Scarcity, opportunity costs and production possibilities

1. Scarcity, opportunity costs and production possibilities

2. The Great Philosopher • Steven Wright once said “Everywhere is within walking distance, if you have the time.”

3. Utility • The amount of satisfaction or usefulness we get out of consuming a good or service or performing an action • How would you measure “utility?” • Economists measure utility in units called “utils”

4. Small Group Discussion Time • What is the predictable, rational response to choosing between two actions/goods/services in relation to utils?

5. Utility • Almost all goods and services provide us with some level of satisfaction (even “negative” levels of satisfaction!) • So how do we choose? What are the consequences of our choices?

6. The Great Philosopher… • Steven Wright also once said… “You can’t have everything…. Where would you put it?”

7. Small Group Discussion Time • What is the difference between an item being described as “scarce” and an item being in “shortage?”

8. Shortage vs. Scarcity • Shortage – usually a temporary condition where demand is greater than the supply of a good or resource. • Market forces will correct for the shortage • Scarcity – a naturally occurring limitation on a good or resource that cannot be replenished. • Everything and anything is naturally scarce

9. Scarcity • Scarcity in Economics means: • Lack of money • Lack of time • Lack of resources • Scarcity in Economics means: • Making choices • Opportunity Costs

10. Opportunity Costs • Consuming or producing more of one thing means consuming or producing less of something else • a cost of consuming one thing and not the other = an opportunity cost • Performing one action means not being able to perform another action • Opportunity costs can be measured in: • Money • Time • Units of production/consumption

11. Decision Matrix – What is the Opportunity Cost?

12. Measuring What We Gain/Lose • Production Possibilities Frontier – • Tells us the frontier of what an economy can produce • Shows the possibilities of making two goods • Also shows the potential tradeoffs • Measuring Efficiency – • By indicating what is produced we see efficiency • Measuring Economic Change – • Shows effects of increased technology or growth/ shrinkage in economy

13. Production Possibilities Curve* • PPC = the graphical representation of opportunity costs of producing/consuming two goods/actions *Also known as the Production Possibilities Frontier

14. Wheat vs. Computer Chip PPF

15. Wheat vs. Computer Chip PPF How would the line change if they found a way to produce more wheat? How would new computer technology affect the line?

16. Increasing vs. ConstantOpportunity Costs

17. Decreasing Opportunity Costs

18. More Steven Wright Quotes: The early bird gets the worm… But the second mouse gets the cheese.

19. Comparative and Absolute Advantage

20. Law of Comparative Advantage • Specialization leads to increased output • WHY? • What do we mean by “division of labor?”

21. Specialization Adam Smith: • The Division of Labor = increased productivity and output David Riccardo: • Nations also can specialize in the production of goods and services • Nations benefit from producing goods and services they are “better” at and freely trading with other nations

22. Comparative and Absolute Advantage Absolute Advantage • Implies that a product can be produced more efficiently (i.e. with fewer inputs) Comparative Advantage • Means that a person/firm/nation can produce the good with a lower opportunity cost

23. A Hypothetical Example Portugal has an ABSOLUTE ADVANTAGE in both products.

24. Comparative Advantage Partner Discussion: How do we determine which country should produce which product to maximize production and trade? You must first determine opportunity costs for both producers and products!

25. Calculations of Opportunity Cost Socrative: Which country has the comparative advantage in cloth? Portugal Socrative: Which country has the comparative advantage in wheat? England

26. Output vs. Input • The previous example used the “input method” to determine comparative advantage • The “input method” measures the amount of resources needed to produce one unit of output • However, the “output method” measures the amount of output that can be produced with a given amount of an input

27. Input Method Socrative: Who has the comparative advantage in producing radios? Ted (1 radio = 4 bushels of wheat) Nancy (1 radio = 2 bushels of wheat) Socrative: Who has the comparative advantage in producing bushels of wheat? Ted (1 bushel of wheat = ¼ radio) Nancy (1 bushel of wheat = ½ radio)

28. Output Method Socrative: Who has the comparative advantage in producing radios? Ted (1 radio = 4 bushels of wheat) Nancy (1 radio = 2 bushels of wheat) Socrative: Who has the comparative advantage in producing bushels of wheat? Ted (1 bushel of wheat = ¼ radio) Nancy (1 bushel of wheat = ½ radio)

29. Cross-Multiplication Method • A “life-hack” to this is the cross-multiplication method • Take the numbers in the matrix and cross multiply them • For outputs – you want the combination of numbers that gives you the greatest/biggest product • For inputs – you want the combination of numbers that gives you the smallest product

30. Input Method With Ted producing radios and Nancy producing wheat, the total amount of time to produce = 300 minutes With Ted producing wheat and Nancy producing radios, the total amount of time to produce = 150 minutes So Ted should produce wheat and Nancy should produce radios

31. Output Method With Ted producing radios and Nancy producing wheat, the total production is 12 units of production. With Ted producing wheat and Nancy producing radios, the total production is 24 units of production. So Ted should produce wheat and Nancy should produce radios.

32. Or Cost/Benefit Analysis Marginal Analysis:Using Resources Efficiently

33. Let’s Read! • Read silently the article “Man Bites Chili Dog: A Taste of Marginal Analysis” • Let’s discuss the overall message of the article • How can we relate this message to the idea of “efficiency?”

34. DEFINITIONS • ALLOCATIVE EFFICIENCY When quantities of goods and services produced are those that people value most highly OR Goods and services are produced at the exact amount and price consumers desire

35. DEFINITIONS • PRODUCTIVE EFFICIENCY All available resources are being used to produce goods and/or services OR Economy is producing on the Production Possibilities Curve

36. DEFINITIONS • MARGINAL One, the next unit, the next one, etc. • MARGINAL BENEFIT The benefit one experiences from consuming one more unit of a good or service

37. DEFINITIONS • MARGINAL COST The cost one experiences from consuming one more unit of a good or service

38. MARGINAL ANALYSIS ACTIVITY • Listen while I give you instructions on how to complete this activity.

39. MARGINAL ANALYSIS • MARGINAL BENEFIT: • Law of Diminishing Marginal Utility: • The more we consume of a good or service the less benefit we gain from it. • Inverse relationship Benefit Quantity

40. MARGINAL ANALYSIS • MARGINAL COST • Law of Increasing Marginal Costs • As the quantity of a good or service consumed/produced goes up so does the marginal cost of consuming/producing one more unit • Direct relationship Cost Quantity

41. MARGINAL ANALYSIS P($) MC MB = MC ALLOCATIVE EFFICIENCY MB Q

42. MARGINAL ANALYSIS • If MB > MC, then the action should be taken • Eg: one additional good or service should be consumed • Consumption should continue until MB = MC • “UTILITY MAXIMIZATION” • If MB < MC (or MC > MB), then the action should be forgone (or not taken) • Eg: one additional good or service should not be consumed

43. Economic Systems

44. 5 Fundamental Questions of Economic Systems: • What goods and services will be produced? • How will the goods and services be produced? • Who will get the goods and services? • How will the system accommodate change? • How will the system promote progress?

45. Command Economy • Socialism or Communism • In this system, who answers the Fundamental Economic Questions? Which questions were answered? • All Fundamental Economic Questions answered by a government bureaucracy. • A central plan was created to determine the parameters of the economy.

46. Map of the Soviet Union

48. Failure of the Command Economy • Coordination of the economy was a HUGE job • No accurate measurement of success • Mistakes were made • Problems in supply of one product could adversely affect other products (lack of substitutions)

49. The Problem with Incentives • What problem with incentives might have occurred in this system? • No incentive to produce what people needed or wanted. Only produce to the quota and nothing more. • No incentive to work harder than necessary. Whether the person sold 1 item or 100 items, the “profit” was the same. • No risk taking in order to move up

50. Market Economy • Capitalism • What are some characteristics of a market economy? • Private ownership of resources • Markets determine economic activity (i.e. “supply and demand”) • Consumers themselves answer some of the fundamental questions • Government plays a role – regulation, encourage competition and fairness, but not direct role in setting prices.