EconomicsAlan J. Carper

Roger Bradley

Brad A. PayneBob Jones University Press

2nd Edition 2010

Unit 1 Economics The Science Of Choice

Chapter 2 Economic Models

Objectives

• Identify the two purposes of economic models• Identify the two common forms of economic

models• Explain the production possibilities curve• List and define the four factors of production• List and describe the four factor costs• List the participants in the cirular flow model• Explain the activities represented in the circular

flow model

Biblical Integration

• As Christians we are to be models of Christ. We are to live our lives with the mind set of imitating Him, “to walk, even as He walked” (I John 2:6)

• For many, it is not enough to just hear about God—they want to see Him in the lives of those who claim to know Him.

(Carper 23)

Models in Economics:

•A model is a simplified representation of a real situation that is used to better understand real-life situations.

•The “other things equal” - assumption = all other relevant factors remain unchanged.

5

Trade-offs: The Production Possibility Frontier (PPF)

• Production Possibility Frontier (PPF) – Illustrates the trade-offs facing an economy that

produces only two goods. – Shows the maximum quantity of one good that

can be produced for any given production of the other.

• PPF improves our understanding of trade-offs by showing it graphically.

6

Production Possibilities Table

Lists the different combinations between two resources “that can be produced with a fixed quantity of scarce resources.”

PastriesPizza

Crusts

0 10

1 8

2 6

3 4

4 2

5 0

7

(Dodge 43)

Production Possibilities

•“If the chef wishes to produce 1 more pastry, she must give up 2 pizza crusts.

•If she wishes 1 more crust, she must give up one-half of a pastry.”

PastriesPizza

Crusts

0 10

1 8

2 6

3 4

4 2

5 0

8

(Dodge 43)

Transactions: The Production Possibilities Frontier

Concepts illustrated by the production possibilities frontier – Efficiency– Opportunity cost– Law of Increasing costs– Economic growth

9

The Production Possibility Model Illustrates the concept of:

1. Efficiency: Any point on the frontier represents = feasible and efficient use of resources (Point A or B)

10

Quantity of Pastries

Quantity of Pizza Crusts

• •

• • A

B

C

D

A point outside the frontier is not feasible given the current amount of resources. (Point D)

Any combination of goods inside the frontier represent a point of inefficiency, does not use all the resources fully. (Point C)

The line curve in the figure is not straight but is concave to the origin.

Production Possibility

In other words:– The opportunity cost of a pastry is two crusts.– The opportunity cost of a pizza crust is one-half of a pastry.”

           

           

           

           

           

           

11

12

10

8

6

4

2

0 0 1 2 3 4 5 6

•

•

•

•

•

•

2. Opportunity costs: The negative slope = an increase in the production of one good and sacrifice of some quantity of the other good.

(Dodge 43)

Production Possibility

12

3. The Law of Increasing Costs “more of a good that is produced, the greater its opportunity cost.” Bowed out = opportunity costs as more of one good is produced

- because resources are not easily transferable from the production of one good to another.

- “resources must be reallocated from pizza crusts production to pastry production. Labor, capital, and natural resources must be removed from crust production and moved

into pastry production.”

10

0

•

4

•

•

•

•

8

6

4

2

3 2 1

Crus

ts

Pastries (Dodge 43)

Production Possibility

• 4. Economic Growth: Over time as a society gains more resources, the PPF shifts outward.

• - because production possibilities are expanded.

13

10

0

•

4

•

•

•

•

8

6

4

2

3 2 1

Crus

ts

Pastries

(Dodge 43)

14

Example

• Assume David Ricardo and Ricky Ricardo are going to throw a party in exactly one hour. They decide on serving homemade pizzas and cakes. Assume they have 15 ovens in their apartment and lots of pots and pans. Use the information in the next slide to determine who should produce what.”

David Ricardo was an “English economist responsible for promoting comparative advantage as the basis of trade. No relation to Ricky Ricardo” (Lucy’s first husband).

(Mayer)

15

ExampleDavid Ricardo

Ricky Ricardo

Bakes Cakes

2 cakes/hr. 4 cakes/hr.

Makes Pizza

6 pizzas/hr. 8 pizzas/hr.

(Mayer)

16

ExampleDavid Ricardo

Ricky Ricardo

Bakes Cakes 2 cakes/hr. 4 cakes/hr.

Makes Pizza 6 pizzas/hr. 8 pizzas/hr.

“Who has the absolute advantage in baking cakes?”“Who has the absolute advantage in making pizza?”

(Meyer)

17

ExampleDavid Ricardo

Ricky Ricardo

Bakes Cakes 2 cakes/hr. 4 cakes/hr.

Makes Pizza 6 pizzas/hr. 8 pizzas/hr.

Why? Because 4 cakes > 2 cakes & 8 pizzas > 6 pizzas.

(Mayer)

18

ExampleDavid Ricardo

Ricky Ricardo

Bakes Cakes 2 cakes/hr. 4 cakes/hr.

Makes Pizza 6 pizzas/hr. 8 pizzas/hr.

“Who has the comparative advantage in baking cakes?”“Who has the comparative advantage in making pizza?”

(Mayer)

19

Example

Why?“Ricky only gives up 2 pizzas in order to bake a cake, whereas David gives up 3 pizzas in order to bake a cake.”

(Mayer)

20

Example

“Furthermore, it only cost David 1/3 of a cake to make a pizza, whereas it costs Ricky ½ of a cake to make a pizza.”

(Mayer)

21

Example

“Who has the comparative advantage in baking cakes?”“Who has the comparative advantage in making pizza?” (Mayer)

Opportunity Cost

Pizza Cakes

David 6/2 = 3 2/6 = 1/3

Ricky 8/4 = 2 4/8 = 1/2

22

Specialization

• Individuals and countries can be made better off, if they will produce in the area they have a comparative advantage and then trade with others for whatever else they want or need.

(Mayer)

Transactions: The Circular-Flow Diagram

•The circular-flow diagram is a model that represents the transactions in an economy by flows around a circle.

The diagram helps us to understand how the economy manages to provide jobs for a growing population.

– The number of jobs are not fixed, because it depends on how much households spend.

– The amount households spend depends on how many people are working. 23

Economic Way of Thinking

• The core problem for economic interactions is a array of diverse and even incompatible individual projects

• Solution: specialization (division of labor)– results from people’s economizing actions– is necessary to increase production

Activity 1

National Council on Economic Education, New York, N.Y.

Scarcity, Opportunity Cost and PPC

Objectives

• Define scarcity and opportunity cost• Apply scarcity and opportunity cost to a number of

everyday situation.• Construct production possibilities curves using

hypothetical data.• Apply concept of opportunity cost to a production

possibilities curve• Analyze the different locations of points on, outside,

and inside a production possibility curve.• Define absolute advantage and comparative

advantage

Activity 2

• The PPC is drawn assuming that all resources (land, labor, capital, entrepreneurship) are fully employed and technology is constant.

• PPC is bowed out or concave to the origin, determines the trade-off in the production of the two commodities.

Activity 2

• Other shapes?

Constant Opportunity Cost Decreasing Opportunity Cost

Activity 2

• As the price declines from P to P1, the quantity increases from

• Q to Q1

• Trade-offs: Remember when you want more of one, you have to give-up some of the other.

Activity 2

Opportunity Cost & Comparative Advantage

Activity 2

• Absolute AdvantageOne individual or nation can produce more output with the same resources as another individual or nation.

• Comparative AdvantageOne individual or nation can produce a good at a lower opportunity cost than another

– Examples of Comparative Advantage

• Economics professor and secretary (teaching vs. typing)• Auto mechanic and medical doctor (repairing a car vs.

caring for the sick and injured)

Activity 2

• For 1 bushel of cornMexico = ½ gallons of sunscreen (150/300)France = ¾ gallon of sunscreen (150/200)

• For 1 gallon of sunscreenMexico = 2 bushel of corn (300/150)France = 1 ⅔ bushel of corn (200/150)

Absolute Advantage- Mexico has the absolute advantage in producing corn- Neither country has the absolute advantage in producing

sunscreenComparative Advantage:

- Mexico has the comparative advantage in producing corn- France has the comparative advantage in producing

sunscreen

Complete:

Opportunity Cost and Comparative Advantage Activity

Payment for Goods and Services

Finished Goods & Services

THE PRODUCT MARKET

HOUSEHOLDS/ PEOPLE

BUSINESSES/

ENTREPRENEUS

Land, Labor, Capital and Entrepreneurship

THE FACTOR MARKET

Income Wages, Rents, Interest, Profit

The Circular Flow

Circular Flow Activity Power Point

Graphs Review

Objectives– Interpret the graphs used in economic models.

– Determine the difference between convex and concave.

– Interpret a constant, zero, decreasing and increasing opportunity cost graph.

– Interpret a scatter diagram, a time-series graph, and a cross-section graph.

– Determine a negative vs. positive slope.

– Define and calculate slope.

– Graph relationships among more than two variables.

Basic IdeaA graph enables us to visualize the relationship

between two variables.To make a graph, set two lines perpendicular to

each other:

• The horizontal line is called the x-axis.

• The vertical line is called the y-axis.

• The common zero point is called the origin.

• Dependent variable is on the vertical axis (Y)

• Independent variable is on the horizontal axis (X)

Y

X

(“Leppel”)

Y

X

• “Negative or inverse relations are downward sloping from left to right.”

Y

X

(“Leppel”)

negative slope

positive slope• “Positive or direct relations are upward sloping from left to right.”

“The negative slope is evident in the graph by the fact that the line slopes downward toward the right.”

beats

mg.

(“Leppel”)

Nonlinear RelationsConvex

“If a curve looks like the letter U or part of a U, it is convex (from below).”

(“Leppel”)

“This curve is downward sloping and convex from below.”

min. per mile

hrs. slept per day(“Leppel”)

“This curve is upward sloping and convex from below.

(It bulges toward some reference point, usually the horizontal axis or the origin of a diagram.)

A curve is convex from below (or convex to something below it) if all straight lines connecting points on it lie on or above it.”calories

wgt

Convex Curve

(“Leppel”)

Concave

“Picture the opening of a cave. If a curve looks like this or part of this, it is concave (from below).”

(“Leppel”)

Nonlinear Relations

“This curve is upward sloping and concave from below.”

wgt

calories

Constant Opportunity Cost GraphY

X

Zero Opportunity Cost GraphY

X

Decreasing Opportunity Cost or Convex Graph

Y

X

Increasing Opportunity Cost or Concave Graph

Y

X

Works Cited

Blade, Robin, and Michael Parkin. Foundations of Economics: Instructor’s Manual. 2nd ed. Boston: Pearson Education, Inc., 2004.

Carper, Alan. Economics for Christian Schools. Greenville: Bob Jones University Press, 1998.

"The New King James Version." Logos Bible Software. CD_ROM. ed. 2004.