs are costs that have already been incurred and can’t be recovered

Sunk cost dilemma - having to choose between continuing a project of uncertain prospects already involving spent costs or discontinuing it

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Macroeconomics

Macroeconomics – deals with the economy as a whole

Why do economies grow (or decline)? What determines a nation’s savings,

investments, consumption? What causes inflation (deflation)? Why does it generate high unemployment?

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Microeconomics

Microeconomics analyzes the behavior of individual households, firms and markets

Why do firms produce what they do? How do they price goods and services? How do markets work? What is the difference between competitive

and non-competitive markets What determines people’s demands?

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Positive and Normative Economics Positive economics – analyzes the way the

economy actually operates Normative economics – founded on value

judgments and leading to assertions what ought to be

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Econometrics

Mathematical and statistical models which analyze economic data

Used to predict economic trends so that firms and government have plans to deal with future events

Analogous to weather forecasting Ceteris Paribus – ‘holding constant’, i.e. that

no major changes occur to influence the analysis

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Marginal Utility

The change in total utility (satisfaction or enjoyment) a person derives from consuming an additional unit of a good

The concept implies that the utility or benefit to a consumer of an additional unit of a product is inversely related to the number of units of that product he already owns.

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Absolute vs. Comparative Advantage Developed by Adam Smith Absolute Advantage exists if one can produce

an item (service) using fewer resources. Comparative Advantage exists if one can

produce an item (service) at smaller opportunity cost.

If one country has an absolute advantage in every type of output, the disadvantaged country can benefit from specializing in and exporting the product with the largest opportunity cost for the other country.

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Example

The standard example is 2 economies producing 2 items.

Aruba: 1 employee can produce 2 tents or 700 shorts per week (opportunity cost: 1 tent = 350 shirts)

Bermuda: 1 employee can produce 1 tent or 300 shorts (opportunity cost: 1 tent = 300 shorts).

Aruba has an Absolute Advantage in tents and shorts. But Bermuda has a Comparative Advantage in tents

since 1 tent = 300 shorts to them while 1 tent = 350 shorts in Country A.

What should Bermuda produce – tents or shorts?

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Determining Comparative Advantage

1. Which nation has an absolute advantage in producing CDs?

2. Which nation has an absolute advantage in producing beef?

3. Which nation has a comparative advantage in producing CDs?

4. Which nation has a comparative advantage in producing beef?

5. Should Japan specialize in CDs or beef?

6. Should Canada specialize in CDs or beef?

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Production Possibility Frontier Related to Production Possibility Curve Used to illustrate shifts (increase or decrease) in

resources (production capacity) Shifts caused by: productivity and efficiency and

changes in factor resources (labor and capital) Allocative efficiency – producing goods that are

in demand Productive efficiency – reduction of waste Distributive efficiency – getting goods to market

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Production Possibility Frontier Shift

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