Download Economics Basics

Economics Basics:
Definitions, Factors of Production,
Scarcity, and Opportunity Cost
Economics – the study of how people make
choices to satisfy their needs and wants…
Things Economists Do…
• Description
• Analysis
• Explanation
• Predictions
• Change the world
• …Get movies
made about them
Economics Basics
• The location of the economy we discuss matters!
– Personal
– Local
– Regional
– National
– International
• Microeconomics – individuals making decisions…
(self, family, business)
• Macroeconomics – Countries or institutions making
decisions (POTUS, Congress, “The Fed”, the UN)
Scarcity
• Scarcity refers to the limited nature of society’s
resources.
• Economics is the study of how society manages
its scarce resources, including
– how people decide how much to work, save,
and spend, and what to buy
– how firms decide how much to produce,
how many workers to hire
– how society decides how to divide its resources
between national defense, consumer goods,
protecting the environment, and other needs
Scarcity
• People have limited resources &
unlimited wants
• Shortages occur when there isn’t enough
of a good to go around – either because
firms will not or cannot produce enough
at the current price
• The Scarcity Principle – “No Free Lunch”
– Although we have boundless needs and
wants, the resources available to us are
limited. So, having more of one thing
means having less of another.
Scarcity and Shortages
• Scarcity occurs when
there are limited
quantities of resources
to meet unlimited
needs or desires
• Shortages occur when
producers will not or
cannot offer goods or
services at current
prices
Factors of Production
• Land
Are
there
3 or 4?
– natural resources that are not created by humans
– Deserts, fields, livestock, sunshine, climate, dirt
• Capital
– human-made resource used in producing other goods and
services
– Physical capital = Tools, equipment, machinery, “financial
capital”
– Human capital = job skills, acquired knowledge
• Labor
– People with their efforts, abilities, and skills
• Entrepreneurs
– Risk-taker in search of profit who does something new
with existing resources
Factors of Production Check
Candles
Cooks
Food
Signs
Salt & pepper
Electricity
Gas
Owner
Furniture
Hostess
Delivery vans
Waiters
Carpet
Ovens
Cashier
Dishes
Driver
Utensils
½ acre of land
Water
Cash register
Manager
Rent
Tables
LAND
CAPITAL
LABOR
The Factors of Popcorn Production
Land
Labor
Capital
Popping Corn
The human effort needed
to pop the corn
Corn-Popping
Device
Vegetable Oil
Section 1 Assessment
1. What is the difference between a shortage and scarcity?
(a) A shortage can be temporary or long-term, but scarcity always exists.
(b) A shortage results from rising prices; a scarcity results from falling prices.
(c) A shortage is a lack of all goods and services; a scarcity concerns a single item.
(d) There is no real difference between a shortage and a scarcity.
2. Which of the following is an example of using physical capital to save time
and money?
(a) hiring more workers to do a job
(b) building extra space in a factory to simplify production
(c) switching from oil to coal to make production cheaper
(d) lowering workers’ wages to increase profits
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Section 1 Assessment
1. What is the difference between a shortage and scarcity?
(a) A shortage can be temporary or long-term, but scarcity always exists.
(b) A shortage results from rising prices; a scarcity results from falling prices.
(c) A shortage is a lack of all goods and services; a scarcity concerns a single item.
(d) There is no real difference between a shortage and a scarcity.
2. Which of the following is an example of using physical capital to save time
and money?
(a) hiring more workers to do a job
(b) building extra space in a factory to simplify production
(c) switching from oil to coal to make production cheaper
(d) lowering workers’ wages to increase profits
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Decision Making in
Economics:
Trade-offs & Opportunity Costs
The Cost-Benefit Principle:
An individual (or firm or society) should
take an action if, and only if, the extra
benefits from taking the action are at
least as great as the extra costs
Trade-Offs
• All the alternative choices you COULD make as
part of a decision…
• Cost-Benefit Analysis
• Grandma sent $100 for your birthday, how will
you spend it?
• It’s WEB, how will you use your time?
Opportunity Cost
• If we make a choice (“choose A”), because things
are scarce, you affect other things (“give up B, C,
D, etc.”)
– Remember the big thing here is a cost/benefit analysis
• Your opportunity cost in a situation is the value of
the most desirable alternative you gave up when
you made your decision
The Decision-Making Grid
• Economists encourage us to consider the benefits and
costs of our decisions.
Karen’s Decision-making
Grid
Alternatives
Sleep late
Wake up early to study
Benefits
Enjoy more sleep
Have more energy during the day
Better grade on test
Teacher and parental approval
Personal satisfaction
Decision
Sleep late
Wake up early to study for test
Opportunity cost
Extra study time
Extra sleep time
Benefits forgone
Better grade on test
Teacher and parental approval
Personal satisfaction
Enjoy more sleep
Have more energy during the day
HOW PEOPLE MAKE DECISIONS
• Decision making is
at the heart of
economics.
• The first four
principles deal with
how people make
decisions.
HOW PEOPLE MAKE DECISIONS
Principle #1: People Face Tradeoffs
All decisions involve tradeoffs. Examples:
• Going to a party the night before your midterm
leaves less time for studying.
• Having more money to buy stuff requires
working longer hours, which leaves less time
for leisure.
• Protecting the environment requires resources
that might otherwise be used to produce
consumer goods.
HOW PEOPLE MAKE DECISIONS
Principle #1: People Face Tradeoffs
• Society faces an important tradeoff:
efficiency vs. equity
• efficiency: getting the most out of scarce
resources
• equity: distributing prosperity fairly among
society’s members
• Tradeoff: To increase equity, can redistribute
income from the well-off to the poor.
But this reduces the incentive to work and
produce, and shrinks the size of the economic
HOW PEOPLE MAKE DECISIONS
Principle #2: The Cost of Something Is What
You Give Up to Get It
• Making decisions requires comparing the
costs and benefits of alternative choices.
• The opportunity cost of any item is whatever
must be given up to obtain it.
• It is the relevant cost for decision making.
HOW PEOPLE MAKE DECISIONS
Principle #2: The Cost of Something Is What
You Give Up to Get It
Examples:
The opportunity cost of…
…going to college for a year is not just the tuition,
books, and fees, but also the foregone wages.
…seeing a movie is not just the price of the ticket, but
the value of the time you spend in the theater.
Thinking at the Margin
• When you decide how much more or less to do,
you are thinking at the margin.
Options
Benefit
Opportunity Cost
1st hour of extra
study time
Grade of C on
test
1 hour of
sleep
2nd hour of extra
study time
Grade of B on
test
2 hours of
sleep
3rd hour of extra
study time
Grade of B+ on test
3 hours of
sleep
• “marginal benefit” and “marginal cost”
– we’ll do more of this later….
HOW PEOPLE MAKE DECISIONS
Principle #3: Rational People Think at the
Margin
• A person is rational if she systematically and
purposefully does the best she can to achieve
her objectives.
• Many decisions are not “all or nothing,”
but involve marginal changes – incremental
adjustments to an existing plan.
• Evaluating the costs and benefits of marginal
changes is an important part of decision
making.
HOW PEOPLE MAKE DECISIONS
Principle #3: Rational People Think at the
Margin
Examples:
• A student considers whether to go to college
for an additional year, comparing the fees &
foregone wages to the extra income he could
earn with an extra year of education.
• A firm considers whether to increase output,
comparing the cost of the needed labor and
materials to the extra revenue.
HOW PEOPLE MAKE DECISIONS
Principle #4: People Respond to Incentives
• incentive: something that induces a person to
act, i.e. the prospect of a reward or
punishment.
• Rational people respond to incentives because
they make decisions by comparing costs and
benefits. Examples:
– In response to higher gas prices,
sales of “hybrid” cars (e.g., Toyota Prius) rise.
– In response to higher cigarette taxes,
teen smoking falls.
Section 2 Assessment
1. Opportunity cost is
(a) any alternative we sacrifice when we make a decision.
(b) all of the alternatives we sacrifice when we make a decision.
(c) the most desirable alternative given up as a result of a decision.
(d) the least desirable alternative given up as a result of a decision.
2. Economists use the phrase “guns or butter” to describe the fact that
(a) a person can spend extra money either on sports equipment or food.
(b) a person must decide whether to manufacture guns or butter.
(c) a nation must decide whether to produce more or less military or consumer
goods.
(d) a government can buy unlimited military and civilian goods if it is rich enough.
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Section 2 Assessment
1. Opportunity cost is
(a) any alternative we sacrifice when we make a decision.
(b) all of the alternatives we sacrifice when we make a decision.
(c) the most desirable alternative given up as a result of a decision.
(d) the least desirable alternative given up as a result of a decision.
2. Economists use the phrase “guns or butter” to describe the fact that
(a) a person can spend extra money either on sports equipment or food.
(b) a person must decide whether to manufacture guns or butter.
(c) a nation must decide whether to produce more or less military or consumer
goods.
(d) a government can buy unlimited military and civilian goods if it is rich enough.
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Use what you know….
You are selling your 1996 Mustang. You have already
spent $1000 on repairs. At the last minute, the
transmission dies. You can pay $600 to have it repaired,
or sell the car “as is.”
In each of the following scenarios, should you have the
transmission repaired?
A. Blue book value is $6500 if transmission works,
$5700 if it doesn’t
B. Blue book value is $6000 if transmission works,
$5500 if it doesn’t
A C T I V E L E A R N I N G 1:
Answers
Cost of fixing transmission = $600
A. Blue book value is $6500 if transmission works,
$5700 if it doesn’t
Benefit of fixing the transmission = $800
($6500 – 5700).
It’s worthwhile to have the transmission fixed.
B. Blue book value is $6000 if transmission works,
$5500 if it doesn’t
Benefit of fixing the transmission is only $500.
Paying $600 to fix transmission is not worthwhile.
28
A C T I V E L E A R N I N G 1:
Answers
Observations:
• The $1000 you previously spent on repairs is
irrelevant. What matters is the cost and
benefit
of the marginal repair (the transmission).
• The change in incentives from scenario A
to scenario B caused your decision to change.
29
“There’s no such thing as a free lunch”
and “The Best things in life are free”
Mental Checks: Do you get it?
• Is it worth it for Bill Gates to stop and
pick up a $100 bill he dropped while
walking down the street?
• Why don’t auto manufacturers make
cars without heaters in them any
more?
• Why do drive-up ATMs have the
keypads with Braille dots on them?
Sooooooo then…
Why are all these Billionaires
giving away their money?
Production Possibilities Graphs
• What is a production possibilities graph?
• How do production possibilities graphs show
efficiency, growth, and cost?
• Why are production possibilities frontiers
curved lines?
Production Possibilities
• A production possibilities graph shows alternative ways
that an economy can use its resources.
• The production possibilities frontier is the line that shows
the maximum possible output for that economy.
Production Possibilities Graph
25
0
15
8
14
14
12
18
9
20
5
21
0
Shoes (millions of pairs)
Watermelons
Shoes
(millions of tons) (millions of pairs)
20
15
10
a (0,15)
b (8,14)
c (14,12)
d (18,9)
5
0
A production
possibilities frontier
e (20,5)
f (21,0)
5
10
15
20
25
Watermelons (millions of tons)
Efficiency
Production Possibilities Graph
25
Shoes (millions of pairs)
• Efficiency means
using resources in
such a way as to
maximize the
production of goods
and services. An
economy producing
output levels on the
production
possibilities frontier
is operating
efficiently.
20
S
15
a (0,15)
b (8,14)
c (14,12)
10
g (5,8)
5
d (18,9)
e (20,5)
A point of
underutilization
0
5
10
f (21,0)
15
20
Watermelons (millions of tons)
25
Growth
Production Possibilities Graph
25
Future production
Possibilities frontier
T
Shoes (millions of pairs)
• Growth If more
resources become
available, or if
technology improves,
an economy can
increase its level of
output and grow.
When this happens,
the entire production
possibilities curve
“shifts to the right.”
20
S
15
a (0,15)
b (8,14)
c (14,12)
10
d (18,9)
5
e (20,5)
f (21,0)
0
5
10
15
20
Watermelons (millions of tons)
25
Cost
• Cost A production possibilities graph shows the cost of
producing more of one item. To move from point c to point d
on this graph has a cost of 3 million pairs of shoes.
Production Possibilities Graph
25
0
15
8
14
14
12
18
9
20
5
21
0
Shoes (millions of pairs)
Watermelons
Shoes
(millions of tons) (millions of pairs)
20
15
c (14,12)
10
d (18,9)
5
0
5
10
15
20
25
Watermelons (millions of tons)
Section 3 Assessment
1. A production possibilities frontier shows
(a) farm goods and factory goods produced by an economy.
(b) the maximum possible output of an economy.
(c) the minimum possible output of an economy.
(d) underutilization of resources.
2. An economy that is using its resources to produce the maximum number
of goods and services is described as
(a) efficient.
(b) underutilized.
(c) growing.
(d) trading off.
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Section 3 Assessment
1. A production possibilities frontier shows
(a) farm goods and factory goods produced by an economy.
(b) the maximum possible output of an economy.
(c) the minimum possible output of an economy.
(d) underutilization of resources.
2. An economy that is using its resources to produce the maximum number
of goods and services is described as
(a) efficient.
(b) underutilized.
(c) growing.
(d) trading off.
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