Scarcity implies the need for choice To help us understand those choices it is useful to have a model of human behavior

Transcription

1 Macro PPF Highlights WCC Big Ideas Scarcity Utility maximization Economic rationality Opportunity cost Efficiency Specialization of inputs Economic growth Production possibilities Consumption possibilities The fundamental problem of economics is scarcity. Without it, economics lacks a raison d'etre, a reason for existence. Without scarcity there are no difficult decisions to make about the allocation of resources. Production Process A B Resources Production Goods & Services Inputs Process Outputs Factors of Production if A is limited then B is limited Resources or factors of production Land (natural resources is text s term) Labor Capital Entrepreneurial Ability Scarcity implies the need for choice To help us understand those choices it is useful to have a model of human behavior ppf basics.doc 1 Revised on 01/22/13

2 Model human behavior not all wants and needs will be satisfied how do we decide which needs to satisfy not random (supermarket example) behavior is teleological pursue a goal, happiness aka utility assume that consumers are out to maximize utility or satisfaction How do we make choices to help us achieve that goal? assume for the most part, that people behave in an economically rational manner requires weighing the benefits against the costs Storytime butterfly collecting judge the method not the goal For economists, cost means opportunity cost. Opportunity Cost - the foregone value of the next best item that is not chosen Opportunity cost includes both explicit and implicit costs associated with a decision. more important than explicit cost/money cost/price desperately important concept in economics, key to understanding both domestic and international trade Demonstrate importance of opportunity cost in decision-making addicted to Coke explicit cost is $3.60 at the corner store explicit cost is $2.50 across town, 10 miles away ppf basics.doc 2 Revised on 01/22/13

3 drive parents car Notes on opportunity cost because OC depends on values it is subjective can also be very hard to judge frequently we can only guess at what the value of the road not taken would have been to us sometimes the next best alternative turns out to be better than what you selected. Recap consumer dealing with scarcity out to maximize utility behave in an economically rational manner comparing opportunity costs of decisions The Production Possibilities Frontier a graph which allows us to examine this process and at the same time explore our Big Ideas shows the maximal combinations of two goods that can be produced, given available resources and technology PPF Assumptions 1) Two goods 2) Fixed quantity and quality of resources 3) Fixed technology 4) Existence of specialization of inputs Draw a couple of PPFs EXPLORING THE PPF Efficiency A vs B attainable vs unattainable region efficiency only on the frontier itself absence of waste ppf basics.doc 3 Revised on 01/22/13

4 Inefficiency How can you end up at A? 1) Not use all available resources 2) Use available resources incorrectly Scarcity responsible for the existence of PPF negative slope Opportunity Cost the next best alternative you forego only two alternatives can be measured by examining the slope of the PPF Explore OC with an example Farmer Phred Example Rice Wheat Point A B C D E F Start by assuming we re producing efficiently at point A. We decide to move to B, increasing rice production by 10K bushels. What do we give up? 2K in wheat production 1/5 bu. wheat per bu rice OC 1 additional bu rice is, on average, 1/2 bu wheat essentially we've just calculated the absolute value of the slope of the PPF, steepness Repeat this exercise B to C 6K in wheat production 3/5 bu wheat per bu rice OC 1 additional bu rice is, on average, 3/5 bu wheat ppf basics.doc 4 Revised on 01/22/13

5 again we've just calculated the absolute value of the slope of the PPF, steepness as we've gained rice, the OC of additional units of rice has increased Discoveries OC of additional rice measured by steepness the OC of an additional bushel of rice rises as we produce more rice Principle (Law) of increasing (opportunity) costs - as you produce more of a given good the opportunity cost of an additional unit of that good increases Does this hold for wheat as well as rice? Yes repeat calculations OC of an additional unit of wheat is equal to the absolute value of the reciprocal of the slope of the PPF OCX = abs(slope) OCY = abs(1/slope) Why might this principle of increasing costs hold? specialization of inputs concavity some inputs are better suited to producing one output than the other - 2 types of land How would the PPF differ if there were no specialization of inputs? trade-off is always constant thus OC of another unit is always constant constant slope to PPF right versus left shoes ppf basics.doc 5 Revised on 01/22/13

6 Scarcity is responsible for the negative slope of the PPF, while specialization of inputs is responsible for the concavity. What holds for individual holds for the economy as a whole. divide everything produced in the U.S. into two groups capital goods and consumption goods draw a PPF to represent our economy almost certainly concave wrt the origin Consumption good - a good used for the immediate gratification of HH wants and needs, one that does not contribute directly to future production, CD or an ice cream bar Capital good - a good used to produce goods and services for future consumption, drill press If the U.S. is producing efficiently where must it be? on the frontier What specifically might cause us to be inside the frontier? unemployment improper resource use discrimination If the U.S. wants more consumption goods, does it have to give up some of its capital goods? static world, starting on the frontier, then yes interior, then no, zero opportunity cost Do we live in a static world? technological change occurs exist in a dynamic world increases our resource base increases what we are capable of producing shifts the PPF outward now possible to obtain more of both goods (free to choose less of one) ppf basics.doc 6 Revised on 01/22/13

7 known as economic growth Economic growth - an outward shift in the PPF due to technological change or the discovery of new resources Why focus on the PPF PPF is also the consumption possibilities frontier Growth one sector versus two sector growth increases the size of the pie better satisfies our wants and needs Technological change new technology techne = knowledge, practical knowledge new discovery transistors replacing vacuum tubes specialization or division of labor Ford and the assembly line Adam Smith and the pin factory We have addressed a number of concepts thus far: scarcity, efficiency, opportunity cost, specialization of inputs, and economic growth to name a few. Why are all of these important? These ideas help explain trade. ppf basics.doc 7 Revised on 01/22/13