v People Face Tradeoffs

Ø There is no such thing as a free lunch!

Ø Every choice has a tradeoff. These can range from the government tradeoff between national defense and consumer goods (guns vs. butter) to your tradeoff between sleeping and attending class.

Ø Frequently we encounter a tradeoff between efficiency and equity

v The Cost of Something is What You Give Up to Get IT

Ø Making good decisions means knowing the full costs, including the opportunity costs, of making one choice over another.

Ø What is an opportunity cost? Can you cite examples in your life?

v Rational People Think at the Margin

Ø How does a small incremental adjustment or a marginal change affect your existing plan?

Ø Why should we ignore the costs or benefits that occurred in the past?

v People Respond to Incentives

Ø When marginal benefits or marginal costs change your incentives will change.

Ø Provide some examples where your incentives have changed

v Trade Can Make Everyone Better Off

Ø Even though there is competition among consumers and among producers in different countries, countries can benefit from specializing in what they do best and trade with each other.

v Markets are Usually a Good Way to Organize Economic Activity

Ø Compare the planned economy of the former Soviet Union to the market economy of the United States

Ø Adam Smith explained this invisible hand in 1776, The Wealth of Nations.

§ When household and firms do what is best for themselves, they end up doing what is best for society, as if guided by an invisible hand or market forces

Ø When the government interferes with markets by changing prices through taxation or price controls, the invisible fails and resources are not allocated in the best possible way. That is social welfare is not maximized when the government interferes.

v Governments can sometimes improve market outcomes

Ø There are two reasons for government intervention: to change the (i) Efficiency, the size of the economic pie or (ii) Equity, how the economic pie is divided.

Ø Sometimes the invisible hand fails. Markets can fail to allocate resources efficiently if the economy has externalities or an economic player has market power.

v A country’s standard of living depends on its ability to produce goods and services

Ø Differences in standard of living in nations around the world can be attributed to differences in productivity.

Ø What is productivity?

Ø How can the government use public policy to change productivity?

v Prices Rise when the Government Prints Too Much Money

Ø Examples: The German Hyperinflation and the inflation of Latin America and South America

Ø What is inflation?

v Society Faces a Short-Run Tradeoff Between Inflation and Unemployment

Ø Reducing inflation is often thought to cause a rise in unemployment.

Ø Are there public policy implications based on the tradeoff? How does the structures of the US affect your answer?

I)                   What is an economy?

A.    Market-oriented economies vs. command economies

Some vocab

1.      economy

2.      economics

3.      market

4.      market-oriented economy

5.      command economy

6.      black market

B.     The interconnectedness of an economy

II)                The Division of Labor

A.    Why the division of labor increases production

What did Adam Smith say about this?

How do the below factors contribute to increased productivity?

1.      division of labor

2.      specialization

3.      economies of scale

III)              Microeconomics and Macroeconomics

A.    Microeconomics: the circular flow diagram

1.      microeconomics

2.      macroeconomics

3.      the circular flow model and its markets: goods and services, labor, financial capital

4.      rate of return, interest rate, principal

     We skipped the last section in the chapter 1 presentation, but it came back in chapter 2 with intemporal choice.

I)                   Choosing what to consume

     A.    A consumption choice budget constraint

           1. Budget constraint, opportunity set

B.     Know how changes in income and prices affect the budget constraint

C.     Personal preferences determine specific choices

           1. What is Utility and what is an Indifference Curve?

II)                Choosing between labor and leisure

          A.   Be able to show an example of a labor-leisure budget constraint

B.     How a change in wages affects the labor-leisure budget constraint

C.     Making a choice along the labor-leisure budget constraint.  Can you show the level of income, the amount consumed, the amount of leisure selected, and the numbers of hours you will work.

III)              Choosing between present and future consumption

A.    Interest rates: the price of intertemporal choice  What are the factors that affect interest rates?

IV)             Three implications of budget constraints: opportunity cost, marginal decision-making, and sunk costs

A.    Opportunity cost

B.     Marginal decision-making and diminishing marginal utility

C.     Sunk costs

1.   Definition of production possibilities frontier: a graph that shows the combinations of output that the economy can possibly produce given the available factors of production and the available production technology.

3.   Because resources are scarce, not every combination of computers and cars is possible. Production at a point outside of the curve (such as C) is not possible given the economy’s current level of resources and technology.

4.   Production is productively efficient at points on the curve (such as A and B). This implies that the economy is getting all it can from the scarce resources it has available. There is no way to produce more of one good without producing less of another.

5.   Production at a point inside the curve (such as D) is inefficient.

a.   This means that the economy is producing less than it can from the resources it has available.

b.   If the source of the inefficiency is eliminated, the economy can increase its production of both goods.

6.   The production possibilities frontier reveals: People face tradeoffs.

7.   The cost of something is what you give up to get it (opportunity cost).

8.   The opportunity cost of a car depends on the number of cars and computers currently produced by the economy.

9.   Economists generally believe that production possibilities frontiers often have this bowed-out shape because some resources are better suited to the production of cars than computers (and vice versa).

10.  The production possibilities frontier can shift if resource availability or technology changes. Economic growth can be illustrated by an outward shift of the production possibilities frontier.

II.   Comparative Advantage: The Driving Force of Specialization

A.   Absolute Advantage

1.   Definition of absolute advantage: the ability to produce a good using fewer inputs than another producer does.

B.   Opportunity Cost and Comparative Advantage

1.   Definition of opportunity cost: whatever must be given up to obtain some item.

2.   Definition of comparative advantage: the ability to produce a good at a lower opportunity cost than another producer.

3.   Because the opportunity cost of producing one good is the inverse of the opportunity cost of producing the other, it is impossible for a person to have a comparative advantage in the production of both goods.

C.   Comparative Advantage and Trade

1.   When specialization in a good occurs (assuming there is a comparative advantage), total output will grow.

2.   As long as the opportunity cost of producing the goods differs across the two individuals, both can gain from specialization and trade.

D.   The Price of the Trade

1.   For both parties to gain from trade, the price at which they trade must lie between the opportunity costs.