1. AP MACROECONOMICS MR. LIPMAN
Introduction to Economics
Modules 1-4
Krugman Pages 2-30
Basic Economic Concepts

2. Module 1

3. What is Economics in General?
Economics is the science of scarcity and choices.
Scarcity results because our wants are greater than our limited resources.
Since we are unable to have everything we desire, we must make choices on how we will use our resources.
In economics we will study the choices of individuals, firms, and governments.
Economics is the study of _________.
choices

4. Economics Defined Economics- The study of scarcity and choice.
Examples:
You must choose between buying jeans or buying shoes.
Businesses must choose how many people to hire
Governments must choose how much to spend on welfare.
Economics Defined
Economics- The study of scarcity and choice.
Macroeconomics- A focus on the overall ups and downs in the economy
Microeconomics- focus is on choices made by individuals or firms.

5. Scarcity: What would parents choose? What would kids choose?

6. The Four Factors of Production
Producing goods and services requires the use of resources.
ALL resources can be classified as one of the following four factors of production:
Land
Labor
Capital
Entrepreneurship

7. Land = All natural resources that are used to produce goods and services. Anything that comes from “mother nature.” (Water, Sun, Plants, Oil, Trees, Stone, Animals, etc.)
Labor = Any effort a person devotes to a task for which that person is paid. (manual laborers, lawyers, doctors, teachers, waiters, etc.)

8. Two Types of Capital:
1. Physical Capital- Any human-made resource that is used to create other goods and services (tools, tractors, machinery, buildings, factories, etc.)
2. Human Capital- Any skills or knowledge gained by a worker through education and experience (college degrees, vocational training, etc.)

9. Profit= Revenue - Costs
Entrepreneurship= ambitious leaders that combine the other factors of production to create goods and services.
Examples-Henry Ford, Bill Gates, Steven Jobs, Inventors, Store Owners, etc.
Entrepreneurs:
Take The Initiative
Innovate
Take the Risk of Failure
So they can obtain _________.
PROFIT
Profit= Revenue - Costs

11. Classify the Factors of Production in the following scenario:
You decide to order a pizza to satisfy the munchies. First, you picked up the telephone and gave your order to the owner that entered it into her computer. This information came up on the chief baker’s monitor in the kitchen and he assigned it to one of his cooks. The cook was busy mixing dough out of salt, flour, eggs, and milk.
The cook finished mixing dough, washed his hands in the sink, and prepared your pizza using tomato sauce, cheese, and sausage. He then placed the pizza in the oven. Within 10 minutes the pizza was cooked and placed in a cardboard box. The delivery person then grabbed your pizza, jumped in the company car, and delivered it to your door.

12. Classify the different Factors of Production in the following scenario:
You decide to order a pizza to satisfy the munchies. First, you picked up the telephone and gave your order to the owner that entered it into her computer. This information came up on the chief baker’s monitor in the kitchen and he assigned it to one of his cooks. The cook was busy mixing dough out of salt, flour, eggs, and milk.
The cook finished mixing dough, washed his hands in the sink, and prepared your pizza using tomato sauce, cheese, and sausage. He then placed the pizza in the oven. Within 10 minutes the pizza was cooked and placed in a cardboard box. The delivery person then grabbed your pizza, jumped in the company car, and delivered it to your door.

13. Trade-offs and Opportunity Cost
ALL decisions involve trade-offs.
Trade-offs are all the alternatives that we give up whenever we choose one course of action over others.
(Examples: going to the movies or going to a game)
The most desirable alternative given up as a result of a decision is known as opportunity cost.
What are trade-offs of deciding to go to college?
What is the opportunity cost of going to college?
GEICO commercial assumes you understand opportunity cost. Why?

14. Which flight should you choose? Why?
Given the following assumptions, make a rational choice in your own self-interest (hold everything else constant)…
1. You want to visit your b/f or g/f for a week
2. You work every weekday earning $100 per day
3. You have three flights to choose from:
Thursday Night Flight = $275
Friday Early Morning Flight = $300
Friday Night Flight = $325
Which flight should you choose? Why?

15. How is Economics used? Positive vs. Normative
Economists use scientific method to make generalizations and abstractions to develop theories. Problem is that many economists have different theories and there is no one absolute theory that always works.
Positive vs. Normative
Positive Statements- Based on facts. Avoids value judgments (what is or what will be).
Normative Statements- Includes value judgments
(what should or ought to be).

16. 5 Key Economic Assumptions
Society’s wants are unlimited, but ALL resources are limited (scarcity).
Due to scarcity, choices must be made. Every choice has a cost (a trade-off).
Everyone’s goal is to make choices that maximize their satisfaction. Everyone acts in their own “self-interest” and “politics” are always a “real-life” factor.
Everyone acts rationally by comparing the marginal costs and marginal benefits of every choice
Real-life situations can be explained and analyzed through simplified models and graphs.

17. Module 2: Macroeconomics
Employment and the Labor Force

18. The Various Business Cycles
Depression
Recession
Expansion or growth (which leads to inflation)
Graph demonstrates changes happening over time as cycles change
Business cycle: The alternation between economic downturns and upturns in the macroeconomy.
The instructor may wish to show a slide of the actual business cycle (figure 2-1 shows the unemployment rate on the vertical axis) or hand-draw a smoothed out version similar to the graph below. The important point is to describe the phases.
peak
Phases of the business cycle over a several‑year period  :
recession
Upward trend
time
Business activity
recovery
trough
   
1. A peak is when business activity reaches a temporary maximum with full employment and near capacity output. The unemployment rate is at its lowest level.
2. A recession is a decline in total output, income, employment, and trade lasting six months or more. The unemployment rate is beginning to rise.
3. The trough is the bottom of the recession period. The unemployment rate is at its highest level.
4. Recovery is when output and employment are expanding toward full‑employment level. The unemployment rate is beginning to fall.
5. The entire business cycle is measured by the elapsed time between peaks in the cycle.

19. Key Terms used in Macroeconomics
Nominal income v. Real income (adjusted for inflation)
Inflation
Deflation
Price Stability
Labor Force = employed+unemployed
Inflation, a rise in the overall price level.
Inflation is bad because it reduces our ability to purchase goods and services. A dollar of our hard-earned income doesn’t go as far if the prices of most goods and services are rising. If inflation is rapid, our wages could become useless for  consumption .
Deflation, a fall in the overall price level.
Deflation is bad too. When overall prices are falling, consumers will hold onto their dollars and continue to wait for lower and lower prices. This waiting creates a problem as producers find they can’t sell goods and services. Producers respond by lower prices and consumers respond by waiting even longer to make a purchase.
Be sure to stress that changes to the prices of a few goods changes the opportunity cost of purchasing those goods, but does not constitute inflation or deflation.
Inflation and deflation are terms are reserved for more general changes in the prices of goods and services throughout the economy.

20. Models are used in Economics to help explain what is happening
Models (aka graphs)
Other things equal assumption
Ceteris Paribus (Latin for “other things equal”)
Economists use the scientific method to establish theories, laws, and principles.
1. The scientific method consists of:
a. Facts/Data. The observation of facts (real data).
b. Hypotheses. The formulations of explanations of cause and effect relationships based upon the facts.
Example: A convenience store owner notices that when the temperature rises, she sells more fountain soft drinks and fewer coffees. The reverse tends to occur when the temperature falls. A hypothesis is born out of this data. “Soft drink sales are positively related, and coffee sales are negatively related, to the outside temperature.”
c. Testing. The testing of the hypotheses.
Months of data is collected on the outside temperature and the quantity of soft drinks and coffee drinks sold at the store.
d. The acceptance, reject, or modification of the hypotheses.
If the data seems to confirm our hypothesis, we might be able to confirm that most of the time, this trend holds.
Note: The instructor could draw a crude scatter-plot with soft-drink sales on the y-axis and temperature on the x-axis. Show the scatter plot with a fairly obvious upward trend.
The determination of a theory, law, principle, or model.
2. Theoretical economics: The systematic arranging of facts, interpretation of the facts, making generalizations.
Theories evolve after hypotheses have been repeatedly tested and favorable results have been accumulated.
After weeks of gathering data on temperature and sales, and with the use of a few statistical tools, we publish a landmark article called “The effect of global warming on beverage choice: a theory of soft drink consumption.”
3. Laws/Principles are very well tested and widely accepted theories. Principles are used to explain and/or predict the behavior of individuals and institutions.
Model: a simplified representation of reality that is used to better understand real-life situations.
On some days our theory holds, on others it doesn’t, but on average we can count on it.
“Other things equal” or ceteris paribus assumption: In order to judge the effect one variable has upon another it is necessary to hold other contributing factors constant. Natural scientists can test with much greater precision than can economists. They have the advantage of a controlled laboratory experiment. Economists must test their theories using the real world as their laboratory.
What factors are we holding constant in our theoretical model? Consumer incomes? Price? Price of other drink options? Price of related goods (the gasoline)?

21. The U.S. Unemployment Rate and the Timing of Business Cycles, 1989–2009. Shaded areas
Indicate periods of a recession

23. Module 3: The Production Possibility Curve
PPC helps explain efficiency; opportunity costs; and economic growth

24. Keys to this Module The importance of trade-offs in economic analysis
What the production possibilities curve model tells us about efficiency opportunity cost, and economic growth
The two sources of economic growth - increases in the availability of resources and improvements in technology

25. When using a PPC always remember that if a point is inside or on the curve it is feasible but if it lies outside the curve then it is not feasible. Being on the curve is most efficient (aka no missed opportunites)
All models have simplifying assumptions:
Available supply of resources is fixed in quantity and quality at this point in time.
Technology is constant during analysis.
Economy produces only two types of products.

26. Another PPC example

27. This graph represents a constant opportunity cost for a business that makes both calzones and pizzas.
A PPC with a straight line has a constant slope, and therefore, constant opportunity cost.

28. This graph represent opportunity cost increasing
This graph represent opportunity cost increasing. By producing more pizzas the store owner has to make less calzones in order to be at maximum efficiency.
Question for Students:
If we want more bulldozers, and if we were controlling this economy, what would we need to do?
We would need to move some pizza makers (and capital, and natural resources) to bulldozer production.
Has anyone ever had a bad pizza or a great pizza? Is it safe to say that not all pizzas are created equal? Then is it also safe to say that not all pizza makers (the labor) are created equal?
Are some pro athletes better than others?
Are some acres of land more fertile (for growing food) than others?
Are all laptop computers equal, or are some faster than others?
The point is that resources are not created equal. Can the students agree that some units of labor are better pizza makers than others? If that’s the case, then let’s redraw the PPC.
Redraw the PPC with a concave shape. You don’t need numbers.
There is something that economists call the “Law of increasing opportunity costs”
1. The amount of other products that must be foregone to obtain more of any given product is called the opportunity cost.
2. The more of a product produced the greater is its (marginal) opportunity cost.
3. The slope of the production possibilities curve becomes steeper (going left to right), demonstrating increasing opportunity cost. This makes the curve appear bowed out, concave from the origin.
Why?
1. Economic recourses are not completely adaptable to alternative uses.
2. To get increasing amounts of Bulldozers, resources that are not particularly well suited for that purpose must be used. Workers that are accustomed to producing Pizza in a restaurant may not do well as heavy equipment builders.
A pizza oven is a piece of capital equipment that is not very adaptable to building Bulldozers.

29. As more of a good is produced its opportunity cost typically
rises because all inputs are used up and then less adaptable inputs must be used.

30. During economic growth the PPC shifts outward but during
A shrinking of economic growth it shifts inward

31. Another example of economic growth
Draw a new PPC that has shifted outward in a roughly parallel manner. How could this happen?
When factors of production expand in quantity or quality. A bigger or a more educated/skilled work force.
When technological advances are occurring. Technology always advances, we don’t forget our technology.

32. Marginal Analysis In economics the term marginal = additional
“Thinking on the margin”, or MARGINAL ANALYSIS involves making decisions based on the difference of additional benefit vs. the additional cost.
For Example:
You have been shopping at the mall for a half hour, the additional benefit of shopping for another half-hour might outweigh the additional cost (the opportunity cost).
After three hours, the additional benefit from staying an additional half-hour would likely be less than the additional cost.

33. Marginal Analysis
Notice that the decision making process wasn’t “should I go to the mall for 3 hours or should I stay home”
In reality the decision making process started with “should I go to the mall at all.”
Once you are there you thought “should I stay for an additional half hour or should I go.”
The MARGINAL ANALYSIS approach to decision making is more commonly used than the “all or nothing” approach.

34. Marginal Analysis
Notice that the decision making process wasn’t “should I go to the mall for 3 hours or should I stay home”
Everyone will continue to do something until the marginal cost outweighs the marginal benefit. Then they will stop doing it.
In reality the decision making process was “should I go to the mall at all.”
Once you are there you thought “should I stay for an additional half hour or should I go.”
The MARGINAL ANALYSIS approach to decision making is more comely used than the “all or nothing” approach.

35. Module 4: Trade & Comparative Advantage
Economies always produce more and obtain a higher standard of living when each economy specializes in a specific task and then trades with another. The process of globalization.

36. Gains from Trade
The key to a much better standard of living for everyone is trade.
The reason we have an economy is that there are gains from trade.
Gains from trade arise from specialization.
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37. Production Possibilities for Two Castaways: Tom and Hank
Figure 4.1
(a) Tom’s Production Possibilities by himself
Quantity of coconuts 30
Tom’s consumption without trade
Figure Caption:
Figure Production Possibilities for Two Castaways
Here, each of the two castaways has a constant opportunity cost of fish and a straight-line production possibility frontier. In Tom’s case, each fish always has an opportunity cost of 3⁄4 of a coconut. 9
Tom’s PPF 28 40
Quantity of fish
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38. (b) Hank’s Production Possibilities by himself
Figure 4.1
(b) Hank’s Production Possibilities by himself
Quantity of coconuts 20
Hank’s consumption without trade
Figure Caption:
Figure Production Possibilities for Two Castaways
Here, each of the two castaways has a constant opportunity cost of fish and a straight-line production possibility frontier. In Hank’s case, each fish always has an opportunity cost of 2 coconuts. 8
Hank’s
PPF 6 10
Quantity of fish
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39. Tom and Hank’s Individual Opportunity Costs
Tom’s Opportunity Cost
Hank’s Opportunity Cost
One fish
¾ coconut
2 coconuts
One coconut
4/3 fish
½ fish
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40. Tom should specialize in catching fish.
Both castaways are better off when they each specialize in what they are good at and trade.
Tom should specialize in catching fish.
Hank should specialize in gathering coconuts.
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41. (a) Tom’s Production and Consumption
(b) Hank’s Production and Consumption
Quantity of coconuts
Quantity of coconuts 30
Tom’s consumption without trade
Hank’s production with trade
Tom’s consumption with trade 20
Hank’s consumption with trade
By specializing and trading, the two castaways can produce and consume more of both goods. Tom specializes in catching fish, his comparative advantage, and Hank— who has an absolute disadvantage in both goods but a comparative advantage in coconuts—specializes in gathering coconuts. The result is that each castaway can consume more of both goods than either could without trade.
Tom’s production with trade 10 10
Hank’s consumption without trade 9 8 T o m 's
Hank's
PPF
PPF 28 30 40
Quantity of fish 6 10
Quantity of fish
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42. An individual has a comparative advantage in producing a good or service if the opportunity cost of producing the good is lower for that individual than for other people.
An individual has an absolute advantage in an activity if he or she can do it better than other people. Having an absolute advantage is not the same thing as having a comparative advantage.
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43. By agreeing to specialize and trade, both traders can be better off.
Comparative advantage is the basis for trade.
Trade can be beneficial to both even if one has an absolute advantage in the production of both goods.
By agreeing to specialize and trade, both traders can be better off.
Everyone has a comparative advantage in something.
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44. Rich Nation, Poor Nation
Most clothing is made overseas in countries that are much poorer than the U.S.
The immediate reason for their poverty is that their economies are much less productive.
Even though these economies are much less productive, these countries hold a comparative advantage in clothing production.
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45. International trade results from comparative advantage.
If the U.S. concentrates on producing pork and ships some of its output to Canada, while Canada concentrates on aircraft and ships some of its output to the U.S., both countries can consume more than if they insisted on being self-sufficient.
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46. (a) The U.S. Production Possibilities Frontier
(b) Canadian Production Possibilities Frontier
Quantity of aircraft
Quantity of aircraft
Canadian production with trade
3,000
U.S. consumption without trade
U.S. consumption with trade
Canadian consumption without trade
2,000
1,500
1,500
U.S. production with trade
Canadian consumption
with trade
Figure Caption:
Figure 2.6: Comparative Advantage and International Trade
In this hypothetical example, Canada and the United States produce only two goods: pork and aircraft. Aircraft are measured on the vertical axis and pork on the horizontal axis. Panel (a) shows the U.S. production possibility frontier. It is relatively flat, implying that the United States has a comparative advantage in pork production. Panel (b) shows the Canadian production possibility frontier. It is relatively steep, implying that Canada has a comparative advantage in aircraft production. Just like two individuals, both countries gain from specialization and trade.
1,000 U
.S.
Canadian
PPF
PPF 1 2 3
0.5 1
1.5
Quantity of pork (millions of tons)
Quantity of pork (millions of tons)
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47. Everyone has a comparative advantage in something.
A higher standard of living comes from specialization and trade and thus globalization is ultimately a benefit for all nations economically.
Comparative advantage explains the source of gains from trade between individuals and countries.
Everyone has a comparative advantage in something.
Absolute advantage is the ability to produce a particular good or service better than anyone else.
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