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Opportunity Cost ALL DECISIONS INVOLVE TRADE-OFFS • Trade-offs: ALL the alternatives that we give up when we make a choice o Examples: going to the movies • Opportunity Cost: more desirable alternative given up when you make a choice What are the trade-offs of deciding to go to college? →Living at home → Eating home cooked meals What is the opportunity cost of going to college? → Getting a job → Utility: Satisfaction → Marginal: Additional →Allocate: Distribute Price vs. Cost Price = Amount buyer pays Cost = Amount seller pays to produce a good or service Investment What is investment? The money spent by BUSINESS to improve their production Example: $1 Million new factory Consumer goods- created for direct consumption (pizza) Capital goods created for indirect consumption (ovens, blenders) THE FOUR FACTORS OF PRODUCTION 1. Land - All natural resources used to produce goods and services (water, sun) 2. Labor - Any effort a person devotes to a task for which that person is paid (manual laborers, lawyers, doctors) 3. Capital a. Physical capital- any human made resources that is used to create other goods and services (tools, tractors) b. Human capital - any skills or knowledge gained by a worker through education and experience 4. Entrepreneurship - Ambitious leaders that create product or start a business (Henry Ford, Bill Gates) a. Entrepreneurs: take initiative, innovate, act as risk bearers to OBTAIN PROFIT b. Profit Revenue - Costs Productivity • Measure of efficiency that shows the number of outputs per unit of input • Example: Bob can make 10 pizzas in 1 hour. • Why do businesses and countries want to improve their productivity? O Since all resources are scarce, improving productivity allows us to produce more stuff with fewer resources. MORE LABOR FORCE DOES NOT MEAN PRODUCTIVITY INCREASES ● 1.2 Notes THE THREE ECONOMIC QUESTIONS 1. What goods and services should be produced? 2. How should these goods and services be produced? 3. Who consumes these goods and services? The way these questions are answered determines the economic system. An economic system is the method used by a society to produce and distribute goods and services Centrally-Planned Economies (Communism) 1. They own all the resources 2. Answers the three economic questions 3. Examples: Cuba, North Korea, Former Soviet Union, China?? 4. Why do centrally planned economies face problems of poor-quality goods, shortages, and unhappy citizens? a. No incentive to make high quality products b. Harder time predicting preferences Advantages 1. Low unemployment-everyone has a job 2. Great job security-the government doesn't go out of business 3. Less income inequality 4. "Free" health care Disadvantages 1. No incentive to work harder 2. No incentive to innovate or come up with good ideas 3. No competition keep quality of goods poor 4. Corrupt leaders 5. Few individual freedoms Free Market Economy ➤ Little government involvement in the economy ➤ Individuals OWN resources and answer the three economic questions The opportunity to make PROFIT gives people INCENTIVE to produce quality items efficiently ➤ Wide variety of goods available to consumers Competition and self-interest work together to regulate the economy (keep prices down and quality up) Examples of how free market regulates itself: ● If consumers want smartphones and only one company is making them ● Other businesses have the INCENTIVE to start making smartphones to earn profit This leads to more competitions This leads to lower price, better quality, and more product variety We produce goods and services that society wants because resources follow profit ● MOST EFFICIENT PRODUCTION OF THE GOODS THAT CONSUMERS WANT, PRODUCED A THE LOWEST PRICE AND HIGHEST QUALITY. ● Examples of Central Planners Why communism failed... → If consumers want smartphones and only one is making them Other businesses cannot start making computers There is no competition Higher prices, lower quality, less product variety More phones will not be made until govt decides to create new factory Shortage of goods that consumers want, produced at higher price and low quality The Invisible Hand • Producers and consumers act in their own self interest and adjustments are made • Examples: Society wants fuel efficient cars O Profit seeking producers will make more o Competition between firms results in low prices, high quality, and greater efficiency O The government doesn't need to get involved since the needs of society are automatically met Mixed Economies Countries with free markets, property rights, and the Rule of Law, have historically seen greater economic growth because they are more productive ● 1.3 Notes Production Possibilities Curve ● A model that shows alternative ways that an economy can use its scarce resources The model graphically demonstrates scarcity, trade-offs, opportunity costs, and efficiency Anywhere on the line is efficient There is scarcity of resources because if you make x computers, you can only make y bikes A point inside the curve is inefficient What To Know About Production Possibilities Curves • The points show how much of each good will be produced when resources shift, thus impacting more production of one good and less of the other. . It doesn't indicate how much of each good should be produced, but the production sacrifice needed to make more of the other good. E: All resources are not being used. F: Any point outside the PPF curve is impossible; more of both goods cannot be produced with current resources. A: More of goods A are being produced and none of goods B are being produced. D: None of goods A are being produced and more of goods B are being produced. the balance Goods A ▬▬▬▬▬▬▬▬▬▬▬▬ A E Goods B • It demonstrates the concept of opportunity cost. F 4 Key Assumptions • Only two goods can be produced Full employment of resources . Fixed Resources Fixed Technology Constant Opportunity Cost- Resources are easily adaptable for producing either good • Like a pizza and a calzone use the same resources Result is a straight line PPC (NOT COMMON) Law of Increasing Opportunity Cost - As you produce more of any good, the opportunity cost (forgone production of another good) will increase Why? Resources are not easily adaptable to producing both goods 3 Shifters of the PPC 1. Change in resource quantity or quality 2. Change in technology 3. Change in trade → If there is an increase in population, the PPC is affected because we have more available labor → Countries that produce more capital goods will have more growth in the future Productive Efficiency • Products are benign produced in least costly way This is any point on the PPC Allocative Efficiency ● The products are being produced are most desired by society The optimal point on PPC depends on desires of society 1.4 Notes • Per unit Opportunity Cost = Opportunity cost/Units Gained Example (Per Unit Opportunity Cost Review) Ronal McDonald can produce 20 pizzas or 200 burgers 1. What is Ronald's opportunity cost for one pizza in terms of burgers given up? a. 1 pizza costs 10 burgers 2. What is Ronald's opportunity cost for one burger in terms of pizzas given up a. 1 burger costs 1/10 pizza Absolute Advantage vs. Comparative Advantage Absolute Advantage: The producer that can produce the most output requires the least amount of inputs (resources) Comparative Advantage: The producer with the lowest opportunity cost Countries should trade if they have a relatively lower opportunity cost • They should specialize in the good that is "cheaper" for them to produce (the one that hey have a comparative advantage) → Trade shifts the PPC → A country can consume beyond its present production possibilities curve when it trades with other countries, thus taking advantage of different opportunity costs Terms of Trade ● Both countries can benefit from trade if they each have relatively lower opportunity costs • Terms of Trade - The agreed upon conditions that would benefit both countries • Mutually Beneficial: Find the middle opportunity cost 1.5 Notes The Circular Flow Model The Product Market - The "place" where goods and services produced by businesses are sold to households. The Resource (Factor) Market - The "place" where resources (land, labor, capital, and entrepreneurship) are sold to businesses. DEMAND $$$ Costs $$$ Resources Businesses Copyright ACDC Leadership 2018 Goods and Services $$$ Revenue $$$ SUPPLY Resource Market Public Goods $$$ Government MAL $$$ Public Goods Product Market SUPPLY $$$ Income $$$ (Factor payments) Resources (Factors of Production) Individuals Goods and Services $$$ Spending $$$ DEMAND 1.6 Notes What is Demand? Demand is the different quantities of goods that consumers are willing and able to buy at different prices. What is the Law of Demand? There is an INVERSE RELATIONSHIP between price and quantity demanded. Why does the Law of Demand occur? 1. The Substitution Effect a. If the price goes up for a product, consumer buys less of that product and they buy more of another substitute product 2. The Income Effect a. If the price goes down for a product, the purchasing power increases for consumers allowing them to purchase more 3. Law of Diminishing Marginal Utility a. UTILITY = SATISFACTION b. We buy goods because we get utility from them c. This law states that as you consume anything, the additional satisfaction you will receive will eventually start to decrease d. The more you buy of ANY GOOD, the less satisfaction you get from each unit consumed ● e. For example, the more slices of pie you eat the less satisfying it gets f. For example, you buy one pumpkin and it is more costly than buying two pumpkins, because that second one is less useful to you. The Demand Curve • Graphical representation of a demand schedule ● It is downward sleeping showing the inverse relationship between price (y axis) and the quantity demanded (x axis) When reading a demand curve, assume all outside factors such as income are held constant Activity Time Shifts in Demand → When you are told something is changed, movement no longer occurs along the demand curve. Rather the entire demand curve shifts → A shift means that at the same prices, more people are willing to and able to purchase that good THIS IS A CHANGE IN DEMAND, NOT A CHANGE IN QUANTITY DEMANDED PRICE DOES NOT SHIFT THE CURVE What causes a shift in demand? 1. Tastes and preferences 2. Number of consumers 3. Price of related goods 4. Income 5. Future expectations about price Changes in PRICE don't shift the curve. It only causes movement along the curve. Prices of Related Goods • The demand curve for one good can be affected by a change in the price of ANOTHER related good 1. Substitutes are goods used in place of one another Ex: If the price of Pepsi falls, demand for coke will... -If the price of one increases, the demand for the other will increase 2. Complements are two goods that are bought and used together Ex: If the price of hot dogs falls, demand for hot dog buns will... -If the price of one increase, the demand for the other will fall Income The incomes of consumers change the demand, but that depends on the type of goods. 1. Normal Goods Ex: Luxury cars, seafood, jewelry, homes -As income increases, demand increases -As income falls, demand falls 2. Inferior goods Ex: Ramen, used cars, used clothes -As income increases demand falls -As income decreases, demand increases Supply What is Supply? • Supply is the different quantities of a good that sellers are willing and able to sell (produce) at different prices What is the Law of Supply? • There is a DIRECT (or positive) relationship between price and quantity supplied. O As price increases, the quantity producers make increases As price falls, the quantity producers make falls Why? Because, at higher prices profit seeking firms have an incentive to produce more. o Example: Mowing Lawns o o 5 Shifters (Determinants) of Supply 1. Prices/Availability of inputs (resources) 2. Number of Sellers 3. Technology 4. Government Action: Taxes and Subsidies a. Subsidies: A subsidy is a government payment to a business or market. Subsidies cause the supply of a good to increase 5. Expectations of Future Profit A CHANGE IN PRICE DOES NOT SHIFT THE CURVE. IT ONLY CAUSES A MOVEMENT ALONG THE CURVE. Supply is the entire supply curve, while quantity supplied is the exact figure supplied at a certain price. 1.8 Notes Double Shifts • Suppose the demand for milk increased at the same time as production technology improved ● Use S&D analysis to show what will happen to price and quantity Double shift Rule If two curves shift at the same time, EITHER price or quantity will be indeterminate • If supply increases and demand falls o P decrease and Q indeterminate ● When the price of a good is less than the equilibrium price o The price will increase to eliminate shortage and return to equilibrium Price Controls • Sometimes the government should intervene in the market to make sure prices aren't too high or low • Price floors and price ceilings ● Price Ceiling: max legal price a seller can charge for a product o Always below equilibrium, so the goal is to make affordable by keeping price from reaching equilibrium o For example → Gas o Does this policy help consumers? ■ Results in Black markets o Another example → Rent control ● Price Floor: Min legal price a seller can sell a product o Goal: keep price high by keeping price from falling to equilibrium O With a price floor, we end up with surplus o The supply is greater than the demand o Minimum wage is most common price floor o Does this policy help? ● If the supply is greater than demand, then there is a misallocation of resources Good Practice: • https://www.houstonisd.org/cms/lib2/TX01001591/Centricity/Domain/29885/Mac ro%20Unit%201%20Practice%20Questions.pdf • https://images.pcmac.org/SiSFiles/Schools/CA/SMJUHSD/Pioneer Valley High/Up loads/DocumentsSubCategories/Documents/ulpractexam.pdf