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Fundamental Economic Concepts
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What is Economics?- The study of mankind’s
unlimited desires in a world of limited resources.-Economics is a social science, dealing with how people
react to changing variables.
-Economists form theories, based on economic models in which they manipulate variables.
-These theories, models and variables are used to describe what is (Positive Economics) and what ought to be (Normative Economics).
Microeconomics deals with individual decisions, Macroeconomics looks at the economy as a whole
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What is the Economy?
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Why Do We Study It?
1. Description
2. Analysis
3. Explanation
4. Prediction
What? or How Much?
How? or Why?
When?
OR…
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Why do we study Economics?
Sowe
don’t get
screwed.
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Book AuctionWhat economic concepts were
demonstrated by the book auction?◦Scarcity◦Value◦Choices◦Rationing◦Equity vs. Efficiency
Which was the sealed auction?
◦Consumer surplus
}Stay Tuned
!
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ScarcitySituation that occurs when wants are greater than available resources.Scarcity is the fundamental problem in economics.
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In this classroom, is/are _________ scarce?Desks?Water?Books?Gasoline?Jolly Ranchers?…
Good looking economics instructors?
But not in the hallway…
Wants are satisfied by available resources
No want for it in classroom, but outside… yes
Wants exceed available resources
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Good looking economics instructors?
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We always assume….People make decisions based
upon RATIONAL SELF-INTEREST
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We must consider…
Examples: Shelter is a need, a mansion is a want.
Food is a need, a large pizza is a want.
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Scarcity forces us to ask the following questions…
WHAT to produce?
HOW to produce?
FOR WHOM to produce?
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Imagine a scenario where…
…we take an all-expenses-paid class trip to…
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Australia!
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Our plane is forced to make a “water landing,” and we are able to swim to an uncharted island.
You are in charge. Prioritize 3-5 things we’ll have to do to survive and how (and with who) we should accomplish these tasks.
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Specialization
• Allocating resources toward production for which they are best suited.
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FACTORS OF PRODUCTION• Land – all gifts of nature• Labor – human efforts and abilities• Capital – tools, equipment, space• Entrepreneurship – risk taking, ideas
– **The “spark” or driving force of the economy**
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EXAMPLES:
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Adam Smith“Wealth of Nations”
◦1776Invisible hand
◦ Meat◦ Bread◦ Candles◦ How do we decide to provide these?
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CIRCULAR FLOW
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UtilityThe satisfaction that
consumption of a good or service provides
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DIMINISHING MARGINAL UTILITY
As you consume additional units of a good, at some point each additional unit will begin providing less utility than the one before it.
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Paradox of ValueWater vs. DiamondsMonetary Value
◦Must be scarce◦Must give utility
Are diamonds scarce?Do they give utility?
Conspicuous consumption◦Examples?
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Cost – Benefit Analysis
Question? :
What do you want RIGHT NOW?
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Cost – Benefit Analysis
Follow up question? :
Why don’t you go get it?
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Cost – Benefit Analysis
• We all make decisions in our own self-interest
• All decisions come with certain trade-offs and alternatives
• THERE IS NO SUCH THING AS A FREE LUNCH!!!Seinfeld example
• Opportunity Cost: the next-best alternative given up when making a choice
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Opportunity Cost
VS.
VS. VS.
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Marginal Cost
Marginal = Additional, next
Additional cost vs. additional benefit
We constantly engage in marginal analysis
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Production Possibilities ModelIllustrate production choices
Assumptions:◦Full employment◦Fixed resources◦Fixed technology◦Two goods
1-31
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Production Possibilities FrontierGuns (thousands)
807560300
Butter (tons)
0150300400450
All possible combinations of two products that can be produced when employing 100% of available resources.
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Production Possibilities Frontier
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Type of Product
Pizzas (in hundred thousands)
Industrial Robots (in thousands)
Production Alternatives
A B C D E
10 9 7 4 0
0 1 2 3 4
Plot Points to Create Graph…
Production Possibilities Table
1-35
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Production Possibilities Curve
Pizzas
Ind
ust
rial
Ro
bo
ts
Attainable
0 1 2 3 4 5 6 7 8 9
14
13
12
11
10
9
8
7
6
5
4
3
2
1
Unattainable
AB
C
D
E
EconomicGrowth
Now Attainable
A’
B’
C’
D’
E’
1-36
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Production Possibilities Curve
Pizzas
Ind
ust
rial
Ro
bo
ts
Attainable
0 1 2 3 4 5 6 7 8 9
14
13
12
11
10
9
8
7
6
5
4
3
2
1
Unattainable
AB
C
D
E
Law of IncreasingOpportunity Cost
A’
B’
C’
D’
E’
Shape of the Curve
1-37
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Quick QuizWhy is the PPF bowed out
from the origin?◦Law of increasing opportunity
costs…◦…due to specialization of
resourcesWhat is the marginal
opportunity cost of the 2nd unit of pizza?◦2 thousand robots
Which point(s) on the curve represent full employment of resources?◦All points ON the curve
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The Future Economy
Consequences of unemployment
Economic growth◦More resources ◦Better quality resources◦Technological advances
1-39
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Future Possibilities
Goods for the Present
Goo
ds f
or t
he F
utur
e
Goo
ds f
or t
he F
utur
eGoods for the Present
P
F
CurrentCurve
CurrentCurve
FutureCurve
FutureCurve
Compare Two Hypothetical Economies
Presentville Futureville
1-40
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Specialization
Shift resources to export industry
Achieve higher overall output and income
Absolute advantage◦Higher output per worker for a good
Comparative advantage◦Lower domestic opportunity cost for a good
5-41
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Comparative Advantage
Product A B C D E
Avocados 0 20 24 40 60Soybeans 15 10 9 5 0
**Optimal domestic production occurs at point C• Opportunity cost of 1 ton of
Soybeans is 4 tons of Avocados• Opportunity cost of 1 ton of
Avocados is .25 tons of Soybeans
Mexico’s Production Possibilities Table (in Tons)
Production Alternatives
5-42
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Comparative Advantage
Avocados 0 30 33 60 90Soybeans 30 20 19 10 0
**Optimal domestic production occurs at point C• Absolute advantage in both goods• Opportunity cost of 1 ton of
Soybeans is 3 tons of Avocados• Opportunity cost of 1 ton of
Avocados is .33 tons of Soybeans
Product A B C D E
U.S.’s Production Possibilities Table (in Tons)
Production Alternatives
5-43
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Comparative Advantage
Mexico will produce avocados
U.S. will produce soybeansU.S. gives up 3 A for 1 SMexico gives up 4 A for 1 S
Terms of trade◦3.5 A for 1 S◦Both countries benefit
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Comparative AdvantageGains from tradeMexico starts at C (24 A and 9S)◦Move to E (60 A and 0 S)◦Trade 35 A for 10 S
U.S. starts at T (33 A and 19 S)◦Move to R (0 A and 30 S)◦Trade 10 S for 35 A
Overall gains?5-45
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Comparative Advantage
Terms of Trade – 1s : 3.5aTrade: 10 tons soybeans for
35 tons avocados