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Fundamental Economic Concepts

Fundamental Economic Concepts. 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.

kathleen-mann
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Fundamental Economic Concepts

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  1. Fundamental Economic Concepts

  2. 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). Microeconomicsdeals with individual decisions, Macroeconomics looks at the economy as a whole

  3. What is the Economy?

  4. Why Do We Study It? 1. Description What? or How Much? 2. Analysis How? or Why? 3. Explanation 4. Prediction When? OR…

  5. Why do we study Economics? So we don’t get screwed.

  6. Book Auction • What economic concepts were demonstrated by the book auction? • Scarcity • Value • Choices • Rationing • Equity vs. Efficiency • Which was the sealed auction? • Consumer surplus } Stay Tuned!

  7. Scarcity Situation that occurs when wants are greater than available resources. Scarcity is the fundamental problem in economics.

  8. In this classroom, is/are _________ scarce? • Desks? • Water? • Books? • Gasoline? • Jolly Ranchers? … • Good looking economics instructors? Wants are satisfied by available resources But not in the hallway… No want for it in classroom, but outside… yes Wants exceed available resources

  9. Good looking economics instructors?

  10. We always assume…. • People make decisions based upon RATIONALSELF-INTEREST

  11. We must consider… Examples: Shelter is a need, a mansion is a want. Food is a need, a large pizza is a want.

  12. Scarcity forces us to ask the following questions… • WHAT to produce? • HOW to produce? • FOR WHOM to produce?

  13. Imagine a scenario where… …we take an all-expenses-paid class trip to…

  14. Australia!

  15. Our plane is forced to make a “water landing,” and we are able to swim to an uncharted island. What will we need to do? What questions will we have to answer?

  16. Specialization • Allocating resources toward production for which they are best suited.

  17. 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**

  18. EXAMPLES:

  19. Adam Smith • “Wealth of Nations” • 1776 • Invisible hand • Meat • Bread • Candles • How do we decide to provide these?

  20. CIRCULAR FLOW

  21. Utility • The satisfaction that consumption of a good or service provides

  22. 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.

  23. Paradox of Value • Water vs. Diamonds • Monetary Value • Must be scarce • Must give utility • Are diamonds scarce? • Do they give utility? • Conspicuous consumption • Examples?

  24. Cost – Benefit Analysis Question? : What do you want RIGHT NOW?

  25. Cost – Benefit Analysis Follow up question? : Why don’t you go get it?

  26. 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

  27. Opportunity Cost VS. VS. VS.

  28. Marginal Cost Marginal = Additional, next Additional cost vs. additional benefit We constantly engage in marginal analysis

  29. Production Possibilities Model • Illustrate production choices • Assumptions: • Full employment • Fixed resources • Fixed technology • Two goods 1-31

  30. Production Possibilities Frontier All possible combinations of two products that can be produced when employing 100% of available resources. Guns (thousands) 80 75 60 30 0 Butter (tons) 0 150 300 400 450

  31. Production Possibilities Frontier

  32. Production Possibilities Table Production Alternatives A B C D E Type of Product Pizzas (in hundred thousands) 0 1 2 3 4 Industrial Robots (in thousands) 10 9 7 4 0 Plot Points to Create Graph… 1-35

  33. Production Possibilities Curve A’ 14 13 12 11 10 9 8 7 6 5 4 3 2 1 B’ Unattainable A Economic Growth B C’ C Industrial Robots D’ D Now Attainable Attainable E’ E 0 1 2 3 4 5 6 7 8 9 Pizzas 1-36

  34. Production Possibilities Curve A’ 14 13 12 11 10 9 8 7 6 5 4 3 2 1 B’ Unattainable A Law of Increasing Opportunity Cost B C’ C Industrial Robots D’ Shape of the Curve D Attainable E’ E 0 1 2 3 4 5 6 7 8 9 Pizzas 1-37

  35. Quick Quiz • Why is the PPF bowed out from the origin? • Law of increasing opportunity costs • What is the marginal opportunity cost of the 2nd unit of pizza? • 2 units of robots • Which point(s) on the curve represent full employment of resources? • All points ON the curve

  36. The Future Economy • Consequences of unemployment • Economic growth • More resources • Better quality resources • Technological advances 1-39

  37. Future Possibilities Compare Two Hypothetical Economies Future Curve Future Curve F Goods for the Future Goods for the Future P Current Curve Current Curve Goods for the Present Goods for the Present Presentville Futureville 1-40

  38. 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

  39. Comparative Advantage Mexico’s Production Possibilities Table (in Tons) ProductA B C D E Production Alternatives Avocados 0 20 24 40 60 Soybeans 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 5-42

  40. Comparative Advantage U.S.’s Production Possibilities Table (in Tons) ProductA B C D E Production Alternatives Avocados 0 30 33 60 90 Soybeans 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 5-43

  41. Comparative Advantage • Mexico will produce avocados • U.S. will produce soybeans • U.S. gives up 3 A for 1 S • Mexico gives up 4 A for 1 S • Terms of trade • 3.5 A for 1 S • Both countries benefit 5-44

  42. Comparative Advantage • Gains from trade • Mexico 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

  43. Comparative Advantage Terms of Trade – 1s : 3.5a Trade: 10 tons soybeans for 35 tons avocados

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