Lecture notes1b_unit1

(1)

Eco 1001-

Introduction to

Macroeconomics

(2)

2 of

36

(3)

THE ECONOMIC PROBLEM:

SCARCITY AND CHOICE

FIGURE 2.1

The Three Basic Questions

Three basic questions must be answered in order to

understand an economic system:

(4)

Capital

Things that are themselves produced and that are then used in

the production of other goods and services.

Labour

The broad category of human effort, both physical and mental

included

Land

Refers not only to land in the conventional sense of tracts of ground,

but all other natural resources

Entrepreneurial ability

The ability to organize production and bear risks.

4 of

34 Resources & Goods and Services

(5)

production

The process that transforms scarce

resources into useful goods and services.

THE ECONOMIC PROBLEM:

SCARCITY AND CHOICE

inputs

or

resources Anything provided

by nature or previous generations that

can be used directly or indirectly to

satisfy human wants.

To use resources,

wages

are paid to

(6)

6 of

34 Specialization, Exchange, and Comparative

Advantage

SCARCITY, CHOICE, AND OPPORTUNITY COST

theory of comparative advantage

(7)

SCARCITY, CHOICE, AND OPPORTUNITY COST

absolute advantage A producer has an

absolute advantage over another in the

production of a good or service if it can

produce that product using fewer

resources.

(8)

Absolute Advantage

(9)

(10)

Comparative Advantage

(11)

Comparative Advantage and

Gains from trade

• _{Does trade still increase overall production?}

• _ASSUMPTION:

_{The two can’t trade and they each spend half}

of their time on each good

• total output of the economy would be

11 bags of chips

and

12.5 jars of salsa

.

• _{Now what if they trade?}

• Specialization

the total output of the economy

would be

10 bags of chips

and

15 jars of salsa

(12)

Comparative Advantage and

Gains from trade

• _{…Imagine that Fifi decides she doesn’t want to spend ALL her}

time making salsa. Say she makes 2 fewer jars of salsa. That

means she can make 2 x 0.8 = 1.6 bags of chips. That brings

the total output of the economy to

11.6 bags of chips

and

13 jars of salsa

, which is higher than our total output was before

we considered the option of trade.

(13)

We trade off present and future benefits in

small ways all the time.

SCARCITY, CHOICE, AND OPPORTUNITY COST

(14)

14 of

34 SCARCITY, CHOICE, AND OPPORTUNITY COST

Capital Goods and Consumer Goods

Consumer goods Goods produced for

present consumption.(

those goods and

services that directly satisfy our wants).

Capital goods satisfy our wants

indirectly by permitting more efficient

production of consumer goods.

(15)

SCARCITY, CHOICE, AND OPPORTUNITY COST

production possibility frontier (ppf) A

graph that shows all the combinations of

goods and services that can be

produced if all of society’s resources are

used efficiently.

(16)

16 of

34 SCARCITY, CHOICE, AND OPPORTUNITY COST

(17)

SCARCITY, CHOICE, AND OPPORTUNITY COST

• _{The production possibilities curve illustrates two essential}

principles

• Scare resources

. There’s a limit to the amount we can produce in

a given time period with available technology and resources

• Opportunity costs

. We can obtain additional quantities of any

desired good only by reducing the potential production of

(18)

18 of

34 SCARCITY, CHOICE, AND OPPORTUNITY COST

Negative Slope and Opportunity Cost

FIGURE 2.4

Inefficiency from Misallocation

of Land in Farming

marginal rate of

transformation (MRT)

(19)

TABLE 2.1 Production Possibility Schedule for Total Corn and Wheat

Production in Ohio and Kansas

POINT ON PPF TOTAL CORN PRODUCTION (MILLIONS OF BUSHELS PER YEAR) TOTAL WHEAT PRODUCTION (MILLIONS OF BUSHELS PER YEAR)

A 700 100

B 650 200

C 510 380

D 400 500

SCARCITY, CHOICE, AND OPPORTUNITY COST

(20)

20 of

34 SCARCITY, CHOICE, AND OPPORTUNITY COST

Economic Growth

(21)

(22)

22 of

34 SCARCITY, CHOICE, AND OPPORTUNITY COST

COMPARATIVE ADVANTAGE AND THE

GAINS FROM TRADE

(23)

SCARCITY, CHOICE, AND OPPORTUNITY COST

(24)

24 of

34 SCARCITY, CHOICE, AND OPPORTUNITY COST

THE ECONOMIC PROBLEM

Recall the three basic questions facing

all economic systems:

(1) What gets produced?

(2) How is it produced?

(3) Who gets it?

(25)

ECONOMIC SYSTEMS

COMMAND ECONOMIES

command economy An economy in

which a central government either

(26)

26 of

34 ECONOMIC SYSTEMS

LAISSEZ-FAIRE ECONOMIES: THE FREE

MARKET

laissez-faire economy

Literally from

the French: “allow [them] to do.” An

economy in which individual people and

firms pursue their own self-interests

without any central direction or

regulation.

market The institution through which

buyers and sellers interact and engage

in exchange.

(27)

ECONOMIC SYSTEMS

consumer sovereignty The idea that

consumers ultimately dictate what will be

produced (or not produced) by choosing

what to purchase (and what not to

purchase).

(28)

28 of

34 ECONOMIC SYSTEMS

free enterprise The freedom of

individuals to start and operate private

businesses in search of profits.

(29)

ECONOMIC SYSTEMS

Distribution of Output

The amount that any one household

gets depends on its income and wealth.

Income

is the amount that a household

earns each year. It comes in a number of

forms: wages, salaries, interest, and the

like.

(30)

30 of

34 ECONOMIC SYSTEMS

Price Theory

In a free market system, the basic economic questions are answered without the help of

a central government plan or directives. This is what the “free” in free market means—

the system is left to operate on its own, with no outside interference. Individuals pursuing

their own self-interest will go into business and produce the products and services

that people want. Others will decide whether to acquire skills; whether to work;

and whether to buy, sell, invest, or save the income that they earn. The basic coordinating