Chapter2 macro


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The chapter discusses opportunity costs, PPF, and economic growth.

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Chapter2 macro

  2. 2. CHOICE AND OPPORTUNITY COST • Because of Scarcity you must pass up another opportunity • Opportunity cost is the best alternative sacrificed for a chosen alternative, i.e. the next best alternative. • The highest valued activity sacrificed in making a choice. • Example: A student may give up going to the movies with a friend for study time. The opportunity cost of the study time would be going to the movies
  3. 3. CHOICE AND OPPORTUNITY COST •Opportunity costs are incurred when a choice is made. •They are subjective and vary across persons. •If an option becomes more costly, an individual will be less likely to choose it. • Milton Friedman once said, “There is no such thing as a free lunch.”
  4. 4. CHOICE AND OPPORTUNITY COST • The true cost of the decision is the opportunity cost of the choice, not the purchasing price. • It is subjective • What is your cost to studying? • Maybe going to a movie • Sleeping • Calculating Opportunity Cost Require Time and Information. • Time is the ultimate constraint
  5. 5. • What is the man’s opportunity cost of the walk? • $175 • What is the dog’s opportunity cost to the walk? • Having to be his friend
  6. 6. Example of Opportunity Costs
  7. 7. SUNK COST AND CHOICE Sunk cost • Incurred cost • Cannot be recovered • Example: A business has spent $100,000 on a new building to expand, but then the economic takes a down-turn an the building is not needed, the building is a sunk cost at this point. • Ignored when making economic choices • Economic decision makers • Relevant: costs affected by the choice • Irrelevant: sunk costs •
  8. 8. LAW OF COMPARATIVE ADVANTAGE  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  Use fewer resources  But does not have the lowest opportunity cost
  9. 9. Example of Comparative and Absolute Advantage Review the Word Document found on BlackBoard
  10. 10. LAW OF COMPARATIVE ADVANTAGE • It is about what productive actions you are giving up, not about how good you are at each action. • It is possible that you can be the best at both goods, but we are interested in the foregone production that may be lost by you doing both actions.
  11. 11. DIVISION OF LABOR  Division of labor  Specialization; Increased productivity  Individual preferences; natural ability  Experience  No need to shift between tasks  Laborsaving machinery  Downside:  Repetitive, tedious  Routine tasks - robots
  12. 12. Example of Division of Labor Model T by Ford Model Company
  13. 13. PRODUCTION POSSIBILITIES FRONTIER (PPF) • The PPF shows the maximize combinations of two outputs that an economy can produce in a given period of time with available resources and technology. • All possible combinations of goods and services that can be produced given a country’s resources. • People try to get the most from their limited resources by making purposeful choices and engaging in economizing behavior.
  14. 14. PPF • A fixed amount of resources (land, capital, and labor) • Output: consumer and capital goods • Production is one year • A fixed amount of technology • Technology is unchanging • Fixed rules of the game • Institutions • Examples: Court System, Property Rights, Roads
  15. 15. PPF • What is Technology? • The body of knowledge applied to how goods are produced.
  16. 16. Production Possibilities Frontier for a nation’s economy (given limited resources) • • Here points A, B, C , S, and T represent points that are efficient • At point S, the economy is producing only clothing • At point T, the economy is producing only food • At point D, the economy is inefficient Only clothing is produced Production Possibilities Frontier ( PPF ) Output of clothing S A D - Inefficiency - B All output combinations on the frontier curve are efficient. C T Only food is produced Output of food
  17. 17. PPF • Why are the points on the graph efficient? • What does this mean ? • Because all the points along the curve are maximum output levels with the given resources and technology
  18. 18. PPF • What happens if the economy does not use all its resources to their full capacity? • For instance, high unemployment levels • Do you think that the U.S. is currently experiencing this? The U.S. economy is currently not using all it’s resources because people are still under-employed or unemployed due to the economy.
  19. 19. THE LAW OF INCREASING OPPORTUNITY COST • The law states that the opportunity cost increases as production of one output expands. Holding the stock of resources and technology constant (ceteris paribus), the law of increasing opportunity costs causes the PPF to display a bowed-out sharp. • If we assume that resources can be substituted and the opportunity cost remains constant, then the PPF is a downward sloping straight line with no bowed out shape.
  20. 20. THE LAW OF INCREASING OPPORTUNITY COST • To explain this in more detail, let’s suppose that you were the employer. • What types of workers would I transfer first? • (A) A very efficient worker who was always on time OR • (B) A worker who was rarely on time and never got anything done • Most likely worker B, because he is not as costly to give up as worker A
  21. 21. SOURCES OF ECONOMIC GROWTH • Economic growth: the ability of an economy to produce greater levels of output, represented by an outward shift of its PPF. • How do we get Sources of Economic Growth? • By Shifting the PPF curve • How???
  22. 22. SHIFTING THE PPF • An increase in the economy’s resource base would expand our ability to produce goods and services. • Shift Factors: • • • • Changes in Resource Availability Increases in the Capital Stock Technological Changes Improvements in the Rules of the Game
  23. 23. Example of Rules of the Game
  24. 24. PRESENT INVESTMENT AND THE FUTURE PPF • Investment: the process of accumulating capital, inventories, such as factories, machines, and inventories used to produce goods and services.
  25. 25. WHAT WE LEARN FROM THE PPF?  Efficiency  Scarcity  Opportunity cost  Law of increasing opportunity cost  Economic growth  Choice  Costs  Benefits
  26. 26. THREE FUNDAMENTAL ECONOMIC QUESTIONS • What to Produce? • How to Produce? • For Whom to Produce?
  27. 27. PURE CAPITALISM  Private property rights  Unrestricted markets  Answer the three questions  Resources – most productive use  Goods and services – most valued  Voluntary buying and selling  Adam Smith: “invisible hand”
  28. 28. THE IMPORTANCE OF PROPERTY RIGHTS • Property rights: Individuals own it • Private property rights involve: •the right to exclusive use. •legal protection against invaders. •the right to transfer to another.
  29. 29. PRIVATE PROPERTY AND INCENTIVES • Private ownership is a key to prosperity because it provides people with a strong incentive to take care of things and develop resources in ways that are highly valued by others. • Private owners can gain by using their resources in ways beneficial to others. • They have a strong incentive to care for and manage what they own. • They have an incentive to conserve for the future (especially if the property’s value is expected to rise).
  30. 30. PURE CAPITALISM: FLAWS  No central authority  People with no resources could starve  Monopoly  Side effects for people not involved  No public goods
  31. 31. PURE COMMAND SYSTEM  Public/communal ownership of property  Government planners  Central plans  Direct resources  Coordinate production  Answer the three questions  Communism
  32. 32. PURE COMMAND SYSTEM: FLAWS  Resources  Used inefficiently  Wasted (no incentives)  Preferences of planners  Limited variety of products  Less freedom of economic choice
  33. 33. How are the incentives of common vs. private property rights different?
  34. 34. MIXED AND TRANSITIONAL ECONOMIES  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