Eco 6351 Economics for Managers Chapter 1. The Challenge of Economics

1. Eco 6351Economics for ManagersChapter 1. The Challenge of Economics Prof. Vera Adamchik

2. Chapter 1 Outline • Scarcity • Production possibility frontier • Production efficiency • Opportunity cost • Economic growth • Working with graphs

3. Scarcity: The Core Problem

4. Resources and Wants Two facts dominate our lives: • We have unlimited wants. • We have limited resources. For example, Amy has $1. She needs to buy notebooks ($1 each), pens (50 c each), and pencils (25 c each). • These two factors (unlimited wants and limited resources) define scarcity, a condition in which the resources available are insufficient to satisfy people’s wants.

5. Scarcity • Scarcity is the source of all economic problems. • Scarcity results in economic activity: People use their limited resources and try to satisfy their unlimited wants. • Scarcity forces us to make choices and face costs. In choosing, we economize--make the best use of the resources available.

6. Scarcity Amy’s feasible choices (available alternatives) are: (a) 1 notebook; (b) 2 pens; (c) 1 pen + 2 pencils; (d) 4 pencils. What choice will she make?

7. Opportunity Cost Unlimited wants must be ranked, and we must choose which wants to satisfy. Let’s assume that Amy’s preferences are: (1st - Amy’s best choice) 1 pen + 2 pencils; (2nd) 1 notebook; (3rd) 2 pens; (4th) 4 pencils. Opportunity cost of the activity chosen is the value of the best next alternative forgone.

8. What is Economics? • All economic questions and problems arise from scarcity – they arise because our wants exceed the resources available to satisfy them. • Faced with scarcity, we must choose among the available alternatives. • Economics is a science of choice – the science that explains the choices that we make to cope with scarcity.

9. Micro- and Macroeconomics • Economists work on the wide array of problems. • One can look at the economy with either a micro or a macro view. • Microeconomics is the study of individual decisions (individuals, firms, governments). • Macroeconomics is the study of the economy as a whole (major players are: households, business sector, local and federal governments, and the ROW (rest of the world).

10. Economic Science A major task of economists is to discover how the economic world works. In pursuit of this goal, economists distinguish between two types of statements: • What is • What ought to be

11. Positive versus Normative Economics • Statements about what is are called positive statements. A positive statement might be right or wrong. It can be tested against the facts. • Statements about what ought to be are called normative statements. They depend on values and cannot be tested.

12. Economic Modeling • To explain the economic world, economists build and test economic models. • Model is abstract (for example, the Supply and Demand model, the AD-AS model). • Reality is the facts/problems to be understood (for example, what is the relationship between price and quantity of a good). • Theory is the link between the model and reality.

13. Two Fundamental Assumptions • Every economic decision-maker tries to make the best out of any situation. Typically, it means maximizing some quantity – profit, well-being, satisfaction, etc. • Every economic decision-maker faces constraints (because of the scarcity of resources).

14. Economic Policy • Efficiency: can we make it for less? • Equity: is it fair? • Growth: can we grow faster? • Stability: can we get a smoother ride?

15. The Economy Decision-makers: • Households (consumers) • Firms • Governments Co-ordination mechanisms: • Markets • Command mechanisms

16. Production • In the microeconomic part of this course we will focus on production. • However, economics is not only about production -- economics of leisure, forensic economics, labor economics, household economics, sports economics, etc.

17. Production: creating things that people value by using productive resources. • Goods and services: the things that people value. They fall into two categories: • consumer goods and services; • capital goods (goods that we have produced and now use to produce other goods). • The resources that can be used to produce goods and services are limited and can be grouped into four categories.

18. Four Basic Factors of Production • Land

19. Land • Natural resources (air, water, surface, mineral resources) are called land.

20. Four Basic Factors of Production • Land • Labor

21. Labor • Human resources ( the number of workers or working time) are called labor. • Human capital is the skill and knowledge of people which comes from education, on the job training, and work experience.

22. Four Basic Factors of Production • Land • Labor • Capital

23. Capital • Capital resources are called capital. • Please note that in economics we consider only physical capital, not financial capital. • Physical capital includes machinery, equipment, buildings, roads, aircraft, bridges, dams, etc.

24. Four Basic Factors of Production • Land • Labor • Capital • Entrepreneurship

25. Entrepreneurship • Productive resources are organized by entrepreneurial ability, that is ability to run the firm/business. • Entrepreneurial ability is the resource that organizes land, labor, and capital.

26. Three Big Questions Economists try to answer three big questions about goods and services: • WHAT to produce? • HOW to produce? • FOR WHOM to produce? • WHEN? • WHERE?

27. Choice and Production We’ll begin our study of the choices people make by looking at the limits to production (Production Possibility Curve/Frontier – PPC or PPF) and at a fundamental implication of choice – opportunity cost.

28. Defining ... Opportunity Costs

29. Defining ... Opportunity Costs Production Possibilities

30. Defining ... Opportunity Costs Production Possibilities a simplified two choice example...

31. Submarines Railroads

32. Submarines Railroads Total Available Labor A B C D E F 1000 1000 1000 1000 1000 1000

33. Submarines Railroads Total Available Labor Output of Subs (200 per Sub) 5 4 3 2 1 0 A B C D E F 1000 1000 1000 1000 1000 1000

34. Submarines Railroads Total Available Labor Total Labor Required for Subs Output of Subs (200 per Sub) 5 4 3 2 1 0 A B C D E F 1000 1000 1000 1000 1000 1000 1000 800 600 400 200 0

35. Submarines Railroads Total Available Labor Total Labor Required for Subs Labor Not Used for Subs Output of Subs (200 per Sub) 5 4 3 2 1 0 A B C D E F 1000 1000 1000 1000 1000 1000 1000 800 600 400 200 0 0 200 400 600 800 1000

36. Submarines Railroads Potential Output of Railroads (150 per Railroad) Total Available Labor Total Labor Required for Subs Labor Not Used for Subs Output of Subs (200 per Sub) 5 4 3 2 1 0 A B C D E F 1000 1000 1000 1000 1000 1000 1000 800 600 400 200 0 0 200 400 600 800 1000 0 1.3 2.7 4.0 5.3 6.7

37. PRODUCTION POSSIBILITIES Submarines Railroads Potential Output of Railroads (150 per Railroad) Total Available Labor Total Labor Required for Subs Labor Not Used for Subs Output of Subs (200 per Sub) 5 4 3 2 1 0 A B C D E F 1000 1000 1000 1000 1000 1000 1000 800 600 400 200 0 0 200 400 600 800 1000 0 1.3 2.7 4.0 5.3 6.7

38. Production Possibilities Submarines Railroads 5 4 3 2 1 Potential Output of Railroads Output of Subs A B C D E F 5 4 3 2 1 0 0 1.3 2.7 4.0 5.3 6.7 Output of Submarines 0 1 2 3 4 5 Output of Railroads

39. Production Possibilities A Submarines Railroads 5 4 3 2 1 Potential Output of Railroads Output of Subs A B C D E F 5 4 3 2 1 0 0 1.3 2.7 4.0 5.3 6.7 Output of Submarines 0 1 2 3 4 5 Output of Railroads

40. Production Possibilities A Submarines Railroads 5 4 3 2 1 Potential Output of Railroads B Output of Subs A B C D E F 5 4 3 2 1 0 0 1.3 2.7 4.0 5.3 6.7 Output of Submarines 0 1 2 3 4 5 Output of Railroads

41. Production Possibilities A Submarines Railroads 5 4 3 2 1 Potential Output of Railroads Output of Subs B C A B C D E F 5 4 3 2 1 0 0 1.3 2.7 4.0 5.3 6.7 Output of Submarines 0 1 2 3 4 5 Output of Railroads

42. Production Possibilities A Submarines Railroads 5 4 3 2 1 Potential Output of Railroads B Output of Subs C A B C D E F 5 4 3 2 1 0 0 1.3 2.7 4.0 5.3 6.7 Output of Submarines D E F 0 1 2 3 4 5 Output of Railroads

43. Production Possibilities Production Possibilities Curve All Points On The Curve AreAttainable and Efficient A Submarines Railroads 5 4 3 2 1 Potential Output of Railroads B Output of Subs C A B C D E F 5 4 3 2 1 0 0 1.3 2.7 4.0 5.3 6.7 Output of Submarines D E F 0 1 2 3 4 5 Output of Railroads

44. Production Efficiency • We achieve production efficiency if we cannot produce more of one good without producing less of some other good. • When production is efficient, we are at a point on the PPF.

45. Production Possibilities A Submarines Railroads 5 4 3 2 1 Potential Output of Railroads B Output of Subs C A B C D E F 5 4 3 2 1 0 0 1.3 2.7 4.0 5.3 6.7 Output of Submarines All Points Inside The Curve Are Attainable but Inefficient D E F 0 1 2 3 4 5 Output of Railroads

46. Inefficient Production • If we are at a point inside the PPF, production is inefficient because we have some unused resources or we have some misallocated resources or both.

47. Production Possibilities All Points Outside The Curve Are Unattainable A Submarines Railroads 5 4 3 2 1 Potential Output of Railroads B Output of Subs C A B C D E F 5 4 3 2 1 0 0 1.3 2.7 4.0 5.3 6.7 Output of Submarines D E F 0 1 2 3 4 5 Output of Railroads

48. Production Possibility Frontier • The production possibility frontier(PPF)is the boundary between those production levels that can be attained and those that cannot • The PPFdepends on the quantities of productive resources and on the state of technology

49. Tradeoff • If we produce at a point on the PPF, we are using all resources efficiently and we can produce more of one good only if we produce less of the other. We face a tradeoff. • All tradeoffs involve a cost – an opportunity cost.

50. Opportunity cost is a ratio • We measure opportunity cost as the decrease in the quantity of what we give up divided by the increase in the quantity of what we get. • Opportunity cost is a ratio -- the decrease in the quantity of one good divided by the increase in the quantity of another good.