Unit 1: Basic Economic

Concepts

1
 What is Economics?
• Economics is the science of scarcity.
• Scarcity- we have unlimited wants but
limited resources.
• Since we are unable to have everything
we desire, we must make choices on how
we will use our resources.
choices
Economics is the study of _______.
In economics we will study the choices of
individuals, firms, and governments. 2
Examples:
You must choose between buying jeans or buying shoes.
Businesses must choose how many people to hire
Governments must choose how much to spend on
welfare.

Textbook Definition
Economics- Social science concerned with the
efficient use of scarce resources to achieve
maximum satisfaction of economic wants.
(Study of how individuals and societies deal with
________)
scarcity
3
 Micro vs. Macro
MICROeconomics-
Study of small economic units such as
individuals, firms, and industries (ex: supply
and demand in specific markets, production
costs, labor markets, etc.)

MACROeconomics-
Study of the large economy as a whole or
economic aggregates (ex: economic growth,
government spending, inflation,
unemployment, international trade etc.)
4
 How is Economics used?
• Economists use the scientific method to make
generalizations and abstractions to develop
theories. This is called theoretical economics.
• These theories are then applied to fix problems
or meet economic goals. This is called policy
economics.
Positive vs. Normative
Positive Statements- Based on facts. Avoids value
judgements (what is).
Normative Statements- Includes value judgements
(what ought to be). 5
 5 Key Economic Assumptions
1. Society has unlimited wants and limited
resources (scarcity).
2. Due to scarcity, choices must be made. Every
choice has a cost (a trade-off).
3. Everyone’s goal is to make choices that maximize
their satisfaction. Everyone acts in their own “self-
interest.”
4. Everyone makes decisions by comparing the
marginal costs and marginal benefits of every
choice.
5. Real-life situations can be explained and
analyzed through simplified models and graphs. 6
 Thinking at the Margin
# Times Benefit Cost
Watching Movie

1st $30 $10

2nd $15 $10
3rd $5 $10
Total $50 $30

Would you see the movie three times?

Notice that the total benefit is more than the
total cost but you would NOT watch the movie
the 3rd time.
7
 Marginal Analysis
In economics the term marginal = additional
Marginal analysis (aka: thinking on the margin)
making decisions based on increments
Example:
• When you decide to go to the mall you consider the
additional benefit and the additional cost (your
opportunity cost).
• Once you get to the mall, you continue to use marginal
analysis when you shop, buy food, and talk to friends.
• Since your marginal benefits and costs can quickly
change your analyzing them every second.
• What if your ex-girlfriend shows up?
The Point: You will continue to do something as long as
the marginal benefit is greater than the marginal cost
8
Analyzing Choices

9
Given the following assumptions, make a rational
choice in your own self-interest (hold everything
else constant)…
1. You want to visit your friend for a week. You will
return Sunday night.
2. You work every weekday earning $100 per day
3. You have three flights to choose from:
Thursday Night Flight = $275
Friday Early Morning Flight = $300
Friday Night Flight = $325

Which flight should you choose? Why? 10

 Trade-offs vs. Opportunity Cost
ALL decisions involve trade-offs.
Trade-offs - ALL the alternatives that
we give up when we make a choice
(Examples: going to the movies)
Opportunity cost- most desirable alternative
given up when you make a choice.
.
What are trade-offs of deciding to go to college?
What is the opportunity cost of going to college?
GEICO assumes you understand
opportunity cost. Why? 11
2008
Audit
Exam
 Economic
Terminology
Utility = Satisfaction!
Marginal = Additional!
Allocate = Distribute!

13
 Price vs. Cost
What’s the price? vs. How much does that cost?
Price= Amount buyer (or consumer) pays
Cost= Amount seller pays to produce a good

Investment
Investment= the money spent by BUSINESSES to
improve their production
Ex: $1 Million new factory
•Consumer Goods- created for direct consumption 14
(example: pizza)
•Capital Goods- created for indirect consumption
(oven, blenders, knives, etc.)
•Goods used to make consumer goods
The 4 Factors of
Production

15
 The Four Factors of Production
ALL resources can be classified as one of the
following four factors of production:
1. Land -All natural resources that are used to produce
goods and services. (Ex: water, sun, plants, animals)
2. Labor -Any effort a person devotes to a task for which
that person is paid. (Ex: manual laborers, lawyers,
doctors, teachers, waiters, etc.)
3. Capital -
Physical Capital- Any human-made resource that is used to
create other goods and services ( Ex: tools, tractors,
machinery, buildings, factories, etc.)
Human Capital- Any skills or knowledge gained by a worker
through education and experience
\ 16
 The Four Factors of Production
4. Entrepreneurship -ambitious leaders that combine the
other factors of production to create goods and services.
• Examples-Henry Ford, Bill Gates, Inventors, Store Owners,
etc.

Entrepreneurs:
1. Take The Initiative
2. Innovate
3. Act as the Risk Bearers
PROFIT
So they can obtain _________.
Profit = Revenue - Costs
17
Unit 1.2: Basic Economic
Concepts

18
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. 21
Economic Systems
1. Centrally-Planned
(Command) Economy
2. Free Market Economy
3. Mixed Economy

22
Centrally-Planned
Economies
(aka Communism)

23
 Centrally Planned Economies
In a centrally planned economy (communism) the government…
1. owns all the resources.
2. answers the three economic questions
Examples:
Cuba, North Korea, former Soviet Union, and China?

Why do centrally planned economies face

problems of poor-quality goods, shortages,
and unhappy citizens?
Little incentive to work harder and central planners
have a hard time predicting preferences
24
 Advantages and Disadvantages
What is GOOD about What is BAD about
Communism? Communism?
1. Low unemployment-everyone has a 1. No incentive to work
job
2. Great Job Security-the government
doesn’t go out of business harder
3. Equal incomes means no extremely
poor people 2. No incentive to
4. Free Health Care
innovate or come up
with good ideas
3. No Competition keeps
quality of goods poor.
4. Corrupt leaders
5. Few individual
freedoms
25
Free Market System
(aka Capitalism)

26
 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).
27
 Example of Free Market
Example of how the free market regulates itself:
If consumers want smartphones and only one
company is making them…
•Other businesses have the INCENTIVE to start
making smartphones to earn PROFIT.
•This leads to more COMPETITION….
•Which means lower prices, better quality, and more
product variety.
•We produce the goods and services that society
wants because “resources follow profits”.
The End Result: Most efficient production of the
goods that consumers want, produced at the lowest
prices and the highest quality.
28
 Example of Central Planners
Example of why communism failed:
If consumers want smartphones 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 phones 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. 29
 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.
30
 Mixed Economies
A system with free markets but also some
government intervention.
Almost all countries, including the US, have mixed
economies

31
Unit 1.3: Basic Economic
Concepts

33
What is the Production Possibilities Curve?
• A production possibilities curve (or frontier) is a
model that shows alternative ways that an
economy can use its scarce resources
• This model graphically demonstrates scarcity,
trade-offs, opportunity costs, and efficiency.

4 Key Assumptions
• Only two goods can be produced
• Full employment of resources
• Fixed Resources (Ceteris Paribus)
• Fixed Technology
34
 Production “Possibilities” Table
A B C D E f
Bikes 14 12 9 5 0 0
Computers 0 2 4 6 8 10

Each point represents a specific

combination of goods that can be
produced given full employment of
resources.
NOW GRAPH IT: Put bikes on y-axis and
computers on x-axis
35
 Production Possibilities
How does the PPG graphically demonstrates scarcity, trade-
offs, opportunity costs, and efficiency?
Impossible/Unattainable
(given current resources)
A
14
B
12
G
10 C
Bikes

8
Efficient
6 D

4 Inefficient/
Unemployment
2
E
0
0 2 4 6 8 10
Computers 36
 Opportunity Cost
Example:

1. The opportunity cost of

moving from a to b is… 2 Bikes
2.The opportunity cost of
moving from b to d is… 7 Bikes

3.The opportunity cost of

moving from d to b is… 4 Computer

4.The opportunity cost of

moving from f to c is… 0 Computers
5.What can you say about point G?
Unattainable

37
The Production Possibilities
Curve (or Frontier)

38
 Production Possibilities
A B C D E
CALZONES 4 3 2 1 0
PIZZA 0 1 2 3 4
• List the Opportunity Cost of moving from a-b, b-
c, c-d, and d-e.
• Constant Opportunity Cost- Resources are easily
adaptable for producing either good.
• Result is a straight line PPC (not common)

39
 Production Possibilities
A B C D E
PIZZA 20 19 16 10 0
ROBOTS 0 1 2 34
• List the Opportunity Cost of moving from a-b, b-
c, c-d, and d-e.
• Law of Increasing Opportunity Cost-
• As you produce more of any good, the
opportunity cost (forgone production of
another good) will increase.
• Why? Resources are NOT easily adaptable to
producing both goods.
• Result is a bowed out (Concave) PPC
 Constant vs. Increasing Opportunity
Cost
Identify which product would have a straight line
PPC and which would be bowed out?
Corn Cactus

Wheat Pineapples
The Production Possibilities
Curve and Efficiency

42
 Two Types of Efficiency
Productive Efficiency-
• Products are being produced in the least
costly way.
• This is any point ON the Production
Possibilities Curve
Allocative Efficiency-
• The products being produced are the
ones most desired by society.
• This optimal point on the PPC depends
on the desires of society. 43
 Productive and Allocative Efficiency
Which points are productively efficient?
Which are allocatively efficient?
Productively Efficient
A
14 combinations are A through D
B G
12
Allocative Efficient
10
combinations depend on
Bikes

8
C
the wants of society
6 E (What if this represents a
4 country with no electricity?)
F
2
D
0
0 2 4 6 8 10
Computers 44
 Why two types of efficiency?
Is combination “A” efficient?
Yes and No. It is productively efficient but it is not the
combination society wants
Size 20 running
shoes

Size 10 running shoes

2008 Audit Exam
2008 Audit Exam
Shifting the Production
Possibilities Curve

48
 Production Possibilities
4 Key Assumptions Revisited
• Only two goods can be produced
• Full employment of resources
• Fixed Resources (4 Factors)
• Fixed Technology
What if there is a change?
3 Shifters of the PPC
1. Change in resource quantity or quality
2. Change in Technology
3. Change in Trade 49
 Production Possibilities
What happens if
there is an increase
in population?
Computers

Pizzas
50
 Production Possibilities
What happens if
there is an increase
in population?
Computers

Pizzas
51
 Production Possibilities
What if there is a
technology improvement
in pizza ovens
Computers

Pizzas
52
 Production Possibilities
What if there is a
technology improvement
in pizza ovens
Computers

Pizzas
53
 Capital Goods and Future Growth
Countries that produce more capital goods will have
more growth in the future.
Panama – Favors Mexico – Favors
Consumer Goods Capital Goods
Current
PPC Future
PPC
Capital Goods

Future
PPC

Capital Goods
Current
PPC

Consumer goods Consumer goods

Panama Mexico
54
 PPC Practice
Draw a PPC showing changes for each of the
following:
Pizza and Computers (3)
1. New computer making technology
2. Decrease in the demand for pizza
3. Mad cow disease kills 85% of cows
Consumer goods and Capital Goods (4)
4. Destruction of power plants leads to severe
electricity shortage
5. Faster computer hardware
6. Many workers unemployed
7. Significant increases in education
55
 Question #1
New computer making
technology

A shift only for

Computers

computers

Pizzas 56
 Question #2
Decrease in the demand for pizza

The curve doesn’t shift!

A change in demand
doesn’t shift the curve
Computers

Pizzas 57
 Question #3
Mad cow disease kills 85% of cows

A shift inward only for

Computers

Pizza

Pizzas 58
 Question #4
Capital Goods (Guns) Destruction of power plants

Decrease in resources
decrease production
possibilities for both

Consumer Goods (Butter) 59

 Question #5
Faster computer hardware
Quality of a resource
Capital Goods (Guns)

improves shifting the

curve outward

Consumer Goods (Butter) 60

 Question #6
Many workers unemployed
The curve doesn’t shift!
Capital Goods (Guns)

Unemployment is just a
point inside the curve

Consumer Goods (Butter) 61

 Question #7
Significant increases in education
Capital Goods (Guns)

The quality of labor is

improved. Curve shifts
outward.

Consumer Goods (Butter) 62

Unit 1.4: Basic Economic
Concepts

63
Specialization and Trade
Why do people trade?

64
 Why do people trade?
1. Assume people didn’t trade. What things would
you have to go without?
Everything you don’t produce yourself!
(Clothes, car, cell phone, bananas, heath care, etc)
The Point: Everyone specializes in the production of
goods and services and trades it to others
2. What would life be like if cities couldn’t trade
with cities or states couldn’t trade with states?
Limiting trade would reduce people’s choices and
make people worse off.
The Point: More access to trade means more
choices and a higher standard of living. 65
Absolute and Comparative
Advantage

66
 Per Unit Opportunity Cost Review
Per Unit Opportunity Cost = Opportunity Cost
Units Gained

Assume it costs you $50 to produce 5 t-shirts. What is your

PER UNIT cost for each shirt?
$10 per shirt
Now, take money our of the equation. Instead of
producing 5 shirts you could have made 10 hats.
1. What is your PER UNIT OPPORTUNITY COST for each
shirt in terms of hats given up?
1 shirt costs 2 hats
2. What is your PER UNIT OPPORTUNITY COST for each hat
in terms of shirts given up?
1 hat costs a half of a shirt 67
 Per Unit Opportunity Cost Review
Ronald McDonald can produce 20 pizzas or 200 burgers
Papa John can produce 100 pizzas or 200 burgers
1. What is Ronald’s opportunity cost for one pizza in terms
of burgers given up? 1 pizza cost 10 burgers
2. What is Ronald’s opportunity cost for one burger in
terms of pizza given up? 1 burger costs 1/10 pizza
3. What is Papa John’s opportunity cost for one pizza in
terms of burgers given up? 1 pizza costs 2 burgers
4. What is Papa John’s opportunity cost for one burger in
terms of pizza given up? 1 burger costs 1/2 pizza

Ronald has a COMPARATIVE ADVANTGE in the production of

burgers
Papa John has a COMPARATIVE ADVANTAGE in the
production of pizza 68
Absolute and Comparative Advantage
Absolute Advantage
•The producer that can produce the most output OR
requires the least amount of inputs (resources)
•Ex: Papa John has an absolute advantage in pizzas
because he can produce 100 and Ronald can only make
20.
Comparative Advantage
•The producer with the lowest opportunity cost.
•Ex: Ronald has a comparative advantage in burgers
because he has a lowest PER UNIT opportunity cost.
Countries should trade if they have a
relatively lower opportunity cost
They should specialize in the good that is “cheaper” for
them to produce 69
Benefits of Specialize
and Trade

70
 International Trade
Trade: 1 Wheat for 1.5 Sugar
S W S W
0 30 45 USA Brazil 20 0
1.5 29 40 18.5 1
3 28 The US Specializes and makes Brazil Makes ONLY 17 2
35
4.5 27 ONLY Wheat Sugar 15.5 3
30 30
6 26 14 4

Sugar (tons)
Sugar (tons)

7.5 25 25 25 12.5 5
9 24 11 6
20 20
10.5 23 9.5 7
15 15
12 22 8 8
13.5 21 10 10 6.5 9
15 20 5 10
5 5
16.5 19 3.5 11
0 0
18 18 5 10 15 20 25 30 5 10 15 20 71
19.5 17 Wheat (tons) Wheat (tons)
 International Trade
TRADE SHIFTS THE PPC!
45 USA Brazil
40

35
AFTER TRADE
30 30

Sugar (tons)
Sugar (tons)

25 25

20 20 AFTER TRADE
15 15

10 10

5 5

0 0
5 10 15 20 25 30 5 10 15 20 72
Wheat (tons) Wheat (tons)
 Wheat Sugar
USA 30 (1W costs 1S) 30 (1S costs 1W)

Brazil 10 (1W costs 2S) 20 (1S costs 1/2W)

Which country has a comparative advantage in wheat?
45

40
1. Which country should EXPORT Sugar?
35
2. Which country should EXPORT Wheat?

Sugar (tons)
Sugar (tons)

30

3. Which
30
country should IMPORT
25 Wheat?
25
20
20
15
15
10

5 10 15 20 25 30 5 10 15 20
Wheat (tons) Wheat (tons) 73
 Output Questions:
OOO=
Output: Other goes Over

74
 Input Questions
(The variable is
resources or time)
IOU=
Input: Other goes Under

75
 Terms of Trade
Both countries can benefit from trade if they
each have relatively lower opportunity costs.
Terms of Trade- The agreed upon conditions that
would benefit both countries
Ex: Trade 1 ton of wheat for 1.5 tons of sugar
76
 Pineapples Radios
Kenya 30 10
India 40 40
1. Who has an absolute advantage in Radios?
2. What is the cost of one radio for India?
3. What is the per unit opportunity cost for 1
pineapple for Kenya?
4. Who has a comparative advantage in pineapples?
5. Who has a comparative advantage in radios?
6. Who should import pineapples?
7. Trading 1 radio for how many pineapples would
benefit both countries?
 Pineapples Radios
Kenya 30(1P costs 1/3R) 10 (1R costs 3 P)

India 40 (1P costs 1R) 40 (1R costs 1P)

Kenya wants Radios
If the terms of trade for 1 radio is greater than 3
pineapples then Kenya is worse off and should make
radios on their own.
India wants Pineapples
If the terms of trade for 1 radio is less than 1
pineapple then India is worse off and should make
pineapples on their own.
What terms of trade benefit both countries?
 Pineapples Radios
Kenya 30(1P costs 1/3R) 10 (1R costs 3 P)

India 40 (1P costs 1R) 40 (1R costs 1P)

Trading 1 radio for 2 pineapples will benefit both

If Kenya produces radios by themselves, they give up
3 Pineapples for each radio. If they can trade 2
pineapples for each radio they are better off.
If India produces pineapples by themselves, they
give up 1 pineapple for one radio. If they can get 2
pineapples for one radio they are better off.
The countries trade at a lower opportunity cost than
if they made the products themselves!
 Comparative Advantage Practice
Create a chart for each of the following problems.
•First- Identify if it is a output or input question
•Second-Identify who has the ABSOLUTE ADVANTAGE
•Third-Identify who has a COMPARATIVE ADVANTAGE
•Fourth- Identify how they should specialize

1. Sara gives 2 haircuts or 1 perm and hour. Megan gives 3 haircuts or 2 perms per hour.

2. Justin fixes 4 flats or 8 brakes per day. Tim fixes 1 flats or 5 brakes per day.
3. Hannah takes 30 minutes to wash dishes and 1 hour to vacuum the house. Kevin takes 15
minutes to wash dishes and 45 minutes to vacuum.
4. Americans produce 50 computers or 50 TVs per hour. Chinese produce 30 computers or 40
TVs per hour.

80
More Practice

81
Input or Output Question?
Number caught per day
Deer Antelope
Henry 4 6
John 24 12

Months to produce one

Car Plane
Canada 8 10
Japan 15 12

Acres to produce 100 bushels

Corn Rice
Henry 9 3
John 8 2 82
 Absolute Advantage?
Number caught per day
Deer Antelope
Henry 4 6
John 24 12

Months to produce one

Car Plane
Canada 8 10
Japan 15 12

Acres to produce 100 bushels

Corn Rice
Henry 9 3
John 8 2 83
Comparative Advantage?
Number caught per day
Deer Antelope
Henry 4 6 OOO
John 24 12

Months to produce one

Car Plane
Canada 8 10 IOU
Japan 15 12

Acres to produce 100 bushels

Corn Rice
Henry 9 3
IOU
John 8 2 84
Comparative Advantage?
Number caught per day
Deer Antelope
Henry 4 (1D=3/2A) 6 (1A =2/3D OOO
John 24 (1D=1/2A) 12(1A=2D)

Months to produce one

Car Plane
Canada 8 10 IOU
Japan 15 12

Acres to produce 100 bushels

Corn Rice
Henry 9 3
IOU
John 8 2 85
Comparative Advantage?
Number caught per day
Deer Antelope
Henry 4 (1D=3/2A) 6 OOO
John 24 (1D=1/2A) 12

Months to produce one

Car Plane
Canada 8 (1C=4/5P) 10 (1P=5/4C) IOU
Japan 15(1C=5/4P) 12 (P=4/5C)

Acres to produce 100 bushels

Corn Rice
Henry 9 3
IOU
John 8 2 86
Comparative Advantage?
Number caught per day
Deer Antelope
Henry 4 (1D=3/2A) 6 OOO
John 24 (1D=1/2A) 12

Months to produce one

Car Plane
Canada 8 (1C=4/5P) 10 IOU
Japan 15(1C=5/4P) 12

Acres to produce 100 bushels

Corn Rice
Henry 9 (1C=3R) 3
IOU
John 8 (1C=4R) 2 87
Unit 1.5: Basic Economic
Concepts

88
 The Circular Flow
Model
The Product Market-
•The “place” where goods and services
produced by businesses are sold to households.
The Resource (Factor) Market-
•The “place” where resources (land, labor,
capital, and entrepreneurship) are sold to
businesses.
89
 Resource Market

$$$
Taxes Taxes

Subsidies Transfer Payments

Public Goods Public Goods

Businesses Government Individuals
$$$

Product Market 90
 Circular Flow Model Vocab
Private Sector- Part of the economy that is run by
individuals and businesses
Public Sector- Part of the economy that is controlled by
the government
Factor Payments- Payment for the factors of
production, namely rent, wages, interest, and profit
Transfer Payments- When the government redistributes
income (ex: welfare, social security)
Subsidies- Government payments to businesses

91
2012 Exam

92
 Circular Flow Model Review
1. Do individuals supply or demand?
Both, they demand products and supply resources
2. Do business supply or demand?
Both, the supply products and demand resources

3. Who demands in the product market?

Individuals and the government
4. Who supplies in the product market?
Businesses

93
Macro 2013 (“Secured Documents Exam”)

94
Macro 2013 (“Secured Documents Exam”)

95
96
97
98
99
100