Download Basic Concepts


Study of scarcity and choice.
 People, firms, and governments make choices
because of scarcity.
Microeconomics
Macroeconomics
•Focuses on the choices
of individuals,
households, and firms
•“Bottom-up”
•Focuses on the
economy as a whole and
aggregate data (GDP,
Unemployment,
Inflation) and how it can
be manipulated
•“Top-down”
•Questions like:
•Questions like:
•Should a business
•How many people
hire another worker
are employed in the
•Should I got to
US Right now?
college or get a job?
•What policies could
the government
VIDEO CLIP!
adopt to increase
economic growth?
Positive
Normative
Focuses on concepts that have definitive
answers.
Focuses on how the world should work.
Right answer everyone can agree on
“What if” questions or questions where
there can be disagreement over the final
outcome.

Rule one of Economics: Resources are scarce
 Resource = anything used to produce something
else


A.K.A. Factors of Production
Can be divided into four areas
 LAND
▪ Water, minerals, oil, and other natural resources
 LABOR
▪ The effort of workers
 CAPITOL
▪ Machinery, buildings, and tools used in production of goods
and services
 ENTREPRENUERSHIP
▪ Risk taking, innovation, and orginizational skills

The economic “cost” of the decision is the
benefit or alternative you give up to do
something.

Example:

Just about every graph we do in this class is in
Quadrant I of a x y plane
 X = Horizontal
 Y = Vertical
 O = origin (0,0)

Now that we have reviewed basic math…
I

Graphical representation of the trade-off an
economy must face when allocating resources
between two goods

The frontier of the curve shows the maximum
quantity of one good that can be produced for
each quantity of the other
Production Possibilities
Planes
60
50
0
50
40
10
40
30
20
20
30
Cars
Cars
30
20
10
10
40
0
50
0
0
20
40
Planes
60

Points that are on the curve (or frontier) itself
represent the use of all resources for
production
 Maximum utilization of resources = efficiency

Points falling under the curve are feasible, but
not efficient.
 This is called underutilization. An economy
producing below what it is capable is not efficient.
▪ This can be caused by inefficiencies such as high
unemployment,

In this graph:
 Points “H” and “D” (and all
other points on the curve
itself) represent efficiency.
▪ more output can be
achieved from the given
inputs
 Point “B” represents
underutilization.
▪ Producing this combination
of goods would be
inefficient.
 What can we determine
about point “A”?

Points beyond the PPC Frontier are
considered to be unattainable due to scarcity
of resources.


A change in the amount
of resources will change
the frontier.
The curve will shift right
when:
 More productive
resources become
available
 Better technology allows
you to use your resources
more efficiently.

Since resources are scarce, increasing
production of a first good entails decreasing
production of a second
 Scarce resources must be transferred to the first
and away from the second.

The loss of production of one good to
increase production of the other is the
opportunity cost.

If the opportunity cost to
change production
remains the same at all
production points, the
PPC will be straight.

The more similar the
resources needed to
produce each good, the
straighter the PPC will be.


The slope of a straight line PPC = Opportunity
Cost
Slope for a straight line PPC should always be
negative

The PPC is "bowed outward"
(concave) from the origin. This
represents INCREASING
OPPORTUNITY COST.
 As more scarce resources are used
to increase production of one good
or service, production of another
good or service falls by larger and
larger amounts.

The less similar the resources
needed to produce each good,
the further the PPC will be
bowed out from the origin.


System that coordinates production and
distribution of goods and services.
Must answer the THREE BASIC questions of:
 What to produce?
 How to produce it?
 Who will consume it?
• The way these questions are
answered (and by whom) determines
what type of economy
Traditional
Market
Command
3 questions are
answered by
tradition and
custom
3 questions are
answered by
individuals
3 questions are
answered by the
government.

The government…
1. owns all the resources.
2. decides what to produce, how much to
produce, and who will receive it.
Examples:
Cuba, North Korea, former Soviet Union, and China
COMMUNISM

Communism is a political
system characterized by a
centrally planned economy
with all economic and
political power resting in the
hands of the government.
Communist governments are
authoritarian in nature.
SOCIALISM

Socialism is a social and
political philosophy based on
the belief that democratic
means should be used to
distribute wealth evenly
throughout a society.
ADVANTAGES
1.
2.
3.
Low unemploymenteveryone has a job
Great Job Security-the
government doesn’t go
out of business
Equal incomes means no
extremely poor people
DISADVANTAGES
1.
2.
3.
4.
5.
No incentive to work
harder
No incentive to innovate
or come up with good
ideas
No Competition keeps
quality of goods poor.
Corrupt leaders
Few individual freedoms
1.
Little government involvement in the economy.
(“Laissez Faire” = Let it be)
2.
Individuals OWN resources and answer the three
economic questions.
3.
The opportunity to make PROFIT gives people
INCENTIVE to produce quality items efficiently.
4.
Wide variety of goods available to consumers.
5.
Competition and Self-Interest work together to
regulate the economy (keep prices down and quality
up).


•
The concept that society’s goals
will be met as individuals seek
their own self-interest.
Example: Society wants fuel
efficient cars…
• Profit seeking producers will
make more.
• Competition between firms
results in low prices, high
quality, and greater efficiency.
• The government doesn’t need
to get involved since the needs
of society are automatically
met.
Competition and self-interest act
as an invisible hand that regulates
the free market.
ADVANTAGES

Economic Efficiency

 As a self-regulating system, a

free market economy is
efficient.

Economic Growth
 Because competition
encourages innovation, free
markets encourage growth.


DISADVANTAGES
Economic Freedom
Free markets offer a wider
variety of goods and services
than any other economic
system
Lack of Economic Equity
With freedom comes a
degree of instability

All modern economies are a mix of market
and command
 “Mixed” economies
Continuum of Mixed Economies
Centrally planned
Free market
France The United Kingdom
Cuba
North Korea
Greece
China
Canada
Source: 1999 Index of Economic Freedom, Bryan T. Johnson, Kim R. Holmes, and Melanie Kirkpatrick
Singapore
Hong Kong
The United States


Government takes of people’s needs
Marketplace takes care of people’s wants.

Simplified view of how money and resources
move through an economy.

In the circular flow model, the inter-dependent
entities of producer and consumer are referred
to as "firms" and "households" respectively and
provide each other with factors in order to
facilitate the flow of income.

Firms provide consumers with goods and
services in exchange for consumer expenditure
and "factors of production" from households.
Goods & Services
$$$$$$
Product
Market
(Goods &
Services)
Goods & Services
$$$$$$$$
Households/Individuals
Factors of Production
Businesses/Firms
Factor/Resource
Market
(Factors of
Production)
FOP

Product Market - any setting where goods and
services are bought and sold by producers and
consumers
 Kroger, target, Taco Bell, ebay
▪ This type of market is where goods and
services are bought by you
▪ Basically any purchase you make is in this
market
▪ Bought by Households, sold by firms
(businesses)

Factor Market – any setting where land, labor,
capital, and entrepreneurship are bought and sold
by producers and consumers
 This market is where Factors of Production are
sold by you (households) and bought by firms
(businesses)
▪ The best example – wages earned for your labor
▪ This market is where households earn money to
spend in the Product market

http://www.reffonomics.com/TRB/Chapter3/c
ircularflow5.swf

The process of buying goods and services
from the rest of the world (importing) and
that of selling goods and services to the rest
of the world (exporting) is referred to as
international trade




Differences in Factor endowments
Variety and quality of goods
Gains from specialization
Political reasons



1723-1790
“Father of Modern
Economics”
Wrote “The Wealth of
Nations”
 Smith argued that it was
impossible for all nations to
become rich simultaneously by
following mercantilism and
instead stated that all nations
would gain simultaneously if they
practiced free trade and
specialized in accordance with
their absolute advantage

A country has an absolute advantage in the
production of a good when it can produce
more of that good than another country
with the same resources.
Suppose that by using x units of
resources…
Wine
France 70
US
50
Computers
2
3
The French have an
absolute advantage
in the production of
wine



One of your friends, Gina, can print 5 t-shirts
or build 3 birdhouses an hour.
Your other friend, Mike, can print 3 t-shirts an
hour or build 2 birdhouses an hour.
Because your friend Gina is more productive
at printing t-shirts and building birdhouses
compared to Mike, she has an absolute
advantage in both printing t-shirts and
building birdhouses.
Came up with the law
of comparative
advantage.
 According to this law,
specialization and free
trade benefits all
trading partners.

 Countries should
specialize in those goods
they can produce at the
lowest opportunity cost

The ability of a firm or individual to produce
goods and/or services at a lower opportunity
cost than other firms or individuals.
 A comparative advantage gives a company the ability
to sell goods and services at a lower price than its
competitors and realize stronger sales margins.
 This is not the same as being the best at something.

Comparative advantage is the basis for all trade
between individuals, regions, and nations.


India can produce 4,000 yards of textile per
day or 1 ton of chocolate per day.
Nepal can produce 1,000 yards of textile a
day or 4 tons of chocolate per day.

India has a comparative advantage in
producing textiles.

Nepal has a comparative advantage in chocolate.
Textiles
(in thousands of yards)
5
4
India
3
2
Nepal
1
1
2
3
Chocolate (in tons)
McGraw-Hill/Irwin
4
5


India has chosen to produce 2,000 yards of
textiles and 0.5 tons of chocolate.
Nepal has chosen to produce 500 yards of
textile and 2 tons of chocolate.
India’s and Nepal’s Individual Possibilities
Textile per day
Chocolate per day
India
2,000 yards
0.5 ton
Nepal
500 yards
2 tons
Total
2,500 yards
2.5 tons

Point A: The combination of textile and chocolate chosen by
India.

Point B: The combination of textile and chocolate chosen by
Nepal.

Point C: The joint combination without trade.
Textiles
(in thousands of yards)
5
4
India
3
2
C
A
Nepal
1
B
1
2
3
4
5
Chocolate (in tons)
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.

The two extreme combinations are:
 both countries producing only textile (point D)
 both producing only chocolate (point E).

The combined production possibilities curve with
no trade is drawn by connecting these two
points.
Textiles
(in thousands of yards)
5
D
4
India
3
2
C
Joint ( trade)
A
Nepal
1
B
E
1
2
3
4
5
Chocolate (in tons)
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.

Point F: This is where each nation is focusing
on that activity for which it has a comparative
advantage.
 India produces 4,000 yards of textile.
 Nepal produces 4 tons of chocolate.
Textiles
(in thousands of yards)
5
D
F
4
India
3
2
C
Joint ( trade)
A
Nepal
1
B
E
1
2
3
4
5
Chocolate (in tons)
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.
Output Questions:
OOO=
Output: Other goes Over
58
Input Questions:
IOU=
Input: Other goes Under
59
A.
B.
C.
D.
E.
Which country has an absolute advantage in the production of tractors? Explain
how you determined your answer.
Which country has an absolute advantage in the production of cars? Explain
how you determined your answer.
Which country has a comparative advantage in the production of cars? Use the
concept of opportunity cost to explain how you determined your answer.
For Xanadu, what is the opportunity cost of producing one car?
If the two countries specialize and trade with each other, which country will
import cars? Explain why?
10 Points Possible
(2 Points For EACH: 1 point answer, 1 point explanation)
A. Answer-Xanadu
Explanation- Because they can produce more total
tractors than Atlantis.
B. Answer-Atlantis
Explanation- Because they can produce more total
cars than Xanadu.
(2 Points For EACH: 1 point answer, 1 point explanation)
C. Answer- Atlantis
Explanation- Because the opportunity cost for Atlantis
to make one car is 1/3 a tractor which is less than then
the opportunity cost for Xanadu (1 car =2 tractors).
D. Answer- Opportunity Costs is 2 Tractors.
No explanation required
(2 Points For EACH: 1 point answer, 1 point explanation)
E. Answer- Xanadu will import cars
Explanation- Xanadu should not make cars. They
should specialize in making tractors and import cars
from Atlantis since they have a lower opportunity
cost.

Simplified view of the
upturns and downturns in
the macroeconomy

The increases and
decreases in output
consisting of four phases:
 Peak: highest point of
output
 Recession: output declining
for 6 months
 Trough: lowest point of
output
 Recovery: output increasing
(trough to peak)

People generally prefer steady, stable growth
to large “ups” and “downs.” Therefore,
government policies, both fiscal and
monetary (see later sections), are aimed at
flattening the business cycle.

The government wants not only to stimulate
the economy when it’s slow, but also to slow
it down when it’s growing too quickly.
EMPLOYMENT

UNEMPLOYMENT
Total number of people
working for pay

Total number of people
looking for work that are
not currently employed
LABOR FORCE
•Sum of employment and
unemployment.

Percentage of labor force that is unemployed
# Unemployed
Labor Force
• Increases during recession
• Decreases during a recovery
Unemployment Rate

Total production of all goods and services in
the economy
 Measured by real GDP


Decreasing output leads to a recession
Increasing output leads to a
recover/expansion

Inflation





Rise in the general level of prices
Reduces the purchasing power of money
Measured with the Consumer Price Index (CPI)
Increases during periods of expansion
Deflation
 The opposite of inflation
 Prices go down
 Purchasing power of money increases
1.
2.
Draw and label the business cycle
Explain what happens to output,
unemployment, and inflation in each stage.