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15 FUNDAMENTAL CONCEPTS BEGINNING WITH THE END IN MIND SCARCITY SCARCITY OF RESOURCES LAND SCARCITY LABOR SCARCITY CAPITAL SCARCITY THE ECONOMIC PROBLEM LIMITED RESOURCES VS. UNLIMITED WANTS AND NEEDS SCARCITY NECESSITATES CHOICE OR TRADEOFFS/OPPORTUNITY COSTS ALL CHOICES INVOLVE TRADEOFFS – YOU MUST CHOOSE A OR B “THERE IS NO SUCH THING AS A FREE LUNCH” SLEEP OR SCHOOL? WORK OR FRIENDS? OR A DOLLAR SPENT ON VACTION IS A DOLLAR NOT SPENT ON RETIREMENT TRADEOFFS/OPPORTUNITY COSTS GUNS VS. BUTTER OR CLEAN ENVIRONMENT VS. HIGHER INCOMES OR TRADEOFFS/OPPORTUNITY COSTS EFFICIENCY VS. EQUITY GETTING THE MOST OUT OF SCARCE RESOURCES VS. FAIRNESS OF DISTRIBUTION TRADEOFFS/OPPORTUNITY COSTS REDISTRIBUTION OF INCOME THROUGH UNEMPLOYMENT AND WELFARE REDUCES INCENTIVE TO WORK HARD MORE EQUAL SLICES BUT SMALLER PIE TRADEOFFS/OPPORTUNITY COSTS ALL TRADEOFFS INVOLVE OPPORTUNITY COSTS – THE COST OF THE NEXT BEST ALTERNATIVE USE OF TIME, MONEY OR RESOURCES SLEEPING IN SATURDAY MORNING COSTS $35?!?!?!?!? TRADEOFFS/OPPORTUNITY COSTS EXPLICIT + IMPLICIT COSTS TRUE COST OF COLLEGE?? – EXPLICIT=TUITION AND BOOKS – IMPLICIT=LOST WAGES ($10/HOUR = ~$20,000/YEAR SHOULD TOP ATHLETES STAY IN COLLEGE? RATIONAL PEOPLE THINK AT THE MARGIN MUST WEIGH ADDITIONAL COSTS WITH ADDITIONAL BENEFIT MARGINAL COST IS THE ADDITIONAL COST OF AN ADDITIONAL UNIT MARGINAL BENEFIT IS THE ADDITIONAL BENEFIT FROM AN ADDITIONAL UNIT RATIONAL PEOPLE THINK AT THE MARGIN NEVER LET YOUR MARGINAL COSTS EXCEED YOUR MARGINAL BENEFITS MC=MR PROFIT MAXIMIZATION SHOULD THE AIRLINE SELL THE $500 TICKET FOR $100 TEN MINUTES BEFORE TAKEOFF??? PEOPLE RESPOND TO INCENTIVES DECISIONS MADE TO GAIN BENEFIT OR PROFIT AND TO AVOID LOSS OR PAIN KNOWING PEOPLE RESPOND PREDICTALBLY TO INCENTIVES SHOULD BE KEPT IN MIND WHEN SETTING PUBLIC POLICY PEOPLE RESPOND TO INCENTIVES SUV TAX BREAK TAXES, UNEMPLOYMENT BENEFITS SOCIAL SECURITY LATE SLIPS RELATIVE SCARCITY DEMAND FOR A GOOD OR SERVICE IN RELATION TO THE SUPPLY OF THAT GOOD 1000 < 10 BALLPLAYERS VS. TEACHERS RELATIVELY SCARCE GOODS = $$$$$ VOLUNTARY EXCHANGE BOTH PARTIES EXPECT TO BE BETTER OFF AFTER THE EXCHANGE WIN/WIN SITUATION COMPETITION BETWEEN BUYERS/SELLERS NET GAIN IS POSITIVE FOR BOTH PARTIES SPECIALIZATION LEADS TO INTERDEPENDENCE SPECIALIZATION: CONCENTRATION OF PRODUCTIVE EFFORTS…LEADS TO GREATER EFFICIENCY BASED ON COMPARATIVE ADVANTAGE…WHO HAS THE LOWEST OPPORTUNITY COST? FORCES RELIANCE ON OTHERS TO LIVE PRICE=SUPPLY + DEMAND SUPPLY SUPPLY PRICE PRICE PRICE PRICE DEMAND DEMAND PRICE=SUPPLY + DEMAND SUPPLY DEMAND PRICE SUPPLY DEMAND PRICE DEMAND SUPPLY PRICE DEMAND SUPPLY PRICE PRICE=SUPPLY + DEMAND HIGH DEMAND AND LOW SUPPLY=HIGH PRICES PRICE=SUPPLY + DEMAND MARKET SYSTEM DEPENDS ON PRICES AND SELF-INTEREST TO GUIDE RESOURCES PRICES=SUPPLY+DEMAND HOUSEHOLDS (DEMAND) AND FIRMS (SUPPLY) INTERACT ADAM SMITH…INVISIBLE HAND, LAISSEZ FAIRE ADAM SMITH “…IT IS NOT THE BENEVOLENCE OF THE BUTCHER, THE BREWER, OR THE BAKER THAT WE EXPECT OUR DINNER, BUT FROM THEIR REGARD TO THEIR OWN INTEREST…” PRICE = SUPPLY+ DEMAND COMMAND ECONOMY…DECISIONS MADE BY GOVERNMENT CENTRALLY PLANNED – WHAT IS PRODUCED? – HOW MUCH IS PRODUCED? – FOR WHOM? WHO SHOULD PRODUCE? PRICE = SUPPLY+ DEMAND COMMAND ECONOMIES – DO NOT MAXIMIZE SOCIAL WELFARE IF RESOURCES ARE NOT GUIDED EFFICIENTLY COMMAND ECONOMIES MAY PROVIDE FOR RAPID SHIFTS IN ECONOMIC ACTIVITY BUT PERFORM POORLY IN THE LONG RUN COMPETITION DRIVES EFFICIENCY EFFICIENCY – ALLOCATIVE OR ECONOMIC GETTING WHAT THE ECONOMY WANTS – TECHNICAL PRODUCING THE MOST WITH THE FEWEST AMOUNT OF RESOURCES COMPETITION INCREASES BOTH LEVELS OF EFFICIENCY COMPETITION DRIVES EFFICIENCY SPORTS ACADEMICS??? DRIVE BEHIND VOUCHERS WALMART VS KMART MUSIC INDUSTRY INTERNET ACCESS AND SERVICES PUBLIC GOODS AND MARKET FAILURES PRIVATE GOODS – EXCLUDABLE – RIVAL CLOTHING, FOOD, DVD PLAYERS… PUBLIC GOODS – NON-EXCLUDABLE – NON-RIVAL DEFENSE, ROADS, PUBLIC PARKS Types of Goods Rival? Yes Private Goods Yes Excludable? No Ice- cream cones Clothing Congested toll roads No Natural Monopolies Fire protection Cable TV Uncongested toll roads Common Resources Public Goods Fish in the ocean The environment Congested nontoll roads National defense Knowledge Uncongested nontoll roads PUBLIC GOODS AND MARKET FAILURES PRIVATE MARKETS HAVE NO INCENTIVE TO PROVIDE FOR PUBLIC GOODS…THIS NECESSITATES GOVERNMENT INVOLVEMENT COMMON POOL RESOURCES – NON-EXCLUDABLE – RIVAL (DEPLETABLE) PUBLIC GOODS AND MARKET FAILURES EXTERNALITIES…ECONOMIC SIDE EFFECT THE IMPOSES COSTS OR BENEFITS ON SOMEONE OTHER THAN THE PRODUCER AND THE CONSUMER EXTERNALITIES NEGATIVE…POLUTION POSITIVE…RESEARCH, EDUCATION PUBLIC GOODS AND MARKET FAILURES MARKET POWER…THE ABILITY TO UNDULY INFLUENCE MARKET PRICES LITTLE OR NO COMPETITION…MONOPOLIES MARKET AWARDS THOSE ACCORDING TO ABILITY TO PRODUCE PRODUCTIVITY/STANDARD OF LIVING STANDARD OF LIVING: QUALTIY OF LIFE MEASURED BY MATERIAL POSSESIONS PRODUCTIVITY: AMOUNT OF GOODS AND SERVICES PRODUCED PER HOUR DIRECT RELATIONSHIP PRODUCTIVITY/STANDARD OF LIVING UNITED STATES $29,000 MEXICO $8,000 NIGERIA $900 STANDARD OF LIVING AND PRODUCTIVITY PRODUCTIVITY/STANDARD OF LIVING REMEMBER THE RULE OF 72!!! ALL ABOUT PRODUCTIVITY – INVESTMENT NEEDED CAPTIAL TECHNOLOGY EDUCATION HISTORICAL, PERSONAL OR NATIONAL COMPARISONS PRODUCTIVITY/STANDARD OF LIVING IMPACT OF GOVERNMENT DEFICIT – DEFICIT: AMOUNT BY WHICH EXPENDITURES EXCEED REVENUE (YEAR TO YEAR) – DEBT: CUMULATIVE EFFECT OF PAST DEFICITS (OVER TIME) DEBATE OVER IMPACT PRODUCTIVITY/STANDARD OF LIVING GOVERNMENT DEFICITS LEAD TO CROWDING OUT HIGHER INTEREST RATES FOR ALL LESS INVESTMENT IN HUMAN AND PHYSICAL CAPITAL CUTTING TAXES WILL SPUR MORE GROWTH…MORE INCENTIVES MORE GROWTH MEANS MORE REVENUE GROW OUT OF THE DEFICIT PRODUCTIVITY/STANDARD OF LIVING IF DEFICITS DO “CROWD OUT” – LOWER INVESTMENT TODAY MEANS LOWER PRODUCTIVITY TOMORROW DO DEFICITS LEAD TO LOWER STANDARDS OF LIVING IN THE LONG RUN??? UNEMPLOYMENT VS INFLATION TWO MAJOR PROBLEMS IN MACROECONOMY TRADEOFF IN THE SHORT RUN PHILLIPS CURVE I U UNEMPLOYMENT VS INFLATION PUBLIC POLICY – FISCAL POLICY TAX AND/OR SPEND – MONETARY POLICY CONTROL OF MONEY SUPPLY LENDERS HURT BY INFLATION INFLATION…GENERAL RISE IN PRICE LEVELS VALUE OF DOLLAR DECREASES IF UNEXPECTED WITH A FIXED INTEREST RATE THEN LENDERS GET PAID BACK IN CHEAPER DOLLARS INTEREST RATES GUIDE THE ECONOMY INTEREST RATES…PRICE OF BORROWING MONEY SAVINGS RATE VS BORROWING RATE FEDERAL RESERVE BOARD CONTROLS MONEY SUPPLY INTEREST RATES GUIDE ECONOMY MORE MONEY LOWER RATES MORE BORROWING MORE SPENDING ECONOMY HEATS UP LESS MONEY HIGHER RATES LESS BORROWING LESS SPENDING ECONOMY SLOWS DOWN INVESTMENT IS NEEDED FOR GROWTH NO PAIN NO GAIN INVESTMENT OF TIME MONEY OR RESOURCES NEEDED FOR GROWTH CAPITAL GOODS TECHNOLOGY HUMAN CAPITAL/EDUCATION INVESTMENT IS NEEDED FOR GROWTH RULE OF 72 AMOUNT OF TIME IT TAKES FOR “INVESTMENT” TO DOUBLE 72/7=10 YEARS TO DOUBLE 72/2=36 YEARS TO DOUBLE