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