2. LO1
Choice and Opportunity Cost
Scarcity
Make a choice
Pass up another
opportunity
Opportunity cost
The value of the best
alternative forgone
Opportunity lost
Monetary aspect
Measured in money
Non-monetary aspect
3. • Suppose your best alternative to reading is
getting some sleep
• Then the cost of reading is passing up the
opportunity of sleep.
• Whenever you must pass up another
opportunity you incur an opportunity cost.
• You are studying in this class because you
have nothing better to do.
4. Examples of Opportunity Cost
• Someone gives up going to see a movie to study for a test in order
to get a good grade. The opportunity cost is the cost of the movie
and the enjoyment of seeing it.
• At the ice cream parlor, you have to choose between rocky road
and strawberry. When you choose rocky road, the opportunity cost
is the enjoyment of the strawberry.
• A player attends baseball training to be a better player instead of
taking a vacation. The opportunity cost was the vacation.
• Jill decides to drive to work instead of taking the bus. It takes her 90
minutes to get there and the bus ride would have been 40, so her
opportunity cost is 50 minutes.
5. Examples of Opportunity Cost
• This semester you can only have one elective and you want both
basket-weaving and choir. You choose basket weaving and the
opportunity cost is the enjoyment and value you would have
received from choir.
• The opportunity cost of taking a vacation instead of spending the
money on a new car is not getting a new car.
• When the government spends $15 billion on interest for the
national debt, the opportunity cost is the program the money might
have been spent on, like education or healthcare.
• If you decide not to go to work, the opportunity cost is the lost
wages.
6. Examples of Opportunity Cost
• For a farmer choosing to plan corn, the opportunity cost would be
any other crop he may have planted, like wheat or sorghum.
• Tony buys a pizza and with that same amount of money he could
have bought a Coke and a hot dog. The opportunity cost is the Coke
and hot dog.
• You decide to spend $80 on some great shoes and do not pay your
electric bill. The opportunity cost is having the electricity turned off,
having to pay an activation fee and late charges. You might also
have food in the fridge that gets ruined and that would add to the
total cost.
• As a consultant, you get $75 an hour. Instead of working one might,
you go to a concert that costs $25 and lasts two hours. The
opportunity cost of the concert is $150 for two hours of work.
7. Examples of Opportunity Cost
• David decides to quit working and got to school to get further training. The
opportunity cost of this decision is the lost wages for a year.
• Caroline has $15,000 worth of stock she can sell now for $20,000. She
wanted to wait two months because the stock was expected to increase.
She decides to sell now. The opportunity cost would be determined in two
months and would be the difference between the $20,000 and the price
she would have gotten if she sold the stock then.
• Jorge really wants to eat at a new restaurant and can only afford it if he
does not order a beverage. The opportunity cost is the beverage.
• A business owns its building. If the company moves, the building could be
rented to someone else. The opportunity cost of staying there is the
amount of rent the company would get.
8. Examples of Opportunity Cost
• When Tobias graduated high school, he decided to go to
college. The opportunity cost of going to college is the
wages he gave up working full time for the number of years
he was in college.
• Mario has a side business in addition to his regular job. If
he decides to spend more time on his side business, the
opportunity cost is the wages he lost from his regular job.
• Mr. Brown makes $400 an hour as an attorney and is
considering paying someone $1000 to paint his house. If he
decides to do it himself, it will take four hours. His
opportunity cost for doing it himself is the lost wages for
four hours, or $1600.
9.
10. • This analysis assumes that other things remain
constant. But if, in your view, attending college is more
of a pain than you expected your next best alternative
to be, then the opportunity cost of attending college is
even higher. In other words, if you are one of those
people who find college difficult, often boring, and in
most ways more unpleasant than a full-time job, then
the cost in money terms understates your opportunity
cost. Not only are you incurring the expense of college,
but you are also forgoing a more pleasant quality of
life. If, on the other hand, you believe the wild and
crazy life of a college student is more enjoyable than a
full-time job would be, then the dollar figures overstate
your opportunity cost, because your next best
alternative involves a less satisfying quality of life.
11. • Apparently, you view college as a wise investment in your future,
even though it’s costly and perhaps even painful. College graduates
on average earn about twice as much per year as high school
graduates, a difference that exceeds $1 million over a lifetime.
These pay gains from college encourage a growing fraction of
college students to pile up debts to finance their education.
• Still, college is not for everyone. Some find the opportunity cost too
high. For example, Bill Gates and Paul Allen dropped out of college
to co-found Microsoft (Gates was the richest person on Earth in
2007; Allen ranked 19th). Tiger Woods, once an economics major at
Stanford, dropped out after two years to earn his fortune in
professional golf. And Paula Creamer, who skipped college to play
golf, won her first $1 million sooner than any LPGA player in tour
history. High school basketball players who believe they are ready
for the pros also skip college, as do most tennis pros. Many actors
even drop out of high school to pursue their craft, including Tom
Cruise, Johnny Depp, Cameron Diaz, Jim Carey, Robert DeNiro,
Colin Farrell, Nicole Kidman, Jude Law, Demi Moore, Keanu Reeves,
Kiefer Sutherland, Hilary Swank, Charlize Theron, and Kate Winslet.
12. LO1
CaseStudy The Opportunity Cost of College
Value of best alternative forgone
Forgone income (full-time
job; $20,000)
Minus income earned as a student
(part-time work: $10,000)
Plus direct cost of college
Tuition, fees, books ($6,000)
$20,000 - $10,000 + $6,000 = $16,000
Not included: room, board, personal
expenses
13. LO1
Opportunity Cost
Opportunity cost is subjective
‘the road not taken’
Calculating opportunity cost
Requires time and information
Time: the ultimate constraint
Opportunity cost varies with
circumstance
Depends on the alternative
14. • Opportunity Cost Is Subjective:
• Only the individual making the choice can identify the
most attractive alternative.
• Calculating opportunity cost requires time, information,
and the assumption that people rationally choose the
most valued alternative
• If you give up an evening of pizza, beer and conversation
with friends to work on a assignment you will never know
what you gave up, you will only know what you expected.
15. • Sultan of Brunei has everything but, if he pursues
one activity he cannot at the same time do
something else. Time is his ultimate constraint
• OC is subjective and sometimes money paid is a
reasonable approximation but it may leave out
value of time involved
– Renting a movie costs 100 Rs rental fees but also
time and travel required to get it, watch it, return it.
16. LO1
Sunk Cost and Choice
Sunk cost
Incurred cost
Cannot be recovered
Ignored when making
economic choices
Economic decision makers
Relevant: costs affected by
the choice
Irrelevant: sunk costs
17. • When in grocery shopping checkout you pick the
shortest line.
• The line barely moves for 10 mins and cashier open
another counter
• Do you switch ? Yes you should why ?
• 10 min spent is sunk cost – cannot be recovered and
should be ignored
• “ No sense crying over spilt milk.”
• Ignore sunk cost in making economic choices
• Sunk costs have already been incurred and are not
affected by choice so they are irrelavant
• Walking out of a bad movie ??? Should you do it ???
18. Law of Comparative
Advantage
LO2
Specialize in the task that you do better
Law of comparative advantage
Specialize in producing a good IF
Lower opportunity cost of producing it
Specialization and exchange
Better off
Absolute advantage
Having AA means using fewer resources
than what other producer requires
19. Comparative Advantage
Activity/Person Typing paper Ironing shirt
You 30 mins 10 mins
Roomie 60 mins 5 mins
If each do their own tasks in one hour
2 typed papers and 3 ironed shirts
Using law of comparative advantage individual with lower OC of producing a particular
output should specialize in producing that output.
In 1 Hour
You type 2 papers or iron 6 shirts
Roomie can type 1 paper or iron 12 shirts
Specialization and exchange - Who should produce what ?
Your OC of typing = 3 ironed shirts
Roomie OC of typing = 12 ironed shirts
Your OC for ironing = 1/3 rd Term paper
Roomie OC of ironing = 1/12th of Term Paper
There fore since you face the lower opportunity cost you should perform typing and
Roomie to do ironing
20. Absolute Advantage
Activity / Person Typing paper ironing
You 30 mins 10 mins
Roomie 60 mins 12 mins
In 1 Hour
You type 2 papers or iron 6 shirts
Roomie can type 1 paper or iron 5 shirts
If you don’t specialize – combined output is 2 papers and 3 shirts
You have absolute advantage in both tasks - Should you specialize now ??
Yes because you face lower OC of producing a particular output and you should
specialize in producing that output.
Who should produce what ?
Your OC of typing = 3 ironed shirts
Roomie OC of typing =5 ironed shirts
There fore since you face the lower opportunity cost you should perform typing and
Roomie to do ironing since you have comparative advantage in typing than ironing.
If you specialize - combined output is 2 papers and 5 shirts.
21. Absolute Advantage
Activity / Person Typing paper ironing
You 30 mins 10 mins
Roomie 60 mins 12 mins
If no specialization take place in 1 hour
You - type 1 paper and iron 3 shirts
Roomie – type one paper only
If you specialize in typing and roomie in ironing shirts out put increases by two shirts
You type 2 papers ( in an hour )
Roomie irons 5 shirts (in an hour)
22. • Individuals, firms, regions or countries with lower
OC of producing a particular good should
specialize in producing that good
• Factor such as climate, workforce skills, natural
resources and capital stock certain parts of the
country and world have Comparative advantage
in producing certain goods.
• E.g. hardware from Taiwan, software from India,
Oranges from Florida etc.
23.
24.
25.
26. Specialization and
Exchange
LO2
Barter
Trade products for other products
Simple economies
Few goods
Works best in economies with Little
specialization
Money
Medium of exchange
Facilitates exchange
Greater specialization
27. • Because of specialization and comparative
advantage
– Most people consume little of what they produce and
produce little of what they consume
– Each individual specializes then exchanges that
product for money which in turn exchanged for goods
and services.
– E.g. Cotton shirt
• Farmer produces cotton -> sells to weaver -> weaver
produces fabric -> sells it to tailor -> tailor sews it into and
shirt -> sells it to the wholesaler ->
28. • Examples of specialization all around us
– Restaurants ( sushi, subs, Italian, Chinese)
– Movie ( light, cameraman, action, make up,
costume, set designer etc)
• How can McDonalds produce food fast ?
• Each worker rather than producing one meal
specializes in one task
• Gains of division of labor
29. Division of Labor
LO2
Division of labor
Specialization; Increased productivity
Individual preferences; natural ability
Develop more Experience
No need to shift between tasks
Laborsaving machinery
Specialized machines
Downside:
Repetitive, tedious
Routine tasks - robots
30. The Economy’s Production Possibilities
• An economy has millions of different
resources that can be combines to produce
millions different goods.
• Develop a model to get some idea of how
much an economy can produce with the
resources available.
31. Efficiency and the PPF
LO3
Production Possibilities Frontier (PPF) model
Assumptions
Output: consumer and capital goods
Productions: 1 year
Fixed resources (quantity, quality)
Fixed available technology
Fixed ‘rules of the game’ legal system property
rights, tax, patent law, manners, customs &
convention of the market
Resources – scarce for the economy
Economy’s production options
32. • PPF identifies possible combination of the
two types of good that can be produced
when all resources are employed efficiently
• Resources are employed efficiently when
there is no change that could increase the
production of one good without decreasing
the production of another good.
33. Efficiency and the PPF
LO3
PPF
Possible combinations of
Consumer and Capital goods that
Can be produced using
All resources efficiently
Inefficient combinations
Unattainable combinations
Movement along the curve explain
34. LO3
Exhibit 1
PPF (AF): Economy uses all
resources and technology
efficiently
PPF: bowed out; law of
increasing opportunity cost
Inefficient: inside PPF
Unattainable: outside PPF
The Economy’s
Production
Possibilities
Frontier
10
20
30
34
43
48
50
Consumergoods(millionsofunitsperyear)
100 50403020
Capital goods (millions of units per year)
A
C
D
E
F
B
U
Unattainable
I
Inefficient
35. The Shape of the PPF
LO3
Movement down along PPF
Give up some consumer goods to get more
capital goods
Bowed-out shape
Law of increasing opportunity costs
Slope of PPF
Opportunity cost of 1 unit capital good
First 10 M units of CAP cost 2 M units of CG
Final 10 M units of CAP cost 20 M units of CG
36. What Can Shift the PPF?
LO3
Economic growth
Expansion in the economy’s PPF
1. Changes in resource availability
Outward shift of PPF – increase in:
Size, health of labor force
Skills of labor force
Availability of other resources
2. Increases in capital stock ( human & physical)
More output; outward shift of PPF
37. What Can Shift the PPF?
LO3
3. Technological change
Employs resources more efficiently
Outward shift of PPF
4. Improvements in the rules of the game
Formal and informal institutions
Economic growth
Outward shift of PPF reflects economic growth
More stable political environment, more
reliable property rights ,lesser taxes,
confidence that property will not be stolen by
thieves, destroyed by civil unrest
38. LO3
(a) Increase in available resources (b) Decrease in available resources
(a) Outward shift of PPF – increase in available
resources; better technology
- enhanced production of both capital and
consumer goods
(b) Inward shift of PPF – decrease in available
resources
- decreased production of both capital and
consumer goods
Shifts of the Economy’s Production Possibilities Frontier
Exhibit 2(a), (b)
A
A’
Consumergoods
F’F
Capital goods
A
A’
Consumergoods
F’ F
Capital goods
40. What We Learn from the PPF?
Efficiency
The PPF describes efficient combinations of outputs, given
the economy’s resources, tech, rules of the game
Scarcity
Opportunity cost
PPF bowed out reflects Law of increasing opportunity cost
Shift outward reflects Economic growth
PPF shows need for Choice which society has to make
Costs
Benefits
What is chosen depends on economic system
41. Rules of the game can affect the PPF by either nurturing or discouraging economic
development. Businesses supply jobs, tax revenue, and consumer products, but
business is risky even in the best of times. How hard is it for an entrepreneur to start a
business, import products for sale, comply with tax laws, and settle business
disputes? A composite measure developed by the World Bank, a nonprofit
international organization, rolls answers to all these questions into a single measure
and ranks 175 countries from best to worst in terms of their ease of doing business.
Exhibit 3 lists the easiest ten and the worst ten countries. The countries with the
friendliest business climate all have a high standard of living and a sophisticated
economy. The United States ranks third best, behind Singapore and New Zealand. The
ten most difficult countries for doing business all have a low standard of living and a
poor economy. Nine of the ten are in Africa.
Consider, for example, the burden facing a business that wants to sell an imported
product. No business in the African country of Burundi makes bicycles, so a shop selling
bicycles there must import them. Bicycles are shipped to Burundi via a port in Tanzania.
In all, it takes the shop owner 19 documents, 55 official signatures, and 124 days to get
the bicycles from the port in Tanzania to the bicycle shop. Contrast this with 3
documents, 1 official signature, and 5 days needed to import products in Denmark.
Burundi is one of the poorest countries on Earth, based on per capita income.
Denmark is among the richest, with a per capita income more than ninety times that
of Burundi.
Rules of the Game and Economic Development
42. Best 10 and Worst 10 Among 181 Countries Based on
Ease of Doing Business, According to the World Bank
Best 10 Worst 10
1. Singapore
2. New Zealand
3. United States
4. Hong Kong
5. Denmark
6. United
Kingdom
7. Ireland
8. Canada
9. Australia
10.Norway
172. Niger
173. Eritrea
174. Venezuela
175. Chad
176. São Tomé and Principe
177. Burundi
178. Republic of Congo
179. Guinea-Bissau
180. Central African Republic
181. Democratic Republic of
Congo
LO3
Exhibit 3
43. How does the burden imposed by business taxes differ across countries? In the Eastern
European country of Belarus, a business is subject to 11 different taxes that total 122
percent of profit. So all business profit and more are eaten up by taxes, in the process
destroying the main incentive to even open a business. Worse yet, just to comply with
tax laws, a Belarus business owner must make 113 tax payments to three government
agencies and spend 1,188 hours on tax preparation. The high tax rate and excessive
paperwork make Belarus’s tax system among the world’s most burdensome.
Meanwhile, a business in Hong Kong pays only two taxes totaling 14 percent of profit.
Complying with business tax laws there requires only one annual electronic filing and
about 80 hours of tax preparation.
Another measure of rules of the game is the effectiveness and reliability of the nation’s
courts in resolving business disputes. The owner of a textiles business in East Timor
never uses the court system, nor does any business the owner deals with. To collect a
$1,000 debt through the court system, for example, a business owner in East Timor
would have to pay $1,800 in court and attorney fees, undertake 69 procedures, and
wait more than three years. In Denmark, on the other hand, collecting that same debt
through the court system costs $65 dollars, requires only 15 procedures, and take only
six months.
Rules of the Game and Economic Development
44. Of course, some level of business regulation and taxation is necessary to ensure public
health and safety and to nurture market competition. Few would argue, however, the
world’s most prosperous economies have allowed businesses to go wild. But why
would a country impose taxes and regulations so severe as to kill business
development, thereby choking off the jobs, taxes, and consumer products that go with
it? One possible explanation is that many countries with the worst business climate
were once under colonial rule and have not yet developed the administrative cadre to
operate government efficiently. Another possibility is that governments in poor
countries usually offer the most attractive jobs around. Politicians there create
government jobs for friends, relatives, and supporters. Overseeing bureaucratic
regulations give all these people something to do, and higher taxes are needed to pay
the salaries of all these political cronies.
Perhaps the darkest explanation for the bad business climate in some countries is that
business regulations and tax laws provide government bureaucrats with more
opportunities for graft and corruption. For example, the more government signatures
needed to execute a business transaction, the more opportunities to seek bribes. In
other words, obstacles are put in the way of business so that government bureaucrats
can demand bribes to circumvent those obstacles. Even Irish rocker Bono, a long-time
advocate of aid to Africa, has called for “advances in fighting the evils of corruption in
Africa.” Regardless of the explanation, poor countries are poor in part because they
have not yet developed the rules of the game that nurture a prosperous economy.
Rules of the Game and Economic Development
45. LO3
CaseStudy
“Ease of doing business”
Friendly business climate
High standard of living
Sophisticated economy
Difficult business climate
Low standard of living
Poor economy
Rules of the Game and Economic Development
46. LO3
CaseStudy Rules of the Game and Economic Development
Sell an imported product
Denmark
3 documents
1 official signature
5 days
Burundi
19 documents
55 official signatures
24 days
47. LO3
CaseStudy
Business taxes
Belarus
11 taxes; 122% of profit
113 tax payments to 3
government agencies
1,188 hours tax preparation
Hong Kong
2 taxes; 14% of profit
1 electronic filing
80 hours tax preparation
Rules of the Game and Economic Development
48. LO3
CaseStudy
Effectiveness and reliability of
courts
Collect a $1,000 debt
East Timor
$1,800 court and attorney
fees
69 procedures; wait 3
years
Denmark
Cost $65
15 procedures
6 months
Rules of the Game and Economic Development
49. LO3
CaseStudy
Possible explanations for bad
business environment
Bad administrative systems
Favoritism in governmental
jobs
Corruption
Bribes
Rules of the Game and Economic Development
50. Three questions
What g&s to be produced?
How to produce ?
What machines to be used
Should offices be in city or out of city ?
For Whom to produce for ? – distribution question
Equal share ? Should weak and sick get more ?
Economic system
Mechanisms
Institutions that resolve what, how and for whom
questions
Answer the three questions
Economic Systems
51. Economic Systems
LO4
Criteria
Ownership of resources
What decision making for Allocation of
resources ?
What Incentives guide economic
decision makers
Range from
Pure capitalism, to
Pure command system
52. Pure Capitalism
LO4
Private property rights allows individuals
to use resources or charge other for their
use
Resource owners charge for supplying
labor capital and natural resources
Unrestricted markets
Answer the three questions
Resources – most productive use
Goods and services – most valued
Voluntary buying and selling
Adam Smith: “invisible hand”
53. Pure Capitalism
• Adam Smith says although each individual
pursues his of her self interest, the invisible
hand of markets promote general welfare
• Capitalism is sometimes called laissez faire –
meaning to let do, to let people choose as
they choose without government
intervention.
54. Pure Capitalism:
Flaws
LO4
No central authority protect enforces
contracts
People with no resources could starve
Monopoly and elimination of competition
Prodtn and constn of some goods involves
side effects that may harm or benefit people
not involved in the transaction
No incentive to produce public goods –
national defense etc because cannot prevent
non-payers from enjoying the benefits of
public goods
55. Pure Command
System
LO4
Public/communal ownership of property
Government planners
Central plans – how much housing and
cars to produce
Direct resources
Coordinate production
Answer the three questions
What g&s to be produced?
How to produce ?
For Whom to produce for ? – distribution
question
Communism
56. Pure Command
System: Flaws
LO4
Resources
Used inefficiently
Wasted (no incentives) bcos each person
has no incentive to employ resources in
their highest value
Preferences of planners not society
Limited variety of products because all are
made by govt.
Less freedom of economic choice
57. • Capitalism
• System of government is democratic
• Property is privately owned
• Driven by free enterprise
• Wealth distributed unevenly
• Education and health care provided by private entities
• Freedom of the press Class distinctions: upper class,
middle class and working class
• Focus is on the individual and his/her own progress in
life
58. • Communism
• System of government is totalitarian
• Property is owned by the state
• No free enterprise is allowed
• Wealth distributed equally
• Education and health care provided by the state
• Press controlled and owned by the state
• Classless society: all members of society are
considered to be equal
• Focus is on the progress of the community as a
whole
59. • The ideology of capitalism
• People need freedom
• When people compete against one another, they
achieve greater things
• Some people have more than others because
they make better use of their abilities
• Governments should not interfere with the rights
of individuals to make their own living
• The government should interfere in the economy
as little as possible
60. • The ideology of communism
• People need one another
• When people work together as equals, they
achieve greater things
• No-one should have more than anyone else -
everybody's needs are equally important
• Governments should make sure that
everyone's needs are being met
• There is central control of the economy
61. Capitalism
• Capitalism is based on private ownership of the means of
production and on individual economic freedom. Most of
the means of production, such as factories and businesses,
are owned by private individuals and not by the
government. Private owners make decisions about what
and when to produce and how much products should cost.
Other characteristics of capitalism include the following:
• Free competition. The basic rule of capitalism is that people
should compete freely without interference from
government or any other outside force. Capitalism assumes
that the most deserving person will usually win. In theory,
prices will be kept as low as possible because consumers
will seek the best product for the least amount of money.
62. Capitalism
• Supply and demand. In a capitalist system
prices are determined by how many products
there are and how many people want them.
When supplies increase, prices tend to drop. If
prices drop, demand usually increases until
supplies run out. Then prices will rise once
more, but only as long as demand is high.
These laws of supply and demand work in a
cycle to control prices and keep them from
getting too high or too low.
63. Communism
• Karl Marx, the 19th century father of communism, was outraged by
the growing gap between rich and poor. He saw capitalism as an
outmoded economic system that exploited workers, which would
eventually rise against the rich because the poor were so unfairly
treated. Marx thought that the economic system of communism
would replace capitalism. Communism is based on principles meant
to correct the problems caused by capitalism.
• The most important principle of communism is that no private
ownership of property should be allowed. Marx believed that
private ownership encouraged greed and motivated people to
knock out the competition, no matter what the consequences.
Property should be shared, and the people should ultimately
control the economy. The government should exercise the control
in the name of the people, at least in the transition between
capitalism and communism. The goals are to eliminate the gap
between the rich and poor and bring about economic equality.
64. Mixed and Transitional
Economies
LO4
Increasing role of government
In capitalist economies
Increasing role of markets
In command economies
Mixed economies
Government
Economic activity
Regulates the private
sector
Economies based on custom or
religion
65.
66.
67. Mixed and Transitional
Economies
• The United States represents a mixed system,
with government directly accounting for about
one-third of all economic activity.
• In addition, government regulates the private
sector in a variety of ways (e.g., antitrust,
workplace safety, environmental quality, and
zoning activities).
• Capitalist economies outperform command
economies e.g. Taiwan vs. China and S. Korea vs.
N. Korea
68. Antitrust
• The antitrust laws apply to virtually all industries and to
every level of business, including manufacturing,
transportation, distribution, and marketing. They
prohibit a variety of practices that restrain trade.
• Examples of illegal practices are price-fixing
conspiracies, corporate mergers likely to reduce the
competitive vigor of particular markets, and predatory
acts designed to achieve or maintain monopoly power.
69. Economies based on Custom
and Religion
• Islam bans charging interest
• Caste system in India restricts occupational
choices
• Some occupations are dominated by Men vs.
Women.