Welcome back to Microeconomics!

1. Welcome back to Microeconomics!

2. Using our textbook situation as an example of economic choices • You were all given a 7th edition textbook that we will not be using. • What should the school do with all these textbooks? • If you already wrote in the textbook, can it be returned to the textbook company? • Who should have to pay for a book that cannot be returned?

3. Review from last class: economics: the study of how people deal with limited resources (scarcity). scarcity: the situation in which the quantity of resources is not enough to meet all wants.

4. Review from last class: economic interactions: exchanges of goods and services between people. market: an arrangement by which economic exchanges between people take place.

5. Scarcity and Choice for Individuals Two Fundamental Individual Choices: What to Consume (Consumer Decisions) What to Produce (Producer Decisions)

6. Scarcity and Choice for Individuals budget constraint: a scarce amount of funds that limits an individual’s spending. opportunity cost (of a choice): the value of the best alternative that was not chosen because something else was chosen.

7. Gains from Trade gains from trade: improvements in income, production or satisfaction owing to the exchange of goods and services.

8. Producer Decisions Consider a situation with two producers: Emily the poet and Johann the printer. Below is a summary of the choices Emily and Johann face because of scarcity. Both of them create cards to sell. The cards need poems inside before they can be sold. If they don’t work together, how many cards can each person produce each day?

9. Producer Decisions What should Emily and Johann do? - Trade with each other to divide their labor and result in more production. division of labor: the division of production into various parts where some workers specialize in one task, while others specialize in another task. specialization: concentration of production effort into a single specific task. So, if Emily and Johann work together, they can produce 10 cards a day, instead of just producing 1 card a day.

10. International Trade Emily and Johann are from different countries, so their interaction is considered international trade. international trade: the exchange of goods and services between people and firms in different countries. Note: Gains from international trade are essentially the same as gains from trade within a country.

11. Production Possibilitiesand Technology production possibilities: alternative combinations of production of various goods that are possible, given the economy’s resources.

12. Production Possibilities Curve production possibilities curve: a curve showing the maximum combinations of production of two goods that are possible, given the economy’s resources and technology.

13. Figure 2: The ProductionPossibilities Curve

14. Production Possibilities Curve Notes: In Figure 2, points A, B, C, D, E, and F are points on the production possibilities curve, and represent production combinations that are efficient. A production combination is efficient if more of either movies or computers CANNOT be produced without decreasing the production of the other good.

15. Production Possibilities Curve Notes: In Figure 2, point I is a point inside the production possibilities curve, and represents a production combination that is inefficient. A production combination is inefficient if more of either movies or computers can be produced without decreasing the production of the other good.

16. Production Possibilities Curve A financial crisis can bring the economy inside the PPC. During a financial crisis, the firm would be unable to get a loan needed to buy the inputs needed to produce computer chips. Without the computer chips, the company can produce a maximum of 20,000 computers, instead of 25,000.

17. Production Possibilities Curve Notes: In Figure 2, point J is a point outside the production possibilities curve, and represents a production combination that is impossible to produce, given the current amount of resources and technology.

18. Shifts in the ProductionPossibilities Curve The Production Possibilities Curve can shift out as a result of: More workers More capital (e.g. more cameras, more studios) Technological innovations (faster movie editing machines)

19. Shifts in the ProductionPossibilities Curve How far the production possibilities curve will shift will depend on how much resources are consumed now vs. how much is invested for the future. Investing less for the future implies less growth. Investing more for the future implies more growth.

20. Figure 4: Shifts in the ProductionPossibilities Curve Depend on Choices • Choosing to allocate a few resources for investment in the future will result in a low growth.

21. Figure 4: Shifts in the ProductionPossibilities Curve Depend on Choices • Choosing to allocate a lot of resources for investment in the future will result in a high growth.

22. Market Economies and the Price System The 3 Fundamental Economic Questions: 1) WHAT is to be produced? 2) HOW are these goods to be produced? 3) FOR WHOM are the goods to be produced?

23. Market Economiesand the Price System Two approaches to answering the 3fundamental questions: • Market economy • Command economy

24. Market Economiesand the Price System 1) Market Economy: an economy where most decisions of what, how and for whom to produce are made by individual firms, consumers and governments interacting in markets. In this economy, production and prices are determined in markets.

25. Market Economiesand the Price System 2) Command Economy: an economy where most decisions of what, how and for whom to produce are made by aselect group of individuals and firms that control the government. In this economy, production and prices are determined by the government.

26. The China Story… • Big changes in the last 50 years!

27. Key Elements of a Market Economy freely determined price: a price that is determined by the interaction of individuals and firms in the market. property rights: rights over the use, sale and proceeds from a good or a resource. incentive: a device that motivates people to take action, usually to increase economic efficiency.

28. A Role for the Government market failure: any situation in which the market does not lead to an efficient economic outcome. government failure: a situation in which the government makes things worse than the market, even though there may be market failure.

29. The Uses of the Price System in a Market Economy Signals: the price of a good sends a signal to producers to increase or decrease production. Incentives: higher or lower prices of goods will increase or decrease the incentives for firms to produce those goods. Distribution: higher or lower worker income resulting from a higher or lower price of the goods or the services they make will affect the distribution of goods and services in the economy.

30. Financial Crisis and Recession In August 2007, the U.S. economy experienced the beginning of a deep financial crisis. The crisis was the likely cause for the recession that started in December 2007. The worst financial crisis and recession in U.S. history occurred during the Great Depression. The Great Debate: Is a financial crisis a market failure or government failure?

31. Article on Prices and Recessions • Read the article: “The Theory of the Business Cycle and the Cause of Recessions” • Questions for discussion: • According to this article, what was the main cause for the financial crisis in America? • America has a market economy. If America had a command economy, what would be different about the prices?

32. Summary of Chapter 1 (page 21) • Everyone faces a scarcity of something. • Scarcity leads to choice, and choice leads to opportunity costs. • Trade leads to gains because people can specialize in what they are good at. • Economic production is efficient if the economy is on the production possibilities curve. Production is inefficient if the economy is inside the production possibilities curve.

33. Summary of Chapter 1 (page 21) • The 3 basic questions an economy faces:what should be produced, how, and for whom. • Prices give signals, provide incentives, and affect the distribution of income in a market economy. If prices are set at the wrong levels, waste and inefficiency will result.

34. Key Terms from Chapter 1 (page 21) • increasing opportunity costs • production possibilities curve • market economy • command economy • freely determined prices • property rights • incentive • market failure • government failure • recession • economics • scarcity • choice • economic interactions • market • financial crisis • opportunity cost • gains from trade • specialization • division of labor • comparative advantage • international trade • production possibilities