Econ 101 Ch. 2
production possibilities curve (PPC)
A graphical representation showing all possible combinations of quantities of goods and services that can be produced using the existing resources fully and efficiently. In Figure 1, units of defense goods and services are measured on the vertical axis, and units of nondefense goods and services are measured on the horizontal axis. If all resources are allocated to producing defense goods and services, then 200 million units can be produced, but there will be no production of nondefense goods and services. The combination of 200 million units of defense goods and services and zero units of nondefense goods and services is point , a point on the vertical axis. At 175 million units of defense goods and services, 75 million units of nondefense goods and services can be produced (point ). Point represents 125 million units of nondefense goods and services and 130 million units of defense goods. Point represents 150 million units of nondefense goods and services and 70 million units of defense goods and services. Point , a point on the horizontal axis, shows the combination of no production of defense goods and services and 160 million units of nondefense goods and services. *illustrates the concept of opportunity cost. Each point on the PPC means that every other point is a forgone opportunity* *represents all combinations of goods and services that can be produced using limited resources efficiently to their full capabilities*
comparative advantage
An advantage derived from comparing the opportunity costs of production in two countries.
how scarce goods and resources can be allocated
Four common approaches are first-come, first-served; prices; government; and random.
resources and income
Goods and services are scarce because resources are scarce
shifts of the production possibilities curve
If a nation obtains more resources or if the existing resources become more efficient, everything else the same, then the PPC shifts outward. Suppose a country discovers new sources of oil within its borders and is able to greatly increase its production of oil without using more resources. Then some resources could be allocated to other uses, and the country would be able to increase production of all types of goods and services and have as much or more oil. Figure 2 shows the production possibilities curve before and after the discovery of oil. is based on the data given in Figure 1. is based on the data given in Figure 2, which shows the increase in production of goods and services that result from the increase in oil supplies. The first combination of goods and services on , point , is 220 million units of defense goods and zero units of nondefense goods. The second point, , is a combination of 200 million units of defense goods and 75 million units of nondefense goods. through are the combinations shown in Figure 2. Connecting these points yields the bowed-out curve . Because of the availability of new supplies of oil, the nation can increase production of all goods, as shown by the shift from to . A comparison of the two curves shows that more goods and services for both defense and nondefense are possible along than along . The outward shift of the PPC can be the result of an increase in the quantity of resources, but it also can occur because the quality of resources improves *Economists call an increase in the quality of resources an increase in the productivity of resources* Consider a technological breakthrough that improves the speed with which data are transmitted. Following this breakthrough, it might require fewer people and machines to do the same amount of work, and it might take less time to produce the same quantity and quality of goods. Each quality improvement in resources is illustrated as an outward shift of the PPC.
specialize where opportunity costs are the lowest
If we have a choice, we should devote our time and efforts to those activities in which we are relatively better than others. In other words, we should specialize in those activities that require us to give up the smallest amount of other things relative to others. If we focus on one thing, how do we get the other things that we want? The answer is that we trade—we earn money and purchase goods and services. The teacher teaches, earns a salary, and hires a plumber to fix the sinks. This is called voluntary trade or voluntary exchange. The teacher is trading money to the plumber for the plumber's services. The teacher is trading her time to the students and getting money in return. By specializing in the activities in which opportunity costs are lowest and then trading, everyone will end up with more than if everyone tried to produce everything. This is the gains from trade.
trade offs
Life is a continuous sequence of decisions, and every single decision involves choosing one thing over another or trading off something for something else def. the giving up of one good or activity in order to obtain some other good or activity means a sacrifice—giving up one good or activity in order to obtain some other good or activity. Because your income is scarce, if you purchase one thing you have to forgo other things. Because your time is limited, if you decide to attend a football game you are forgoing time spent studying or sleeping. You trade off time at studying for time spent at the football game.
the value of resources
People obtain income by selling their resources or the use of their resources. For instance, people sell the use of their labor in return for wages and salaries. People rent land or apartments or sell the produce of the land. And people invest in stocks and bonds and start businesses and receive interest and profits. The greater the value of resources, the more income that the owners of those resources earn. Resources have value when their use is in goods that have value. People can earn more income when they increase the value of their resources by making them more useful to business. A business will pay a higher salary to someone whose labor is more valuable than to someone whose labor has little value Location, location, location, is the mantra of increasing the value of land. If your land is located on the coast with a great view of the ocean or on a ski hill with a great view of the mountain, your land will have greater value than if your land is located somewhere without a view and without the amenities of ocean or mountains.
points outside the production possibilities curve
Point in Figure 1 represents the production of 200 million units of defense goods and services and 75 million units of nondefense goods and services. Point , however, represents the use of more resources than are available—it lies outside the production possibilities curve. Unless more resources can be obtained and/or the quality of resources improved (for example, through technological change) so that the nation can produce more with the same quantity of resources, there is no way that the society can currently produce 200 million units of defense goods and 75 million units of nondefense goods.
incentives
Since each allocation mechanism is unfair, how do we decide which to use? One way might be by the incentives that each creates. Do the incentives lead to behavior that will improve things, increase supplies, and raise standards of living?
output and resources
Societies, like individuals, face scarcities and must make choices. A nation cannot produce as much of everything as it wants. When it produces more health care, it must forgo the production of some education, automobiles, or military hardware. The items it has to forgo constitute the opportunity cost of its action.
points inside the production possibilities curve
Suppose a nation produces 130 million units of defense goods and services and 25 million units of nondefense goods and services. That combination, point in Figure 1, lies inside the production possibilities curve. A point lying inside the production possibilities curve indicates that resources are not being fully or efficiently used. If the existing work force is employed only 20 hours per week, it is not being fully used. If two workers are used when one would be sufficient—say, two people in each Domino's Pizza delivery car—then resources are not being used efficiently. If there are resources available for use, society can move from point to a point on the PPC, such as point . The move would gain 100 million units of nondefense goods and services with no loss of defense goods and services. During recessions, unemployment rises and other resources are not fully and efficiently used. A point inside a nation's PPC could represent recession. This would be represented as a point inside the PPC, such as . Should the economy expand, and resources become more fully and efficiently used, this would be represented as a move out from a point such as to a point on the PPC, such as point.
flow of resources and income
Three types of resources are used to produce goods and services: land, labor, and capital. See 3(a). The owners of resources are provided income for selling their services. Landowners are paid rent, laborers receive wages, and capital receives interest. See 3(b). Figure 3(c) links Figures 3(a) and 3(b). People use their resources to acquire income with which they purchase the goods they want. Producers use the money received from selling the goods to pay for the use of the resources in making goods. Resources and income flow between certain firms and certain resource owners as people allocate their scarce resources to best satisfy their wants.
the production possibilities curve
Trade-offs can be illustrated in a graph known as the production possibilities curve (PPC) The production possibilities curve shows all possible combinations of quantities of goods and services that can be produced when the existing resources are used fully and efficiently Figure 1 shows a production possibilities curve for the production of defense goods and services and nondefense goods and services by a nation. Defense goods and services include guns, ships, bombs, personnel, and so forth that are used for national defense. Nondefense goods and services include education, housing, health care, and food that are not used for national defense. All societies allocate their scarce resources in order to produce some combination of defense and nondefense goods and services. Because resources are scarce, a nation cannot produce as much of everything as it wants. When it produces more health care, it cannot produce as much education or automobiles; when it devotes more of its resources to the military area, fewer resources are available to devote to health care.
scarcity, opportunity costs, and voluntary trade
Virtually everything is limited; there is not enough to go around. = scarcity: refers to the idea that there is not enough of something to satisfy everyone who would like that something. People have unlimited wants—they always want more than they have or can purchase with their incomes Whether they are wealthy or poor, what they have is never enough. Since people do not have everything they want, they must use their limited time and income to select those things they want most and forgo the rest
gains from trade
Why do people engage in this type of voluntary trade? Because they benefit from it. People could choose to be self-sufficient—using their resources and producing what they want and need themselves— but they typically do not. Most people specialize in one or two activities for which they earn income and then purchase whatever else they want. *As long as trade is voluntary, people trade only when trading benefits them* - If all parties in an exchange did not anticipate to gain, then at least one of the parties would refuse to make the exchange. In other words, people are better off focusing on those activities that have the lowest opportunity costs to them than in doing activities that have higher opportunity costs. This is called comparative advantage—focusing on activities that have the lowest opportunity costs. ex. A plumber does not do plumbing, teaching, and electrical work because doing all three would provide him less (that is, cost him more) than if he sticks to plumbing.
first-come, first-served
allocation scheme the incentive is to be first You have no reason to improve the quality of your products or to increase the value of your resources. There is no incentive to increase the amounts of goods and services supplied. Why would anyone produce when all everyone wants is to be first? As a result, with a first-come, first-served allocation system, growth will not occur, and standards of living will not rise. A society based solely on first-come, first-served would die a quick death.
international trade (who has the comparative advantage in a wider scope)
comparative advantage of countries is determined by: - productivity differences, factor abundance (natural resources,), human skills international trade is restricted through: - govt. policy (tarrifs, quotas, subsidies, preferential trade agreements) product life cycles (innovators/ efficient copiers) and consumer preferences also influence the direction of trade
each decision is a marginal decision
def. additional; incremental By marginal, economists mean additional or incremental or next unit. For instance, each term you must decide whether or not to register for college. You could work full time and not attend college, attend college and not work, or work part time and attend college The time you devote to college will decrease as you devote more time to work. You trade off hours spent at work for hours spent in college; in other words, you compare the benefits you think you will get from going to college this term with the costs of college this term You decide to spend the next hour studying by comparing the benefits you expect to receive from an additional hour of studying to the costs of not studying for that hour.
resources
def. goods used to produce other goods i.e. land, labor, and capital are goods used to produce other goods. For instance, to make chocolate chip cookies we need flour, sugar, chocolate chips, butter, our own labor, and an oven. To distinguish between the ingredients of a good and the good itself, we call the ingredients resources. *Resources are also called factors of production and inputs; the terms are interchangeable.)* The ingredients of the cookies are the resources, and the cookies are the goods.
financial capital
def. the source of funds used to purchase capital (bonds, stocks)
gains from trading
def.: The difference between what can be produced and consumed without specialization and trade and with specialization and trade. By specializing in an activity that one does relatively better than other activities, one can trade with others and gain more than if one carried out all activities oneself. This additional amount is referred to as gains from trade.
opportunity cost
def.: the highest- valued alternative that must be forgone when a choice is made If you have $25, you could purchase many things. Suppose you select a video game. The cost of the video game is $25, but more accurately, it is anything else that you could have purchased with $25 We say the opportunity cost of the video game is the benefit you do not enjoy from purchasing something else. Opportunity cost includes not just the dollars you give up but all costs involved with your purchase For instance, buying used books saves money but could increase frustration and affect your grades. The book might be missing pages, unreadable in spots, or out of date. The full or opportunity cost of the used book is the price you paid for the used copy plus the frustration of having an incomplete book. When economists refer to costs, it is opportunity costs they are measuring. The cost of anything is what must be given up to get that item. When the cost of something falls, typically that something becomes more attractive to us, all else being the same.Footnote For instance, when the cost of text messaging phone service dropped, more of us signed up for the service. Conversely, when the cost of something rises, and all else remains unchanged, we tend to use less of it. When photo radar machines were placed on the freeways, the cost of speeding went up because the likelihood of getting caught speeding dramatically increased. As a result, the amount of speeding dropped—average speeds went from 78 to 65 virtually overnight.
specialization and trade
enable individuals, firms, and nations to get more than they could without specialization and trade.
marginal costs and benefits
ex. (in relation to the ppc curve seen earlier) point B = 175 DG - 130 DG = lost 45 units of defense goods (that's what we gave up; our opp. cost of going from point B to C) - this is also your "marginal cost" due to it being the result of an additional unit being taken into consideration marginal benefits = what you GAIN when you make a choice [point B 75 NDG to point C 125 NDG = you GAINED 50 units of defense goods] *whatever you give up, is the opp. cost for that decision*
the market process: arbitrage
ex. The same type of situation occurred with the introduction of the Mini Cooper in 2001. The car was selling for much more in California than in New York and Chicago, so people purchased the cars in Chicago or New York and had the cars shipped to California. Similarly, there is a price differential on the BMW X5 in the United States and China. In the United States it lists for about $60,000, while in China it lists for nearly three times that much. Some people are purchasing the X5 in the United States and selling it in China. Suppose an electronics firm is inefficient, its employees are surly, and its products are not displayed well. To attempt to earn a profit, the firm charges more than the efficiently run firm down the street. Where do customers go? Obviously, they seek out the best deal and go to the more efficient firm. The more efficient store has to get more supplies, hire more employees, acquire more space, and so on. The inefficient store lays off employees, sells used equipment, and gets rid of its inventory. The resources thus go from where they were not as highly valued to where they are most highly valued. Why does the market process work? For a very simple reason: People are looking for the best deal—the highest-quality products at the lowest prices. So when an opportunity for a "best deal" arises, people respond to it by purchasing where the price is low and selling where the price is high. As long as the market is free to change, it will ensure that resources are allocated to where they have the highest value and people get what they want at the lowest price. But what happens if something interferes with the market process? - What do you bright entrepreneurs see? That's right—an arbitrage opportunity: You could load up a Boeing 747 with Big Macs in Phoenix and fly to Tokyo and sell the Big Macs for a nice profit. The larger supply in Tokyo would reduce the Tokyo price, and the greater demand in Phoenix would raise the price there. Why does that not happen? Part of the reason might be that the food is not portable; it deteriorates in the airplane. Another reason is that regulations would not allow it: Japan would not allow someone to simply land on the tarmac and beginning selling Big Macs out of a cargo hold. Arbitrage in the movement of Big Macs does not take place because regulations interfere with the market process. So, when something interferes with the market process, resources do not go to where they are most highly valued, and consumers do not get what they want at the lowest prices.
specialization
generally, resources are NOT perfectly adaptable to alternative uses thus, as we transfer resources to be used in the production of other goods and services, we experience the *law of increasing opp. costs* = the observation that the opp. cost of additional units of a good generally increases as society attempts to produce more of that good least specialized resources will be transferred first ex. labor = secretarial, janitorial (more adaptable to alt. resources) specialized resources - ex. rocket scientist; rocket engineer; fighter pilot (their skills are not going to be perfectly adaptable to an alt. use) this concept applies to ALL resources ex. table vs. fighter jet (f.j. is more specialized vs. the table which is less specialized - you will get more use out of it) *as more and more non-defense goods are produced, the more specialized resources have to be switched. This means higher opp. costs* why does it occur? - more valuable & productive; we can produce more goods/ services overall in the world w/ specialization
trade
in theory, by specializing in activities in which opp. costs are lowest and then trading, countries or individuals will end up with more than if each tried to produce everything if there are no "gains from trade", then trade WILL NOT occur
random allocation system
incentivizes you to do nothing—you simply hope that manna from heaven falls on you.
the incentives each allocation system creates
is a fundamental reason that markets are selected to do the allocation. *Only a market system creates the incentives that lead to increasing standards of living*
production possibilities curve
is a graph with the quantity of one output measured along the vertical axis and the quantity of another output measured along the horizontal axis. The production possibilities curve is defined by the quantity and quality of resources. With fewer resources, the curve would shift in; with more resources, the curve would shift out. The production possibilities curve illustrates scarcity by sloping down. It begins when all resources are devoted to the production of one good, and as more of the other good is produced, less of the first good is produced.
allocation system
is a way to determine who gets the scarce goods and resources. Allocation schemes include lottery; government; market; and first-come, first-served. The advantage of a market system over other allocation schemes is the incentive created by the market system.
allocation systems
is the process of determining who gets the goods and services and who does not. There are many different allocation systems that we might use. One is to have someone, say the government, determine who gets what, as in Cuba or Cameroon. Another is to have a first-come, first-served system, where those who arrive first get the goods and services. A third is to have a lottery, with the lucky winners getting the goods and services. A fourth is the market or price system, where those with the incomes are able to buy the goods and services.
economists have classified resources into 3 general categories: land, labor, and capital
land: includes all natural resources, such as minerals, timber, and water, as well as the land itself. labor: refers to the physical and intellectual services of people and includes the training, education, and abilities of the individuals in a society. capital: refers to physical products such as machinery and buildings that are used to produce other goods and services. *You will more often hear the term capital used to refer to financial items such as stocks and bonds than to the physical capital*. Economists try to distinguish between these two by referring to funds used to purchase the physical capital as financial capital.
Production possibilities curve
more of one type of good can be produced only by reducing the quantity of other types of goods that are produced "underutilization" = resources that are capable of being used, however, they are not being used (ex. society in a recession) society is NOT EVER fixed on the amount of resources that it has. (or in terms of their production capabilities = shift in the ppc)
fairness
none of the allocation approaches is "fair" if fairness means that everyone gets what he or she wants. In every case, someone gets the good or service and someone does not. This is what scarcity is all about—there is not enough to go around. With the market system, it is those without income or wealth who must do without. Is this fair? No. Under the first-come, first-served system, it is those who arrive later who do without. This is not fair either, since those who are slow, old, disabled, or otherwise not first to arrive will not get the goods and services. Under the government scheme, it is those who are not in favor or those who do not match up with the government's rules who do without. None of these allocation systems is fair in the sense that no one gets left out. Scarcity means that someone gets left out. Only if your measure of fair is equal opportunity is the lottery system fair. When everything is allocated by lottery, everyone has an equal chance of winning. But otherwise, life is not fair.
opportunity cost and tradeoffs
opp. cost is easy to understand when you think of it as a trade off. In other words, the "value" of the trade-off is represented by the opp. cost ex. suppose you earn 20$/ hr tutoring students after class. Today, however, you cancel your 2 hr tutoring session to attend a movie that costs $10. What is your opp. ost of this decision? 20 x 2 = $40 (opp. cost if you had engaged in your tutoring session) $10 (movie) - highest valued alternative $40 + the $10 you could've spent on something else (opp. cost)
specialization and trade
private property rights are necessary in order for voluntary trade to occur private property rights create incentives do you have infrastructure that enforces private property rights? - yes? your property is more valuable and you can engage in trade, if not, there is no incentive
a govt. scheme
provides an incentive either to be a member of government and thus help determine the allocation rules or to do exactly what the government orders you to do. There are no incentives to improve production and efficiency or to increase the quantities supplied, and thus there is no reason for the economy to grow. This type of system is a failure, as evidenced by the Soviet Union, Mao Tse-Tung's China, Cuba, and socialist systems in Latin America and Africa and in virtually every poor country in the world.
goods and services are scarce b/c
resources are scarce. Only a couple of dozen chocolate chip cookies can be made from one 12-ounce bag of chocolate chips. Only so many wells can be dug on 100 acres of land having oil and natural gas under it. Only so many iPads can be produced in a year because of limitations on labor, capital, and land. When the quantity and/or the quality of resources increases, the quantity of goods and services that can be produced increases. In 1850, 75 percent of the U.S. population lived and worked on the farm. Today, less than 2 percent of the U.S. population are farmers. But, because the people, the machines, and the land have become so much more efficient and productive, these 2 percent produce far more than the 75 percent did in 1850.
comparative advantage
the ability of one person or nation to do something at a lower opp. cost than another ex. hiring someone to clean your house ex. econ - elena 10 -> gives up 10 math (opp. cost) 10/10 = 1; 10/10 = for 1 econ prob. her opp cost. is 1 math problem josh -> for 5 econ ->10 ; 5/5 = 1; 10/5 = 2 for 1 econ prob., his opp. cost is 2 math problems = who gives up less? = lower opp cost. = Elena has the comparative advantage in econ. Math - Elena - 10 math -> 10 econ. (opp cost); divide both by 10 (1 math -> 1 econ, for every 1 math problem she does, she gives up 1 econ problem) - Josh - 10 math -> 5 econ - divide both by 10 (1 math -> 1/2 econ) Josh has the comparative advantage in math b/c he gives up less === it is possible that these two individuals can gain from trade
market system
the incentive is to acquire purchasing ability—to obtain income and wealth. This means that you must provide goods that have high value to others and provide resources that have high value to producers—to enhance your worth as an employee by acquiring education or training, and to enhance the value of the resources you own. Very importantly, the market system also provides incentives for quantities of scarce goods to increase - In the case of the water stand in Scenario I, if the price of the water increases and the owner of the water stand is earning significant profits, others may carry or truck water to the top of the hill and sell it to thirsty hikers; the amount of water available thus increases. Since the market system creates the incentive for the amount supplied to increase, economies grow and expand, and standards of living improve. The market system also ensures that resources are allocated where they are most highly valued. If the price of an item rises, consumers may switch to another item, or another good or service, that can serve about the same purpose. When consumers switch, production of the alternative good rises, and thus the resources used in its production must increase as well. As a result, resources are reallocated from lower-valued uses to higher-valued uses.
the rule of specialization
the individual (firm, region, or nation) will specialize in the activity in which it has the lowest opportunity cost.
scarcity
the shortage that exists when less of something is available than is wanted at a zero price
voluntary trade and exchange
the simple act of purchasing a drink from Starbucks includes many different exchanges. You had to obtain income; you may have sold or rented your resources (your labor, probably) for money. You then trade the money for the drink. And all the people working at the coffee shop are getting paid for their labor; the coffee growers, dairy farmers, truck drivers, and on and on all carried out trades or exchange. All of this just to get you your coffee drink.
