What Economics Is All About

Chapter 1

What is Economics All About?

n Satisfying human wants and needs.

n … as many as we can

n … with the resources available

n … with as little waste as possible

Utility from Goods and Services

n Utility – Satisfaction you receive from using a good or service.

n Good – Anything from which you receive utility or satisfaction

n Service – Any action from which you receive utility or satisfaction

Producing Goods and Services

n Resources – inputs into the production process

n Goods and Services – outputs from the production process

n Production process – the method by which we transform resources into goods and services

Resource Categories

n Land

n Labor

n Capital

n Entrepreneurship

Land

n All natural resources

n Minerals

n Forest products

n Water

n Agricultural products

Labor

n The physical and mental talents people contribute to the production process.

n Each worker’s time, talent, and effort.

Capital

n Goods that are produced to be used as inputs to produce other goods.

n Factories

n Machinery

n Tools

n Vehicles

n Also called capital goods.

Entrepreneurship

n A talent some people have to:

n organize resources to produce goods

n identify new business opportunities

n develop new ways of getting things done

Transformation process (chart)

Technology

n The application of knowledge to the production process

n to improve the capital goods.

n to improve the process.

Efficiency

n A process is efficient if the maximum possible amount of output (goods and services) can be produced out of the inputs consumed in the process.

n Inefficiency? – Waste products are produced.

Inefficient Transformation process (chart)

Scarcity

n The condition in which our wants and needs are greater than the limited resources available to satisfy them.

n Unlimited wants and needs

n Limited resources

n Scarcity has always existed and will always exist in the future.

We Must Choose!

n Which wants and needs will not be fulfilled?

n What are our priorities?

n Whose wants and needs will not be fulfilled?

n Who decides?

We Must Choose!

n Which is the best option?

n Which now?

n Which must be put off until later?

n …. according to our value system.

Value

n Intensely personal

n What is it worth to you?

n … based on your preferences, experiences, and learning.

Goal: Betterment

n Improve your situation

n Increase your net worth

n In business, make a profit

Influences

n Your valuation of:

n The benefits

n The costs

n Rewards

n Punishments

How Do We Do This?

n Act rationally

n Gather information

n Think it through

n Choose to maximize your betterment

n Do it one small step at a time …

Marginal Analysis

n Take small steps

n Value the marginal benefit (MB)

n Value the marginal cost (MC)

n Compare MB to MC

Decide

n If MB > MC, do it!

n Net worth goes up

n If MB < MC, don’t do it!

n If you do, net worth will go down

Efficiency

n Accept all steps where MB > MC.

n Reject all steps where MB < MC.

n Arrive at the step where MB = MC.

n Then, you have gained all you can possibly gain:

n You are efficient!

Efficiency: MB = MC (chart)

The Cost of Making a Decision

n When you choose Option A (your most valued option)

n …. you lose the opportunity to choose Option B (your second best choice).

n You suffer an opportunity cost.

Opportunity Cost

n It is the value you place on the next best alternative.

n The option you didn’t choose

n The option you put off

n The foregone alternative

n Every decision has an opportunity cost.

Types of Societies

n Command

n Market

n Mixed

Three Questions

n What to Produce?

n How to Produce?

n For whom to Produce?

Command

n The leader makes all decisions (to better himself first)

n What? Produce what the leader tells you to

n How? Do it the way the leader wants it done

n For whom? Goods are distributed according to the leader’s wishes

Market

n Individuals make decisions to better themselves

n What? Produce what consumers are willing to buy

n How? Profitably; set up a process to produce a salable good, keeping costs as low as possible

n For whom? Sell to those who are willing and able to buy

Mixed

n Most modern societies are a mixture of the market and command systems.

Rationing Device

n In any society, not everyone can get all wants and needs filled.

n There must be a rationing device:

n Market – purchasing power.

n Command – favoritism.

n People will compete to acquire the rationing device.

Definitions

n Economics: Studies how people make choices under the restraint of scarcity

n Macroeconomics: How a society, via its government, organizes to make these decisions

n Microeconomics: How individuals interact to make those decisions

Economics vs. Politics

n Positive statements: facts

n “what is”

n Normative statements: opinions

n “what should be”

Economic Activities: Producing and Trading

Chapter 2

The Economic Goal

n Satisfy the most valued wants and needs

n Do so by efficiently using available resources and technology

Production: The Key to Prosperity

n Goal: Satisfy as many unmet wants and needs as possible.

n With what? Produced goods and services.

n More production …. more satisfactions of wants and needs …. higher standard of living

Production Possibilities Frontier (PPF)

n Assumptions:

n Fixed amount of available resources

n Fixed technology

n PPF graphs all of the combinations of two goods that are possible to produce

PPF: data and graph (chart)

PPF: Trade-Off

n The trade-off identifies what must be given up of one good to get more of the other good

PPF: Trade-Off (4 charts)

Specialized Resources

n Any resource is better suited to do one task than it can do the other task.

n Shifting resources from one task to another may move some away from their best use

n … and toward where they are not so good

Law of Increasing Costs

n The Law of Increasing Costs:

n The trade-off gets worse and worse

n It costs more each time to get the same size increase, or …

n For the same cost, you get less in return each time.

The Law of Increasing Costs (chart)

Economic Concepts on the PPF (chart)

Concepts on the PPF

n Scarcity: We can only produce so much with the limited resources.

n Choice: Society must choose where on the PPF to operate.

n Opportunity Cost: Choose point A and we can’t have point B.

Concepts on the PPF

n Efficiency: Produce as much as possible using available resources.

n Inefficiency: Produce less than the maximum possible; waste resources.

PPF: efficient, inefficient, unattainable points (chart)

Concepts on the PPF

n Growth: expand the PPF outward (into the unattainable area) by:

n adding resources

n improving technology

n More wants and needs can be satisfied.

n Standard of living increases.

PPF: Economic Growth (chart)

PPF: Economic Growth

n Economic growth will occur faster if society emphasizes capital formation over consumer goods

n Producing capital goods adds resources

n PPF pushes outward faster

Trade

n We are not self-sufficient.

n We rely on others to produce what we need to satisfy our wants and needs.

n In our money economy, we work for an income, so we can purchase goods and services.

Buyer-Seller Relationship

n Buyers buy when perceived value of a good (MB) > price (MC).

n Sellers sell when price (MB) > costs of producing and marketing the good (MC).

n Otherwise, no deal.

Who Produces?

n Specialists produce goods and services because they have a comparative advantage over the buyers.

n Comparative advantage:

n you can produce a good at a lower opportunity cost than some one else.

Raising the Standard of Living

n People specialize to produce a product in which they have a comparative advantage.

n Specialists produce more goods more efficiently.

n Less waste of resources

n More wants and needs get satisfied.

n Standard of living goes up.

Raising the Standard of Living

n “The wealth of a nation is not in the king’s treasury, but in the talents and productivity of its citizens.”

n “An Invisible Hand guides each person to not only better himself but to make his fellow man better off, promoting the greater good as well.”

n - Adam Smith, 1776

Who Buys?

n Those who cannot produce goods and services at a comparative advantage.

n … who do not have a comparative advantage and would produce the good at a higher opportunity cost.

n It is wise to become the customer and let the specialist produce the product.

Before the Trade

n Buyer values the good (MB).

n Buyer values the price (MC).

n If MB > MC, buy!

n Buyer is better off.

n If MB < MC, don’t buy!

During the Trade

n Buyer:

n gets the good.

n pays the price.

n Seller:

n gets the price.

n gives up the good.

After the Trade

n Reality:

n Is the value of the good really greater than the price?

n Yes? – You made a good deal.

n No? – Buyer’s remorse. Learn from your mistake.

Terms of Trade

n How much of one thing must you give up to acquire another thing.

n In modern trade: product for money

n Terms of trade must be below buyer’s valuation and above seller’s cost of production, or no deal.

Value and Cost

n Value – what the buyer thinks the product is worth

n Cost – what the seller must pay to produce and market the product

n Both terms include opportunity cost (what could I do instead?)

Price

n Offering price – the seller tags a good at a dollar amount at which he wants to sell

n Actual price – the agreed upon dollar amount the buyer will pay the seller

Deal? … or No Deal?

n Buyer’s value > price…

n … and price > seller’s cost? DEAL!

n Buyer’s value < price? NO DEAL!

n Price < seller’s cost? NO DEAL!

What Sets the (actual) Price?

n The interaction of:

n buyers’ behavior (law of demand) and

n sellers’ behavior (law of supply).

How does the market work?

n Set up buyer behavior (demand)

n Set up seller behavior (supply)

n Let demand and supply interact

n Quickly accommodate for:

n changes in demand and

n changes in supply