Principles of Microeconomics Module 1.1. Scarcity, Limited Resources and Opportunity Costs

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1 Principles of Microeconomics Module 1.1 Scarcity, Limited Resources and Opportunity Costs

2 What is Economics? Economics is the study of how people and society allocate scarce resources Scarce resources: For people: Time, Money ect. For firms: Factors of Production à Land, Labor and Capital Since we don t have an infinite amount of resources what do we do with what we have?

3 Tradeoffs in Decisions People face tradeoffs in decisions because of scarce resources Cannot do everything, buy everything, make everything Need to choose how to allocate our time, our money, our resources When you make one choice you give up the other option

4 Opportunity Costs Opportunity Cost: What you give up to get something Example: How many times can you hit the snooze button? Benefit Opportunity Cost Hit it once More Sleep Feel rushed in the morning Hit it twice More Sleep Feel rushed Skip breakfast Hit it three times More Sleep Feel rushed Skip breakfast Skip the gym Hit it four times More Sleep Feel rushed Skip breakfast Skip the gym Late for work

5 Opportunity Cost Opportunity Costs are subjective to the individual and change depending on circumstances What if it was Saturday morning and you hit the snooze button? Benefits of more sleep may outweigh any costs if you don t have to wake up! What if you work in the afternoon? You do not have the same constraints as someone who needs to go to work in the morning!

6 Opportunity Costs Opportunity Costs drive the decisions we make every day We face them all the time We weigh the costs and benefits of each decisions consciously or subconsciously and make a choice Test yourself: What was a recent decision you made? What did you give up when you made that choice? What was the opportunity cost for you?

7 Principles of Microeconomics Module 1.2 Opportunity Costs and Production Possibilities Frontier 7

8 Production Possibilities Frontier Production possibilities frontier (PPF) represents the opportunity costs an economy faces in the production of two goods. All economies have scarce resources -- need to decide how to allocate those resources to produce goods. If you produce more of one good need to produce less of the other (with no change in available resources) 8

9 PPF Exercise Consider an economy that produces two goods: Leather jackets and leather boots. A B C D E Boots Jackets Draw the PPF curve for this economy As we move from one point to the next calculate the change in the number of boots produced and the number of jackets produced. What does this tell you about how opportunity costs change? 9

10 PPF Exercise A B C D E Boots Jackets Δ Boots Δ Jackets As we move along the PPF curve: Opportunity Cost changes O.C. RISES as give up more of the good that is SCARCE O.C. is LOWER when the good is in relative ABUNDANCE 10

11 PPF Exercise Suppose now that there is a shortage in rubber. - What happens in the boot industry? - What happens in the jacket industry? 11

12 PPF Exercise With a shortage in rubber, this affects the production of boots relatively more than the production of jackets Bias shift of PPF If there is a change in resources need to consider the impact this has on both industries equal or bias? 12

13 Key Takeaway All economic agents face tradeoffs when making decisions Whatever they choose comes with an opportunity cost what they could otherwise do with their time, money, resources Apply this concept to understand how an economy makes choices between the production of goods in the PPF 13

14 Comparative advantage, specialization, and trade Principles of Microeconomics Module 1.3

15 How can we satisfy our needs/wants? 1. Economic Self-sufficiency: Produce all of the goods we need/want to consume ourselves 2. Specialization and Trade: Produce one good that we have a Comparative Advantage in and trade with others for what we need GAINS FROM TRADE: We can CONSUME MORE while working the same amount.

16 Trade Exercise Amount Produced in One Day Bread Sweaters Seamstress 8 loaves 4 sweaters Baker 24 loaves 8 sweaters Who is better at producing bread? Who is better at producing sweaters? If they split their time evenly between producing both goods, how much can they consume (no trade)?

17 Economic Self-Sufficiency

18 Opening to Trade If the baker and seamstress decide to trade, they can focus on making one good and trading it for the other. How do we know who makes what? Need to determine: Comparative Advantage

19 Opening to Trade Comparative Advantage Lower opportunity cost: Comparative Advantage in that good Opportunity Costs: How much of Good A do we give up to make Good B? Seamstress can make 8 bread (or) 4 sweaters in one day

20 Amount Produced in One Day Opportunity Cost Bread Sweaters Bread Sweaters Seamstress 8 loaves 4 sweaters ½ Sweater 2 Breads

21 Opening to Trade Comparative Advantage Lower opportunity cost: Comparative Advantage in that good Opportunity Costs: How much of Good A do we give up to make Good B? Baker can make 24 bread (or) 8 sweaters in one day

22 Amount Produced in One Day Opportunity Cost Bread Sweaters Bread Sweaters Baker 24 loaves 8 sweaters 1/3 Sweater 3 Breads

23 Trade Exercise To make 1 Bread, give up: Opportunity Cost Opportunity Cost determines specialization To make 1 Sweaters, give up: Seamstress ½ Sweater 2 Breads Baker 1/3 Sweater 3 Breads

24 Trade Exercise Suppose the agents agree that each person completely specializes: Produce only the product in which they have a comparative advantage

25 Trade Exercise AMOUNT PRODUCED Bread Sweaters Seamstress 0 4 sweaters Baker 24 bread 0

26 Trade Exercise AMOUNT PRODUCED Bread Sweaters Seamstress 0 4 sweaters Baker 24 bread 0 What if they trade 2 sweaters for 5 bread?

27 Trade Exercise Trade: 2 sweaters for 5 bread AMOUNT CONSUMED Bread Seamstress 0 bread + 5 bread = 5 bread Baker 24 bread - 5 bread = 19 bread Sweaters 4 sweaters 2 sweaters = 2 sweaters 0 sweaters + 2 sweaters = 2 sweaters

28 Trade Exercise Trade: 2 sweaters for 5 bread AMOUNT CONSUMED Bread Seamstress 0 bread + 5 bread = 5 bread Sweaters 4 sweaters 2 sweaters = 2 sweaters Baker 24 bread - 5 bread = 19 bread 0 sweaters + 2 sweaters = 2 sweaters

29 Trade Exercise Trade: 2 sweaters for 5 bread AMOUNT CONSUMED Bread Seamstress 0 bread + 5 bread = 5 bread Sweaters 4 sweaters 2 sweaters = 2 sweaters Baker 24 bread - 5 bread = 19 bread 0 sweaters + 2 sweaters = 2 sweaters

30 Trade Exercise Trade: 2 sweaters for 5 bread AMOUNT CONSUMED Bread Seamstress 0 bread + 5 bread = 5 bread Sweaters 4 sweaters 2 sweaters = 2 sweaters Baker 24 bread - 5 bread = 19 bread 0 sweaters + 2 sweaters = 2 sweaters

31 Trade Exercise Trade: 2 sweaters for 5 bread AMOUNT CONSUMED Bread Sweaters Seamstress 5 bread 2 sweaters Baker 19 bread 2 sweaters

32 With Trade Consumption With Trade 5 Consumption With Trade 2

33 Comparative Advantage Agent with the lower opportunity cost in producing the good will have a comparative advantage in its production No single agent can have a comparative advantage in both goods. As long as the opportunity costs between two agents differ both can gain from trade.

34 Key Takeaway Trade and specialization make everyone better off because consume more without working more Trade can be beneficial even when one economic agent is much better at producing both goods To determine which goods an economic agent will produce need to understand comparative advantage (or) opportunity cost in producing each good

35 Principles of Microeconomics Module 1.4 (A) Economic Systems 26

36 Economic Systems Economic systems are systems of Production Resource Allocation Exchange Distribution of goods and services 1. What to produce? 2. How much to produce? 3. Who receives the output? 27

37 Property Rights and Economic Systems Property rights are an important component of economic systems Because an economy is trying to answer the previous three questionsà who owns what influences the type of system we have Property Rights determine who owns a resource and who decides how it is used. Individuals Associations Government 28

38 Property Rights and Economic Systems Property rights are an important component of economic systems Because an economy is trying to answer the previous three questionsà who owns what influences the type of system we have Property Rights determine who owns a resource and who decides how it is used. Individuals Associations Government 29

39 Property Rights and Economic Systems Property rights are an important component of economic systems Because an economy is trying to answer the previous three questionsà who owns what influences the type of system we have Property Rights determine who owns a resource and who decides how it is used. Individuals Associations Government 30

40 Four Components of Property Rights 1. The right to use the good 2. The right to earn income from the good 3. The right to transfer the good to others 4. The right to enforce property rights 31

41 Economic Systems OWNERSHIP Planned Private Allocation Planned Socialist Planned Economy Command Capitalism Private Market Socialism Capitalism 32

42 Market-based Economy 33

43 Principles of Microeconomics Module 1.4 (B) Marginal Analysis 34

44 In this video we will discuss marginal analysis and how changes in incentives will change decisions of firms and consumers

45 Marginal Analysis Marginal analysis: examination of the associated costs and potential benefits of specific business activities or financial decisions. Goal: to determine if the costs associated with the change in activity will result in a benefit that is sufficient enough to offset them. Instead of focusing on business output as a whole, the impact on the cost of producing an individual unit is most often observed as a point of comparison.

46 Marginal Analysis Marginal analysis: examination of the associated costs and potential benefits of specific business activities or financial decisions. Goal: to determine if the costs associated with the change in activity will result in a benefit that is sufficient enough to offset them. Instead of focusing on business output as a whole, the impact on the cost of producing an individual unit is most often observed as a point of comparison.

47 Marginal Analysis Marginal analysis: examination of the associated costs and potential benefits of specific business activities or financial decisions. Goal: to determine if the costs associated with the change in activity will result in a benefit that is sufficient enough to offset them. Instead of focusing on business output as a whole, the impact on the cost of producing an individual unit is most often observed as the best point of comparison.

48 Example of Marginal Analysis A manufacturer wishes to expand its production A marginal analysis of the costs and benefits is necessary. COSTS Additional manufacturing equipment BENEFITS Estimated increase in sales attributed to the additional production Additional employees for increased output Larger or New Facilities Additional materials for production

49 Example of Marginal Analysis If the increase in income > the increase in cost, the expansion may be a wise investment COSTS Additional manufacturing equipment BENEFITS Estimated increase in sales attributed to the additional production Additional employees for increased output Larger or New Facilities Additional materials for production

50 Incentives People face trade-offs in the every decisions that they make Weigh the costs/benefits associated with their choices Choose what fits their needs/wants best Incentives change costs/benefits of a decision Because they alter the costs or benefits of doing something they may change the choice a person makes 41

51 Examples of Incentives and Disincentives INCENTIVES DISINCENTIVES Retail store sales: Buy-one get-one sales Attendance policies in class Taxes on cigarettes, alcohol ect. Calorie reports at fast-food restaurants Tax subsidy for new green technology Pollution tax

52 Examples of Incentives and Disincentives INCENTIVES DISINCENTIVES Retail store sales: Buy-one get-one sales Attendance policies in class Taxes on cigarettes, alcohol ect. Calorie reports at fast-food restaurants Tax subsidy for new green technology Pollution tax

53 Key Takeaways Marginal analysis is used frequently by firms to weigh the benefits and drawbacks of business decisions People do this too! They weigh the costs and benefits of various decisions and make a choice Incentives/disincentives change the costs or benefits of a choice, therefore may alter the decision someone makes

Principles of Macroeconomics Module 1.1. Scarcity, Limited Resources and Opportunity Costs

Principles of Macroeconomics Module 1.1 Scarcity, Limited Resources and Opportunity Costs What is Economics? Economics is the study of how people and society allocate scarce resources Scarce resources: