CH 01:LIMITS, ALTERNATIVES, ANDCHOICES Rondi A. Schei
Preliminary Definitions Opportunity Cost represents the “price we pay” to obtain something. In other words, it is that next best alternative that you would have otherwise chosen. Utility refers to the “amount of satisfaction” you get from consuming (using) a product or service. Marginal Analysis is the analytical process by which we measure the benefits and costs of our decisions or actions. Economizing Problem refers to issues revolving around how to budget our limited time, money, and resources
Preliminary Definitions Optimal Allocation is when the right mix of goods and services are being produced for the product market. This is determined via Marginal Analysis Economic Growth increases societies ability to produce goods and services This happens in 3 ways: 1. There is an increase in the supply of resources 2. There is improvement in resource quality 3. There is an advancement in technology
Economic Principles Economic theories and principles are statements about economic behavior that help predict outcomes from various actions Three things to know: 1. They are GENERALIZATIONS and represent the tendencies of average people and firms 2. They use the “OTHER-THINGS EQUAL” assumption (aka ceteris paribus) meaning that any factors other the ones of direct interest will have no effect on an outcome. 3. They use GRAPHICAL EXPRESSION. Many theories and principles can be shown as a graphical model.
Individual’s Economizing Problem Individuals have to make choices about what products and services to buy or how to use their time. People generally have a fixed amount of income and only 24 hours in a day. A Budget Line represents the tradeoff between two goods/choices with fixed income/time.
Budget Line Example:Jack has $20 in his wallet and no credit/debit cards. He mustdecide between two goods: pizza and beer from the local pub. slice of pizza = $2 pint of Beer = $4 10 8 All possible Slices of Pizza combinations 6 for $20 4 2 0 1 2 3 4 5 Pints of Beer
Attainable CombinationsCombination Z:Total Cost = (4x$4) + (8x$2) = $32Combination X: 10 UnattainableTotal Cost = (1x$4) + (4x$2) = $12 8 Slices of Pizza Z Unattainable 6 The region to the right 4 X of the budget line 2 Attainable Attainable 0 The region to the left of 1 2 3 4 5 Pints of Beer the budget line
Question What is Jack’s opportunity cost of consuming a third pint of beer? (What do we give up?) What else can we say about opportunity costs? If he is consuming a 3rd beer, then he has already had two. To obtain a 3rd beer costs $4 With $4 he could buy 2 slices of pizza Therefore, he gives up the opportunity of eating two more slices of pizza. Every time Jack drinks a beer he gives up the opportunity to consume 2 slices of pizza. This means the opportunity cost is constant. *Note: Opportunity cost measures from one choice to the next. Therefore it is a MARGINAL COST!
Economic Resources Economic Resources are those natural, human, and manufactured resources that go into the production of goods and services. They are the factors of production. Four Categories: 1. Land: All natural resources. 2. Labor: The physical actions and mental activities that people contribute to the production of goods. 3. Capital: All manufactured aids used in producing consumer goods. Investment: the money used to purchase capital resources. 4. Entrepreneurial Ability (EA): That human talent that combines the above resources into innovative products, who makes strategic decisions, and bears risk.
Society’s Economizing Problem With the individual we were looking at just one resource such as time or money. When we look at society we have to consider multiple resources. All resources are not made equal. All resources are SCARCE. A Production Possibilities Model shows the tradeoffs between producing two different goods with scarce resources.
Production Possibilities Model The Necessary Assumptions: 1. Full Employment: The economy is using all its available resources 2. Fixed Resources: The quantity and quality of the factors of production are fixed 3. Fixed Technology: The available methods used to produce do not change 4. Two Goods: Assume there are only two goods in the economy. We categorize them into capital goods and consumer goods.
ExampleWe have 2 products: shoes & trucks. The table represents the units ofshoes and the units of trucks than can be produced with availableresources. 1 unit shoes = 100,000 and 1 unit trucks = 1,000 A 10 1 B Shoes Trucks 8 2 C A 0 10 Trucks 6 B 1 9 3 C 2 7 4 D D 3 4 2 4 E 4 0 E 0 1 2 3 4 5 Shoes
Opportunity Costs A 10 1 B 8 2 Trucks (1,000) C 6 3 4 D 2 4 E 0 1 2 3 4 5 Shoes (100,000)
Questions Are opportunity costs constant? No. The bowed out shape of the production possibilities curve represents increasing opportunity costs and diminishing marginal returns. Why do the opportunity costs increase rather than remain constant? Because resources are not equally substitutable. Just because a person is an awesome truck driver does not mean they are also good at making shoes and vice versa.
Economic Growth Economic Growth will cause the production possibilities curve to shift outward. Trucks If there is an increase in available resources, technology, or quality improves, we can produce more shoes AND Shoes more trucks If there is an technological improvement that only affects the shoe Trucks industry, then the curve will shift outward on only the shoe axis. Shoes