ECO 120Principles of Economics

CHAPTER 1Introduction to Economics

What is Economics?

Economics

Microeconomics Macroeconomics

Study of how people use their limited resources to fulfill unlimited wants and need.

study of individual economic unit.

ex: household, firm and government choice.

studies the aggregate behavior of the entire economy

ex: unemployment, inflation, GDP, international trade, etc

Economists study the choices we make and also the consequences of these choices

Economic Concepts Scarcity

• scarce – impossible to satisfy our unlimited wants – limited resources• wants always exceeding limited resources• Peoples’ wants are greater than the economy’s ability to produce desirable goods & services• Because our resources are limited, we must sacrifice one thing for another.

SCARCITY CHOICES

Choices• because of scarcity, choose from the available alternatives.

Opportunity Cost• the second best alternative that has to be forgone for another choice which gives more satisfaction.• THE OPPORTUNITY COST of an action is the next best foregone alternative.

Production Possibilities Curve (PPC)

• Various possible combinations of goods and services produced within a specified time with all its resources fully and efficiently employed.

• A curve that shows the maximum combinations of two outputs that an economy can produce, given its available resources and technology.

Assumption to Illustrate PPC

– Producing 2 goods– Fixed resources– Fixed technology– Producing at full employment

FIGURE 1-1: Production Possibility Frontier

At point A, can produce 20 units of clothes & 4 units of potatoes.

At B, can produce 18 unit of clothes and 7 unit of potatoes.

Without more resources, points outside PPC are unattainable (Point E)

Points “inside” the PPC are inefficient – waste of resources (Point D).

CLOTHES

9

19A

C

POTATOES0 4 14

•E

•D

15

20

scarcity

Opportunity cost

choices

Movement from one point to another – point A to B

B18

7

Insights From The PPC Model

Scarcity - The quantities of the goods that can be produced fall short of what is desired .

Choice - combinations of goods among which society must choose.

Opportunity cost - When there is efficiency in production, the only way to have more of one good is to have less of another.

PPC - Example

1 2 3 4 5

5

9

12

1514

a

b

c

d

e

f

clothing

food

Figure 1

Food Clothing

0 15

1 14

2 12

3 9

4 5

5 0

Production Possibilities

Good Y

4

910

A

B

Opportunity cost ofGood X = 1 unit of good Y

Opportunity cost ofGood X = 2 unit of good Y

2

Good X0 3 4 1213

Production Possibility Curve

opportunity cost of good X rises so that it is much higher at point B (1 unit of good X costs 2 unit of good Y).

Opportunity costs of economic action not constant, but vary along PPC

Combination of goods

Radios (R) (unit)

Televisions (TV) (unit)

Opp. cost of radio (Total)

Opp. cost of radio(per unit)

A 0 10 - -

B 4 9 1 TV ¼ = 0.25 TV

C 7 7 2 TV 2/3 = 0.67 TV

D 9 4 3 TV 3/2 = 1.5 TV

E 10 0 4 TV 4/1 = 4 TV

Increasing opp. cost

Combination of goods

Radios (R) (unit)

Televisions (TV) (unit)

Opp. cost of radio (Total)

Opp. cost of radio

(per unit)

A 0 12 - -

B 2 10 2 TV 2/2 = 1 TV

C 4 8 2 TV 2/2 = 1 TV

D 6 6 2 TV 2/2 = 1 TV

E 8 4 2 TV 2/2 = 1 TV

F 10 2 2 TV 2/2 = 1 TV

g 12 0 2 TV 2/2 = 1 TV

Constant opp. cost

Shift of PPC- PPC depends on the availability of the factors of production (resources) and technology.

Decrease

Increase

Good Y

Good X

0

Good Y

Good X

Initial PPF

New PPF

Why would the PPF shift outward?

-- more resources: land, labor, capital, and human capital (economic growth)

-- technological progress

-- larger population

0

10

20

30

40

50

60

70

0 10 20 30 40 50 60 70

Production of Food

Pro

du

cti

on

of

Clo

thin

g

PPC1

PPC2

Production Possibilities Curve

Improvement that benefits both products. PPC shifts outward (to the right), from PPC1 to PPC2.

Increase in Resources or Technology

Production Possibilities Curve

0

10

20

30

40

50

60

0 10 20 30 40 50 60 70

Production of Food

Pro

du

ctio

n o

f C

loth

ingImprovement that benefits Food production only – from PPC1 to PPC2

PPC1

PPC2

Production Possibilities Curve

0

10

20

30

40

50

60

70

0 10 20 30 40 50 60 70

Production of Food

Pro

du

ctio

n o

f C

loth

ing

Improvement that benefits clothing production only – from PPC1 to PPC2

PPC1

PPC2

Shape of The PPFs

Good Y

Good X

Increasing Opportunity Costs

Constant Opportunity Costs

Decreasing Opportunity Costs

Basic Economic Problems• What to produce?

– types of goods the society wants to produce given limited factors of production (eg: radios or televisions)

• How much to produce?

– Quantity of goods to be produced

• How to produce?

– Methods of production (labor or capital intensive)

– The cheapest method of production – minimum cost of production

• For whom to produce?

– Target group (rich, poor, working people, etc)