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This unit:Defines Economics.Distinguishes between Microeconomics and Macroeconomics.Reviews some relevant math concepts.Looks at the economic problem using the

concepts of scarcity, choice, opportunity cost, trade-off and efficiency.Introduces the Production Possibility Frontier (PPF) and its related concepts.

Several definitions have been introduced over time.

Milton Friedman: Economics is the science of how a particular society solves its economic problems.”

Lionel Robbins: “Economics is the science which studies human behaviour as a relationship between ends and scarce means which have alternative uses.”

Alfred Marshall: “Economics is the study of mankind in the ordinary business of life.”

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Jolting JPS demand - Customer charged $288,000 despite not using service

Hanover cop's corruption trial adjourned until September

  Promo work won't slow down Bolt - Publicist

says star sprinter's obligations will not affect World Champs preparation

  Manpower problem - Hanover fire department

hampered by severe staff shortage  Mother of 11-month-old fire victim faces more

questions - The mother of an 11-month-old girl who died in a fire in Salem, near Runaway Bay in St Ann, on Saturday night remained in police custody Sunday afternoon.

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Asafa could near quadruple your money - One could earn almost quadruple their money on a bet that Asafa Powell will dethrone champion Usain Bolt through a win in the 100 metres final at the 2011 IAAF World Athletics Championships.

Steve Mullings tests positive - The future of Jamaican sprinter Steve Mullings now hangs in the balance after revelations that he tested positive for a masking agent

  Kartel's bleaching draws international media

attention - Deejay Vybz Kartel has come under fire from International media over his skin bleaching

  Anglicans, UDC butt heads - State agency

denies 'land grabbing' threat against Nuttall Hospital 5

We will define economics as: The study of how society allocates its

scarce resources among competing uses.

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Microeconomics is the study of the behaviour of individual markets. It is also the detailed analysis of the behaviour of individual agents such as firms and consumers.

Macroeconomics is the study of how the economy behaves on a large scale. Therefore individual agents are not the focus, but the entire system.

Microeconomics studies issues such as:

(a) How will the market for potatoes in Haiti be affected after Hurricane Irene?

(b) What are the factors which determine the choice that a person makes between buying a Honda Accord or a Toyota Corolla?

Macroeconomics is concerned with questions like:

How much did the Barbadian economy grow last year?

What will the inflation rate be for Guyana this year?

How will the Jamaican economy be affected if there is another recession in the USA?

Micro or Macro?Jolting JPS demand - Customer charged $288,000 despite not using serviceAsafa could near quadruple your money - One could earn almost quadruple their money on a bet that Asafa Powell will dethrone champion Usain Bolt through a win in the 100 metres final at the 2011 IAAF World Athletics Championships.Kartel's bleaching draws international media attention - Deejay Vybz Kartel has come under fire from International media over his skin bleachingNo IMF worries - Financial Secretary Wesley Hughes is dismissing concerns that the country could be in dire straits because of its inability to draw down on an estimated US$300 million under the standby agreement with the IMFIMF cautions Gov't - Fund says Jamaica falling short in some areasJamaica’s economy can grow — Shaw – Minister of Finance and the Public Service Audley Shaw says Jamaica’s economy can grow to high levels and China’s economic development can be used as a source of inspiration

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In ECON1001/EC10C we are concerned with Microeconomics - the study of the behaviour of individual economic agents, and how they interact in a market.

International trade theory and policy Monetary Economics Development Economics Agricultural Economics Labour Economics Economics of Education, Health,

Entertainment, Sports, Energy, etc.

Every economy faces three questions it must answer with respect to the allocation of its resources given a world of scarcity and choice1. What to produce? Which combination of

goods will we produce?2. How to produce it? What technologies,

methods, and techniques will we use to produce in the most efficient manner?

3. Who will get it? How will the output be distributed among the citizens?

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Free enterprise market based system or central planning…or some combination of the two? In a market based system decisions about what to

produce are made by millions of individual market participants based on the pursuit of their own best interests, given their talents, skills, abilities and motivation

Under central planning, decisions about what to produce are made by bureaucrats in a central planning agency

Adam Smith noted in The Wealth of Nations that people are adept at pursuing their own self-interest and that a market system harnesses this self-interest remarkably well

The pursuit of self-interest inevitably leads to specialization and division of labour and the exploitation of people’s comparative advantages

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Specialization and division of labor Breaks up a task into smaller, more specialized tasks

allowing each worker to become more adept at a particular job

This allows the worker to become more productive and output increases – real life, non-business application: sports teams!

Smith observed that different people are more or less adept at some tasks than others

People (and economies) become more efficient if people specialize in doing what they do best and then trading some of their output for things that others do better

What is not so obvious is that two people (or businesses or nations) can generally gain from trading even if one is more efficient at producing everything than another…a concept called the principle of comparative advantage

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The answer to this question is subjective…who best decides how the output of society should be distributed…each individual or someone else?

If we look historically at which systems tend to work the best we see that resource allocation and distribution decisions tend to be optimized when individual producers and consumers are left free to pursue their own self interest without central direction

Market systems work very well at solving many of society’s basic economic problems, but it fails to remedy others and may even create some of its own

One major purpose in becoming an economic thinker is to understand when to let the market work and when (and why) intervention by government may be necessary

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A model is a hypothesis about the relationships among variables.

Everyone uses models.

Economists use models to simplify reality in order to improve our understanding of the world.

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Variables represent persons or objects that can be manipulated, controlled, or merely measured for the sake of research.

Two main types Independent (input) variables

The variable that you decide to change Dependent (outcome) variables)

The variable that changes as a result of a change in the independent variable. It is the variable that you measure.

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EC10C Grade = f(no. of hours spent studying)

But this assumes a critical concept referred to as ‘ceteris paribus’ which means “holding all other factors constant”

This is relationship can be demonstrated on a graph.

Recall: Equation of line: Y = mX + c

M = gradient/slope C = constant/intercept

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Two-variable diagrams Horizontal axis Vertical axis Origin

Benefits of Economic graphs Large quantity of data - quickly Facilitate data interpretation & analysis At a glance

Important statistical relationships

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Price (per patty) $20 $30 $40 $50 $60

Quantity demanded12 8 6 4 2

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Quantity

2 4 6 8 10 12 140

Pric

e

10

20

30

40

50

60

b

Q

P

(a)

Quantity

2 4 6 8 10 12 140

Pric

e10

20

30

40

50

60

Q

P

(b)

a

D

a

b

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(a)

Y

X0

(b)

Y

X0

(c)

Y

X0 (d)

Y

X0

Negative slope

Positive slope

Zero slopeInfinite slope

The slope of a linear curve is calculated as Rise/Run. This means that we divide the change in the variable on the y- axis by the change in the variable on the x- axis.

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(a)

Y

X0

(b)

Slope = 1/10

133

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A

C

B

Y

X0

Slope = 3/10

133

8

11

A

C

B

Curves change slopes along their lengths.

Since the slope is always changing, then we can only find the slope at a given point on the curve. This slope is given by the slope of the tangent.

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(a)

Y

X0

(b)

Y

X0

(c)

Y

X0 (d)

Y

X0

Negative slope Positive slope

Positiveslope

Negative slope

Negativeslope Positive

slope

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E

X1 2 3 4 5 6 70 8 9 10

Y

1

2

3

4

5

6

7

8 r

rT

R

G

M

t

tB

F

A

C

D

Y-intercept Ray through origin

Y-intercept = zero 45° lines

Rays through origin Slope = 1 Angle = 45° X=Y

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30

X1 2 30 4 5

Y

1

2

3

4

5

A

B

K

E

D

CSlope = +1

Slope = +1/2

Slope = +2

Equations with unknowns

For example: 2y -12 = 0 The objective is to group like terms- the unknowns on one side

and the constants (or known terms) on the other side of the equal sign:

2y = 12

We then divide both sides by 2 to give:

2y/2 = 12/2

y = 6

The economic problem is mainly concerned with (1) the scarcity of resources, (2) the choices that we are forced to make in determining what to use these resources for, and (3) the opportunity costs of our choices.

In order to have more of one good then it means less of an alternative good. Therefore we have a trade-off. It is also important that we use these scarce resources efficiently.

Scarcity

Scarcity- Resources are limited in supply

The possible uses of resources exceed their actual supply

Resources/ Factors of Production (FoPs):

1. Land: Gifts of nature/ natural resources.

2. Labour: All human resources, mental and physical, inherent and acquired by training.

3. Capital: All man-made aids to facilitate and enhance production. These are used to make other goods instead of being consumed.

4. Entrepreneurship: Those persons who bring all the above factors together to engage in production.

NOTE: It is often the case that the factors of production are identified as only land, labour and capital.

Scarcity (Cont’d)

The Water- Diamond Paradox

Why are diamonds so expensive, while water (which is essential for survival) so cheap?

Diamonds are usually scarce in supply, and so they command a high price.

Water is not scarce, so the price is low.

How would the values of water and diamonds change if you are stranded in the middle of a desert?

Scarcity (Cont’d)

The answer is that the price of water would rise, the price of diamonds would fall, and water may even become more expensive than diamonds.

Because of the limited supply- and you need water to survive- then it will command a high price.

Confronted by the reality of scarcity, individuals need to make choices between alternatives.

In making such a choice, individuals balance the benefits derived from having more of something against the cost of having less of something else.

This essentially means that people face trade-offs.

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Opportunity Cost

Opportunity Cost is defined as the cost of a decision expressed in terms of the value of the foregone next best alternative.

Opportunity Cost occurs because resources are scarce and so we have to make choices.

Calculating Opportunity Cost:

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what is given up

what is produced

Efficiency

Efficiency in the production process means that for a given value of resources, we get the maximum value of output

All the preceding concepts - scarcity, choice, opportunity cost, trade-off and efficiency, can be explained in one graph.

This graph is the Production Possibility Frontier (PPF).

The Production Possibility Frontier shows the combinations of different types of output which are just attainable when the factors of production are efficiently employed.

The PPF is also known as:

1. The Production Possibility Curve 2. The Production Possibility Boundary3. The Transformation Curve4. The Transformation Boundary5. The Transformation Frontier

The PPF represents the efficient levels of production of the goods.

With the given resources, either 3000 units of sugar cane can be produced or 4000 units of bananas, or a combination of both goods.

0

Sugar Cane

Bananas

3000

4000

The PPF

Scarcity: There will be some levels of production that are attainable/ can be produced. However, there will also be levels of production that the existing resources and technology cannot produce (the unattainable region). The unattainable region is outside the boundary of the PPF.

Choice: There are many points along the PPF where production can occur. However, there must be a decision / choice to produce a certain combination of goods ( for example to produce at point A or point B).

Efficiency: Points along the PPF represent the combinations of the goods that can be produced efficiently - i.e. without wasting resources (or leaving them idle).

The concepts of scarcity, choice and efficiency are shown in the graph of the PPF below:

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Sugar Cane

Bananas

3000

4000

The Efficient Level of

Production (the PPF)

Attainable

Unattainable

A

B

Opportunity Cost

If we initially produce at point A, then we will have 2800 units of both sugar cane and bananas.

If we then want to produce at point B, then it means that we will have to give up 300 units of sugar cane (2800 -2500) to gain 1000 more units of bananas (3800 -2800).

Here we have the concept of trade-off, because in order to get more bananas, then we had to give up some amount of sugar cane production.

The Opportunity Cost of this increase in banana production is 300 units of sugar cane.

A

B

Unattainable

AttainableEfficiency – on

the frontier

Production Possibility Frontier (cont’d)

Sugar cane

Bananas

3000

4000

2800

2500

2800 3800

The concepts of scarcity, choice and efficiency are shown in the graph of the PPF below:

Opportunity Cost (Cont’d)

The concave shape of the PPF indicates that the Opportunity Cost (OC) is increasing over time. We can see this in an example:

Suppose we produce 3000 units of sugar cane and no bananas. To produce at point A, then we will have to give up 200 units of sugar cane (3000 - 2800) to produce 2800 units of bananas. The OC is 200 units of sugar cane.

To produce 3800 units of bananas, then sugar cane production has to fall by a further 300 units (2800 – 2500). The additional OC is now 300 units of sugar cane. The total OC is 500 units of sugar cane.

As we produce more and more bananas, then the opportunity costs (in terms of sugar cane) increases.

We have Increasing Opportunity Costs because as we produce more bananas, then we end up using resources that are more suitable to producing sugar cane.

In the case where we increase sugar cane production, then we will also have increasing opportunity costs, as after using up all the resources best suited for sugar cane (flat land), then we end up using resources which are more suitable for banana production.

Let us look at the case where we increase sugar cane production:

Initially, we are producing 4000 units of bananas and no sugar cane. If we decide to produce at point B, then we will have to give up 200 units of bananas (4000 – 3800) to gain 2500 units of sugar cane. The OC is 200 units of bananas.

Suppose we decide to produce more sugar cane - point A. Then we will have to give up an additional 1000 units of bananas (3800- 2800), to produce 2800 units of sugar cane. The additional OC is now 1000 units of bananas. The total OC is 1200 units of bananas.

The Opportunity Cost (OC) of sugar cane production is also increasing.

How can we move beyond the boundary of the PPF? Or alternatively, how can we shift the PPF outwards?

The amount of productive resources increase – e.g. additional labour and capital.

Technological progress/ improvements in knowledge and technology.

When the PPF shifts outwards, then we are experiencing economic growth.

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Patties

CANES

What is the effect of an improvementin the technology for producing patties?

What is the effect of an improvementin the technology for producing patties?

0

100

200

300

400

0 10 20 30 40 50 60

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Patties

CANE

What’s the effect of an increase in total resources (inputs)?

What’s the effect of an increase in total resources (inputs)?

0

100

200

300

400

0 10 20 30 40 50 60

PPF is a very useful model in illustrating all the concepts associated with limited resources.

The concave shape of the PPF reflects increasing costs.

Points “outside” the PPF are unattainable.

Points “on” the PPF are efficient.

Points “inside” the PPF are inefficient.

For any point “inside” there corresponds some point that represents more production of both goods.

The PPF also shows how economic growth is possible.

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Absolute advantage: Ability to produce a good or service using fewer resources.

Comparative advantage : Ability to produce a good or service at a lower opportunity cost.

Absolute advantage does not necessarily imply comparative advantage.

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Even though a person (or country) may have an absolute advantage at producing every good, the less efficient person (or country) is said to have a comparative advantage over another person (or country) if it can produce one of the goods at a lower opportunity cost than the other

In determining the most efficient patterns of production and trade it is comparative advantage that matters…not absolute advantage

A country can gain by importing a good even if it can be produced more efficiently at home, if the opportunity cost of producing it at home is greater than the opportunity cost in the other country

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Absolute Advantage

Who can produce more with the same resources (materials, time, etc.)

or Who can produce the same output with

less resources

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Kilos of Kilos of CassavaCassava

Kilos of Kilos of OnionsOnions

SeanSean 15

DavidDavid 25

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Who has an absolute advantage in what goods?

Who has an absolute advantage in what goods?

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Comparative Advantage Who can produce with lowest opportunity

cost

The theory of comparative advantage states that a producer should specialize in the production of that good that has the lowest opportunity cost.

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CassavasCassavas OnionsOnions

SeanSean 1515 4545

DavidDavid 5050 2525

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Example: Comparative advantage in Cassavas?

Compare opportunity cost:

Sean: 4515 =3 David:

5025 = 1

2

CassavasCassavas OnionsOnions

SeanSean 1515 4545

DavidDavid 5050 2525

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Example: Comparative advantage in Onions?

Compare opportunity cost:

Sean: 1545 = David:

2550 =2

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Opportunity Opportunity Cost of 1 acre Cost of 1 acre of Cassavasof Cassavas

Opportunity Opportunity Cost of 1 acre Cost of 1 acre of Onionsof Onions

SeanSean 33

DavidDavid 22

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Table showing opportunity costs of the 2 farmers

1/3

1/2

For Unit 1, we have covered:

The definition of economics The difference between microeconomics and

macroeconomics The Economic Problem The PPF Absolute and Comparative Advantage

Remember your readings: Baumol and Blinder (chapters 1 & 3)