Basic Ideas of Economics

Study Questions

1. How do individuals make decisions? 2. Why does the existence of scarcity

force us to make decisions? 3. How are goods and services produced? 4. Why is there always a cost in making

decisions, even if no money changes hands?

Study Questions

5. What are the alternative organizing mechanisms a society can choose?

6. How do these alternative organizing mechanisms differ in answering vital economic questions?

7. What is the payoff when there is state protection of property rights?

Study Questions

8. What does the production possibilities curve show us?

9. Why do we want economic growth?

What do you think of when you think of

ECONOMICS?

Definition of EconomicsThe study of how people, both individually and in groups, deal with the

problem of scarcity.

Why is economics considered a social science?

Scarcity forces human beings to make choices

Why has there always been an economic problem?

man’s wants are virtually unlimited

scarcity of resources

*Have to prioritize

All resources regardless where they are located are scarce.

The scarcity causes most to have a cost because the demand does not go away…. Supply is limited

The scarcity of resources causes most things to have a cost.

 

Remember****

Society has virtually unlimited wants BUT limited resources

This means prioritization!When did you last have to prioritize?Companies? Are you seeing them prioritize? WhereWhat about government?

Principal Assumption

People act rationally.Plan ahead.Think things through.Gather information.Recall past experiences.

Economics is a Social Science

What does that mean?

Why Act Rationally?

People want to better themselves. Improve their net worth.Obtain satisfaction.Obtain happiness.

Satisfying Unfilled Wants and Needs Rational people set priorities.

Satisfy the highest priority first. What satisfies?

Goods things produced

Services actions produced

ResourcesWhat are the factors of production? Inputs into a production process.

LandLabor CapitalEntrepreneurship

Putting it together

Make sure you have the right mix

Resources Inputs Process

OUTPUT

Figure 1-1.Transformation Process

INPUTS PROCESS OUTPUTS

Resources

Goods and services

thatsatisfy wants

and needs

Technologycan improvethe process

or the capitalgoods

The Production Process

Inputs are processed into outputs. Inputs = resourcesOutputs = goods and servicesProcess = how the transformation is done

Efficiency

Defined:get the maximum salable output from the lowest possible cost of inputswhile minimizing the waste.

Technology

Defined: the application of knowledge to improve the process, or to improve the capital input

Scarcity

Unlimited wants and needs Limited resources

which leads to limited amount of satisfying goods and services

Anything is scarce if it is useful and there is a limited amount of it.

Economic vs non-economic wants

Decision Making

Since everyone’s wants and needs cannot be satisfied, decisions have to be made to determine which will be satisfied now

… and which will be put off until later … or never satisfied. ………………..Trade Off ………………………opportunity cost

Scarcity forces individuals and groups to do what?

All economies evolve around a basic conflict.. Want more than we can have.

What is a Trade-off

Giving up one thing to get something else.

Thing you give up is called “opportunity cost.”

So if resources are limited and wants are unlimited…. Makes for an interesting “trade-off.”

Reality of Trade-offsJust a few of the products getting a start

from a barrel of oil:Aspirin furniture not to mention gasolineCandles hair dryers carpetsCD players lipstick paintsClothing luggage fertilizerCompact discs perfumes oils of all kindsComputers photographsCredit cards piano keysDeodorant roller bladesDiapers shampooDinnerware soft contact lensesDVDs toothpasteEyeglass frames vitamin capsules

Decision Making

Cost-benefit analysis:weigh the value of what will be obtained (the

benefit) and …the value of what must be given up (the

cost), and…then decide whether or not to take the next

step.

Marginal Analysis

This cost-benefit analysis takes one step at a time:compare the marginal benefit (MB) to the

marginal cost (MC).use your unique valuation system to do this.keep the steps small, so a mistake won’t hurt

too much.

Decision Matrix

If MB > MC, taking the next step is worthwhile.do it! and your net worth goes up.

If MB < MC, taking the next step is not worthwhile.don’t do it! because, if you do, your net worth

goes down.

Opportunity Cost

When you commit a resource to satisfying one want or need, it is no longer available to be used for another want or need.You satisfy the most valued need first.The value you place on the foregone

alternative need (second best choice) is your opportunity cost of making the decision.

Trade-Off

You must always give up one thing to get another thing. This is the trade-off. If MB (what you get) > MC (what you give up),

then the trade-off is worth making. Included in MC above is the opportunity cost

of making the decision.

Basic Economic Questions

All societies must answer the following:What to produce?How to produce?For whom to produce?

Invisible Hand- apolitical Individuals rather than government

should answer the 3 basic questions.What to produceHow to produceFor Whom to produce

But not just carte’ blancheSmith distinguished between self-interest

and greed! It is in our self-interest to have Rule of Law

in place – (property rights, patents, copyright, protection of workers, regulations, etc.)

Three basic economies

Market capitalist (capitalism) Command dictatorship (communism) socialism

Traditional Society

What? – exactly what our ancestors produced

How? – in the time-honored, old-fashioned way

For whom? – in the way they always have been distributed

Rationing: distribution method

Not everyone can have a good (scarcity)The market society uses purchasing power to

ration out available goodsThe command society uses political favor to

ration out available goods Whatever the rationing device, people will

compete to obtain it.

Private Property Rights

Enlightened government should protect the rights of its citizens to earn, own, and keep private property.protect from government confiscationprovides incentive to accumulate goodsprovides incentive to improve their lot

People move out of poverty and into the “middle class”

Private and Public Property

Owners care for their own goods Owners put their own goods to their best use. Publicly owned property is abused and

overused. Most pollution problems deal with publicly owned

goods, not privately owned goods: the atmosphere the lakes and rivers the oceans

Adam Smith

Wrote “The Wealth of Nations” in 1776 The Wealth of a Nation is “not in the king’s

treasury, but in the capability of its people to create and produce.”

“Invisible hand” causes us to operate for the betterment of society (even when we do not intentionally intend to do so).

Two things that allow economies to progress

This is an Adam Smith concept:

Division of labor

Specialization of labor

Recipe For Success

Select the option that is best in your own self interest.Make a good that satisfies the customer.Pay enough to cover the seller’s costs.Both become better off.

Self interest (both become better off) is not selfish (just me becomes better off)

What is Standard of Living?How can you calculate it?

How well off people are!

How well off are you?

Divide total production by population…

If production is high and population is low…. “get more stuff.”

3rd world countries… high population/low production

Per capital income China = $8,500Per capita income U.S.= $41,663

Social Examples U.S. Households90% have microwave ovens

88% have television in living room

87% subscribe to cable or satellite TV

77% own personal computer

72% have flat screen TV

68% have broadband Internet service

68% have television in their bedrooms.

Market or Command?

Market -each individual: decides for himself owns and controls

resources and property

Command - the ruler: makes all decisions controls the use of

resources and property, no matter who owns them

PPC illustrates 4 concepts

1. Scarcity

2. Choice

3. Opportunity Cost

4. Law of Increasing cost

THE WAY EACH COUNTRY ANSWERS THESE 3 QUESTIONS… INDICATES THE TYPE OF ECONOMY THEY HAVE

Figure 1-2. PPC: data and graph

PRODUCTION POSSIBILITIES CURVE (PPC)

0

1

2

3

4

5

0 10 20 30 40 50 60 70 80 90 100

COOKIES

CA

KE

Data:Cake Cookies 3 0 2 30 1 50 0 60

Production Possibilities CurvePPC

A

B

C

D

E

F

OUT

PUT

OF

SHO

ES

5

4

3

2

1

0 1 2 3 4 5OUTPUT OF TELEVISIONS

Note Difference in Shape of Curve

Direct Correlation … Two items produced… 1 to 1 ratio. Can Relinquish one part of resources and not have to give upMore of another. No law of increasing cost.

Economics

English

Increasing Opportunity Costs

Step 1: give up one shoe

Step 2: get two TVs

Step 4: get one more TV

A

B

C

D

E

F

5

4

3

2

1

0 1 2 3 4 5OUTPUT OF TELEVISIONS

At any point in time, a full-employment, full-production economy must sacrifice some of product X to obtain more of product Y. Do you know why?

Limited Resources meansa limited output...

Production Possibility

Q

QQPizzas (hundred thousands)

1413121110 9 8 7 6 5 4 3 2 1

1 2 3 4 5 6 7 8

A B

C

D

E

W

Attainablebut

Inefficient

Unattainable

Law of Increasing Opportunity CostsThe amount of other products that must beforgone or sacrificed to obtain 1 unit of a specific

product is called the opportunity cost of that good.

A graph of the production possibilities curve will be CONCAVE - bowed out from the origin.

Economic resources arenot completely adapt-able to other uses. Crude Oil is not adaptable to

making bread.

Figure 1-3. PPC:Trade-Off

PRODUCTION POSSIBILITIES CURVE (PPC)

0

1

2

3

4

5

0 10 20 30 40 50 60 70 80 90 100

COOKIES

CA

KE

Data:Cake Cookies 3 0 2 30 1 50 0 60

-1

+30-1 +20-1 +10

The Trade Off Gets Worse

More and more cake must be given up to get another increase in cookies.Resources are usually specialized to do one

job better than another.Shifting them between jobs causes the trade

off to get worse.The PPC gets bowed outward because of

this.

Q

Q

Ro

bo

ts (t

ho

usa

nd

s)

Pizzas (hundred thousands)

1413121110 9 8 7 6 5 4 3 2 1

1 2 3 4 5 6 7 8

U

Unemployment &Underemployment Shown by Point U

More of either orboth is possible

Economic GrowthThe ability to produce

a larger total output - OR

a rightward shift of

the production

possibilities curve caused by... ????????

Figure 1-5. PPC: Economic Growth

PRODUCTION POSSIBILITIES CURVE (PPC)

0

1

2

3

4

5

0 10 20 30 40 50 60 70 80 90 100

COOKIES

CA

KE

z

PPF and Economic Growth

Research and Development R&D

1 – Increase in resource supplies2 - New Resources 3 – Better resource quality 4 – Technological

advances

Where does the impetus of this R & D come from? More from private or public?

PPC: Trade-Off

PRODUCTION POSSIBILITIES CURVE (PPC)

0

1

2

3

4

5

0 10 20 30 40 50 60 70 80 90 100

COOKIES

CA

KE

Data:Cake Cookies 3 0 2 30 1 50 0 60

-1

+30

PPC: Trade-Off

PRODUCTION POSSIBILITIES CURVE (PPC)

0

1

2

3

4

5

0 10 20 30 40 50 60 70 80 90 100

COOKIES

CA

KE

Data:Cake Cookies 3 0 2 30 1 50 0 60

-1

+30-1 +20

Inefficient, Efficient, and Unattainable Points Any point inside the PPC is inefficient.

Produce more by moving out to the PPC. Any point on the PPC is efficient.

All resources and technology are being used. Any point outside the PPC is unattainable.

Not enough resources and technology exist to make these combinations of goods.

Figure 1-5. PPC: Economic Growth

PRODUCTION POSSIBILITIES CURVE (PPC)

0

1

2

3

4

5

0 10 20 30 40 50 60 70 80 90 100

COOKIES

CA

KE

z

Any Questions?

Are you learning to think in Economic Terms?????

When you drive by a strip mall –

What do you see? What do you think? Does the economy

come to mind? How did McDonald’s get

so popular back in 60”s

QUESTIONS?