The Basics of Economics PDF

The Basics of Economics PowerPoint Slides prepared by: Andreea CHIRI...

The Basics of Economics PowerPoint Slides prepared by: Andreea CHIRITESCU Eastern Illinois University © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed 1 with a certain product or service or otherwise on a password-protected website for classroom use.  Economics: A Study of Resource Allocation Decisions Economy – “oikonomos” (Greek) – “One who manages a household” Household - many decisions – Allocate scarce household resources to produce goods they want; decide how to divide it among members Resources are factors of production; what people can use to produce goods and services What do people use to produce something? © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed 2 with a certain product or service or otherwise on a password-protected website for classroom use.  Resources – factors of production Land or natural resources– the gifts of nature; land, forest, waters, wildlife, rain, wind, minerals Labor or human capital – quantity and quality (health, knowledge and skills) of the human work force Physical Capital – man-made goods used to produce more goods; tools, buildings, equipment, machines, roads, irrigation, factories, office space, seaports, airports 3 of 40  Economics: A Study of Resource Allocation Decisions  Economics As A Study of Resource Allocation Decisions Society has to make similar decisions – Allocate resources - decide on what to produce – Decide who will get what Economics is the study of how individuals and societies choose to use scarce resources to produce commodities that satisfy human wants. © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed 5 with a certain product or service or otherwise on a password-protected website for classroom use.  Economics as a Social Science Social Science – the study of human behavior. Ex. Economics, Psychology, Sociology, Anthropology, Political Science, etc. Physical Science – the study of natural phenomena. Ex. Physics, Chemistry, Biology, etc. What do they have in common? 6 of 33  Scientific Method The observation of an event and defining the problem. Ex. An apple falling from the tree Formulation of a theory or hypothesis. Ex. Newton’s Law of Gravitation. Testing the theory through experiments. 7 of 33 Law of Gravitation  The Scientific Method in Economics The observation of an event and defining the problem. Ex. Money supply and prices. Formulation of a theory or hypothesis. Ex. Quantity Theory of Money. P=VM/Y. Testing the theory through statistical techniques using historical or cross- section data. 9 of 33 The Quantity Theory of Money  Economics as a Resource Allocation Decision: The Economic Problem Human wants are unlimited But resources are scarce; scarcity Society has to decide what to produce with its limited resources, how, and for whom © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed 11 with a certain product or service or otherwise on a password-protected website for classroom use.  Resources are Scarce Natural resources are non- renewable or take time to be renewed; fossil fuels and trees Development of human capital takes time Physical capital depreciates and it takes time to rebuild or reproduce 12 of 40  Human Wants are Unlimited Distinguish between human wants and human needs Human needs refer to the basic necessities for human survival such as food, clothing, shelter, medical services, etc. Human wants consists of human needs and the desire for other goods and services that enhance human welfare  Implication of Scarcity Resources are scarce and have alternative uses; human wants are unlimited Society has to use its resources efficiently; resources should not be wasted Allocation decision: society cannot produce everything people want; needs to decide what and how much of each good and service to produce  The Resource Allocation Problem Because resources are scarce and have alternative uses, society faces trade-offs; to get more of one good, it has to get less of another good What society gives up or foregoes when it chooses one alternative over another is the opportunity cost of the good  How People Make Decisions People face trade-offs when making decisions To get something we like we often have to give up something else that we also like ex. Pair of shoes versus 2 pairs of pants When parents decide to spend their income on a car, it means less will be available for other things like a family vacation When a student spends more time watching TV or browsing social media, less time will be available to study © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed 16 with a certain product or service or otherwise on a password-protected website for classroom use.  How People Make Decisions The cost of something is what you give up to get it Opportunity cost – Whatever must be given up to obtain one item Because people face trade-offs, they have to compare the benefits and costs of their decisions © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed 17 with a certain product or service or otherwise on a password-protected website for classroom use.  Ex. College Education Benefits – intellectual enrichment, a lifetime of better job opportunities, and higher earnings, status and prestige Opportunity costs – tuition, books, room and board, income foregone from current employment If the benefits exceed the costs: go for it. Otherwise...l 18 of 40  Principle#2: TheCost of Something IsWhat YouGiveUptoGet It.  Basketball star LeBron James understands opportunity costs and incentives. He chose to skip college and go straight fromhigh school to the pros where he earns millions of dollars. CHAPTER 1 TENPRINCIPLES OF ECONOMICS 11 © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed 19 with a certain product or service or otherwise on a password-protected website for classroom use.  Another Example: Allocation of Land for Alternative Uses Vast tracks of irrigated, productive, agricultural land (Pampanga, Bulacan, Laguna, Batangas) converted for industrial, commercial, housing) Concerned policy makers pushing for the enactment of the National Land Use Act to regulate land allocation from agriculture to alternative uses Economists are concerned: why prevent conversion if the benefits from additional conversion exceed the additional costs  A Framework for Understanding Economic Decision-Making Rational people think at the margin Rational people – Systematically & purposefully do the best they can to achieve their objectives Marginal changes – Small incremental adjustments to a plan of action In making a decision, rational people compare marginal benefits and marginal costs © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed 21 with a certain product or service or otherwise on a password-protected website for classroom use.  How People Make Decisions Marginal benefits – Additional benefits Marginal costs – Additional costs Rational decision maker – Take action only if: – Marginal benefits > Marginal costs © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed 22 with a certain product or service or otherwise on a password-protected website for classroom use.  Examples We do not decide whether to get an education or not; we decide if the marginal benefit of additional education is greater than the marginal cost 10 hamburgers x P200 = P2000, total cost = P1500, profit = P500; plan to increase production by 3 more and this will cost an additional P700. Should you increase production by 3 more hamburgers? Suppose government has to pay P100M a year for a nuclear power plant for 20 years with an annual operating cost per year of P50M and sales of P100M. Plant life is 20 years. Should it operate the plant? Partial scholarships © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed 23 with a certain product or service or otherwise on a password-protected website for classroom use.  Seatwork It costs an airline $100,000 in fixed costs (fuel, crew, etc.) to fly a 200-seat plane across the country plus $20 per passenger for meals (variable cost). Suppose it charges each passenger $600 for a plane ticket but on average can only sell 190 tickets. It can sell all 200 tickets if it offers a 50% discount on 10 tickets on a first-come basis to standby passengers. The additional cost of taking in the 10 additional passengers is $20 per passenger for the meals, snack and refreshments. 1. What is the marginal benefit of taking in ten additional passengers with the discount? 2. What is the additional cost of the ten additional passengers? 3. What is net profit of the airline if it does not offer the discount? 4. What is the net profit if it offers the discount? 5. Should it offer the discount, yes or no?  The Production Possibilities Frontier Concepts illustrated by the production possibilities frontier – Scarcity – Choice – Opportunity cost – Efficiency – Economic growth  The Production Possibilities Frontier The production possibilities frontier is a graph that shows the maximum combinations of output that the economy can produce given the available factors of production (natural resources, human capital, physical capital) and the available production technology. Potential output  The Production Possibilities Frontier Quantity of Computers Produced 3,000 C A 2,200 2,000 B Production possibilities frontier 1,000 D 0 300 600 700 1,000 Quantity of Cars Produced  Production Possibilities Frontier All resources devoted to the production of cars = 1000 cars, 0 computers; All resources devoted to computers = 3000 computers, 0 cars Allocate resources to produce both, point A or B or any other point between the two end points Because resources are scarce, C is not attainable; only points along or below the PPF Points A, B or any point along the PPF is efficient. Points below such as D are inefficient. Efficient – economy produces all it can given its resources and technology Inefficient – economy is producing less than it can; wasteful because it there is no opportunity cost to increasing production of any good. Once we have reached the efficient points, there are tradeoffs; when we want more of one thing, we must give up another thing What we give up is the opportunity cost Economic Growth  Economic Growth The PPF can expand outwards reflecting economic growth Economic growth → growth in productivity Productivity – the amount of goods and services produced from each hour of a worker’s time – Increases in the factors of production – Technological change or progress  Economic Growth Can be achieved thru an increase in productivity via – Increase in natural resources – Increase in human capital – Increase in physical capital – Technological progress Increase in natural resources -ex. discovery of oil, transforming deserts into arable land, etc. © 2007 Thomson South-Western Increase in human capital investments in the education, skills, and health of the workforce Increase in physical capital Increase in investment; investment is the increase in the capital stock (machines, equipment, tools) 34 of 40  Technological progress – through research and development; ex, hybrid seeds, robotics, © 2007 Thomson South-Western  Mechanisms for Resource Allocation: Economic Systems Command economies The market system The mixed economy (market and command) © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed 36 with a certain product or service or otherwise on a password-protected website for classroom use.  Command Economy In a command economy, a central government either directly or indirectly sets output targets, incomes, and prices. Central agency guided by long, medium, and annual plans Has led to shortages and surpluses and long lines Collapse of the Soviet Union; market reforms in China  Market Economy Allocates resources – Through decentralized decisions of many firms and households – Firms decide whom to hire and what to make and how much; households decide where to work and what to buy – Interact in markets for goods and services – Guided by prices and self interest © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed 38 with a certain product or service or otherwise on a password-protected website for classroom use.  Market Economy How is the well-being of society promoted in an economy of numerous buyers and sellers each pursuing its own interest? Households and firms interacting in markets are guided in their decisions by prices Prices reflect both the value of the good to the consumer and its cost to the producer Ex. if a good is valued more, price rises, firms produce more of it  Market Economy Adam Smith’s “invisible hand” – Households and firms interacting in markets Act as if they are guided by an “invisible hand” – the price system Leads them to desirable market outcomes © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed 40 with a certain product or service or otherwise on a password-protected website for classroom use. The Market Economy  Firms and Households: The Basic Decision-Making Units A firm is an organization that transforms resources (inputs) into products (outputs). Firms are the primary producing units in a market economy. An entrepreneur is a person who organizes, manages, and assumes the risks of a firm, taking a new idea or a new product and turning it into a successful business. Households are the consuming units in an economy.  Input Markets and Output Markets: The Circular Flow The circular flow of economic activity shows how firms and households interact in input and output markets. Product or output markets are the markets in which goods and services are exchanged. Input markets are the markets in which resources—labor, capital, and land—used to produce products, are exchanged.  Factor Markets Input or factor markets are the markets in which the resources used to produce products are exchanged. They include: – The labor market, in which households supply work for wages to firms that demand labor. – The capital market, in which households supply their savings, for interest or for claims to future profits, to firms that demand funds to buy capital goods. – The land market, in which households supply land or other real property in exchange for rent. Market Economy: The Circular Flow MARKETS Revenue FOR Spending GOODS AND SERVICES Goods Firms sell Goods and and services Households buy services sold bought FIRMS HOUSEHOLDS Produce and sell Buy and consume goods and services goods and services Hire and use factors Own and sell factors production of of production Factors of MARKETS Labor, land, production FOR and capital FACTORS OF PRODUCTION Wages, rent, Households sell Income and profit Firms buy = Flow of inputs and outputs = Flow of dollars  The Role of Government If a market economy is efficient, do we need to have governments? Should government intervene in the economic sphere? What is the role of government in a market economy?  Governments can improve market outcomes We need government – Enforce rules and maintain institutions Enforce property rights – Promote efficiency Remedy market failure (public goods, externality, market power of cartels and monopolies) – Promote equity Reduce inequality (disparities in economic wellbeing) © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed 47 with a certain product or service or otherwise on a password-protected website for classroom use.  1. Uphold property rights Property rights – Ability of an individual to own and exercise control over scarce resources; people will not produce if anyone is free to steal, contracts are violated with impunity Need for government to uphold valid contracts, defend the right to own property, keep people safe from those who would deprive them of their possessions © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed 48 with a certain product or service or otherwise on a password-protected website for classroom use.  Uphold Property Rights Government passes laws and establishes a court system to enforce property rights Need for a justice system that is impartial, fair, and firm No one would sell property, invest in a business, or have confidence in contracts if this fair, impartial legal system did not exist  2. Remedy market failure Market failure – Situation in which the market on its own fails to produce goods that people want Causes of market failure Externality – Impact of one person’s actions on the well-being of a bystander; pollution (negative); vaccination (positive) Public goods some goods will not be provided because firms cannot earn from it (street lights), national defense, police protection Market power – Ability of a single economic actor (or small group of actors) to have a substantial influence on market prices (manipulate prices) © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed 50 with a certain product or service or otherwise on a password-protected website for classroom use.  3. Promote equity and fairness in the distribution of commodities Disparities in economic wellbeing – rich becoming richer; poor becoming poorer Rich can go to better schools, earn more, accumulate more land and capital and become richer Poor cannot afford to go to school and will earn less; and so with their children and their children’s children Markets do not ensure that everyone has sufficient food, decent clothing and shelter, and adequate education and healthcare But most people are concerned with the well-being of others; it is the underlying value of most religions © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed 51 with a certain product or service or otherwise on a password-protected website for classroom use.  Promote equity Government intervention: Public policies Tax wealthy and use revenues to subsidize quality education, health services, housing and food May diminish inequality But process far from perfect; may diminish efficiency, lead to lower productivity Taxes may diminish incentive to work for rich; subsidies diminish incentive of poor to work Trade-off between efficiency and equity