Economics Basics: Definitions, Factors of Production, Scarcity, and Opportunity Cost Economics – the study of how people make choices to satisfy their needs and wants…

Things Economists Do… Description Analysis Explanation Predictions Change the world …Get movies made about them

Economics Basics The location of the economy we discuss matters! Personal Local Regional National International Microeconomics – individuals making decisions… (self, family, business) Macroeconomics – Countries or institutions making decisions (POTUS, Congress, “The Fed”, the UN)

Scarcity Scarcity refers to the limited nature of society’s resources. Scarcity refers to the limited nature of society’s resources. Economics is the study of how society manages its scarce resources, including how people decide how much to work, save, and spend, and what to buy how firms decide how much to produce, how many workers to hire how society decides how to divide its resources between national defense, consumer goods, protecting the environment, and other needs You might want to elaborate a bit on some of the points made here. Some examples are below: “How do people decide how much to work?” Time is scarce resource – many of our students know this very well. There’s just not enough time to do everything we’d like to do. How do we decide how much of our time to spend working? There’s a tradeoff: the more time we spend working, the higher our income, and therefore the more stuff we can buy. But, the more time we spend working, the less time we have for leisure – hanging out with friends, going hiking, watching movies, etc. (You might want to ask your students how THEY decide how much time to spend working. Some will say it depends on how many classes they are taking, or the time requirements of the available jobs. But probably at least a few will say the wage – the higher the wage, the more worthwhile to work.) “How do firms decide what kind of labor to hire?” Firms can hire unskilled or skilled workers. The skilled workers are more productive, but cost more than the unskilled workers. “How do firms decide how much to produce?” Ask your students, and see if any of them say “it depends on the price of the product they sell.” (Probably some will say “it depends on whether there’s a lot of demand for the product”. To which you might respond “and if there’s a lot of demand for the product, what does that mean for the price that firms can get for the product?”)

Scarcity People have limited resources & unlimited wants Shortages occur when there isn’t enough of a good to go around – either because firms will not or cannot produce enough at the current price The Scarcity Principle – “No Free Lunch” Although we have boundless needs and wants, the resources available to us are limited. So, having more of one thing means having less of another.

Scarcity and Shortages Scarcity occurs when there are limited quantities of resources to meet unlimited needs or desires Shortages occur when producers will not or cannot offer goods or services at current prices

Factors of Production Land Capital Labor Entrepreneurs Are there 3 or 4? Land natural resources that are not created by humans Deserts, fields, livestock, sunshine, climate, dirt Capital human-made resource used in producing other goods and services Physical capital = Tools, equipment, machinery, “financial capital” Human capital = job skills, acquired knowledge Labor People with their efforts, abilities, and skills Entrepreneurs Risk-taker in search of profit who does something new with existing resources

Factors of Production Check Candles Cooks Food Signs Salt & pepper Electricity Gas Owner Furniture Hostess Delivery vans Waiters Carpet Ovens Cashier Dishes Driver Utensils ½ acre of land Water Cash register Manager Rent Tables LAND LABOR ENTREPRENEURSHIP CAPITAL

The Factors of Popcorn Production Land Popping Corn Vegetable Oil Labor The human effort needed to pop the corn Capital Corn-Popping Device

Section 1 Assessment 1. What is the difference between a shortage and scarcity? (a) A shortage can be temporary or long-term, but scarcity always exists. (b) A shortage results from rising prices; a scarcity results from falling prices. (c) A shortage is a lack of all goods and services; a scarcity concerns a single item. (d) There is no real difference between a shortage and a scarcity. 2. Which of the following is an example of using physical capital to save time and money? (a) hiring more workers to do a job (b) building extra space in a factory to simplify production (c) switching from oil to coal to make production cheaper (d) lowering workers’ wages to increase profits Want to connect to the PHSchool.com link for this section? Click Here!

Section 1 Assessment 1. What is the difference between a shortage and scarcity? (a) A shortage can be temporary or long-term, but scarcity always exists. (b) A shortage results from rising prices; a scarcity results from falling prices. (c) A shortage is a lack of all goods and services; a scarcity concerns a single item. (d) There is no real difference between a shortage and a scarcity. 2. Which of the following is an example of using physical capital to save time and money? (a) hiring more workers to do a job (b) building extra space in a factory to simplify production (c) switching from oil to coal to make production cheaper (d) lowering workers’ wages to increase profits Want to connect to the PHSchool.com link for this section? Click Here!

Decision Making in Economics: Trade-offs & Opportunity Costs The Cost-Benefit Principle: An individual (or firm or society) should take an action if, and only if, the extra benefits from taking the action are at least as great as the extra costs

Trade-Offs All the alternative choices you COULD make as part of a decision… Cost-Benefit Analysis Grandma sent $100 for your birthday, how will you spend it? It’s WEB, how will you use your time?

Opportunity Cost If we make a choice (“choose A”), because things are scarce, you affect other things (“give up B, C, D, etc.”) Remember the big thing here is a cost/benefit analysis Your opportunity cost in a situation is the value of the most desirable alternative you gave up when you made your decision

The Decision-Making Grid Economists encourage us to consider the benefits and costs of our decisions. Benefits Enjoy more sleep Have more energy during the day Better grade on test Teacher and parental approval Personal satisfaction Decision Sleep late Wake up early to study for test Opportunity cost Extra study time Extra sleep time Benefits forgone Wake up early to study Alternatives Karen’s Decision-making Grid

HOW PEOPLE MAKE DECISIONS Decision making is at the heart of economics. The first four principles deal with how people make decisions. Decision-making is at the heart of economics. The individual must decide how much to save for retirement, how much to spend on different goods and services, how many hours a week to work. The firm must decide how much to produce, what kind of labor to hire. Society as a whole must decide how much to spend on national defense (“guns”) versus how much to spend on consumer goods (“butter”).

HOW PEOPLE MAKE DECISIONS Principle #1: People Face Tradeoffs All decisions involve tradeoffs. Examples: Going to a party the night before your midterm leaves less time for studying. Having more money to buy stuff requires working longer hours, which leaves less time for leisure. Protecting the environment requires resources that might otherwise be used to produce consumer goods.

HOW PEOPLE MAKE DECISIONS Principle #1: People Face Tradeoffs Society faces an important tradeoff: efficiency vs. equity efficiency: getting the most out of scarce resources equity: distributing prosperity fairly among society’s members Tradeoff: To increase equity, can redistribute income from the well-off to the poor. But this reduces the incentive to work and produce, and shrinks the size of the economic “pie.” The last point is expressed rather tersely on the slide; you may want to elaborate verbally to insure that the point is clear. “Redistribute income from the rich to the poor” is accomplished through the progressive tax system, as well as social programs like food stamps and unemployment insurance that try to provide a safety net for people at the low end of the income distribution. “But this reduces the incentive to work hard” – the reward for working hard is a high income. Taxes reduce this reward, and therefore reduce the incentive to work hard.

HOW PEOPLE MAKE DECISIONS Principle #2: The Cost of Something Is What You Give Up to Get It Making decisions requires comparing the costs and benefits of alternative choices. The opportunity cost of any item is whatever must be given up to obtain it. It is the relevant cost for decision making.

HOW PEOPLE MAKE DECISIONS Principle #2: The Cost of Something Is What You Give Up to Get It Examples: The opportunity cost of… …going to college for a year is not just the tuition, books, and fees, but also the foregone wages. …seeing a movie is not just the price of the ticket, but the value of the time you spend in the theater. Here’s a fun tangent, if you have the class time and are so inclined: Ask your students about the saying “The best things in life are free.” Ask them to name some of these things that supposedly are free. Ask them what “free” means in this context. The idea here is to get them to see that even things without an explicit monetary cost are not truly “free,” because they have an opportunity cost. For example, when you ask them to name the “best things” that are “free,” they will respond with answers like love, sitting at the top of a mountain you just climbed and enjoying an awesome view, or maybe witnessing the joy of a child who has just been given a new toy. In each case, there is no explicit monetary cost, but there’s an opportunity cost. For example, a day spent climbing a mountain represents a day of foregone wages. And the fact that the mountain offers the incredible view probably means that land has been set aside for a national park that might otherwise be used to produce industrial chemicals, or it might be used for a subdivision of million-dollar homes. With love, it’s less obvious, but if prodded enough, your students will be able to think of non-monetary costs associated with love. For example, you might not want to see the latest Ashton Kutcher film, you might think he’s the world’s worst actor. But your boyfriend/girlfriend/teenaged daughter or other loved one is DYING to see it, they are BEGGING you to take them. So you take them. That’s true love, don’t you think? And it’s certainly not free.

Thinking at the Margin When you decide how much more or less to do, you are thinking at the margin. “marginal benefit” and “marginal cost” we’ll do more of this later…. 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

HOW PEOPLE MAKE DECISIONS Principle #3: Rational People Think at the Margin A person is rational if she systematically and purposefully does the best she can to achieve her objectives. Many decisions are not “all or nothing,” but involve marginal changes – incremental adjustments to an existing plan. Evaluating the costs and benefits of marginal changes is an important part of decision making. This definition of “rational” is new to the 4th edition of the textbook. You might want to elaborate a bit on what economists mean by “rational.” In economics, a rational consumer makes decisions about the goods she buys (which ones and how much of each) with the goal of maximizing her well-being, subject to her income, the prices of the goods, and her preferences. Another rational economic actor – the firm – decides how much output to produce, what price to charge, and how many workers to hire in order to maximize its profits.

HOW PEOPLE MAKE DECISIONS Principle #3: Rational People Think at the Margin Examples: A student considers whether to go to college for an additional year, comparing the fees & foregone wages to the extra income he could earn with an extra year of education. A firm considers whether to increase output, comparing the cost of the needed labor and materials to the extra revenue.

HOW PEOPLE MAKE DECISIONS Principle #4: People Respond to Incentives incentive: something that induces a person to act, i.e. the prospect of a reward or punishment. Rational people respond to incentives because they make decisions by comparing costs and benefits. Examples: In response to higher gas prices, sales of “hybrid” cars (e.g., Toyota Prius) rise. In response to higher cigarette taxes, teen smoking falls. The definition of “incentive” is new to the 4th edition.

Section 2 Assessment 1. Opportunity cost is (a) any alternative we sacrifice when we make a decision. (b) all of the alternatives we sacrifice when we make a decision. (c) the most desirable alternative given up as a result of a decision. (d) the least desirable alternative given up as a result of a decision. 2. Economists use the phrase “guns or butter” to describe the fact that (a) a person can spend extra money either on sports equipment or food. (b) a person must decide whether to manufacture guns or butter. (c) a nation must decide whether to produce more or less military or consumer goods. (d) a government can buy unlimited military and civilian goods if it is rich enough. Want to connect to the PHSchool.com link for this section? Click Here!

Section 2 Assessment 1. Opportunity cost is (a) any alternative we sacrifice when we make a decision. (b) all of the alternatives we sacrifice when we make a decision. (c) the most desirable alternative given up as a result of a decision. (d) the least desirable alternative given up as a result of a decision. 2. Economists use the phrase “guns or butter” to describe the fact that (a) a person can spend extra money either on sports equipment or food. (b) a person must decide whether to manufacture guns or butter. (c) a nation must decide whether to produce more or less military or consumer goods. (d) a government can buy unlimited military and civilian goods if it is rich enough. Want to connect to the PHSchool.com link for this section? Click Here!

Use what you know…. You are selling your 1996 Mustang. You have already spent $1000 on repairs. At the last minute, the transmission dies. You can pay $600 to have it repaired, or sell the car “as is.” In each of the following scenarios, should you have the transmission repaired? A. Blue book value is $6500 if transmission works, $5700 if it doesn’t B. Blue book value is $6000 if transmission works, $5500 if it doesn’t

A C T I V E L E A R N I N G 1: Answers Cost of fixing transmission = $600 A. Blue book value is $6500 if transmission works, $5700 if it doesn’t Benefit of fixing the transmission = $800 ($6500 – 5700). It’s worthwhile to have the transmission fixed. B. Blue book value is $6000 if transmission works, $5500 if it doesn’t Benefit of fixing the transmission is only $500. Paying $600 to fix transmission is not worthwhile. 28

A C T I V E L E A R N I N G 1: Answers Observations: The $1000 you previously spent on repairs is irrelevant. What matters is the cost and benefit of the marginal repair (the transmission). The change in incentives from scenario A to scenario B caused your decision to change. If you wish, you can omit this slide and just give this information to the class verbally. 29

“There’s no such thing as a free lunch” and “The Best things in life are free”

Mental Checks: Do you get it? Is it worth it for Bill Gates to stop and pick up a $100 bill he dropped while walking down the street? Why don’t auto manufacturers make cars without heaters in them any more? Why do drive-up ATMs have the keypads with Braille dots on them?

Sooooooo then… Why are all these Billionaires giving away their money?

Production Possibilities Graphs What is a production possibilities graph? How do production possibilities graphs show efficiency, growth, and cost? Why are production possibilities frontiers curved lines?

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. Watermelons (millions of tons) Shoes (millions of pairs) 25 20 15 10 5 Production Possibilities Graph a (0,15) 15 8 14 b (8,14) 14 18 20 21 12 9 5 A production possibilities frontier c (14,12) d (18,9) e (20,5) f (21,0)

Shoes (millions of pairs) Watermelons (millions of tons) 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. Shoes (millions of pairs) 25 20 15 10 5 Watermelons (millions of tons) Production Possibilities Graph c (14,12) d (18,9) e (20,5) f (21,0) a (0,15) b (8,14) S g (5,8) A point of underutilization

Shoes (millions of pairs) Watermelons (millions of tons) 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.” Shoes (millions of pairs) 25 20 15 10 5 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

Watermelons (millions of tons) Shoes (millions of pairs) 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. Watermelons (millions of tons) Shoes (millions of pairs) 25 20 15 10 5 Production Possibilities Graph 14 18 21 12 9 8 c (14,12) d (18,9)

Section 3 Assessment 1. A production possibilities frontier shows (a) farm goods and factory goods produced by an economy. (b) the maximum possible output of an economy. (c) the minimum possible output of an economy. (d) underutilization of resources. 2. An economy that is using its resources to produce the maximum number of goods and services is described as (a) efficient. (b) underutilized. (c) growing. (d) trading off. Want to connect to the PHSchool.com link for this section? Click Here!

Section 3 Assessment 1. A production possibilities frontier shows (a) farm goods and factory goods produced by an economy. (b) the maximum possible output of an economy. (c) the minimum possible output of an economy. (d) underutilization of resources. 2. An economy that is using its resources to produce the maximum number of goods and services is described as (a) efficient. (b) underutilized. (c) growing. (d) trading off. Want to connect to the PHSchool.com link for this section? Click Here!