Unit Four: Basic Economic Concepts
“Principles & Foundations of Economics”
Economic Goals
1. Economic growth – produce more and better goods and services
2. Full employment – suitable jobs for all citizens who are willing and able to work
3. Economic efficiency – achieve the maximum production using available resources
4. Price-level stability – avoid large fluctuations in the price level (inflation +
5. deflation)
6. Economic freedom – businesses, workers, consumers have a high degree of
7. freedom in economic activities
8. Equitable distribution of income – try to minimize gap between rich and poor
9. Economic security – provide for those who are not able to earn sufficient income
10. Balance of trade – try to seek a trade balance with the rest of the world
Economics is a study of the choices individuals and nations make when dealing with
the reality of scarcity. Basically, every individual is assumed to have unlimited and
changing wants. The only problem is the limited availability of resources to satisfy those
wants. This, of course leads to the basic economic problem.
The Basic Economic Problem: Humans' wants and needs are infinite, while
the resources needed to satisfy those wants
and needs are limited and scarce.
Scarcity: occurs when something is both desirable and limited.
Why Study Economics?
Economics: The study of how people use scarce and limited resources to
satisfy unlimited needs and wants. So, we study economics because we all want
to learn how to maximize our satisfaction!!!
Productive Resources: Economics is about the allocation of resources among
society’s various needs and wants. These resources are
separated into four factors of production.
Factors of Production:
In order to produce anything, three types of productive resources must be employed (used):
Land: the "gifts of nature". Includes forests (timber), minerals, fisheries,
agricultural land, real estate, cotton, silk, corn, soy beans, etc...
ANYTHING THAT ORIGINATED FROM LAND, SEA or AIR.
Also called "NATURAL RESOURCES"
Labor: Two types are physical and intellectual. Also called "HUMAN
RESOURCES" or "HUMAN CAPITAL"
Unit Four: Basic Economic Concepts
Capital: the "machinery" of an economy. Can be as simple as a pair of scissors
and tape or as complicated as an industrial robot. Also called "PHYSICAL
or RESOURCE CAPITAL"
Entrepreneurship: The fourth productive resource. Entrepreneurs are the "risk
takers" who put their skills and innovations to the test; they
are willing to bet they will succeed in the marketplace.
Entrepreneurship is the only resource that is not considered
"scarce" since there is no limit to the creativity of humans.
Payments for resources: Since resources are scarce, there is a cost associated with
their use.
Land = rent, labor = wages, Capital = Interest, Entrepreneur = Profits
Determinants for Production: One must compare marginal benefits and marginal
costs to determine the best or optimal output mix on the Production Possibilities Curve.
Externalities
Definition of externality: the uncompensated impact of one person’s actions on the
well-being of a bystander.
A. If the effect on the bystander is adverse, we say that there is a negative
externality.
B. If the effect on the bystander is beneficial, we say that there is a positive
externality.
Negative Externalities:
Example: an aluminum firm emits pollution during production.
Pollution by the firm imposes costs on third parties. The firm is likely emitting
pollution because this is the cheapest method of production. The firm is using a
resource in production that it is not paying for.
Solution: Because the producer does not pay the true cost of producing aluminum,
the market will produce more aluminum than is optimal. This negative externality
could be fixed by placing a tax on producers for each unit of aluminum sold. In this
way, the producer would have to bear the social cost of the pollution.
Positive Externalities:
Example: education.
Education yields positive externalities because a better educated population leads to
a better government and more production.
Solution: Allow government to subsidize education.
Opportunity Cost
One of the MOST important concepts in all of economics is that of Opportunity Cost
Because resources are scarce, every decision humans make involves a choice or
(Tradeoff). You must give something up in order to have something you want.
Unit Four: Basic Economic Concepts
Opportunity Cost: The opportunity cost of anything is what you had to give up. The
opportunity cost would have been your 2nd choice, not everything you could have done.
(alternative foregone)
Examples:
The opportunity cost of watching TV on a weeknight is the benefit you could have
gotten from studying.
The opportunity cost of going to college is the income you could have earned by
getting a job out of high school
The opportunity cost of starting your own business is the wage you give up by
working for another company
The opportunity cost of using forest resources to build houses is the enjoyment
people get from having pristine forests.
Economics Vocabulary:
Macroeconomics – concerned with the economy as a whole or with aggregates – like
government, business sectors, or households. Macroeconomics is concerned with an
overview of the economy.
Microeconomics – concerned with specific economic units or individual markets under
a microscope. Emphasis is on individual households, industries, or firms [like the # of
workers employed by Ford]
Producers Supply (firms) and Consumers Demand (households): The
economy is made up of these two major groups (there’s also government, but that
comes later). Most interactions in the marketplace are between households (that’s us)
and firms (that’s the companies who make the stuff we demand)
Marginal Analysis: In economics, marginal means additional, extra, or one
more. A rational person will change their decision if the
expected marginal benefit (revenue) exceeds the expected
marginal cost.
Trade and exchange: Without trade, none of us would be here right now.
Economics will help you understand how trade makes
everyone better off. Markets are where all economic
transactions take place. (ebay, Publix)
Good: any tangible element of the product market – physical object
Service: intangible element of the product market (mechanic)
Resource: anything used to produce a Good or Service
Sunk Cost a cost you cannot recover, ex. Time spent in a line waiting
Unit Four: Basic Economic Concepts
Announcement: All economics students will
receive a FREE LUNCH of pizza and soda
compliments of your Economics teacher this
Friday!
Reality:
"THERE'S NO SUCH THING AS A FREE LUNCH!” Choices always have Cost.
What is the OPPORTUNITY COST of having lunch a "free lunch" with your Economics
teacher on Friday?
The Production Possibilities Curve/Frontier (PPC or PPF)
What is the PPC? The PPC illustrates the possible combinations of goods or
services
that can be produced by a single nation, firm, or individual
using resources efficiently
What does it show? That nothing is free and that everything has an opportunity
cost. If society wants more pizzas, it must give up
robots.
What basic economic concepts can it be used to model?
Scarcity, tradeoffs, opportunity cost, economic growth, efficiency, unemployment.
Law of increasing opportunity cost:
As the production of a particular good increases, the opportunity cost of
producing an additional unit rises.
Rationale: Economic resources are not completely adaptable to alternative uses. Many
resources are better at producing one type of good than at producing others.
Unit Four: Basic Economic Concepts
Assumptions Economist make when analyzing the PPC:
Points on the curve are only attainable if a nation achieves full-employment of its
productive resources
The nation's resources are fixed in quantity – this means that for the moment we will not
increase our productive capacity by developing new technology or finding more
resources.
Assumes the nation must choose between only two goods, usually capital vs. consumer
goods
The economy is closed, i.e. does not allow trade with other countries
Represents only one country's economy
Questions to consider about the PPC:
1. Which point(s) are attainable and most desirable? WHY?
2. Which point(s) are attainable but not desirable? WHY?
3. Which point(s) are currently unattainable? Is this point desirable? Explain.
4. Which point will mean more consumption in the future? Explain.
5. Which point means more consumption now? Explain.
6. Why is the PPC bowed outwards?
7. How does the PPC illustrate opportunity cost? Tradeoff? Scarcity?
8. Suppose that additional resources (land, labor, capital and entrepreneurial ability
was found. (In other words the economy is expanding.) HOW WOULD THIS
AFFECT OUR PPC? (Illustrate your response)
9. What happens if a technological advancement is made toward only one product?
(Illustrate your response)