What Economics Is About
Utility
n
What you receive from using a good or service:
n
The utility
n
The satisfaction
n
The benefit
A Good
n
Anything from which you can receive utility or
satisfaction of a previously unfulfilled want or need.
n
Also called a product.
n
Anything from
which you can receive utility or satisfaction of a previously unfulfilled want
or need.
n
Also called a
product.
n
Two types:
n
Goods – can be
produced ahead of time and put into inventory
n
Services – cannot
be produced ahead of time; must be produced in real time
A “Bad”
n
Anything you use that gives you dissatisfaction
n
Disultility
n
The dissatisfaction you receive from using a
“bad”.
Scarcity
n
Human wants are always greater than the limited
resources available for use to satisfy them.
n
This is the economic problem.
n
It exists whenever scarce means must be used to
satisfy alternative ends.
n
-Milton Friedman
Resources
n
Inputs into a process that transforms them into
outputs designed to satisfy wants and needs.
n
Four categories:
n
Land
n
Labor
n
Capital (capital goods)
n
Entrepreneurship
Land
Ø
All natural resources, such as:
Ø
Minerals and petroleum
Ø
Forests
Ø
Water
Ø
Acreage
Ø
Agricultural products
Labor
n
The physical and
mental talents and the time people contribute by going to work.
n
Time
n
Talent
n
Effort
Capital (capital goods)
n
Produced
goods that are
used as inputs for further
production, such as:
factories
tools
machinery
buildings
vehicles
Entrepreneurship
n
The
talent of some
people to:
organize a production
process
seek new business
opportunities
develop new ways of
producing
Transformation Process (add diagram)
Technology
n
The application of knowledge to the production
process:
n
To improve the process itself.
n
To improve the capital goods (tools).
n
To improve the ability of labor.
Wants and Needs
n
The unfilled desires of people.
n
Which is which? Depends on the urgency.
n
You place a higher priority on some wants and
needs over other wants and needs
Economics
n
The science of dealing with scarcity.
n
The study of how individuals and societies deal
with scarcity.
n
The study of how humans go about their ordinary
business of life
Scarcity
n
Peoples’ wants are unlimited.
n
The resources used to satisfy those wants are
limited.
n
Therefore, some of these wants will not be
fulfilled.
n
High priority wants will be filled first.
n
Scarcity requires choice must be made.
n
Who makes the choices?
Scarcity and Choice
n
In a world of limited resources, somebody must
choose which (and whose) wants will be satisfied and which will go unsatisfied
(for now).
n
Who chooses?
n
you for yourself, or
n
somebody else for you
Rationing Device
n
This is a method of deciding who gets what
quantities of the available resources and the available goods.
n
People compete for the rationing device:
n
in a market based system: purchasing power
(income)
n
in a command based system: the dictator’s favor
What do these Groups compete for?
n
Buyers
n
Sellers
n
Employers
n
Employees
n
Nations
n
Students
n
Everyone
Opportunity Cost
n
This is the one cost every choice has.
n
It is the value the decision maker places on the
next best choice, the choice not taken, the foregone alternative.
n
If opportunity cost is low, it is very easy to
make the choice.
n
If opportunity cost is high, it is very hard to
make the choice.
Marginal Analysis: Benefits and Costs
n
Every choice
involves:
n
the value
of what you will get (the benefit)
n
and the value
of what you must give up to get it (the cost).
n
Most choices
should be made step-by-step.
n
This is called
the marginal step.
n
Thus, we have:
n
marginal
benefit (MB) of the next step
n
marginal cost
(MC) of the next step
Benefit-Cost Analysis
n
Should you take the next step?
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If MB > MC, do it!
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You will get back more than you give up.
n
You will be better off.
n
If MB < MC, don’t do it!
n
You would get back less than you give up.
n
You would be worse off.
n
If you don’t do it, you are no better nor no
worse off than before.
Efficiency
n
Getting the most valued wants and needs
fulfilled with the consumption of the smallest amount of resources.
n
Eliminating the production of waste products.
How to be Efficient
n
If MB > MC, say “yes” and evaluate the next
step.
n
Keep doing this step after step until MR = MC,
then stop.
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If MR = MC … you are efficient.
n
You can’t do better than that.
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If MB < MC, say “no”.
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Do not take the next step.
Incentives and Disincentives
n
Incentives (Rewards):
n
Raises MB
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Make you more likely to say “yes”
n
Disincentives (Punishments):
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Raises MC
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Make you more likely to say “no”
“There is no such thing as a free
lunch”
n
Nothing is really “free”
n
Resources must be used up to create a
satisfaction
n
Alternative uses of those resources must be
foregone
n
An opportunity cost is always incurred
Ways of Looking At Economics
n
Positive Economics – how things ACTUALLY DO work
n
facts; “what is”; cause and effect
n
Normative Economics – how we WISH things would
work
n
opinions; “what should be”
Ways of Looking At Economics
n
Microeconomics –
study of human behavior and choice making as individuals, as a firm, an
industry, an employer, an employee, a seller and a buyer
n
Macroeconomics –
study of human behavior and choice making as a society and as participants in
government, the agent of society
Macro Questions
n
How should society be organized?
n
market-based or command-based
n
What causes economic problems?
n
unemployment, inflation, stagnation
n
What causes economic growth and an increase in
the standard of living?
n
How can government influence these problems?
Our Approach
n
What are the
Production Possibilities?
n
Market vs.
Command Societies
n
Operating in a
Market System
n
Macroeconomic
Measurements
n
Modeling Economic
Problems
n
Policies to Solve
Economic Problems
n
Fostering
Economic Growth
n
Global Economics
Economic Activities: Producing and
Trading
Production Possibilities Frontier (PPF)
n
Shows the possible combinations of two goods that
an economy can produce.
n
Assumes a fixed amount of resources available
and a given state of technology.
Production Possibilities Frontier (PPF)
n
Society can
choose from combinations of capital goods and consumer goods:
(add the diagram)
n
CAPITAL CONSUMER
n
20 0
n
18 1
n
14 2
n
8
3
n
0
4
PPF – Trade-off
n
Society must give
up production of one good to increase production of the other good: (add the
diagram)
n
CAPITAL CONSUMER
n
20 0
n
18 1
n
14 2
n
8
3
n
0
4
Production Possibilities Frontier (PPF)
n
As more of a good
is produced, the opportunity cost of producing that good increases.
n
Law of Increasing
Costs:
n
resources and
technology are better suited to produce one of the goods than the other.
n
shifting them
from one to the other makes the trade-off worse each time more is shifted.
n
because of this,
the PPF is bowed outward
PPF – The Law of Increasing Costs
n
Increased
production of one good will be more and more costly in what must be given up of
the other good (add the diagram)
n
CAPITAL CONSUMER
n
20 0
n
18 1
n
14 2
n
8
3
n
0
4
PPF – The Law of Increasing Costs
n
It works the
other way, too (Then it is called the Law of Diminishing Returns)
n
CAPITAL CONSUMER
n
20 0
n
18 1
n
14 2
n
8
3
n
0
4
Example: Law of Increasing Costs (diagram)
Economic Concepts on the PPF (diagram)
Economic Concepts on the PPF
n
The PPF itself
represents scarcity.
n
The point on the
PPF selected by society represents the need to choose.
n
When society
chooses one point, it gives up the opportunity to choose some other point,
incurring an opportunity cost.
Economic Concepts on the PPF
n
Moving from one
point to another on the PPF (green arrow) demonstrates MB and MC and the
trade-off (red arrows) inherent in making a decision.
n
Each shift incurs
an opportunity cost.
Economic Concepts on the PPF (diagram)
n
Productive
efficiency: any point on the PPF (red X).
n
Productive
inefficiency: any point inside the PPF (blue X). There are unemployed
resources.
n
Unattainable: any
point outside the PPF (green X).
Economic Concepts on the PPF (diagram)
n
Short-run
economic growth:
n
Put unemployed
resources to work.
n
Move from an
inefficient point inside the PPF out to the PPF.
n
Long-run economic
growth:
n
Add resources
and/or technology.
n
The PPF pushes
outward.
n
More can be
produced by society.
n
Economic growth
will occur faster if society emphasizes capital goods over consumer goods.
Trade
n
You will trade one item for another if you get
back greater value than you give up.
n
You trade to become better off.
n
Buyer: value received > price, or no deal.
n
Seller: price > cost to produce and market,
or no deal.
Before A Trade
n
Gather information
n
Place a value on the item you’ll get (MB)
n
Place a value on what you’ll give up (MC)
n
If you perceive MB > MC, make the trade
During A Trade
n
Buyer:
n
Receives the good (MB)
n
Pays the price (MC)
n
Seller:
n
Receives the price (MB)
n
Turns over the good (MC)
After A Trade
n
Reality sets in (no longer in the future)
n
Still believe MB > MC?
n
Yes: you made a good decision
n
No: buyer’s remorse.
n
Strive to do a better job of decision making
next time
n
(Learn from your mistakes)
Terms of Trade
n
= How much of one thing must you give up to
acquire another thing.
n
School yard barter: 2 candy bars for 1 toy
n
Modern market: $30,000 for 1 Toyota Camry
n
Terms of trade must be below buyer’s valuation
and above seller’s cost of production, or no deal.
What are we looking for?
n
Buyer: satisfaction of an unfilled want
n
Seller: profit from producing and marketing a
good
n
Matching up a buyer and a seller involves
transaction costs
n
The entrepreneur strives to lower transaction
costs
Comparative Advantage
n
The ability to produce a good at a lower
opportunity cost than others.
n
If you have the comparative advantage, you
produce the good and the others become your customers.
Comparative Advantage
n
If you have the comparative advantage,
specialize in producing that good.
n
Produce more than you need and sell it to others
for income.
n
Use the income to acquire the goods you want.
n
This concept applies to individuals and to
nations.
Organizing using 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.
Economic Systems: Command
n
Dictator chooses which combination of goods to
produce.
n
According to his value system.
n
Where on the PPF society will be.
n
Rationing is done by favoritism.
n
You can succeed by getting in good with the
dictator.
Economic Systems: Command
n
Dictator rewards those he favors.
n
Dictator punishes those he does not favor.
n
Government controls the decision making
mechanism.
Economic Systems: Market
n
Individuals
choose which combination of goods to produce.
n
According to each
individuals’ value system.
n
Where on the PPF
society will be.
n
Rationing is done
by purchasing power.
n
You can succeed
by making yourself more valuable to society and your employer.
n
In this way, your
income (and purchasing power) rises.
Economic Systems: Market
n
The market provides goods to those who want them
and can afford them.
n
It provides no goods to those who don’t want
them, can’t afford them, or have higher priorities elsewhere.
n
Individuals control the decision making
mechanism.
Economic Systems: The Three Economic Questions
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What to Produce?
n
How to Produce?
n
For Whom to Produce?
Command System’s Answers
n
What?
n
Whatever the dictator says to produce
n
How?
n
In the way the dictator wants it done
n
For whom?
n
For those in favor of the dictator
Market System’s Answers
n
What?
n
Produce goods
customers are willing to buy
n
How?
n
Profitably;
produce an acceptable good while keeping production costs low
n
For Whom?
n
Produce for those
who are both willing and able to buy it.
Property Rights
n
Basic question: Who decides what can be done
with property accumulated as a result of work, income, and use of purchasing
power?
Property Rights
n
Command System:
n
This right is reserved to the dictator.
n
Market system:
n
This right is reserved to the individual who has
acquired the property.
Property Rights
n
Nations that
protect the rights of its citizens to acquire and hold property have faster
economic growth and a higher standard of living than those that do not.
n
No property
rights?
n
Two classes: the
few ruling elite and the numerous poor.
n
Property rights?
n
A robust
prosperous middle class emerges out of the poor.
Property Rights
n
Protected
property rights generate incentives to:
n
Improve oneself
n
Acquire education
n
Accumulate goods
n
As a result:
n
A prosperous
middle class is created
n
PPF pushes
outward faster
n
Standard of
living increases faster
The Wealth of A Nation
n
Adam Smith, 1776
n
“The wealth of a
nation is not in the king’s treasury, but in the talents and productivity of
its citizens.”
n
“It is as if an Invisible
Hand guides each person, in the process of bettering himself, must make his
fellow man better off and promote the greater good as well.”
n
An enlightened
government promotes the Invisible Hand