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The Economizing Problem Lake County Schools

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The Economizing Problem Lake County Schools Powered By Docstoc
					Uncle Sam wants you to
 do your homework!
Do a very quick review of slides 2-11 as FoPs
  and Resource Payments should be part of
                 their reading
  Economizing Problem
unlimited wants & limited resources


           Choices
     Unlimited       Limited
    needs & wants   Resources
 GOODS & SERVICES PROVIDE...

UTILITY [satisfaction]
Classification of Products:
                         .
                              Luxuries


                       V.
          NECESSITIES



     Food          Clothing      Shelter
  *The Four Factors of Production
       Resources beget production, which. beget income, which beget wealth.

1. Land [natural resources] – Nature’s items [“gifts of nature”]
 A. In the earth - coal, oil, water, fossil fuels, etc.
 B. On the earth – vegetation and water
 C. In the atmosphere – sun, wind, and rain
    [Land is the starting point         of all production.
      “Stuff” from which everything is made.




     Water                 Wind




      Sun              Fossil fuels        “Gifts of Nature”
2.   Labor [human resources] {“effort”}
                         .



  anyone who works [“paid work”]
 [Labor is the “brain-power” and
 “muscle-power” of human beings]
 A. Physical – pro athletes & lumberjacks
 B. Intellectual – ministers, doctors & lawyers
 *Most important resource – 70% of input cost




               “Hired Help”
                                     .




3. *Capital Resources – all “man-made inputs” used in the
  production process (tools, machinery, and physical plants).

Two Goods:
 A. Capital goods – goods [machinery, buildings, & tools] used to
   produce other goods. [crane, Ford plant, hammer]
   [products meant for “future consumption”]
 B. Consumer goods – products meant for “immediate consumption”.


A product can be both a consumer & a capital good – depends on its use.

Ex: Jet aircraft used by a movie star to visit friends (consumer good).
  The same aircraft used by a business manager to serve customers
  [capital good].

Ex: F150 pick-up to deliver produce [capital good] or
               take family to church [consumer good]
Three Types of Capital:
                                       .


   1. Real/Physical
      Can produce something directly with these
      Is a FoP
      Hammers, factories, robots, etc
   2. Financial
       Can’t produce anything directly with these
       NOT a FoP
       Money, Stocks, Bonds
   3. Human
        Intrinsic qualities of an individual
        Not a FoP
        Intelligence, education, drive, charisma, attractiveness, etc
4. Entrepreneurship
  – starting a new business or introducing a new product.

     • “Sparkplugs” who introduce the product or start the
       new business.

        – She combines land, labor, & capital to produce
          products.


     Are you
     tracking
      on the
      FoPs?
     1, 2, or 3
*Resource payments:
     Money given to the owners of the factors of Production
     for the use of their FoPs.




 Rent    Wages         Interest       Profits
 Land    Labor         Capital        Entrepreneur
You MUST know the information on
      the following slides:

  The circular flow is Important.
                       Be able to:
                            Draw it
                            Know how everything flows
                         Know it forwards and backwards




 *The Circular Flow Model (or CF of Economic Activity)
   illustrates, in a simplified manner, the transactions
              that take place in an economy.
            CIRCULAR FLOW MODEL
Two markets through which the transactions are completed:

                                RESOURCE
                                 MARKET



To main Actors:


             BUSINESSES                           HOUSEHOLDS




                                 PRODUCT
                                  MARKET
                    RESOURCE
                     MARKET


        AKA: RESOURCES        AKA: INPUTS
             Factors of Production

BUSINESSES                             HOUSEHOLDS




                    PRODUCT
                    MARKET
              Resource Payments
AKA: COST$                           AKA: INCOME$
                    RESOURCE
                     MARKET


        RESOURCES                 INPUTS
             Factors of Production

BUSINESSES                             HOUSEHOLDS



        GOODS &                GOODS &
        SERVICES               SERVICES

                    PRODUCT
                    MARKET
              Resource Payments
$ COSTS                                    $ INCOMES
                    RESOURCE
                     MARKET


        RESOURCES                 INPUTS
             Factors of Production

BUSINESSES                            HOUSEHOLDS



        GOODS &                GOODS &
        SERVICES               SERVICES

                    PRODUCT
                     MARKET
               Resource Payments
$ COSTS                                     $ INCOMES
                     RESOURCE
                      MARKET


        RESOURCES                  INPUTS
              Factors of Production

BUSINESSES                               HOUSEHOLDS



        GOODS &                 GOODS &
        SERVICES                SERVICES

                     PRODUCT
                      MARKET
$ REVENUE                             $ CONSUMPTION
             Consumer Expenditures
   The Circular-Flow Diagram
                 Product Market
                 1
                 2

                 What flow are the following?
             2   A. Consumer expenditures?  Businesses
             1   B. Goods and services?
             4   C. Land, labor, capital,
                    and entrepreneurs?
             3   D. Rent, wages, interest,    Businesses
Households         and profits?

                     3

                     4
                     Resource Market
             The Circular-Flow Diagram
                    Resource Market

                    1

                2

                 What flow are the following?
               4 A. Goods/services?
Businesses
               1 B. Factors of Production?
               3 C. Consumer Expenditures?
               2 D. Resource Payments?
 Businesses                               Households

                    3

                4


                        Product Market
                       Practice
                     Score: __ /9 points




Clearly Draw the circular flow of economic activity. (1)
      Pass out and explain Homework:
   – Properly Label:
      • BothMorton Micro Activity
             Markets (2)                      5–
                  The (2)
      • Both Participants Circular Flow
      • What is being exchanged (4)

                         Review as class at
                         whiteboard when
                            completed.
           TODAY:
   Begin PPC lecture on slide 31



           Tomorrow:
Complete CF extension & Continue to
          delve into PPF
                       POP Quiz
                       Score: __ /9 points
                            No Notes




Clearly Draw the circular flow of economic activity. (1)
   – Properly Label:
      • Both Markets (2)
      • Both Participants (2)
      • What is being exchanged (4)
     Extended Analysis of The
          Circular Flow:



• See Next Slide:
PUBLIC SECTOR: GOVERNMENT’S ROLE


       $ COSTS                                $ INCOMES
                                     GOVERNMENT
  NET TAXES FLOW           RESOURCEGOODS & SERVICES
  TO GOVERNMENT             MARKET
                                 FLOW TO BUSINESSES
  FROM BUSINESSES
             RESOURCES                    INPUTS


                    G/S
                                              HOUSEHOLDS
     BUSINESSES   Taxes
                          GOVERNMENT
             GOODS &                   GOODS &
             SERVICES                  SERVICES

                           PRODUCT
                            MARKET
     $ REVENUE                             $ CONSUMPTION
PUBLIC SECTOR: GOVERNMENT’S ROLE

      $ COSTS                              $ INCOMES
                                NET TAXES FLOW
   GOODS & SERVICES     RESOURCETO GOVERNMENT
                         MARKETFROM HOUSEHOLDS
 FLOW TO HOUSEHOLDS
  FROM GOVERNMENT
             RESOURCES                  INPUTS


                                       G/S

                                                National Defense
    BUSINESSES                         Taxes
                        GOVERNMENT               HOUSEHOLDS

             GOODS &                 GOODS &
             SERVICES                SERVICES

                         PRODUCT
                          MARKET
     $ REVENUE                               $ CONSUMPTION
PUBLIC SECTOR: GOVERNMENT’S ROLE

      $ COSTS                                 $ INCOMES
                        RESOURCE
                         MARKET


              RESOURCES         FoPs INPUTS



     BUSINESSES                            HOUSEHOLDS
                        GOVERNMENT

             GOODS &                 GOODS &
                                      RESOURCES
             SERVICES                SERVICES
                                       FLOW TO
    EXPENDITURES
                                     GOVERNMENT
       FLOW TO            PRODUCT
  ACQUIRE RESOURCES        MARKET
     $ REVENUE                          $ CONSUMPTION
PUBLIC SECTOR: GOVERNMENT’S ROLE

      GOVERNMENT
     $ COSTS                               $ INCOMES
                                GOODS & SERVICES
     EXPENDITURES
        FLOW TO         RESOURCE    FLOW TO
    PRODUCT MARKET       MARKET   GOVERNMENT

             RESOURCES                  INPUTS


                       GOVERNMENT
     BUSINESSES                             HOUSEHOLDS



            GOODS &                G/S
            SERVICES                  GOODS &
                                     SERVICES
                         PRODUCT
                          MARKET
    $ REVENUE                            $ CONSUMPTION
PUBLIC SECTOR: GOVERNMENT’S ROLE


     $ COSTS                                   $ INCOMES
                        RESOURCE
                         MARKET


             RESOURCES                INPUTS


                       GOVERNMENT
     BUSINESSES                            HOUSEHOLDS



            GOODS &
            SERVICES                GOODS &
                                    SERVICES
                         PRODUCT
                          MARKET
    $ REVENUE                           $ CONSUMPTION
Note:

  – Unless otherwise stated, you will only need to draw the
    basic CF chart.
     • That is, you do not have to include the government
       section of the chart.
         – This doesn’t mean, however, that you won’t be
           tested on it
You MUST know the information on
      the following slides:

  Efficiency and the PPC is very
            Important.
              Be able to:
                   Draw it
                  Explain everything about it
              ECONOMICS & EFFICIENCY
Econ is concerned about obtaining the most utility from available resources
    Efficiency is about getting the most out of the least amount of FoP
                               Ex.: Leftovers

In order to obtain the best use of resources a society must have both:

  Full Employment
         ALL available FoPs are in use
                       by law/custom
                              Nat. Parks aren’t avail for oil drilling
  Full Production
        Using employed (those being used) FoPs to provide
  max utility for society
                 Underemployment
                        Failure to achieve max utility from
                        employed FoPs
              ECONOMICS & EFFICIENCY
Econ is concerned about obtaining the most utility from available resources
    Efficiency is about getting the most out of the least amount of FoP
                               Ex.: Leftovers


Full Production implies *2 kinds of efficiency:

       *Productive Efficiency
             Producing any mix of G/S in the least costly way
                    CDs & Walnuts; Microwaves & Socks

        *Allocative Efficiency
               Producing the mix of G/S most desired by society in
 Tracking? the least costly way
                      The “right” mix of G/S at the least cost
 FE/FP/PE/                    Defense & Schools, Robots & Pizza,
     AE
  1, 2, or 3
                              Bert & Ernie
PRODUCTION POSSIBILITIES (tables/curves)
 To know if we are producing efficiently we must 1st know how
much we can actually produce (AKA: our production possibilities)


**When creating a PPC (Or PPF [Frontier]) we assume 4 things:

   1.   Full Employment and Productive Efficiency
   2.   Fixed Resources
   3.   Fixed Technology
   4.   Two Goods



                                  for example...
Two Goods:
A Consumer Good?
Two Goods:
 A Capital Good?
             PRODUCTION POSSIBILITIES
 What if we could only produce ...
             10,000 Robots
                                    or
                                  400,000 Pizzas


Using all of our resources, to get some pizza, we must give up
some robots!
                                                  for example...
PRODUCTION POSSIBILITIES
in table form
PIZZA                    0    1   2   3   4
(in hundred thousands)
ROBOTS                   10   9   7   4   0
(in thousands)
     PRODUCTION POSSIBILITIES
     in table form
      PIZZA                               0   1      2      3        4
      (in hundred thousands)
      ROBOTS                             10   9      7      4        0
      (in thousands)

graphical form
                                (thousands)
                       Robots




                                        Pizzas (hundred thousands)
      PRODUCTION POSSIBILITIES
      in table form
       PIZZA                               0   1      2      3        4
       (in hundred thousands)
       ROBOTS                             10   9      7      4        0
       (in thousands)

graphical form
                                 (thousands)
                        Robots




                                         Pizzas (hundred thousands)
   PRODUCTION POSSIBILITIES
   in table form
    PIZZA                               0   1      2      3        4
    (in hundred thousands)
    ROBOTS                             10   9      7      4        0
    (in thousands)

graphical form
                              (thousands)
                     Robots




                                      Pizzas (hundred thousands)
      PRODUCTION POSSIBILITIES
      in table form
       PIZZA                               0   1      2      3        4
       (in hundred thousands)
       ROBOTS                             10   9      7      4        0
       (in thousands)

graphical form
                                 (thousands)
                        Robots




                                         Pizzas (hundred thousands)
      PRODUCTION POSSIBILITIES
      in table form
       PIZZA                               0   1      2      3        4
       (in hundred thousands)
       ROBOTS                             10   9      7      4        0
       (in thousands)

graphical form
                                 (thousands)
                        Robots




                                         Pizzas (hundred thousands)
      PRODUCTION POSSIBILITIES
      in table form
       PIZZA                               0   1      2      3        4
       (in hundred thousands)
       ROBOTS                             10   9      7      4        0
       (in thousands)

graphical form
                                 (thousands)
                        Robots




                                         Pizzas (hundred thousands)
            PRODUCTION POSSIBILITIES
Limited Resources means a limited output...

            At any point in time,
a full-employment, full-production economy
must sacrifice some of product X to obtain
             more of product Y.
                            Example:
             You have 5 hours before you go to bed.
               You can either study (X) or work (Y).
       If you choose to work more you have to study less
  The opportunity cost is the increased grade that you would’ve
                    earned by studying more
                 PRODUCTION POSSIBILITIES
**It is very important
that you
understand the 13
                 Q 14
concepts of         12
                 Robots (thousands)                               Unattainable
attainability       11 A
and efficiency.     10
                                              B
                                                                      w/o trade
                                      9           C                   W
                                      8
You will see,                         7
hear, and be                          6
                                                          D                   Attainable
tested on this                        5
                                      4
                                          Attainable                          & Efficient
throughout
                                      3       but
the course!                           2   Inefficient
                                      1                           E

Any questions?                            1   2       3       4       5   6    7   8   Q
                                          Pizzas (hundred thousands)
   Prod. possibilities
PointsPoint C to D: of a country that can produce 2 goods:
From A-C: D E:
  PhDs and collar workers workers leaving pizza production to
  Original master degree leaving pizza production to make
 Avg blueItalian pizza makers leaving production to make
  make robots. Not much pizzaPizzaproduction and very robots
           HUGE decrease in is given up but big gains in robot
  robots. Biggerdecrease in pizza and smaller incr. in small
  production b/c they are better at making robots makers. who
  incr. in are better pizza makers master pizza makers
  b/c theyrobot production b/c are than robot than pizzas.
  have no clueQ 14 to make a robot.
                how
                                          13
             Pizzas (hundred thousands)   12         *Why does the sacrifice of pizzas
                                          11   A     increase as we produce more robots?
                                                   B
                                          10
                                                                 W
                                           9           C
                                           8
                                                               B/c economic resources are
                                           7                        not completely adaptable
                                                               D
                                           6                               to alternative uses!
                                           5
                                           4                        7 P Lost
                                           3   1
                                               2 P Lost             .5 R Gained
                                           2   2.5 Gained
                                               1 R R Gained
                                           1                        E

                                               1   2       3    4       5   6   7   8   Q
                                                   Robots (thousands)
PRODUCTION POSSIBILITIES

       Q 14
                     13
                     12   Notes...         Unattainable
                          A LAW OF INCREASING
Robots (thousands)
                     11
                              B
                     10     OPPORTUNITY COSTS
                      9           C
                          The amount of otherW
                      8   products that must be
                      7
                      6
                          forgone or sacrificed to Attainable
                                       D
                          obtain 1 unit of a specific
                      5
                      4
                           Attainable
                          product is called the
                                                      & Efficient
                      3        but
                          opportunity cost of that
                      2    Inefficient
                          good.
                      1                    E

                          1   2    3   4       5   6   7   8   Q
                          Pizzas (hundred thousands)
Opportunity Costs on a PPC/PPF
           What is the Op. Cost of producing 300k pizzas?
                 ~2,500 Robots
           Q 14 What’s the O.C. of making 7.5 Robots?
             13         100K Pizza
             12
                                        What’s the OC for
    Robots (thousands)
             11 A
                    B                 ? producing 400K
             10
              9         C          W    Pizzas?
              8                            ~10k Robots
                         7                   D
                         6
                         5                                   ?
                         4
                                 ?
                         3
                         2
                         1                           E

                             1       2   3       4       5   6   7   8   Q
                             Pizzas (hundred thousands)
Increasing Opportunity Costs
                                            Notes...
                                               LAW OF INCREASING
       Q 14                                    OPPORTUNITY COSTS
                     13                     A graph of the production
                     12 1P = 100R
                                            possibilities curve will be
Robots (thousands)
                     11   A
                     10       B 1P = 750R   CONCAVE - bowed out
                      9                     from the origin.
                      8             C
                      7                     Economic resources are
                      6
                      5 1P = 1,100R
                                            not completely adapt-
                      4                     able to other uses.
                      3
                      2    1P = 10,000R
                      1                     D

                         1    2   3    4        5   6   7   8   Q
                          Pizzas (hundred thousands)
             Constant Opportunity Costs
                                                                 Notes...



                                        8
                                                                   LAW OF CONSTANT
                       Q                                           OPPORTUNITY COSTS


                                        7
                                                                 A graph of the production
             Cake (hundred thousands)                            possibilities curve will be
                                        6
                                        5                        STRAIGHT
                                                   1P = 1C
                                               A               In this case economic
                                        4



                                                               resources are
                                                       1P = 1C
                                                      B        completely adapt-
                                        3




                                                               able to other uses.
                                                             C
                                        2




Tracking?                                     1P = 1C
                                                                  D
                                                      1P = 1C
                                        1




   Op.
 Cost?                                        1      2       3   4    5    6   7    Q
                                                                                    8
1, 2, or 3                                  Pizzas (hundred thousands)
At which point is this economy producing at allocative efficiency?
                              Unknown!
       Allocative efficiency must be determined by society
                (will be stated on tests/quizzes/etc)
                     Q 14
                                   13       Where is this economy producing at
                                   12
              Robots (thousands)                FE and Productive Effic.?
                                   11   A
                                   10
                                            B            Points A-E
                                    9           C                   W
                                    8
                                    7                   D
                                    6
                                    5
                                    4
                                    3
                                    2
                                    1                           E

                                        1   2       3       4       5   6   7   8   Q
                                        Pizzas (hundred thousands)
 Allocative Efficiency is determined by comparing the Marginal Benefits and Marginal
                                          Costs
• 1st look at Benefits
    – Benefits = amount of utility derived from a single unit
    – Marginal Benefits is _____________
                  Shoes Consumed   Total Utility   Marginal Utility
 What do you             0               0                 -
                                                                          What do you
 notice about            1              20               20                notice about
                         2              45                25
 Total Utility?                                                         Marginal Utility?
                         3              75               30
 Increasing              4             100               25                 Increasing
   w/each                5             120               20                   w/each
  additional             6             135               15                  additional
  unit up to             7             145                10                 unit up to
    9 pairs              8             150                5           Pair 3 then declining.
                         9             150                 0
                         10            140
                                                                        This is called…
                                                         -10
The Law of Diminishing Marginal Utility
Law of Dim. Marg. Utility explains why the MB curve slopes down.
      The more we have of something the less we value it.

                         Example:
                   P     The starving society values 100K pizzas at $15/pie
                               Give them an extra 100K pizzas and the benefit
                   $15         of each pie is valued at only $10
                                      Give them another 100K pizzas and
Marginal Benefit




                                      the benefit value drops another $5
                                             Think of your GF/BF:
                   10
                                             How much would you value them if you
                                             Only saw them 1 hour/day as opposed
                                             To seeing them every min. of every day?
                   5

                                                    MB
                            1       2        3          Q
           Quantity of Pizzas (in hundred thousands)
                  Opportunity Cost explains why the MC curve slopes up.
          The more pizzas we have, the more of something else we have to give up.
          Example:
          At 100K pizzas, society only has to give up $5 of product Y per pie produced
                P     Give them an extra 100K pizzas and it now costs society $10 of
                      product Y for each pie
                $15                                    MC
                                                       Give them another 100K pizzas and it
Marginal Cost




                                                       now costs society an additional $5 of
                                                       product Y per pie.
                10
                                                    Think of your GF/BF:
                                                    How much would it cost you if you only
                                                    saw them 1 hour/day as opposed the
                5                                   Cost of seeing them every min. of every
                                                    day?



                               1        2          3            Q
         Quantity of Pizzas (in hundred thousands)
Allocative Efficiency: MB=MC
 This is the amount of pizza that society wants
                                 P
                                                                 MC
       Marginal Benefit & Cost   $15
                                                   MB=MC

                                       MB>MC                   MB<MC
                                 10



                                 5

                                                                  MB

                                               1    2      3           Q
                       Quantity of Pizzas (in hundred thousands)
PRODUCTION POSSIBILITIES

       Q 14                       Unemployment & Underemployment
                     13
                     12           of resources are shown by Point U
Robots (thousands)
                     11
                     10                   Better employment of these
                      9                   resources is possible and
                      8                   Necessary to achieve a strong
                      7
                                          Economy.
                      6
                      5       U
                      4
                      3
                      2
                      1

                          1       2   3   4   5    6   7    8   Q
                          Pizzas (hundred thousands)
PRODUCTION POSSIBILITIES

       Q 14
                     13          Unemployment
                          Notes...                &
                     12    **Economic Growth
Robots (thousands)
                     11           Underemployment
                          The ability to produce
                     10
                      9   a largerShown by Point U
                                   total output -
                      8
                      7   a rightward shift of
                      6   the production
                      5     U            More of either or
                          possibilities curve
                      4
                      3   caused by... both is possible
                      2
                      1

                          1   2   3   4   5   6   7    8   Q
                          Pizzas (hundred thousands)
PRODUCTION POSSIBILITIES

 Q 14
Notes...
   13       Unemployment                         &
 **Causes of Economic Growth
   12
Robots (thousands)
   11                             Underemployment
                     10 1 – Increase in resource
                     9            Shown by Point U
                           supplies
                     8
                     7
                     6   2 – Better resource quality
                     5        U         More of either or
                     4
                     3
                                        both is possible
                         3 – Technological Production
                     2        advances
                     1

                          1       2   3   4   5   6    7   8   Q
                          Pizzas (hundred thousands)
PRODUCTION POSSIBILITIES

       Q 14               A’

Robots (thousands)
                     13
                     12
                                   B’       Economic Growth
                     11
                     10
                                                 C’
                      9
                      8
                      7
                      6                                       D’
                      5
                      4
                      3
                      2
                      1                                                E’

                          1    2        3    4        5   6    7   8    Q
                          Pizzas (hundred thousands)
        PRODUCTION POSSIBILITIES
             Two Examples of Economic Growth
     ALTA
Favors producing
Consumer goods
                           CURRENT
                            CURVE
      Capital Goods




                                 FUTURE
                                 CURVE
                               CONSUMPTION


                      Consumer Goods
                        Alta
       PRODUCTION POSSIBILITIES
            Two Examples of Economic Growth
     ALTA                                       ZORN
Favors producing                            Favors producing
Consumer goods                               Capital goods
                          CURRENT                                CONSUMPTION
                           CURVE
     Capital Goods




                                            Capital Goods
                                FUTURE                                  FUTURE
                                CURVE                                   CURVE
                              CONSUMPTION                              CURRENT
                                                                        CURVE

                     Consumer Goods                         Consumer Goods
                       Alta                                     Zorn
                                         Reminder:
The PPF shows how much G/S a nation can produce (AKA: its supply)
                    at a given point in time.

*When the PPF shifts so does the volume of the nation’s supply of G/S

When the PPC shifts left the economy now has a Larger / Smaller supply of g/s
When the PPC shifts right the economy now has a Larger / Smaller supply of g/s
              Capital Goods




                                                      *The shifting of an
                                                     economy’s volume of
                                                      supply of g/s is an
                                                     important concept to
                                                         remember.
                              Consumer Goods    We’ll be returning to this concept
                                                in more detail later in the course.
           Note for Mr. Oliver

• The next slide could be a 3 question quiz if I
  change the animation to have the answers
  come after Pass out and Explain HW: been
             all of the questions have
              Morton Micro Activity 2 –
  shown.Scarcity, Opportunity Cost, and PPC
  Britain uses economic resources to produce tea and crumpets.
 A movement from which points would indicate economic growth?
                            A-E to W
A movement from Z to A-E is not growth b/c Britain is merely meeting its potential.
                   Q14
                    13                    What 3 things would cause this
                  Tea (pounds in thousands)
                    12
                    11 A
                                   W
                                               economic growth?
What does the                  B            Increase in resource supplies
                    10
shape of the         9             C              Better resource quality
PPF tells us         8                          Technological Production
about the Op         7                   D                  advances
Cost of              6
                     5
producing                     Z
                     4
crumpets?            3
                     2
O.C. rises the       1                        E
More crumpets
Are produced.                                 1   2   3   4   5   6   7   8   Q
                                              Crumpets (pounds in thousands)
You + Ocala Forest + Genie
        Survival?
Every society must answer three questions:
  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.
• 3 Main Types of Economic Systems
  – Based on how they answer the 3 basic questions
  – There are no “pure” economic system
     • They are all mixed
           1. Traditional
               1.   Based on Traditions and Customs
           2. Command
               1.   AKA: Centrally-Planned
               2.   Based on Gov’t
               3.   Individuals have little influence
           3. Market
               1.   AKA: Capitalism
               2.   Command’s complete opposite
               3.   Most efficient of the three
               4.   Circular Flow of Economic Activity
Businesses



             Most needy   or Most money
                    Connection to the PPC
Communism in the                    Free Markets in the
   Long Run                             Long Run
                     CURRENT
                      CURVE                                      FUTURE
Capital Goods




                                                                 CURVE
                           FUTURE




                                    Capital Goods
                           CURVE
                                                                 CURRENT
                                                                  CURVE


                Consumer goods                      Consumer goods

                    Cuba                            Puerto Rico
        PRIVATE          FREEDOM OF
                         ENTERPRISE
        PROPERTY         & CHOICE



        ROLE OF
Ch. 4                   COMPETITION
        SELF-INTEREST



                         ACTIVE, BUT
        MARKETS          LIMITED,
        & PRICES         GOVERNMENT
1. Private Property – the right of individuals to
  exercise control over things owned. Freedom to
  negotiate binding legal contracts.
 Contracts are legally binding in oral or written form.
 [A verbal agreement is binding only if it involves a small sum of money
 over a short period of time and does not involve real estate purchases.]



 Watch:
 The Real Story Behind Thanksgiving – John Stossel
 (_ minutes)




 Be able to answer the following questions:
1. Private Property – the right of individuals to
  exercise control over things owned. Freedom to
  negotiate binding legal contracts.
 Contracts are legally binding in oral or written form.
 [A verbal agreement is binding only if it involves a small sum of money
 over a short period of time and does not involve real estate purchases.]


2. Freedom of Enterprise (business) & Choice
  Can move within the economy to any job, to
  buy or sell property, or start a business.
 The consumer is “sovereign” (king) in the economy. His
 dollars vote as it is he who decides what gets produced.
 The U.S. has over 100,000 business failures each year.       K-Mart?



3. Role of Self-Interest–each producer or consumer
  tries to do what is best for themselves. Self interest
  is the main force driving the economy.
  Producers aim for maximum profits.
  Consumers seek the lowest prices & highest quality.
Pure Capitalism (No G) and the Circular Flow
[Capitalism – “private ownership of capital”]

4. Competition – economic rivalry of a large number of buyers & sellers.
[central mechanism of market economy]
         Competition prevents one seller from controlling the market
         (AKA: monopolies).
                Monopolies become fat & unresponsive to consumers
                (higher prices & fewer choices).
5. Markets & prices. Markets bring the buyers and sellers into contact.


Prices send signals.  High prices send signals to increase
production and for other producers to enter the market.


Low prices send signals       to decrease production
and for producers to exit the market.


6. Limited Government Intervention in the economy.
The role of government was one of “laissez faire.” [“hands off”]
In the words of Adam Smith, the government should not interfere with
the operation of the economy except serve as an arbitrator in settling
disputes.
The government’s role:
 (according to Smith)
 a. provide defense,
 b. administer justice, and
                                                     Arbitrator
 c. maintain certain public institutions.            [settling disputes]
   Small Group
   Team Review

2-3 people w/white boards
 .
2 A student decides that, having already spent three hours studying for an
  exam, she should spend one more hour studying for the same exam. Which
  of the following is most likely true?

     (A) The marginal benefit of the fourth hour is at least as great as the marginal cost of the
     fourth hour.
     (B) The marginal benefit of the fourth hour is at least as great as the marginal cost of the
     fourth hour.
     (C) Without knowing the student’s opportunity cost of studying, we have no way of knowing
     whether or not her marginal benefits outweigh her marginal costs.
     (D) The marginal cost of the third hour was likely greater than the marginal cost of the fourth
     hour.
     (E) The marginal benefit of the third hour was less than the marginal cost of the third hour.


(B) – If we observe her studying for the fourth hour, then it must be that case that MB ≥ MC of
     studying for that next hour. If we observe her putting her books away and doing something
     else, the opposite must be true.
                         PPC Practice Questions
1. An economy that is fully employing all its productive
   resources but allocating less to investment than
   to consumption will be at which of the following
   positions on the PPC to the right?
 a. A     b. B   c. C    d. D   e. E

2. Which of the following best explains the shape of the
   PPC for the two-commodity economy shown above?
 a. Opportunity cost of producing another unit of each stays the same.
 b. Opportunity cost of producing another unit of each decreases.
 c. Opportunity cost of producing another unit of each increases.

3. Which of the following is true of the PPC on the right?
 a. Point Q is attainable but undesirable.
 b. Point R is unattainable but undesirable.
 c. A technological improvement of watches would move
    the economy from T to P.
 d. There is unemployment at point T because workers
 e. The opportunity cost of moving from S to T is the # of
    watches given up.
                                                                         A

4. If we move from B to C on the graph (right),                          H   B
  the opportunity cost is?                                                       C
 a. AH units of good Y                                                   G
 b. OG units of good Y
 c. EF units of good X                                                   O
 d. HG units of good Y
The island of Beckham uses economic resources to produce tea and
 crumpets. Use the following production possibilities frontier for
 questions 3-4.

                               D




                         TEA
                                   C
                                       E


                               A
                                       B

                                           Crumpets


3. Economic Growth is best represented by a
movement from
(A)   A to B
(B)   B to C
(C)   C to D
(D)   D to E
(E)   E to A

  D - Economic Growth is an outward expansion of the entire PPF. A movement
  from the interior to the frontier (A to B) is not growth, it just tells us that some
  unemployed resources (A) are now being used to their full potential (B).
                            NS 33-39
[Scarcity, choices, and opportunity costs are building blocks].
33. The economizing problem is deciding how to make the best
   use of (limited/unlimited) resources to satisfy (limited/unlimited) wants.
34. Money is not considered an economic resource because
   money (is/is not) productive. The process of accumulating
   capital goods [tools, machinery, and factories) is
  (depreciation/investment).
                                           Any tool, machine, or factory
35. Give examples of real capital. ________________________
36. The payments for the 4 factors of production are:
     Rent           Wages            Interest               Profits
     Land            Labor           Capital            Entrepreneur
37. The PPC illustrates the principle that if all resources of an
   economy are in use, more of one good can be produced
   only if (more/less) of another good is produced.
38. Give two reasons that could shift the PPC outward.
    More or better resources; better technology
   __________________________________________________
39. The opportunity (cost/benefit) is the 2nd best choice.
                              D




                        TEA
                                  C
                                      E


                              A
                                      B

                                          Crumpets

    4. The shape of this PPF tells us that:
    (A) Economic resources are perfectly substitutable from production of
        tea to production of crumpets
    (B) Citizens prefer that an equal amount of tea and crumpets be
        produced.
    (C) The opportunity cost of producing crumpets rises as more crumpets
        are produced.
    (D) The opportunity cost of producing crumpets is constant along the
        curve.
    (E) The opportunity cost of producing tea falls as you produce more
        tea.
C – When the PPF is concave (or bowed outward) it is an indicator of the Law of
Increasing Costs. This is a result of economic resources not being perfectly
substitutable between tea and crumpets. A baking sheet used to bake crumpets might
be quite useless in producing tea leaves.
PPC Practice Questions                          [continued]

5. Which of the following would cause the
   PPC shown (right) to shift outward?
 a. Reopening steel plants that had been closed
 b. Rehiring laid-off workers              Missiles
 c. Using machinery for missile production
    instead of steel production
 d. Using machinery for steel production
    instead of missile production
                                                              Steel
 e. Developing a more efficient steelmaking process


6. Base on the graph (right), which statements
   are true?
 I. The opportunity cost of moving from P to R
    is 10 units of Y.
 II. The opportunity cost of moving from R to P
    is 8 units of X.
 III. The opportunity cost of moving from Q to R
    is 0 units.
   a. I only b. III only c. I & II only d. I, II, & III        X
                 A
                                          PPC
          C
          A          B             G
          P
          I              C       More or better resources or better technology
          T
                     F
          A
          L                  D
          G
          O
          O                    E
          D
          S   Consumer Goods
40. At what letter is there unemployment [recession]? F
41. What letters represent resources being used in their
    most productive manner? [full employment,
    full production, and best available technology] A,B,C,D,E
42. What letter represents an improvement in technology,
    therefore a new PPC frontier line? G
43. The (straight line/curve) illustrates the “law of increasing cost”?
44. The (straight line/curve) illustrates the “law of constant cost.”
45. At what letter would there be the most economic growth in
    the future if a country were producing there now? A
46. What is the opportunity cost when moving from “C” to “D”; Capital
    when moving from E to B; Consumer
    & do we have to give anything up when moving from F to D? no
                  NS 56-59




                                              Fuzzy Wuzzy
56. In the product market (householders/businesses) are the
   demanders and (householders/businesses) are the suppliers.
57. In the resource market (householders/businesses) are the
   demanders and (householders/businesses) are the suppliers.
58. In the resource market, (householders/businesses)
    sell resources to (householders/businesses).
59. In the product market, (householders/businesses) sell
   products [goods/services] to (householders/businesses).
NS 60-63




   Outhouse
              4
                  3
                          1
                      2
The End
CIRCULAR FLOW MODEL

  $ COSTS                                   $ INCOMES
                    RESOURCE
                     MARKET


          RESOURCES                INPUTS



  BUSINESSES                           HOUSEHOLDS



         GOODS &                GOODS &
         SERVICES               SERVICES

                      PRODUCT
                      GDP
                       MARKET
  $ REVENUE                         $ CONSUMPTION
             PRODUCTION POSSIBILITIES
             Applications...
• Productive Inefficiency
   • An economy is operating w/in the PPF when workers are
     unemployed due to economic circumstances, discrimination,
     etc
      • Also when a nation produces based on custom, heredity,
         and caste rather than on efficiency.

• PPC illustrates Tradeoffs and Opportunity Costs
Going to War (U.S.) When            the U.S. entered WWI, we had severe unemployment.
We were able to step up production of consumer goods and war materials simply by
getting to full production. We went from 14.6% unemployment in 1940 to 1.2% in 1944.
Over 7 million people went to work that were not working in 1940.



                    War Goods
                                             C              United States
                                      F                   [Beginning of WWII]
                                 Civilian Goods
Going to War(Russia). Russia, on the other hand, entered WWII at full capacity.
So their preparedness entailed a shifting of resources from civilian goods and a drop in
their standard of living.
The U.S. position was similar as we entered the Viet Nam War at full employment.
We increased both military spending and domestic spending on the “War on
Poverty.” Our attempt to achieve more “guns and butter” in a FE economy was
doomed. We were trying to spend beyond capacity and ended up with double
digit inflation in the 1970s.
                                                  C
                        War Goods
                                                                   Russia
                                                      D     [Beginning of WWII]

                                      Civilian Goods
Economic Systems
 1. Centrally-Planned
    (Command) Economy
 2. Free Market Economy
 3. Traditional Economy
 4. Mixed Economy
Centrally-Planned
   Economies
 (aka Communism)
   Centrally Planned Economies
In a centrally planned economy (communism)
   the government…
   1. owns all the resources.
   2. decides what to produce, how much to
      produce, and who will receive it.
Examples:
  – Cuba, China, North Korea, former Soviet Union

   NO PROFIT MEANS NO INCENTIVES!!
   Advantages and Disadvantages
     What is GOOD      What is BAD about
 about Communism?          Communism?
1. Low unemployment- 1. No incentive to work
   everyone has a job            harder
2. Great Job Security-   2. No incentive to
   the government       innovate or come up
   doesn’t go out of        with good ideas
   business              3. No Competition
3. Equal incomes means      keeps quality of
   no extremely poor          goods poor.
   people                4. Corrupt leaders
4. Free Health Care       5. Few individual
                               freedoms
Free Market System
   (aka Capitalism)
   Characteristics of Free Market
1. Little government involvement in the economy.
               (Laissez Faire = Let it be)
2. Individuals OWN resources and answer the three
                economic questions.
 3. The opportunity to make PROFIT gives people
    INCENTIVE to produce quality items efficiently.
 4. Wide variety of goods available to consumers.
 5. Competition and Self-Interest work together to
    regulate the economy (keep prices down and
                     quality up).
                 Reword for Communism
    Example of Free Market
     Example of how the free market regulates itself:
If consumers want computers and only one company is
                     making them…
 Other businesses have the INCENTIVE to start making
               computers to earn PROFIT.
         This leads to more COMPETITION….
   Which means lower prices, better quality, and more
                     product variety.
   To maintain profits, firms find most efficient way to
              produce goods and services

 The End Result: Most efficient production of the goods
that consumers want, produced at the lowest prices and
                  the highest quality.
     Example of Communism
           Example of why communism failed:
If consumers want computers and only one company is
                     making them…
   Other businesses CANNOT start making computers.
              There is NO COMPETITION….
   Which means higher prices, lower quality, and less
                     product variety.
 More computers will not be made until the government
             decides to create a new factory.

  The End Result: There is a shortage of goods that
 consumers want, produced at the highest prices and
                 the lowest quality.
                  The Invisible Hand
     The concept that society’s goals will be met as
        individuals seek their own self-interest.

      Example: Society wants fuel efficient cars…
         •Profit seeking producers will make more.
   •Competition between firms results in low prices, high
                quality, and greater efficiency.
    •The government doesn’t need to get involved since
        the needs of society are automatically met.

Competition and self-interest act as an invisible hand that
               regulates the free market.
  The Case for the Market System
 Efficiency, Incentives, and Freedom
Adam Smith said the “invisible hand” determines what
gets produced, how, & for whom. It is the invisible hand
that moves us along the PPC. The invisible hand is now
called the market mechanism. Its essential feature is
the price signal.
                               ADAM SMITH
                          WEALTH OF NATIONS – 1776
                              [explained the free market concept]


The “INVISIBLE HAND” – when individual consumers/
producers compete to achieve their own private self-interest.
The “role of government” [“LAISSEZ-FAIRE” – “HANDS OFF”]
is limited to national defense, public education, maintaining the
infrastructure, and enforcing contracts. Smith said the market
system was best because it encouraged specialization, resulting in
increased output & more economic growth.
Government was like an “INVISIBLE FOOT” – government action
to benefit particular groups. Keynes will say the G can act as a pressure
gauge,   letting off excess steam   or building it up as needed. [active-not all inclusive role]
                                                    So mercantilism died
                                                    as economic theory.
Smith’s book was an             attack on mercantilism.
Wealth doesn’t come from an accumulation of gold and silver but
from more productive people. A nation is wealthier if its citizens
Are more productive. It is the ability of people to produce products
 and trade in free markets that creates a nation’s wealth.

				
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