PrinciplesofMicroeconomicsModule1.1

Scarcity,LimitedResourcesandOpportunityCosts

WhatisEconomics?

• Economicsisthestudyofhowpeopleandsocietyallocatescarceresources

• Scarceresources:• Forpeople:Time,Moneyect.• Forfirms:FactorsofProductionà Land,LaborandCapital

• Sincewedon’thaveaninfiniteamountofresources– whatdowedowithwhatwehave?

TradeoffsinDecisions

• Peoplefacetradeoffsindecisionsbecauseofscarceresources• Cannotdoeverything,buyeverything,makeeverything• Needtochoosehowtoallocateourtime,ourmoney,ourresources

• Whenyoumakeonechoice– yougiveuptheotheroption

OpportunityCosts

• OpportunityCost:Whatyougiveuptogetsomething• Example:Howmanytimescanyouhitthesnoozebutton?

Benefit Opportunity Cost

Hititonce MoreSleep Feelrushed inthemorning

Hitittwice MoreSleep Feel rushedSkipbreakfast

Hititthreetimes MoreSleep Feel rushedSkipbreakfastSkipthegym

Hititfourtimes MoreSleep Feel rushedSkipbreakfastSkipthegymLateforwork

OpportunityCost

• OpportunityCostsaresubjectivetotheindividualandchangedependingoncircumstances

• WhatifitwasSaturdaymorningandyouhitthesnoozebutton?• Benefitsofmoresleepmayoutweighanycostsifyoudon’thavetowakeup!

• Whatifyouworkintheafternoon?• Youdonothavethesameconstraintsassomeonewhoneedstogotoworkinthemorning!

OpportunityCosts

• OpportunityCostsdrivethedecisionswemakeeveryday• Wefacethemallthetime• Weweighthecostsandbenefitsofeachdecisionsconsciouslyorsubconsciouslyandmakeachoice

• Testyourself:Whatwasarecentdecisionyoumade?Whatdidyougiveupwhenyoumadethatchoice?Whatwastheopportunitycostforyou?

PrinciplesofMicroeconomicsModule1.2

OpportunityCostsandProductionPossibilitiesFrontier

7

ProductionPossibilitiesFrontierProductionpossibilitiesfrontier(PPF)representstheopportunitycostsaneconomyfacesintheproductionoftwogoods.

Alleconomieshavescarceresources-- needtodecidehowtoallocatethoseresourcestoproducegoods.

Ifyouproducemoreofonegood– needtoproducelessoftheother(withnochangeinavailableresources)

8

PPFExerciseConsideraneconomythatproducestwogoods:Leatherjacketsandleatherboots.

• DrawthePPFcurveforthiseconomy• Aswemovefromonepointtothenext– calculatethechangeinthenumberofbootsproducedandthenumberofjacketsproduced.

• Whatdoesthistellyouabouthowopportunitycostschange?

A B C D E

Boots 0 20 40 60 80

Jackets 100 90 70 40 0

9

PPFExerciseA B C D E

Boots 0 20 40 60 80Jackets 100 90 70 40 0ΔBoots +20 +20 +20 +20ΔJackets - 10 - 20 - 30 - 40

AswemovealongthePPFcurve:OpportunityCostchanges

• O.C.RISES asgiveupmoreofthegoodthatisSCARCE

• O.C.isLOWERwhenthegoodisinrelativeABUNDANCE

10

PPFExercise

Supposenowthatthereisashortageinrubber.- Whathappensinthebootindustry?- Whathappensinthejacketindustry?

11

PPFExerciseWithashortageinrubber,thisaffectstheproductionofbootsrelativelymorethantheproductionofjackets

BiasshiftofPPF

Ifthereisachangeinresources– needtoconsidertheimpactthishasonbothindustries– equalorbias?

12

KeyTakeaway

• Alleconomicagentsfacetradeoffswhenmakingdecisions

• Whatevertheychoosecomeswithanopportunitycost– whattheycouldotherwisedowiththeirtime,money,resources

• ApplythisconcepttounderstandhowaneconomymakeschoicesbetweentheproductionofgoodsinthePPF

13

PrinciplesofMicroeconomicsModule1.3

Comparativeadvantage,specialization,andtrade

How can we satisfy our needs/wants?1.EconomicSelf-sufficiency:Produceallofthegoodsweneed/wanttoconsumeourselves

2.SpecializationandTrade: ProduceonegoodthatwehaveaComparativeAdvantageinandtradewithothersforwhatweneed

GAINSFROMTRADE:WecanCONSUMEMOREwhileworkingthesameamount.

TradeExercise

• Who is better at producing bread?• Who is better at producing sweaters?• If they split their time evenly between producing both goods, how

much can they consume (no trade)?

AmountProducedinOneDayBread Sweaters

Seamstress 8loaves 4sweaters

Baker 24loaves 8sweaters

Economic Self-Sufficiency

OpeningtoTradeIfthebakerandseamstressdecidetotrade,theycanfocusonmakingonegoodandtradingitfortheother.

Howdoweknowwhomakeswhat?Needtodetermine:

ComparativeAdvantage

Opening to TradeComparativeAdvantage

• Loweropportunitycost:ComparativeAdvantageinthatgoodOpportunityCosts:HowmuchofGoodAdowegiveuptomakeGoodB?

• Seamstresscanmake8bread(or)4sweaters inoneday

AmountProducedinOneDay

OpportunityCost

Bread Sweaters Bread SweatersSeamstress 8loaves 4sweaters ½Sweater 2Breads

Opening to TradeComparativeAdvantage

• Loweropportunitycost:ComparativeAdvantageinthatgoodOpportunityCosts:HowmuchofGoodAdowegiveuptomakeGoodB?

• Bakercanmake24bread(or)8sweatersinoneday

AmountProducedinOneDay

OpportunityCost

Bread Sweaters Bread SweatersBaker 24loaves 8sweaters 1/3Sweater 3Breads

Trade Exercise

Opportunity Costdeterminesspecialization

OpportunityCostTomake1Bread,

giveup:Tomake1Sweaters,

giveup:Seamstress ½Sweater 2Breads

Baker 1/3Sweater 3Breads

Trade Exercise

Supposetheagentsagreethateachpersoncompletelyspecializes:

Produceonlytheproductinwhichtheyhaveacomparativeadvantage

Trade Exercise

AMOUNT PRODUCEDBread Sweaters

Seamstress 0 4 sweaters

Baker 24 bread 0

Trade Exercise

AMOUNTPRODUCEDBread Sweaters

Seamstress 0 4sweaters

Baker 24bread 0

Whatiftheytrade2sweatersfor5bread?

Trade Exercise

AMOUNTCONSUMED

Bread Sweaters

Seamstress 0bread+5bread=5bread

4sweaters– 2sweaters=2sweaters

Baker 24bread- 5bread=19bread

0sweaters+2sweaters=2sweaters

Trade:2sweatersfor5bread

Trade Exercise

AMOUNTCONSUMED

Bread Sweaters

Seamstress 0bread+5bread=5bread

4sweaters– 2sweaters=2sweaters

Baker 24bread- 5bread=19bread

0sweaters+2sweaters=2sweaters

Trade:2sweatersfor5bread

Trade Exercise

AMOUNTCONSUMED

Bread Sweaters

Seamstress 0bread+5bread=5bread

4sweaters– 2sweaters=2sweaters

Baker 24bread- 5bread=19bread

0sweaters+2sweaters=2sweaters

Trade:2sweatersfor5bread

Trade Exercise

AMOUNTCONSUMED

Bread Sweaters

Seamstress 0bread+5bread=5bread

4sweaters– 2sweaters=2sweaters

Baker 24bread- 5bread=19bread

0sweaters+2sweaters=2sweaters

Trade:2sweatersfor5bread

Trade Exercise

AMOUNTCONSUMED

Bread Sweaters

Seamstress 5bread 2sweaters

Baker 19bread 2sweaters

Trade:2sweatersfor5bread

With Trade

18

2

19ConsumptionWithTrade

5ConsumptionWithTrade

Comparative AdvantageAgent with the lower opportunity cost in

producing the good will have a comparative advantage in its production

• Nosingleagentcanhaveacomparativeadvantageinbothgoods.

• Aslongastheopportunitycostsbetweentwoagentsdiffer– bothcangainfromtrade.

Key Takeaway• Trade and specialization make everyone better off because –

consume more without working more

• Trade can be beneficial even when one economic agent is much better at producing both goods

• To determine which goods an economic agent will produce –need to understand comparative advantage (or) opportunity cost in producing each good

PrinciplesofMicroeconomicsModule1.4(A)

EconomicSystems

26

EconomicSystems

• Economicsystemsaresystemsof• Production• ResourceAllocation• Exchange• Distributionofgoodsandservices

1. Whattoproduce?2. Howmuchtoproduce?3. Whoreceivestheoutput?

27

PropertyRightsandEconomicSystems

• Propertyrightsareanimportantcomponentofeconomicsystems• Becauseaneconomyistryingtoanswerthepreviousthreequestions-à whoownswhatinfluencesthetypeofsystemwehave

• PropertyRights– determinewhoownsaresourceandwhodecideshowitisused.

• Individuals• Associations• Government

28

PropertyRightsandEconomicSystems

• Propertyrightsareanimportantcomponentofeconomicsystems• Becauseaneconomyistryingtoanswerthepreviousthreequestions-à whoownswhatinfluencesthetypeofsystemwehave

• PropertyRights– determinewhoownsaresourceandwhodecideshowitisused.

• Individuals• Associations• Government

29

PropertyRightsandEconomicSystems

• Propertyrightsareanimportantcomponentofeconomicsystems• Becauseaneconomyistryingtoanswerthepreviousthreequestions-à whoownswhatinfluencesthetypeofsystemwehave

• PropertyRights determinewhoownsaresourceandwhodecideshowitisused.

• Individuals• Associations• Government

30

FourComponentsofPropertyRights

1. Therighttousethegood2. Therighttoearnincomefromthegood3. Therighttotransferthegoodtoothers4. Therighttoenforcepropertyrights

31

EconomicSystems

Allocation

OWNERSHIP

Planned Private

Planned SocialistPlannedEconomy

CommandCapitalism

Private MarketSocialism Capitalism

32

Market-basedEconomy

33

PrinciplesofMicroeconomicsModule1.4(B)

MarginalAnalysis

34

• Inthisvideowewilldiscussmarginalanalysisandhowchangesinincentiveswillchangedecisionsoffirmsandconsumers

MarginalAnalysis• Marginalanalysis:examinationoftheassociatedcostsandpotentialbenefits ofspecificbusinessactivitiesorfinancialdecisions.

• Goal:todetermineifthecostsassociatedwiththechangeinactivitywillresultinabenefitthatissufficientenoughtooffsetthem.

• Insteadoffocusingonbusinessoutputasawhole,theimpactonthecostofproducinganindividualunitismostoftenobservedasapointofcomparison.

MarginalAnalysis• Marginalanalysis:examinationoftheassociatedcostsandpotentialbenefitsofspecificbusinessactivitiesorfinancialdecisions.

• Goal:todetermineifthecosts associatedwiththechangeinactivitywillresultinabenefitthatissufficientenoughtooffsetthem.

• Insteadoffocusingonbusinessoutputasawhole,theimpactonthecostofproducinganindividualunitismostoftenobservedasapointofcomparison.

MarginalAnalysis• Marginalanalysis:examinationoftheassociatedcostsandpotentialbenefitsofspecificbusinessactivitiesorfinancialdecisions.

• Goal:todetermineifthecostsassociatedwiththechangeinactivitywillresultinabenefitthatissufficientenoughtooffsetthem.

• Insteadoffocusingonbusinessoutputasawhole,theimpactonthecostofproducinganindividualunitismostoftenobservedasthebestpointofcomparison.

ExampleofMarginalAnalysis• Amanufacturerwishestoexpanditsproduction• A marginalanalysisofthecostsandbenefitsisnecessary.

COSTS BENEFITS

Additionalmanufacturingequipment Estimatedincreaseinsalesattributedtotheadditionalproduction

Additional employeesforincreasedoutput

Larger orNewFacilities

Additionalmaterialsforproduction

ExampleofMarginalAnalysis• Iftheincreaseinincome>theincreaseincost,theexpansionmaybeawiseinvestment

COSTS BENEFITS

Additionalmanufacturingequipment Estimatedincreaseinsalesattributedtotheadditionalproduction

Additional employeesforincreasedoutput

Larger orNewFacilities

Additionalmaterialsforproduction

Incentives

• Peoplefacetrade-offsintheeverydecisionsthattheymake• Weighthecosts/benefitsassociatedwiththeirchoices• Choosewhatfitstheirneeds/wantsbest

• Incentiveschangecosts/benefitsofadecision• Becausetheyalterthecostsorbenefitsofdoingsomething– theymaychangethechoiceapersonmakes

41

ExamplesofIncentivesandDisincentives

INCENTIVES DISINCENTIVES

Retailstoresales:Buy-one get-onesales

Taxesoncigarettes,alcohol ect.

Attendance policiesinclass Calorie reportsatfast-food restaurants

Taxsubsidy fornewgreentechnology Pollution tax

ExamplesofIncentivesandDisincentives

INCENTIVES DISINCENTIVES

Retailstoresales:Buy-one get-onesales

Taxesoncigarettes,alcohol ect.

Attendance policiesinclass Calorie reportsatfast-food restaurants

Taxsubsidy fornewgreentechnology Pollution tax

KeyTakeaways

• Marginalanalysisisusedfrequentlybyfirmstoweighthebenefitsanddrawbacksofbusinessdecisions

• Peopledothistoo!Theyweighthecostsandbenefitsofvariousdecisionsandmakeachoice

• Incentives/disincentiveschangethecostsorbenefitsofachoice,thereforemayalterthedecisionsomeonemakes