ECON 2001 Chapter 2: Macroeconomic Principles Slides PDF

ECON 2001 Macroeconomic Principles Chapter 2 Scarcity and the World of Trade-Offs Chapter Outline 2.1 Scarcity 2.2 Opportunity Cost, Trade-Offs, and Choices 2.4 Economic Growth, Production Possibilities, and the Trade-Off between Present and Future 2.5 Comparative Advantage and Ma...

ECON 2001 Macroeconomic Principles Chapter 2 Scarcity and the World of Trade-Offs Chapter Outline 2.1 Scarcity 2.2 Opportunity Cost, Trade-Offs, and Choices 2.4 Economic Growth, Production Possibilities, and the Trade-Off between Present and Future 2.5 Comparative Advantage and Maximizing Your Future Income 2.1 Scarcity Recall that in Chapter 1, we learned: We never have enough of everything, including time, to satisfy our every desire. Scarcity: occurs when society’s resources for producing things that people desire are insufficient to satisfy all wants. Economics is the social science of making optimal choices under conditions of scarcity. Note that scarcity is not a shortage or the same thing as poverty, it is a fact of our life.  2.2 Opportunity Cost, Trade-Offs, and Choices Scarcity makes all choices involve tradeoffs - more of A is at the cost of less of B. “Choose Two Law” of College Life National defense (Guns) or consumer goods (Butter)?  2.2 Opportunity Cost, Trade-Offs, and Choices “The Cost of Something Is What You Give Up to Get It.” Opportunity Cost (OC): the highest-valued, next-best alternative that must be sacrificed to obtain something or to satisfy a want, not all alternatives. Examples? The OC of 1. Going to college for a year? Not the tuitions and room and board expenses, but the foregone wages from a possible job. 2. Watching a football game of your favorite team? Not the price of the ticket, but the value of the time. 2.2 Opportunity Cost, Trade-Offs, and Choices Whenever you engage in any activity, using any resource, you are trading off the use of that resource for one or more alternative uses. “There ain't no such thing as a free lunch.” In economics, cost is always a forgone opportunity. Our first model: a graphical analysis of opportunity cost - production possibilities curve or frontier (PPC or PPF): an economic model that represents all possible combinations of the maximum outputs of two goods that could be produced in an economy. 2.2 Opportunity Cost, Trade-Offs, and Choices Assumptions: One resource: labor (measured in hours). Two goods, computers and wheat. The economy has 5,000 labor hours per month available for production. Resources and technology are fixed.  2.2 Opportunity Cost, Trade-Offs, and Choices Producing 1 computer = 10 hours labor. Producing 1 ton of wheat = 1 hour labor. 2.2 Opportunity Cost, Trade-Offs, and Choices  2.2 Opportunity Cost, Trade-Offs, and Choices A. On the graph, find the point that represents (100 computers, 3000 tons of wheat), label it F. Would it be possible for the economy to produce this combination of the two goods? Why? 2.2 Opportunity Cost, Trade-Offs, and Choices Point F: 100 computers, 3000 tons of wheat. Point F requires 4,000 hours of total labor. It is possible but not efficient.  2.2 Opportunity Cost, Trade-Offs, and Choices B. Next, find the point that represents (300 computers, 3500 tons of wheat), label it G. Would it be possible for the economy to produce this combination of the two goods? Why? 2.2 Opportunity Cost, Trade-Offs, and Choices Point G: 300 computers, 3500 tons of wheat. Point G requires 6,500 hours of total labor. It is not possible/ unattainable.  2.2 Opportunity Cost, Trade-Offs, and Choices Points on the PPC (like A–E): possible and efficient-all resources are fully utilized Moving along a PPC involves shifting resources (e.g., labor) from one good to the other. Wheat and computer are each other’s OC. 2.2 Opportunity Cost, Trade-Offs, and Choices In which country is the opportunity cost of cloth lower? 2.2 Opportunity Cost, Trade-Offs, and Choices Rule of thumb for comparing OC with PPC: flatter PPC means lower OC for good on the horizontal axis! The PPC could be a straight line or bow-shaped. Depending on what happens to OC as an economy shifts resources from one product to another. i. If opp. cost remains constant, PPC is a straight line. ii. If opp. cost of a good rises as more of the good is produced, PPC is bow-shaped/concave. PPC is bow-shaped when resources are not perfectly adaptable for alternative uses. 2.2 Opportunity Cost, Trade-Offs, and Choices For example, different workers have different skills in producing tanks and autos. A bow-shaped PPC follows the law of increasing opportunity cost: as more of a particular good is produced in an economy, the OC of additional units of that good keeps increasing. Also known as the law of diminishing returns. 2.4 Economic Growth, Production Possibilities, and the Trade-Off between Present and Future Over time, PPC can shift: i. Increases in resources ii. Improvement in technology It is possible to have more of everything, which is called “economic growth.” This is the eventual alleviation of scarcity, as illustrated by an outward shift of the PPC. 2.4 Economic Growth, Production Possibilities, and the Trade-Off between Present and Future The PPC can also be used to illustrate the trade-off between present and future consumption. Two types of goods in general i. Consumer/consumption goods: produced for personal satisfaction. ii. Capital goods: used to produce more/other goods. Less consumption today means more capital goods today to produce more of both consumption/capital goods in the future. 2.5 Comparative Advantage and Maximizing Your Future Income Should Tom Brady Mow His Own Lawn? Brady(Terrific), in 2 hours Mow his lawn, or Film a TV commercial, earn $1,000,000 Forest Gump, in 2 hours Mow Brady’s lawn Work at McDonald’s, earn $30 “ They did a nice job Trade makes everyone better off! mowing this grass.” 2.5 Comparative Advantage and Maximizing Your Future Income Watch this: Why Do We Exchange Things: https://www.youtube.com/watch?v=W-qGYlRtCcM In addition to economic growth, the other solution to deal with scarcity is trade, as the opposite choice, self-sufficiency, yields a very low standard of living. Watch this: I, Pencil https://www.youtube.com/watch?v=67tHtpac5ws Watch this too: How I built a toaster from scratch: https://www.youtube.com/watch?v=5ODzO7Lz_pw Trade can help deal not only with scarcity due to the “exchange,” it can also leads to greater productivity! 2.5 Comparative Advantage and Maximizing Your Future Income Trade allows people to specialize, and specialization leads to the division of labor: the segregation of resources into different specific tasks. - Adam Smith, in The Wealth of Nations A “specific task” is best assigned to people with a particular comparative advantage, and to trade for everything else they don’t specialize in. Comparative advantage: the ability to produce a good or service at a relatively lower opportunity cost than another producer— in terms of things given up. Gains from trade arise from comparative advantage.  2.5 Comparative Advantage and Maximizing Your Future Income Note that comparative advantage differs from absolute advantage: the ability to produce a good or service with fewer resource inputs than another producer; or produce more units of a good or service with a given quantity of resource inputs. In our above example, who has a comparative advantage in mowing the lawn/filming a TV commercial? When nations specialize in what they have a comparative advantage and trade, economic efficiency and productivity improve:  Output increases  Average standard of living rises  2.5 Comparative Advantage and Maximizing Your Future Income Trade also increases production possibilities without requiring more resources or better technology, allowing a country to consume beyond its PPC. Recall point G is called “not possible/ unattainable”. With free trade, it is attainable now!