Ch2 Microeconomics ECO

2PART I INTRODUCTION TO ECONOMICS

The EconomicProblem:

Scarcityand Choice Scarcity, Choice, and

Opportunity CostScarcity and Choice in a One-Person EconomyScarcity and Choice in an Economy of Two or MoreThe Production Possibility FrontierThe Economic Problem

Economic SystemsCommand EconomiesLaissez-Faire Economies:

The Free MarketMixed Systems, Markets, and Governments

CHAPTER OUTLINE

The Economic Problem: Scarcity And Choice

FIGURE 2.1 The Three Basic Questions

Every society has some system or process that transforms its scarce resources into useful goods and services. In doing so, it must decide what gets produced, how it is produced, and to whom it is distributed. The primary resources that must be allocated are land, labor, and capital.


The term resources is very broad. Some resources are the products of nature: land, fertile soil, minerals, wind...

In addition, the resources available to an economy include things such as buildings and equipment that have been produced in the past but are now being used to produce other things.

Also: the human workforce forms part of the resources.


Things that are produced and then used in the production of other goods and services are called capital.

The basic resources available to a society are often referred to as factors of production (or factors).


The process that transforms scarce resources into useful goods and services is called production.

The three key factors of production are land, labor, and capital.

Resources or factors of production, that is, anything provided by nature or previous generations that can be used directly or indirectly to satisfy human wants, are the inputs into the process of production; goods and services of value to households are the outputs of the process of production..

Scarcity, Choice, And Opportunity Cost

Scarcity and Choice in a One-Person Economy

Nearly all the same basic decisions that characterize complex economies must also be made in a simple economy.

The individual has to decide what s/he wants to produce; s/he must look at the possibilities he has.

Given the resources are limited, the individual has to decide how to best use them to satisfy his/her wants.

The concepts of constrained choice and scarcity are central to the discipline of economics.

Given the scarcity of time and resources, there will be a trade-off of doing one activity rather than another.

Opportunity Cost


opportunity costs The best alternative that we give up, or forgo, when we make a choice or decision.


Using a day at the beach as an example, what is the opportunity cost of leisure?

a. Leisure is free. For example, you don’t have to pay for the benefit of enjoying the sun or relaxing at the beach.

b. Leisure has an opportunity cost only if there is a cost associated with it. For example, entering the beach may require you to pay a fee.

c. The opportunity cost of leisure at the beach is the value of the things that you could have produced during the time you were at the beach. For example, you could have used the time to work and earn some money.

d. According to economists, leisure activities are the only activities that do not carry an opportunity cost.



The growth of the frozen food market in the last 50 years is a good example of the role of opportunity costs in our lives.

Opportunity Cost

Frozen Foods andOpportunity Costs

Specialization, Exchange, and Comparative Advantage


theory of comparative advantage Ricardo’s theory that specialization and free trade will benefit all trading parties, even those that may be “absolutely” more efficient producers.

SIMPLE EXAMPLE: Suppose that Bill and Colleen have only 2 tasks: gathering food to eat and cutting logs to burn.

If Colleen could cut more logs than Bill in 1 days and Bill could gather more food than Colleen could, specialization would clearly lead to more total production.

However, specialization would also work even if Colleen is better in both tasks:

Scarcity and Choice in an Economy of Two or More

Scarcity, Choice, And Opportunity CostScarcity and Choice in an Economy of Two or More

FIGURE 2.2 Comparative Advantage and the Gains from Trade


absolute advantage A producer has an absolute advantage over another in the production of a good or service if he or she can produce that product using fewer resources. (In the previous example Colleen has an absolute advantage in the production of both goods)

comparative advantage A producer has a comparative advantage over another in the production of a good or service if he or she can produce that product at a lower opportunity cost.

In the previous example, Bill has a comparative advantage over Colleen in the production of food because he gives up only 4 logs for an additional 8 bushels, whereas Colleen gives up 8 logs. On the other hand, Colleen has comparative advantage in the production of wood.

Specialization, Exchange, and Comparative Advantage



FIGURE 2.3a Production Possibilities with No Trade

A Graphical Presentation of Comparative Advantage and Gains from Trade



FIGURE 2.3b Production Possibilities with No Trade

A Graphical Presentation of Comparative Advantage and Gains from Trade



Before we saw that both could be better off :

Colleen:3 days food / 27 days logs.Bill: all his time on food.

Colleen trades 100 logs to Bill in exchange for 140 bushels of food.

So, after trade:

Colleen: 170, 170

Bill: 100, 100

Graphically:


FIGURE 2.4 Colleen and Bill Gain from Trade



Weighing Present and Expected Future Costs and Benefits

Very often we find ourselves weighing benefits available today against benefits available tomorrow.

A simple example of trading present for future benefits is the act of saving. When you put aside income today for use in the future, you give up some things that you could have had today in exchange for something tomorrow.



Capital Goods and Consumer Goods

A society trades present for expected future benefits when it devotes a portion of its resources to research and development or to investment in capital. Capital is anything that has already been produced that will be used to produce other valuable goods or services over time.

In a modern society, resources used to produced capital goods could have been used to produce consumer goods, that is, goods produced for present consumption.

Capital is not necessarily tangible: human capital = investment in education. This capital will continue to exist and yield benefits to you for years to come.



Capital Goods and Consumer Goods

The process of using resources to produce new capital is called investment.

A wise investment in capital is one that yields future benefits that are more valuable than the present cost.

Because resources are scarce, the opportunity cost of every investment in capital is forgone present consumption.



production possibility frontier (ppf) A graph that shows all the combinations of goods and services that can be produced if all of society’s resources are used efficiently.

It illustrates the principles of constrained choice, opportunity cost, and scarcity.

The Production Possibility Frontier



All points below and to the left of the curve (the shaded area) represent combinations of capital and consumer goods that are possible for the society given the resources available and existing technology.

Points above and to the right of the curve, such as point G, represent combinations that cannot be reached.If an economy were to end up at point A on the graph, it would be producing no consumer goods at all; all resources would be used for the production of capital.



Points that are actually on the ppf are points of both full resource employment and production efficiency.

Resources are not unused, and there is no waste.



Although an economy may be operating with full employment of its land, labor, and capital resources, it may still be operating inside its ppf, at a point such as D. The economy would be using those resources inefficiently.Periods of unemployment also correspond to points inside the ppf, such as point D Moving onto the frontier from a point such as D means achieving full employment of resources.



To be efficient, an economy must produce what people want. This means that in addition to operating on the ppf, the economy must be operating at the right point on the ppf.

This is referred to as output efficiency, in contrast to production efficiency.



Negative Slope and Opportunity Cost

When the resources are fully and efficiently employed, a society can produce more capital goods only by reducing the production of consumer goods.

The opportunity cost of the additional capital is the forgone production of consumer goods. (see next figure)

The slope of the ppf is negative

The slope of the production possibility frontier (ppf) is called the marginal rate of transformation (MRT).


FIGURE 2.5 Production Possibility Frontier



TABLE 2.1 Production Possibility Schedule for Total Corn and Wheat Production in Ohio and Kansas

Point on ppf

Total Corn Production

(Millions of Bushels Per Year)

TotalWheat Production

(Millions of Bushels Per Year)

A 700 100

B 650 200

C 510 380

D 400 500

E 300 550

The Law of Increasing Opportunity Cost


FIGURE 2.7 Corn and Wheat Production in Ohio and Kansas

Consider the figure below. As this country moves from point D to point B along the production possibility frontier AE,

a. the opportunity cost of building more consumer goods rises.

b. the opportunity cost of building more capital goods rises.

c. the opportunity cost is not affected because the curve does not shift.

d. the opportunity cost of producing more of either consumer goods or capital goods rises.

Refer to the figure. A 10-ton increase in the production of agricultural goods requires a sacrifice of manufactured goods that is:

a. greater between points b and c than between points e and f.

b. greater between points e and f than between points b and c.

c. proportionally the same between any two points.

d. less and less as you move downward along the curve.


Economic Growth

economic growth An increase in the total output of an economy. It occurs when a society acquires new resources or when it learns to produce more using existing resources.

New resources may mean a larger labor force or an increased capital stock. The production and use of new machinery and equipment (capital) increase workers’ productivity.

Improved productivity also comes from technological change and innovation, the discovery and application of new, more efficient production techniques.



TABLE 2.2 Increasing Productivity in Corn and Wheat Productionin the United States, 1935–2007

CORN WHEAT

Yield Per Acre (Bushels)

Labor Hours Per 100 Bushels

Yield Per Acre (Bushels)

Labor HoursPer 100 Bushels

1935–19391945–19491955–19591965–19691975–19791981–19851985–19901990–19951998200120062007

26.136.148.778.595.3

107.2112.8120.6134.4138.2145.6152.8

1085320

743

NAa

NAa

NAa

NAa

NAa

NAa

13.216.922.327.531.336.938.038.143.243.542.340.6

67341711

97

NAa

NAa

NAa

NAa

NAa

NAa

a Data not available.

Economic Growth



FIGURE 2.8 Economic Growth Shifts the PPF Up and to the Right

Economic Growth



Sources of Growth and the Dilemma of Poor Countries


FIGURE 2.9 Capital Goods and Growth in Poor and Rich Countries


The Economic Problem

Recall the three basic questions facing all economic systems:

(1) What gets produced?

(2) How is it produced?

(3) Who gets it?

Given scarce resources, how do large, complex societies go about answering the three basic economic questions?

This is the economic problem, which is what this text is about.

Economic Systems

Command Economies

command economy An economy in which a central government through a combination of government ownership of state enterprises and central planning, either directly or indirectly sets output targets, incomes, and prices.

While the extremes of central planning have been rejected, so too has the idea that markets solve all problems.

One of the major themes of this book is that government involvement, in theory, may improve the efficiency and fairness of the allocation of a nation’s resources.

At the same time, a poorly functioning government can destroy incentives, lead to corruption, and result in the waste of a society’s resources.

Economic Systems

Laissez-faire Economies: The Free Market

At the opposite end of the spectrum from the command economy is the laissez-faire economy.

laissez-faire economy Literally from the French: “allow [them] to do.” An economy in which individual people and firms pursue their own self-interest without any central direction or regulation.

The central institution through which a laissez-faire system answers the basic questions is the market, a term that is used in economics to mean an institution through which buyers and sellers interact and engage in exchange.

Some markets are simple and others are complex, but they all involve buyers and sellers engaging in exchange. The behavior of buyers and sellers in a laissez-faire economy determines what gets produced, how it is produced, and who gets it.

Economic Systems

In a free market, goods and services are produced and sold only if the supplier can make a profit, i.e. if selling goods or services for more than it costs to produce them is possible.

It’s not possible to make profits unless someone wants the product that you are selling.

This logic leads to the notion of:

consumer sovereignty The idea that consumers ultimately dictate what will be produced (or not produced) by choosing what to purchase (and what not to purchase).

Consumer Sovereignty


Economic Systems

Under a free market system, individual producers must also determine how to organize and coordinate the actual production of their products or services.

Often the market system is called a free enterprise system.

free enterprise The freedom of individuals to start and operate private businesses in search of profits.

Proponents of free market systems argue that free enterprise leads to more efficient production and better response to diverse and changing consumer preferences. In a free market economy competition forces producers to use efficient techniques of production. It is competition then that ultimately dictates how output is produced.

Individual Production Decisions: Free Enterprise


Economic Systems

Distribution of Output

In a free market system the distribution of output –who gets what- is also determined in a decentralized way.

The amount that any one household gets depends on its income and wealth.

Income is the amount that a household earns each year. It comes in a number of forms: wages, salaries, interest, and the like.

Wealth is the amount that households have accumulated out of past income through saving or inheritance.


Economic Systems

Price Theory


The basic coordination mechanism in a free market system is price

A price is the amount that a product sells for per unit, and reflects what society is willing to pay.

Prices of inputs- labor, land, and capital – determine how much it costs to produce a product.

Prices of various kinds of labor, or wage rates, determine the rewards for working in different jobs and professions.

Economic Systems

Mixed Systems, Markets, And Governments

The differences between command economies and laissez-faire economies in their pure forms are enormous.

In fact, these pure forms do not exist in the world; all real systems are in some sense “mixed.”

That is, individual enterprise exists and independent choice is exercised even in economies in which the government plays a major role.

Conversely, no market economies exist without government involvement and government regulation.

Economic Systems

Mixed Systems, Markets, And Governments

Advocates of free market argue that such markets work best when left to themselves. The result is quality and variety. But market systems have problems too.

1) They do not always produce what people want at the lowest cost – there are inefficiencies

2) Rewards (income) may be unfairly distributed and some groups may be left out

3) Periods of unemployment and inflation recur with some regularity

Many people point to these problems as reasons for government involvement. Indeed for some problems government involvement may be the only solution. But governments may fail to improve matters as well.

A market exists primarily in what type of economic system?

a. A command economy.

b. A laissez-faire economy.

c. A democracy.

d. A dictatorship.

e. An economy in transition.

Exercise: Consider the following data for the harvest of crabs versus the harvest of fish off the coast of Virginia, US, in answering the following questions.

Graph the production possibilities frontier and calculate theaverage opportunity cost of any of the first fifteen crabs produced.

Date post:	23-Jan-2016
Category:	Documents
Upload:	bazil-nawaz
View:	222 times
Download:	0 times

Ch2 Microeconomics ECO

Documents