Chapter 2: Some Tools of Economic Analysis PDF

Chapter 2 Some Tools of Economic Analysis Choice and Opportunity Cost u Scarcity u Make a choice u Pass up another opportunity u Opportunity cost u The value of the best alternative forgone u Opportunity lost ...

Chapter 2 Some Tools of Economic Analysis Choice and Opportunity Cost u Scarcity u Make a choice u Pass up another opportunity u Opportunity cost u The value of the best alternative forgone u Opportunity lost  The Opportunity Cost of College u Value of best alternative forgone Case Study u Forgone income (full-time job; $16,000) u Minus income earned as a student (part-time work: $7,000) u Plus direct cost of college u Tuition, fees, books ($5,000) u $16,000 - $7,000 + $5,000 = $14,000  Opportunity Cost u Opportunity cost is subjective u ‘the road not taken’ u Calculating opportunity cost requires time and information u Time: the ultimate constraint u Opportunity cost varies with circumstance  Sunk Cost and Choice u Sunk cost u Incurred cost u Cannot be recovered u Ignored when making economic choice 1 The Economy's production possibilities Efficiency and the Production possibility Frontier u Production Possibilities Frontier (PPF) u Assumptions u Output: consumer and capital goods u Productions: 1 year u Fixed resources (quantity, quality) u Fixed technology u Resources – scarce for the economy u Economy’s production options Efficiency and the PPF u PPF Possible combinations of consumer and capital goods that can be produced using all resources efficiently u Inefficient combinations u Unattainable combinations  Exhibit 1 A The Economy’s Consumer goods (millions of units per year) 50 48 B C Production 43 U Possibilities 34 D Unattainable Frontier 30 Inefficient PPF (AF): Economy uses all resources and technology I E 20 efficiently PPF: bowed out; law of 10 increasing opportunity cost F Inefficient: inside PPF 0 10 20 30 40 50 Unattainable: outside PPF Capital goods (millions of units per year)  The Shape of the PPF u Movement down along PPF u Give up some consumer goods to get more capital goods u Bowed-out shape u Law of increasing opportunity costs What Can Shift the PPF? u Economic growth u Expansion in the economy’s PPF 1. Changes in resource availability u Outward shift of PPF – increase in: u Size, health of labor force u Skills of labor force u Availability of other resources 2. Increases in capital stock u More output; outward shift of PPF LO 3 What Can Shift the PPF? 3. Technological change u Employs resources more efficiently u Outward shift of PPF LO 3 LO 3 Exhibit 2(a), (b) Shifts of the Economy’s Production Possibilities Frontier (a) Increase in available resources (b) Decrease in available resources Consumer goods Consumer goods A’ A A A’ F F’ F’ F Capital goods Capital goods (a) Outward shift of PPF – increase in available (b) Inward shift of PPF – decrease in resources; better technology available resources - enhanced production of both capital and - decreased production of both capital consumer goods and consumer goods LO 3 Exhibit 2(c), (d) Shifts of the Economy’s Production Possibilities Frontier (c) Change in resources, technology, or (d) Change in resources, technology, rules that benefits consumer goods or rules that benefits capital goods Consumer goods Consumer goods A’ A A F F F’ Capital goods Capital goods  Economic Systems u Three questions u What? u How? u For Whom? u Economic system u Mechanisms u Institutions u Answer the three questions LO 4  Economic Systems u Criteria u Ownership of resources u Allocation of resources u Incentives u Range from u Pure capitalism, to u Pure command system LO 4  Pure Capitalism u Private property rights u Unrestricted markets u Answer the three questions u Resources – most productive use u Goods and services – most valued u Voluntary buying and selling u Adam Smith: “invisible hand” LO 4  Pure Capitalism: Flaws u No central authority u People with no resources could starve u Monopoly u Side effects for people not involved u No public goods LO 4  Pure Command System u Public/communal ownership of property u Government planners u Central plans u Direct resources u Coordinate production u Answer the three questions u Communism LO 4  Pure Command System: Flaws u Resources u Used inefficiently u Wasted (no incentives) u Preferences of planners u Limited variety of products u Less freedom of economic choice LO 4  Mixed and Transitional Economies u Increasing role of government u In capitalist economies u Increasing role of markets u In command economies u Mixed economies u Government u Economic activity u Regulates the private sector u Economies based on custom or religion LO 4