Appendix A

What’s in Economics

for You?

LEARNING OBJECTIVES

A.1 Explain scarcity and describe why you must

make smart choices among your wants

A.2 Define and describe opportunity cost

A.3 Describe how comparative advantage,

specialization, and trade make us all better off

A.4 Explain how markets connect us all using the

circular flow of economic life

A.5 Illustrate and explain the Three Steps to Smart

Choices

ARE YOU GETTING ENOUGH?

SCARCITY AND CHOICE

Because you can never satisfy all of your wants,

making the most out of your life requires

smart choices about what to go after,

and what to give up.

SCARCITY AND CHOICE

Problem of scarcity arises because of limited money,

time, and energy

Resources can produce only a fraction of the goods and services desired by people

Scarcity implies the need for choice.

Every choice has an associated cost -- opportunity cost

Opportunity cost is defined as the benefit given up by not using resources in the best alternative way.

She wishes to spend it all on two types of candy.

Bubble gums cost 5 cents each and lollipops cost 10 cents each.

Combination A is unattainable.

Quantity of Lollipops

Unattainable

Qu

an

tity

of B

ub

ble

Gu

m

2 3

4

6

Attainable

5

10

•A

4

8

Consider the choice that must be made by a child who has only 50 cents to spend.

Combination B is attainable.

The negatively sloped line

provides a boundary between

attainable and unattainable

combinations.

The opportunity cost of getting

1 more lollipop is the 2 bubble

gums that must be given up.

Quantity of Lollipops

Unattainable

Qu

an

tity

of B

ub

ble

Gu

m

2 3

4

6

Attainable

5

10

4

8

B

•A

Point d shows scarcity; it is unattainable with current resources.

Points a and b show choice. They are both attainable, but which one will be chosen?

The PPB illustrates: • scarcity • choice • opportunity cost

The negative slope illustrates opportunity cost.

Attainable

combinations

• c

• a

• b

• d

Unattainable

combinations

Quantity of Military Goods

Quantity

of C

ivili

an G

oods

PPB

The Production Possibility Boundary

GIVE IT UP FOR OPPORTUNITY COST

Opportunity cost is the single most important concept

both in economics and for making smart choices in life.

OPPORTUNITY COST

• Every choice involves a trade-off, you have to give

up something to get something else

• True cost of any choice is the opportunity cost,

cost of best alternative given up

• For a smart choice, value of what you get must be

greater than value of what you give up

GAINS FROM TRADE

Opportunity cost and comparative advantage

are key to understanding why specializing and trading

make us all better off.

GAINS FROM TRADE

With voluntary trade, each person feels what they

get is better than what they give up

Absolute advantage

ability to produce at lower absolute cost

Comparative advantage

ability to produce at lower opportunity cost

Opportunity cost =

Comparative advantage key to mutually beneficial

gains from trade

Trade makes individuals better off when each

specializes in producing product/service

with comparative advantage

(lower opportunity cost)

trades for the other product/service

Give Up

Get

Bread

(loaves)

Wood

(cords)

50 0

40 20

30 40

20 60

10 80

0 100

Fig. A.1 Jacqueline's Production Possibilities

Fig. A.2 Samantha’s Production Possibilities

Bread

(loaves)

Wood

(cords)

40 0

30 5

20 10

10 15

0 20

Fig. A.3 Opportunity Cost for Jacqueline & Samantha

Opportunity Cost of 1 Additional

Loaf of Bread Cord of Wood

Jacqueline Gives up 2 cords wood Gives up 1/2 loaf bread

Samantha Gives up 1/2 cord wood Gives up 2 loaves bread

Comparative

Advantage

Samantha lower

opportunity cost

bread-making

Jacqueline lower

opportunity cost

wood-chopping

Even if one individual has absolute advantage

in producing everything, differences in

comparative advantage allow mutually

beneficial gains from specializing and trading

CHOOSING YOUR WAY

THE CIRCULAR FLOW OF ECONOMIC LIFE

The circular-flow diagram of economic life

is a map showing how markets connect us all.

It illustrates how smart choices by households,

businesses, and governments interact in markets.

THE CIRCULAR FLOW OF ECONOMIC LIFE

All the complexity of the Canadian economy

can be reduced to three sets of players —

households, businesses, and governments

o in input markets —

households are sellers and businesses are buyers

o in output markets —

households are buyers and businesses are sellers

o governments set rules of the game and can

choose to interact in any aspect of economy

continued…

• Microeconomics

analyzes individual choices in households,

businesses and governments

• Macroeconomics

analyzes performance of the whole Canadian

economy and global economy

WEIGH MARGINAL BENEFITS & COSTS

• Three Keys to Smart Choices

1 Choose only when additional benefits are

greater than additional opportunity costs

2 Count only additional benefits and additional

opportunity costs

3 Be sure to count all additional benefits and

costs, including implicit costs and externalities

• Marginal benefits

additional benefits from next choice

• Marginal opportunity costs

additional opportunity costs from next choice

• Implicit costs

opportunity costs of investing your money or time

• Negative (or positive) externalities

costs (or benefits) that affect others external to

a choice or a trade

The problem of scarcity

a) exists because all human wants cannot be satisfied with limited time, money and energy

b) would disappear if we did not have to make choices c) can be solved in a market economy

d) exists because the limited human expectations cannot be satisfied with available knowledge

ECON100: Chapter 1A January 14, 2013

Which of the following is one of the three steps to smart choices?

a) The choice is smart when benefits are greater than additional opportunity costs

b) The choice is smart when total benefits are greater than total costs

c) The choice is smart when measurable benefits are greater than measurable costs

d) Be sure to count all benefits and costs, excluding implicit costs or externalities

The main implication of scarcity in economics is that people must

a) be unhappy

b) make choices c) be selfish

d) not be selfish

The circular flow diagram of economic life shows

a) output markets where businesses are buyers and households are sellers

b) input markets in which households are sellers and businesses are buyers

c) input markets in which businesses are sellers and households are buyers

d) input and output markets in which the government determines sellers and buyers

Microeconomics a) is scientific in its approach, while macroeconomics is not b) analyzes the consequences of small changes in economic

choices; macroeconomics analyzes the consequences of large changes in economic choices.

c) analyzes the choices of individual economic units; macroeconomics analyzes the performance of overall economy

d) analyzes the performance of overall economy; macroeconomics analyzes choices of individual economic units