1. Chapter 1 Fundamental Economic Concepts

2. The Economic Perspective Economists view things from the economic perspective and are concerned with: 1.Scarcity and choice 2.Purposeful behavior 3.Marginal Analysis: Benefits/costs

3. Economics and Scarcity Economics is the study of how people make choices to satisfy their needs and wants. Scarcity results from the fact that our wants are unlimited and the resources which must be used to satisfy them are limited. Unlimited Wants + Limited Resources = Scarcity

4. Scarcity v Shortage ScarcityScarcity involves almost everything out there. It is faced by everyone because the resources used to produce the goods and services are very limited while our desire for these goods and services is endless. Shortage involves a very specific situation where the quantity demanded is greater than the quantity supplied. Right now there is a huge demand for gasoline while there is not enough oil being pumped in order to produce all the gasoline people wish to purchase – therefore a shortage exists (that is why the price keeps going up!)

5. Purposeful Behavior Economics assumes that human behavior reflects “rational self-interest” and that individuals look for ways to increase their “utility” or pleasure or satisfaction from consuming a good or service. (Do not confuse this with selfishness in which individuals increase personal satisfaction, without regard to others).

6. Marginal Analysis: Benefits and Costs To an economist, “marginal” means “extra,” “additional” or “a change in.” Most choices in life involve either marginal benefits or marginal costs. In our world of scarcity, the decision to obtain the marginal benefit always involves some marginal cost. Are you willing to pay the cost?

7. Thinking at the Margin When you decide how much more or less to do, you are thinking at the margin. Options 1st hour of extra study time 2nd hour of extra study time 3rd hour of extra study time Benefit Grade of C on test Grade of B on test Grade of B+ on test Opportunity Cost 1 hour of sleep 2 hours of sleep 3 hours of sleep

8. The Decision-Making Grid Economists encourage us to consider the benefits and costs of our decisions. BenefitsEnjoy more sleep Have more energy during the day Better grade on test Teacher and parental approval Personal satisfaction DecisionSleep lateWake up early to study for test Opportunity costExtra study timeExtra sleep time Benefits forgoneBetter grade on test Teacher and parental approval Personal satisfaction Enjoy more sleep Have more energy during the day Sleep lateWake up early to study Alternatives Karen’s Decision-making Grid

9. Marginal benefits/costs Allocative/production efficiency Marginal benefit: The benefit that a person receives from consuming one more unit of a good or service Marginal cost: The opportunity cost of producing one more unit of a good or service Allocative efficiency: When we produce the combination of goods and services on the PPC/PPF that we value most highly. Production efficiency: A situation in which we cannot produce more of one good without producing less of some other good—production is on the PPC/PPF.

10. Marginal benefit/cost All the combinations of goods on the PPC/PPF achieve production efficiency. But only one combination is the most highly valued and this point is the allocative efficient production point. The combination that is most highly valued is the combination where the marginal benefit equals the marginal cost.

11. Economists rely on Scientific Methods Observation of real world behavior and outcomes A hypothesis is developed from observations Continued testing may result in an “economic principle” Always use ceteris paribus or “other-things- equal assumption”

12. Macroeconomics and Microeconomics Microeconomics The part of economics concerned with individual units such as a person, household, firm or industry. We look at decision- making by individual consumers, workers, households and business firms. We examine the sand, rocks, and shells…not the beach. Macroeconomics The part of economics concerned with the economy as a whole or its basic subdivisions or aggregates (government, household, and business sectors). Such economic measures as total output, total employment, total income, aggregate expenditures and the general level of prices are examined. We examine the beach…not the sand, rocks, and shells.

13. We have limited income and unlimited wants A Need is a requirement for survival – 5 of them - Air, Water, Food, Clothing and Shelter A Want is something desirable but not required for survival

14. Trade-Offs Trade-offs are when people choose one thing in place of another. For example, I may choose to sleep instead of going running at 4am. Or I might be willing to only run a mile and a half instead of three miles so I could sleep a few more minutes.

15. Opportunity Cost Opportunity Cost is the cost of the loss of the next best alternative use of a resource. When you choose to use your time to talk on the phone instead of doing homework, the “cost” of that decision is the homework which you have given up.

16. Goods v. Services Services are tasks which are performed by someone. Goods are tangible items which are produced.

17. Free v. Scarce Goods Free Goods are ones which you can have without giving up anything to get them. Scarce goods are ones for which you must give up something in order to get them.

18. Consumer v. Capital Goods Consumer goods are final goods which are used by the purchaser for their own personal use/benefit. Capital Goods are manmade goods which are used to produce other goods and services.

19. Factors of Production (resource categories) Land – Natural Resources untouched by man. Labor – Human Resources performing a task. Capital – Manmade goods used to produce other goods and services – typically tools and/or equipment. Entrepreneurship – creative combining of the other factors of production to produce a good or service.

20. Production Possibilities Production Possibilities show the potential combinations of how to use resources efficiently The model assumes that you have: Full employment - economy is using all its available resources) Fixed resources - quantity an quality of factors of production are fixed Fixed technology – state of technology is constant Two goods – consumer goods and capital goods

21. Watermelons (millions of tons) Shoes (millions of pairs) 25 20 15 10 5 0 252015105 Production Possibilities Graph Watermelons (millions of tons) 0 a (0,15) 15 814 b (8,14) 14 18 20 21 12 9 5 0 A production possibilities frontier c (14,12) d (18,9) e (20,5) f (21,0) Production Possibilities A production possibilities graph shows alternative ways that an economy can use its resources. The production possibilities frontier is the line that shows the maximum possible output for that economy.

22. Classic Guns and Butter

23. Law of increasing opportunity costs (In the real world, most activities have increasing opportunity costs) The law of increasing opportunities costs is reflected in the shape of the production possibilities curve. The curve is bowed out from the origin of the graph. As the economy moves down along the curve, it must give up successively larger amounts of product. This is known as the slope of the production possibilities curve, which becomes steeper.The economic rationale is that resources are not completely adaptable to alternative uses. When initially increasing the production of one good, resources (highly-trained people, state of the art machinery, etc.) that are well suited for its production are used. When still more of the good is produced, resources that are less well suited must be used (untrained temporary workers, machines that are breaking down, etc.) Because the resources are ill suited, more are necessary to increase production of the first good, and the foregone amount of the other good increases. Constant costs are represented by a straight curve.

24. Watermelons (millions of tons) Shoes (millions of pairs) 25 20 15 10 5 0 252015105 Production Possibilities Graph Watermelons (millions of tons) 14 18 20 21 12 9 5 0 015 814 c (14,12) d Cost Cost A production possibilities graph shows the cost of producing more of one item. To move from point c to point d on this graph has a cost of 3 million pairs of shoes.

25. Shoes (millions of pairs) 25 20 15 10 5 0 252015105 Watermelons (millions of tons) Production Possibilities Graph g (5,8) A point of underutilization c (14,12) d (18,9) e (20,5) f (21,0) a (0,15) b (8,14) S Efficiency Efficiency means using resources in such a way as to maximize the production of goods and services. An economy producing output levels on the production possibilities frontier is operating efficiently. Any point (see “g”) inside the curve represents situations of a failure to achieve “full employment” of resources

26. Remember … Moving ALONG the PPC illustrates tradeoffs because in order to produce more of something you have to produce less of something. Moving from INSIDE THE PPC TO A POINT ON THE PPC, more of some goods and services can be produced without producing less of others—a free lunch.

27. What is Economic Growth? It is the sustained expansion of production possibilities. If more capital is accumulated, production possibilities increase and the PPC shifts outward.

28. What is the benefit of economic growth? The benefit from economic growth is increased consumption per person in the future after the production possibilities have expanded. That is, AFTER the PPC has shifted outward.

29. Shoes (millions of pairs) 25 20 15 10 5 0 252015105 Watermelons (millions of tons) Production Possibilities Graph T Future production Possibilities frontier c (14,12) d (18,9) e (20,5) f (21,0) a (0,15) b (8,14) S Growth Growth If more resources become available, or if technology improves, an economy can increase its level of output and grow. When this happens, the entire production possibilities curve “shifts to the right.”

30. What is the cost of economic growth? Economic growth requires: developing new technologies accumulating more human capital accumulating more capital All of the above avenues require resources, so the opportunity cost of economic growth is the decrease in the current production of goods and services.

31. Opportunity Cost is a Ratio Along the PPC or PPF, the opportunity cost of one good (A) equals the quantity of the other good forgone or lost (B) divided by the increase in the good (A). Reworded The opportunity cost per unit of Good “A,” from gaining some of Good “A” while losing some of Good “B,” equals: Loss in Good B Gain in Good A

32. Confused? Of course you are…let’s look at an examples together. *Note to teacher—go to Checkpoint 3.2, pg. 32, 37