SECTION 1 Basic Economic Concepts Review from summer

SECTION 1: Basic Economic Concepts

Review from summer reading Economics is the study of scarcity and choice. Simple definition • At the most basic level, we are going to look at individual choice, decision made by everyone regarding what to do and what not to do Economy is a system that coordinates choices about production (businesses) with choices about consumption (individuals), and distributing good and services to the people who want them.

Review from summer reading Traditional Economies: • Decisions about what to produce, how to produce and to whom goods and services will be allocated generally repeat decision made in earlier times (previous generations) • Found in parts of Africa, Asia, South America, the Middle East, and Canada (Inuit cultures) Command Economies: • Decisions of production are publicly owned and economic activity is controlled by a central authority that determines what is produced, how goods and services are produced, and whom gets them

Review from summer reading Market economy: Production and consumption are the result s of decentralized decisions made by firms and individuals. Choices drive everything, no central authority deciding for us. • Firms will make choices based on what will be most profitable • Individuals make choices on what will benefit them the most Incentive: rewards or punishments that motivate particular choices • In market economies, incentive drives choices Property rights: Establish ownership and grant individuals the right to trade goods and services with one another • Ownership creates incentive to produce things of value, either to keep, or to trade for mutual gain

Review from summer reading The gain from doing something one more time is called a marginal benefit • EXAMPLE: Where else can I go (what will I gain) when I put in one more gallon of gas into my car for the week? The cost of doing something one more time is called a marginal cost • EXAMPLE: What will I lose (what is the my cost) of buying a second latte today; what will I miss out on with the $4? The study of marginal benefits vs marginal costs is called marginal analysis • VERY IMPORTANT because the formula of doing things until the marginal benefit no longer exceeds the marginal costs is the key to deciding how much we do of any activity, both in business and our personal lives

Review from summer reading How do we decide what to do? • Many of our decisions are made on an incremental basis • if MB >= MC, do it. • If MB < MC, do not.

Review from summer reading A Resource is anything that can be used to produce something; ECONOMIC Resources are called Factors of Production (Four categories): • Land – all resources that come from nature; timber, water, minerals, animals, etc…) • Labor – the effort of workers • Capital – machinery, buildings, tools, and all manufactured goods used to other make goods and services • Entrepreneurship – risk taking, innovation, the organization of other resources All resources are scarce: there is not enough to satisfy the various needs and wants of society Society makes choices on how to use its resources through individual choices. The sum of all individual choices results in societal choice • You decide what gets consumed and produced through your purchasing habits • There are instances where there is no incentive to act a certain way even though there is a need for the result • Ie parks and green spaces. Firms may not be profitable by creating parks – governments will buy up land to create it (this is called market failure which will be covered later)

Opportunity Costs • Opportunity costs: the value of what you must give up when you make a particular choice • EXAMPLE: The opportunity cost of choosing an activity is not equal to all of the forgone opportunities; it is the cost of the one with the highest value. For example, suppose a student chooses to study economics for one hour after school. In that hour, he could have: • Worked at the grocery store for $10 per hour, or • Mowed his grandmother’s yard for $20. What is the opportunity cost of studying? • The opportunity cost of studying is $20, not $30, because he could not have both worked at the grocery store and mowed the yard.

Positive vs. Normative Economics • Are we answering a question with a right or wrong answer? This is called positive economics. • Are we answering a question about how things should be or work? This is called normative economics. • This is what we see in the news today with the presidential race: • Positive Economics • How many jobs are created as a result of increased infrastructure spending? • How many jobs are created as a result of tax breaks for green energy research and development? • How much revenue will be generated if the tax rate for the richest Americans is raised? • How much will GDP decrease if we continue to cut government programs? • Normative Economics • Should we increase taxes on the rich? • Should decrease government spending? Increase? • Should we provide tax breaks for green industries?

PRODUCTION POSSIBILITIES MODEL Module 3

Class Activity Get into 4 groups

Production Possibilities Curve (PPC)

Production Possibilities Curve (PPC) • Production Possibilities Curve is a model that demonstrates trade-offs • Simplifies the economy by showing only two goods • Curve shows the maximum efficient output with the given resources • Points inside the curve are inefficient • Points outside the curve are unattainable at this time with the resources we have • You could get there with more capital, labor skills, etc…

Production Possibilities Curve (PPC) The goal is to achieve efficiency. An economy is efficient when there are no missed opportunities; there is no way to make some people better off without making others worse off. We are using all resources to produce along the curve • Inefficiency within our economy • Involuntary unemployment – people want jobs • There could possibly be more produced if people were employed

Constant Opportunity Costs

Constant Opportunity Costs • Slope (Opportunity Cost) • Opportunity Cost of moving from A to B • 8 more fish, 6 fewer coconut • 8 fish = 6 coconuts • 1 fish = ¾ coconut

Increasing Opportunity Costs

Increasing Opportunity Costs • The opportunity cost of producing the first 20 fish • 20 fish = 5 coconuts • 1 fish = ¼ coconuts • The opportunity cost of producing an additional 20 fish • 20 fish = 25 coconuts • 1 fish = 5/4 coconuts

Increasing Opportunity Costs This is more realistic for most choices There is something that economists call the “Law of increasing opportunity costs” • The more of a product produced the greater is its (marginal) opportunity cost. • 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.

Does the curve move? • If resources are scarce, how can the economy grow? • Increase in population • More efficient capital • Technological Advances • The PPC shows what economic growth means; a sustained rise the aggregate output • Aggregate; the sum total, collective whole

Economic Growth

COMPARATIVE ADVANTAGE AND TRADE Module 4

Are we better off when we trade? Could your family take care of all of its needs? • Grow all of your own food? • Make your own cloths? • Create your own entertainment? • Product your housing?

Are we better off when we trade? We are better off as individuals and society from trade; people dividing tasks among themselves and each person provides those goods and services to other in exchange for the goods and services they want • Increases our standard of living, quality of life • We can produce more The reason we have an economy is because there are gains from trade; we can get more of what we want than if we were self-sufficient • The division of tasks (labor) is called specialization; • This is the key to trade

Adam Smith, The Wealth of Nations “One man draws out the wire, another straights it, a third cuts it, a fourth points it, a fifth grinds it at the top for receiving the head; to make the head requires two or three distinct operations; to put it on, is a particular business, to whiten the pins is another; it is even a trade by itself to put them into the paper; and the important business of making a pin is, in this manner, divided into about eighteen distinct operations. … Those ten persons, therefore, could make among them upwards of forty-eight thousand pins in a day. But if they had all wrought separately and independently, and without any of them having been educated to this particular business, they certainly could not each of them have made twenty, perhaps not one pin a day. …”

Specialization (Division of Labor) How do we see specialization is our society? • Medical Industry • Docs, Nurses, PAs, Technicians, etc… • Airline Industry • Pilots, mechanics, air traffic controllers • Lawyers • Construction Industry • Etc…they all take time to study, we could not possibly study everything we need due to time constraints

Comparative Advantage PPCs help illustrate the gains from trade, trade based on comparative advantage Comparative advantage exists if the opportunity costs (what is given up) for producing the good or service is lower for another producer • It costs that producer less to produce the same amount

Comparative Advantage • Trade is beneficial is each party is more specialized in a different area • Trade is beneficial even if one party is not necessarily specialize (good) in something

Comparative Advantage

Comparative Advantage As long as people have different opportunity costs, EVERYONE has a comparative advantage in something, and everyone has a comparative disadvantage in something NOTE: Tom has an absolute advantage in both goods. • He can produce more of both goods with a given amount of input (time). • As it is shown, Tom can still gain with trade because Hank has a comparative advantage • Comparative advantage determines trade benefits • This is the argument against isolationism; • Producing goods for Americans within our borders, no imports of foreign goods

International Trade

Comparative Advantage Example 2

Comparative Advantage Example 2 Will these two countries gain from trade if 100 units of malaria medicine are traded for 200 cotton shirts? To find out: 1. Calculate the opportunity costs of production for each country 2. Determine the comparative advantage for each country 3. Determine if the terms of trade are mutually beneficial

Comparative Advantage Example 2 Bangladesh United States Cotton Shirts (C) 750 C = 250 M 1 C = 1/3 M 1000 C =1000 M 1 C = 1 M Malaria Medicine (M) 250 M = 750 C 1 M = 3 C 1000 M =1000 C 1 M = 1 C

Comparative Advantage Example 2 Cotton Shirts (C) Malaria Medicine (M) Bangladesh United States 750 C = 250 M 1 C = 1/3 M 1000 C =1000 M 1 C = 1 M 250 M = 750 C 1 M = 3 C 1000 M =1000 C 1 M = 1 C Bangladesh has a comparative advantage in Cotton Shirts (C) because they only give up 1/3 unit of medicine while The United States must give up 1 unit of medicine to gain 1 cotton shirt. The United States has a comparative advantage in Malaria Medicine (M) because they only give up 1 cotton shirt while Bangladesh must give up 3 cotton shirts to gain 1 unit of medicine.

Comparative Advantage Example 2 The terms of trade are mutually beneficial as long as they are between the two countries’ opportunity costs. Bangladesh United States Cotton Shirts (C) 750 C = 250 M 1 C = 1/3 M 1000 C =1000 M 1 C = 1 M Malaria Medicine (M) 250 M = 750 C 1 M = 3 C 1000 M =1000 C 1 M = 1 C For example, any amount of medicine greater than 1/3 and less than 1 traded for 1 cotton shirt would represent mutually beneficial terms of trade. Likewise, any number of cotton shirts greater than 1 and less than 3 traded for 1 unit of medicine would represent mutually beneficial terms of trade.

Comparative Advantage Example 3 Apples Timber Opp. Cost of Apples Oregon 10 40 1 Timber = ¼ Apples 1 Apple = 4 Timber Washington 40 10 1 Timber = 4 Apples 1 Apples = ¼ Timber

Apples Timber Opp. Cost of Apples Oregon 10 40 1 Timber = ¼ Apples 1 Apple = 4 Timber Washington 40 10 1 Timber = 4 Apples 1 Apples = ¼ Timber