Economics Module 2: Why It Matters: Choice in a World of Scarcity
Bianca, a small oil producer is talking to her chief engineer, Pete, about repairs and upgrades to an oil well. Pete: "...additional upgrades on the well would cost $5,000 but would allow increased production and revenue of more than $10,000 per year." Bianca: "I already spent $20,000 on this well, it is a money pit; we should not spend anymore on it." Based on the information given, what is the sunk cost?
$20,000 spent on prior repairs
production possibilities frontier (or curve)
a diagram that shows the productively efficient combinations of two products that an economy can produce given the resources it has available
Peyton and Paul are brothers who own a manufacturing business and are considering opening a new distribution center. They estimate that the project would add $5 million in expenses and that their profit would increase by $1.5 million per year for the next 5 years (other things equal). Peyton and Paul decide
to go ahead with the project because the expanded marginal benefit ($7.5 million over 5 years) is greater than the estimated marginal cost of the project ($5 million)
Normative statements are based upon
value judgments
allocative efficiency
when the mix of goods being produced represents the mix that society most desires
Self-interest is not necessarily selfish, some say. In fact, self-interest likely includes an individual's consideration for
Close friends and family
positive statement
conclusions based on logic and evidence that can be tested
Statement 2: The government should take measures to reduce inflation.
normative
If Stephanie decides to buy 4 dresses, how many pairs of shoes can she afford?
2 pairs of shoes
Let's consider again our example of Stephanie who is planning a cruise to the Caribbean and has a budget for new evening wear of $500. The average price for a pair of shoes is $50 while the average price for an evening dress is $100. She found 6 pairs of shoes and 2 dresses she likes. She decides that she does need one more dress. What is the opportunity cost of buying a 3rd dress?
2 pairs of shoes
Consider the Production Possibility Frontier for the country Z producing 2 groups of goods, cell phones and clothing. The opportunity cost of moving from the combination of cell phones and clothing B to D is
4 cell phones
The country of Mambia produces cars and TVs as laid out in the Production Possibility schedule below. What would be the opportunity cost of producing a fourth car (increasing production from 3 to 4 cars)?
5 TVs
Stephanie is planning a cruise to the Caribbean and has a budget for new evening wear of $500. She plans to purchase new shoes and dresses. The average price for a pair of shoes is $50 while the average price for an evening dress is $100. What is a combination of dresses and shoes that Stephanie could afford?
6 pairs of shoes and 2 dresses
Consider the example presented above about Bianca, a small oil producer, trying to decide about investing more money into an oil well. If upgrades cost $5,000 but increase revenue will be more than $10,000 a year, what should Bianca do (assuming the $5,000 is available to her)?
Bianca should spend $5,000 on the well with the expectation that the additional revenue would outweigh the additional spending.
Based on the graph of Maren's budget constraint for dresses and shoes, what accurately describes the slope of her budget constraint?
It is negative because of scarcity and the amount of money available to Maren.
Suppose that a family decides to spend all of their available money on a fancy vacation instead of purchasing a much needed new automobile. From an economist's perspective, which of the following statements about this decision is likely to be true?
The decision is rational in the sense that it reflects the family's preference for vacations over new automobiles
Imagine that a high school junior sold her old car at the end of the summer and now has the funds from the sale in her bank. She decides to purchase a much needed new automobile instead of saving that money to pay for her senior trip coming up next year. From an economist's perspective, which of the following statements about this decision is likely to be true?
The decision is rational in the sense that it reflects the junior's preference for a new automobile over a senior trip.
Juan has a monthly budget of $100 to spend on entertainment. A concert ticket costs $20 while a movie ticket costs $10. This month Juan has attended one concert and 5 movies so far. If Juan decides to only go to movies for the rest of the month. How many movie tickets can he afford to purchase and stay within his budget?
Three tickets.
Two countries are trying to decide which product should have an increased production. Both Canada and Costa Rica produce coffee and corn, but it is easier for Canada to raise corn than grow coffee. Costa Rica easily grows coffee, but has a more difficult time growing corn. In comparison with Canada, Costa Rica has
a comparative advantage with coffee
budget constraint
all possible consumption combinations of goods that someone can afford, given the prices of goods, when all income is spent; the boundary of the opportunity set
Assumption of Rationality
also called the theory of rational behavior, it is the assumption that people will make choices in their own self-interest
A combination of clothing and cell phones that would meet the allocative efficiency would be:
any combination on the production possibilities frontier that brings the highest level of satisfaction to the people in the economy
Law of dininishing returns
as additional increments of resources are devoted to a certain purpose, the marginal benefit from those additional increments will decline
normative statement
conclusions based on value judgments that cannot be tested (what should be)
sunk costs
costs that are made in the past and cannot be recovered
marginal analysis
examination of decisions on the margin, meaning comparing costs of a little more or a little less
productive efficiency
given the available inputs and technology, it's impossible to produce more of one good without decreasing the quantity of another good that's produced
Consider the Production Possibility Frontier below for the country Z producing 2 groups of goods, cell phones and clothing. The opportunity cost of one additional cell phone is ________.
greater at B than C
Now if the economy is currently producing 18 pieces of clothing and 2 cell phones (combination B), then
it could be reaching allocative efficiency if combination B best meets the needs of Country Z
The following statement given at a political rally: 'Poverty should be eliminated given the size of our economy; and that's a fact." This is normative because
it is expressing someone's values and beliefs
Scarcity is imposed on individual households in the form of
limited income and the prices of the goods that a person may purchase
opportunity cost
measures cost by what is given up in exchange; opportunity cost measures the value of the forgone alternative
Statement 3: The inflation should be kept at 0%.
normative
Statement 1: The inflation has been above 5% per year for the last 5 years.
positive
In order to satisfy as many wants as possible, it is necessary to achieve allocative efficiency,
since otherwise output may go to where it is less valued
marginal cost
the difference (or change) in cost of a different choice
marginal benefit
the difference (or change) in what you receive from a different choice
Consider a new Production Possibility Frontier for the country Z that produces 2 groups of goods, cell phones and clothing. If the economy is currently producing the 10 clothing and 4 cell phones (combination D),
the economy is not reaching productive efficiency because it could produce more phones without having to give up clothes
Raj and Annie, owners of a trucking company, are discussing opening a new distribution center and are analyzing the estimated cost and potential benefits of the project. Raj and Annie are behaving rationally because
their decision is based on self-interest