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Got stuff?

Who made it?

How was it made?

How did you get it?

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I. The Economic Problem

the basic economic problem isscarcity:

-- wants are unlimited, but resourcesare limited

so with scarcity, we must make

choices, and with choices, come costs

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Cost is the opportunity cost

-- what you give up when you make achoice

-- theres no such thing

as a free lunch

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Cost of going to college

-- what you can buy with tuition & fees

-- what you could earn by working-- what you could do with the free time

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you are willing to give up

-- tuition

-- wages

-- leisure time

to go to college-- b/c you expect higher income ormore rewarding career

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economics is the study of choices

of how to allocate scarce resources

choices made by

-- consumers-- businesses

-- governments

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What are resources?

use resources to produce goods andservices

factors of production-- land

-- labor

-- capital

-- entrepreneurship

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Land

all natural resources

-- land

-- minerals

-- water

-- wildlife

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Labor

size of labor force (quantity)

skills of labor force (quality)

-- human capital the value of time

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Capital

physica lcapital-- goods used to make other goods

-- factories

-- machines

-- infrastructure

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entrepreneurship

human resource

ideas

-- doing things better-- e-commerce

-- new products

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Three Questions to answer:

1. What to produce?

2. How to produce the stuff in #1?

3. For whom to produce?(who gets the stuff in #1?)

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Example: A Lexus

1. What to produce? Toyota designs a luxury car with buyers in

mind Toyota decides how much to produce give

the price and their costs

Buyers decide how many to buy, based onprice, their income, tastes, etc.

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Toyota designs factory, usesmachinery, & trains workers to minimize

cost BUT retain a certain quality

U.S. government restricts this decision:

Pollution laws

safety laws labor laws

2. How to produce?

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Those who are willing and able topay $50,000 for one.

(this is why I drive a Dodge) With markets, price rations a scarce

resource

3. Who gets the Lexus?

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Who answers #1-3?

pure capitalism

when buyers and sellers interact to

answer these questions markets unrestricted

private property

prices coordinate #1-3

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the U.S. is a mixed marketeconomy,since government plays a role

enforces property rights

regulates markets

taxes to provide goods & services

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command system

the government answers questions 1-3

former U.S.S.R., N. Korea

reduced incentives for efficiency

coordination failures

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Specialization

How do we get the most out of ourresources?

We specialize in what we do bestand trade that for what we need

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I teach.

I get paid for it.

I use the money to buy

food

oil changes

clothes

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If I

grew my own food

made my own clothes

fixed my own car

I would not consume as much

Specialization produces gains!

I can consume more

than what I could makeon my own

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Who specializes in what?

Comparative advantage

if you produce a good at a lower

opportunity costthen you should specialize in it

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Example: married couple

Husband: surgeon $250,000 /year

Wife: 5th grade teacher

$50,000 /year who should run the household?

Who has lower opportunity cost?

The wife.

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with specialization,

division of labor

different people specialize in differentthings

people become very good at their task

efficiency gains

-- get more out of same resources

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specialization is everywhere

doctors

neurosurgeon, obstetrics, pediatrics,

lawyers divorce, real estate, patent law,

personal injury...

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The bottom line:

Scarcity & opportunity cost areunavoidable.

BUT efficiency & specialization

make the most of scarce resources

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II. Production Possibilities Frontier(PPF)

model of scarcity, choice, &opportunity cost

choice between 2 goods

PPF shows maximum possible

output combos of 2 goods,

given current resources

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PPF example

2 goods:

-- CDs

-- bottled water use land, labor, capital to make

these goods

Bottled

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Supposethese are

6 possiblepairs:

CDs(millions per

yr.)

Bottled

Water(millions per

yr.)

A 15 0

B 14 1C 12 2

D 9 3

E 5 4F 0 5

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We can graph the table & get thePPF:

CDs

bottledwater

15

5

9

3

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Using the PPF

points on or inside the PPF are possible

CDs

bottledwater

points INSIDE the PPFare inefficient

points ON the PPFare efficient

9

3

6

2

-- do not use all resources

-- use all resources

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Using the PPF

points outside the PPF are NOT possible at this time

CDs

bottledwater

9

3

15

6

cannot produce 15 CDs AND6 bottles of water

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scarcity & tradeoffs

the PPF shows limits to production

so must choose between bottled

water & CD combinations-- give up water to get more CDs

-- give up CDs to get more water

-- TRADEOFF

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Opportunity Cost

on PPF there are tradeoffs

-- how much is given up?

= opportunity cost

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opportunity cost of 1 bottle ofwater:

A to B

= 1 CD

B to C= 2 CDs

C to D

= 3 CDs

CDs(millions per

yr.)

Bottled

Water(millions per

yr.)

A 15 0

B 14 1C 12 2

D 9 3

E 5 4F 0 5

Opp cost

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CDs(millions per

yr.)

Bottled

Water(millions per

yr.)

Opp. cost

of 1 bottle

of water (in

terms ofCDs)

A 15 0

B 14 1 1C 12 2 2

D 9 3 3

E 5 4 4F 0 5 5

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opportunity costs are increasing

cost (in CDs) increasesas water production increases

PPF is concave (bowed out)

why?

-- harder to switch resources

between CDs and water

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At first when making more water

switch the best resources fromCD production

But as we make more water

resources switched are less and less

suitable for water production

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Shifts in the PPF

if we get more resources OR

if technology improves

then the PPF will shift out produce more CDs and more water

economic growth!

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CDs

bottledwater

9

3

15

6

With economic growth,

the unattainable becomes

attainable

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II. Economic analysis

models

positive vs. normative

fallacies

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Microeconomics

studies choices of consumers, firms,and how government affects thesechoices

studies parts of the economy or aparticular market

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Macroeconomics

studies whole economy

-- inflation

-- unemployment-- recessions

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Building economic models

ask a question

simplify reality

make assumptions

make prediction

test the prediction

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Models may be described with

-- words-- math

-- pictures (graphs)

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example

Model consumer behavior in buyingpizza

how does a change in price of pizzaimpact the amount of pizza bought?

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assume only price changes, andother factors remain constant

-- ceteris paribusother things being equal

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make a prediction:

Words:when the price of pizza rises,

people buy less pizza

Math:quantity of pizza = 10 - .2(price of pizza)

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graph

price

Quantity of pizza

demand

T ti d l

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Testing models

Do model predictions matchthe data?

Do people buy less pizza when its

price rises?

must distinguish cause and effect

in the real world other factors arenot held constant

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Positive statements

statements about what is

may be right or wrong

testable

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Normative statements

statements about what ought to be

based on opinions and values

not testable

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Example 1

Employer-provided daycare reducescosts due to employee sick days andlost productivity

positive-- statement of fact

(but it may be wrong)

-- testable

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Example 2

Firms should provide on-site daycarefor their employees.

normative

-- opinion

-- cannot test what firms should do,

only the result of what they do

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Economists

discover, collect positive statements

about how economy works.

predict AVERAGE behavior use positive statements as support

for normative statements.

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Faulty economic analysis

correlation vs. causation

post hoc, ergo p ropter hoc

fallacy of composition

ignoring secondary effects

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correlation vs. causation

if a rises when b rises,

positively correlated

NOT necessarily true that a causesb

b could cause a OR

third factor causes both a andb

E l

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Example

assault and ice cream sales arepositively correlated

Does ice cream make people want tohit someone?

Do bullies go out for ice cream aftera good fight?

No, both increase due to warmerweather

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post hoc, ergo propter hoc

if A happened right before B, then Amust have caused B.

what about coincidence?

a third unrelated causal factor?

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example

nutrasweet and brain tumors increase in tumors in 1980s due to

nutrasweet approval in 1981

http://www.junkscience.com/news/nutrasweet.html

But Duran Duran became a band in

1979.coincidence?

http://www.junkscience.com/news/nutrasweet.htmlhttp://www.junkscience.com/news/nutrasweet.htmlhttp://www.junkscience.com/news/nutrasweet.htmlhttp://www.junkscience.com/news/nutrasweet.html

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fallacy of composition

what is true for one part is true forthe whole

example: Paradox of thrift

should you save more $?

what if everybody did?

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