Fundamental Economic Concepts

What is Economics?- The study of mankind’s

unlimited desires in a world of limited resources.-Economics is a social science, dealing with how people

react to changing variables.

-Economists form theories, based on economic models in which they manipulate variables.

-These theories, models and variables are used to describe what is (Positive Economics) and what ought to be (Normative Economics).

Microeconomics deals with individual decisions, Macroeconomics looks at the economy as a whole

What is the Economy?

Why Do We Study It?

1. Description

2. Analysis

3. Explanation

4. Prediction

What? or How Much?

How? or Why?

When?

OR…

Why do we study Economics?

Sowe

don’t get

screwed.

Book AuctionWhat economic concepts were

demonstrated by the book auction?◦Scarcity◦Value◦Choices◦Rationing◦Equity vs. Efficiency

Which was the sealed auction?

◦Consumer surplus

}Stay Tuned

!

ScarcitySituation that occurs when wants are greater than available resources.Scarcity is the fundamental problem in economics.

In this classroom, is/are _________ scarce?Desks?Water?Books?Gasoline?Jolly Ranchers?…

Good looking economics instructors?

But not in the hallway…

Wants are satisfied by available resources

No want for it in classroom, but outside… yes

Wants exceed available resources

Good looking economics instructors?

We always assume….People make decisions based

upon RATIONAL SELF-INTEREST

We must consider…

Examples: Shelter is a need, a mansion is a want.

Food is a need, a large pizza is a want.

Scarcity forces us to ask the following questions…

WHAT to produce?

HOW to produce?

FOR WHOM to produce?

Imagine a scenario where…

…we take an all-expenses-paid class trip to…

Australia!

Our plane is forced to make a “water landing,” and we are able to swim to an uncharted island.

You are in charge. Prioritize 3-5 things we’ll have to do to survive and how (and with who) we should accomplish these tasks.

Specialization

• Allocating resources toward production for which they are best suited.

FACTORS OF PRODUCTION• Land – all gifts of nature• Labor – human efforts and abilities• Capital – tools, equipment, space• Entrepreneurship – risk taking, ideas

– **The “spark” or driving force of the economy**

EXAMPLES:

Adam Smith“Wealth of Nations”

◦1776Invisible hand

◦ Meat◦ Bread◦ Candles◦ How do we decide to provide these?

CIRCULAR FLOW

UtilityThe satisfaction that

consumption of a good or service provides

DIMINISHING MARGINAL UTILITY

As you consume additional units of a good, at some point each additional unit will begin providing less utility than the one before it.

Paradox of ValueWater vs. DiamondsMonetary Value

◦Must be scarce◦Must give utility

Are diamonds scarce?Do they give utility?

Conspicuous consumption◦Examples?

Cost – Benefit Analysis

Question? :

What do you want RIGHT NOW?

Cost – Benefit Analysis

Follow up question? :

Why don’t you go get it?

Cost – Benefit Analysis

• We all make decisions in our own self-interest

• All decisions come with certain trade-offs and alternatives

• THERE IS NO SUCH THING AS A FREE LUNCH!!!Seinfeld example

• Opportunity Cost: the next-best alternative given up when making a choice

Opportunity Cost

VS.

VS. VS.

Marginal Cost

Marginal = Additional, next

Additional cost vs. additional benefit

We constantly engage in marginal analysis

Production Possibilities ModelIllustrate production choices

Assumptions:◦Full employment◦Fixed resources◦Fixed technology◦Two goods

1-31

Production Possibilities FrontierGuns (thousands)

807560300

Butter (tons)

0150300400450

All possible combinations of two products that can be produced when employing 100% of available resources.

Production Possibilities Frontier

Type of Product

Pizzas (in hundred thousands)

Industrial Robots (in thousands)

Production Alternatives

A B C D E

10 9 7 4 0

0 1 2 3 4

Plot Points to Create Graph…

Production Possibilities Table

1-35

Production Possibilities Curve

Pizzas

Ind

ust

rial

Ro

bo

ts

Attainable

0 1 2 3 4 5 6 7 8 9

14

13

12

11

10

9

8

7

6

5

4

3

2

1

Unattainable

AB

C

D

E

EconomicGrowth

Now Attainable

A’

B’

C’

D’

E’

1-36

Production Possibilities Curve

Pizzas

Ind

ust

rial

Ro

bo

ts

Attainable

0 1 2 3 4 5 6 7 8 9

14

13

12

11

10

9

8

7

6

5

4

3

2

1

Unattainable

AB

C

D

E

Law of IncreasingOpportunity Cost

A’

B’

C’

D’

E’

Shape of the Curve

1-37

Quick QuizWhy is the PPF bowed out

from the origin?◦Law of increasing opportunity

costs…◦…due to specialization of

resourcesWhat is the marginal

opportunity cost of the 2nd unit of pizza?◦2 thousand robots

Which point(s) on the curve represent full employment of resources?◦All points ON the curve

The Future Economy

Consequences of unemployment

Economic growth◦More resources ◦Better quality resources◦Technological advances

1-39

Future Possibilities

Goods for the Present

Goo

ds f

or t

he F

utur

e

Goo

ds f

or t

he F

utur

eGoods for the Present

P

F

CurrentCurve

CurrentCurve

FutureCurve

FutureCurve

Compare Two Hypothetical Economies

Presentville Futureville

1-40

Specialization

Shift resources to export industry

Achieve higher overall output and income

Absolute advantage◦Higher output per worker for a good

Comparative advantage◦Lower domestic opportunity cost for a good

5-41

Comparative Advantage

Product A B C D E

Avocados 0 20 24 40 60Soybeans 15 10 9 5 0

**Optimal domestic production occurs at point C• Opportunity cost of 1 ton of

Soybeans is 4 tons of Avocados• Opportunity cost of 1 ton of

Avocados is .25 tons of Soybeans

Mexico’s Production Possibilities Table (in Tons)

Production Alternatives

5-42

Comparative Advantage

Avocados 0 30 33 60 90Soybeans 30 20 19 10 0

**Optimal domestic production occurs at point C• Absolute advantage in both goods• Opportunity cost of 1 ton of

Soybeans is 3 tons of Avocados• Opportunity cost of 1 ton of

Avocados is .33 tons of Soybeans

Product A B C D E

U.S.’s Production Possibilities Table (in Tons)

Production Alternatives

5-43

Comparative Advantage

Mexico will produce avocados

U.S. will produce soybeansU.S. gives up 3 A for 1 SMexico gives up 4 A for 1 S

Terms of trade◦3.5 A for 1 S◦Both countries benefit

5-44

Comparative AdvantageGains from tradeMexico starts at C (24 A and 9S)◦Move to E (60 A and 0 S)◦Trade 35 A for 10 S

U.S. starts at T (33 A and 19 S)◦Move to R (0 A and 30 S)◦Trade 10 S for 35 A

Overall gains?5-45

Comparative Advantage

Terms of Trade – 1s : 3.5aTrade: 10 tons soybeans for

35 tons avocados