BasicEconomicIdeas:

Money,

OpportunityCostand

ProductionPossibilityFrontiers

ASECONOMICSChapter1TheEconomicProblemUnlimitedWantsScarceResources–Land,Labour,CapitalResourceUseChoicesTheEconomicProblemWhatgoodsandservicesshouldaneconomyproduce?–shouldtheemphasisbeonagriculture,manufacturingorservices,shoulditbeonsportandleisureorhousing?Howshouldgoodsandservicesbeproduced?–labourintensive,landintensive,capitalintensive?Efficiency?Whoshouldgetthegoodsandservicesproduced?–evendistribution?morefortherich?forthosewhoworkhard?OpportunityCostDefinition–thecostexpressedintermsofthenextbestalternativesacrificedHelpsusviewthetruecostofdecisionmakingImpliesvaluingdifferentchoicesStudyorwork?Youhavealreadyansweredthisquestion,butdidyouanalysethisprobleminthesamewayasaneconomistwould?Theproblemis;Whatdeterminesthedemandforeducation?Whatarethevariablesweneedforthismodel?5OpportunityCostLet’slookatsomefactorsinthisquestion:Cost;howmuchwilleducationcost?Return;howmuchisitworthtoyou–orwhatwillgetforyoureducation?Whereisthescarcityinthisproblem?ForQ3thescarcethingsarejobsandhighlyskilledpeople.ThecostofeducationHowmuchisauniversitydegree?RMB1,000,000?Whataboutthealternativetoeducation;work?Howmuchwouldyouearnifyouwentstraighttowork?ThisiscalledtheOpportunityCost7StudyorWork?continued8Anyotherfactors?EducationasInvestmentLoseenowforgreatereinthefuture!ANDConsumptionvalue;Gettingoutofbedat10amgoingtotwolecturesandthenhometowatchTV–betterthanworking,right?9ProductionPossibilityFrontiersShowthedifferentcombinationsofgoodsandservicesthatcanbeproducedwithagivenamountofresourcesNo‘ideal’pointonthecurveAnypointinsidethecurve–suggestsresourcesarenotbeingutilisedefficientlyAnypointoutsidethecurve–notattainablewiththecurrentlevelofresourcesUsefultodemonstrateeconomicgrowthandopportunitycostProductionPossibilityFrontiersCapitalGoodsConsumerGoodsYoXoABY1X1Assumeacountrycanproducetwotypesofgoodswithitsresources–capitalgoodsandconsumergoodsIfitdevotesallresourcestocapitalgoodsitcouldproduceamaximumofYm.IfitdevotesallitsresourcestoconsumergoodsitcouldproduceamaximumofXmYmXmIfthecountryisatpointAonthePPFItcanproducethecombinationofYocapitalgoodsandXoconsumergoodsIfitreallocatesitsresources(movingroundthePPFfromAtoB)itcanproducemoreconsumergoodsbutonlyattheexpenseoffewercapitalgoods.TheopportunitycostofproducinganextraXo–X1consumergoodsisYo–Y1capitalgoods.ProductionPossibilityFrontiersCapitalGoodsConsumerGoodsYoXoA.BCY1X1ProductioninsidethePPF–e.g.pointBmeansthecountryisnotusingallitsresourcesItcanonlyproduceatpointsoutsidethePPFifitfindsawayofexpandingitsresourcesorimprovestheproductivityofthoseresourcesitalreadyhas.ThiswillpushthePPFfurtheroutwardsEconomicandFreeGoodsEconomicGoodsaretheproductofthe4factorsofproductionandhaveanopportunitycost.Freegoodsaregiftsfromnatureandhavenoopportunitycost.Examples?Sunshine SpringWaterRainWindButwhathappenswhenthespringwaterisputinabottle?14WhatarethethreeFundamentalEconomicQuestions?Whattoproduce?Howtoproduce?Forwhomtoproduce?SpecialisationandExchangeEconomicgrowtharoundtheworldhasbeenfastbecauseofonesimpleeconomicphenomenon.SpecialisationThisiswhenasingleperson,firm,regionorwholecountrydecidestoconcentrateondoingonethinginsteadoftryingtodoeverything.SpecialisationSomepeopleeteachers,someechefs,drivers,factoryworkersordoctorsSomefirmsproduceelectronicswhileothersmaymakecars.Somecountriesfocusonmanufacturing,someonprimarygoodslikebananasorcoffeebeans.Othercountriesspecialiseinservices.ExchangeObviouslypeoplecannotliveoncoffeebeansalone.Inordertogetthethingsweneedwehavetoexchangeourspecialisationwithotherpeopleorcountries.Theimportantthingisthis;byspecialisinginonething,wecanproducemoreofit.DivisionofLabourAgoodexampleofthisiswhathappensinsideabigcompany.AdamSmith,(5June1723–17July1790)“thefatherofmoderneconomics”observedthatwithalargeworkforce,productioncouldbebrokendownintoaseriesofspecifictasks.Workerswouldthenspecialiseinoneofthosetasksande‘expert’ThisdivisionoflabourmeansmorecanbeproducedDivisionofLabourIfeachworkerhadtomakethewholeproductalotoftimewouldbewastedmovingfromplacetoplace,lookingfortherighttools,(capital),andnobodywouldeverygoodatanyparticulartask.Specialisationallowsworkerstoeverygoodatonetask,buttheproblemis…Itcanbeveryboring!Whatis

OpportunityCost?ThebestalternativesacrificedforachosenalternativeWhatOpportunityCostamIexperiencingnow?ThemostmoneythatIcouldbemakingifIweresomewhereelseinsteadofteachingeconomicshere!CanOpportunityCostbesomethingotherthanmoney?

ThatmostdesiredactivitythatyouarepresentlygivingupisconsideredanopportunitycostYes!Whatis

MarginalAnalysis?Marginal–ThisisaKEYeconomicswordAnexaminationoftheeffectsofadditionstoorsubtractionsfromacurrentsituationMarginalAnalysisMarginalTheedgeorsideofsomething–ineconomicsitmeansthenextunitproducedornextitempurchased.e.g.Youbuy10apples,the11thapplewouldbethemarginalappleMarginalAnalysisAnalysisThedetailedstudyofsomething.e.g.MarginalAnalysiswouldbethestudyoftheeffectofbuyingan11thappleonthebuyer’slevelofsatisfaction.26WhatisanexampleofMarginalAnalysis?Whenyourbenefitofbuyinganextraappleexceedstheopportunitycost,youwillbuyanotherapple.27WhatisaProductionPossibilitiesCurve?Acurvethatshowsthemaximumcombinationsoftwooutputsthataneconomycanproduce,givenitsavailableresourcesandtechnology28WhatisTechnology?Thebodyofknowledgeandskillsappliedtohowgoodsareproduced29ABMilitaryGoodsConsumerGoodsUnattainableInefficientProductionPossibilitiesCurveEfficient30WhatthreeassumptionsunderlietheProductionsPossibilitiesCurveModel?FixedresourcesFullyemployedresourcesTechnologyunchanged31WhatistheconclusionoftheProductionPossibilitiesCurve?Scarcitylimitsaneconomytopointsonorbelowitsproductionpossibilitiescurve32WhatistheLawofIncreasingOpportunityCosts?Theprinciplethattheopportunitycostincreasesasproductionofoneoutputexpands33Whatis

EconomicGrowth?Theabilityofaneconomytoproducegreaterlevelsofoutput,representedbyanoutwardshiftofitsproductionpossibilitiescurve34AComputersPizzasTechnologicalAdvanceWhathappenswhenacountrydecidesnottoinvestinnewtechnology?Everythingelsebeingequal,thecountrywillnotgrowWhatisInvestment?

Theaccumulationofcapital,bothintellectualandphysicalsuchasaskilledworkforce,factories,machinesandinventoriesthatareusedtoproducegoodsandservicesWhatistheOpportunityCostofinvestment?TheconsumergoodsthatcouldhavebeenpurchasedwiththemoneyspentforplantandothercapitalWhatdoesanincreaseininvestmentsmakepossibleinthefuture?EconomicgrowthandmoregoodsandservicesWhatconclusioncanwemakeaboutinvestments?Anationcanaccelerategrowthbyincreasingproductionofcapitalgoodsinexcessofthecapitalbeingwornout40ThefunctionofMoneyanditsSupplyWhatisMoney?Money……iswhatmakestheworldgoround…“can’tbuylove”…is“l(fā)ikeasixthsensewithoutwhichitisimpossibletofullyenjoytheotherfive”Noneofthesestatementsreferstomoneyaseconomist’susetheterm,rathertheyrefertoeorwealthFunctionsofMoneyMoneyisanassetthatperformsthreefunctionsMoneyisamediumofexchangeStandardfordeferredpaymentMoneyisastoreofvalueMoneyisaunitofaccountMoneyDivisiblePortableDurableMediumofExchangeAmediumofexchangeisanythingthatisreadilyacceptableaspaymentforgoodsandservicesThisroleofmoneyiskeyinimprovingtheefficiencyoftheeconomyTradewithoutmoney(barter)ispossiblebutdifficultItrequiresa“doublecoincidenceofwants”BarterDoublecoincidenceofwantsStandardfordeferredpaymentItisJulynow.Youwanttobuystrawberrieswhichgrowinthesummer,butyouonlyhavepotatoeswhichgrowinthewinter.Strawberrieslastoneweekbeforetheyarebad.Whatdoyoudo?YouneedtotradestrawberriesforpotatoesStandardfordeferredpaymentBarteristhetradeofonegoodforanothergood.AstrawberryforapotatoButthereisaproblem–TIMEStrawberriesandpotatoesgrowatdifferenttimesoftheyearanddonotlastalongtime.StandardfordeferredpaymentMoneyCashisbasicallyapromisetopayforstrawberriesnowwithpotatoesinthefuture.It’sanIOU(Ioweyou)StoreofValueAstoreofvalueisanitemthatpeoplecanusetotransferpurchasingpowerfromthepresenttothefutureMoneyisonewayofholdingwealthHowever,moneyisnottheonlywayofstoringwealthAUnitofAccountAunitofaccountistheyardstickpeopleusetopostpricesandrecorddebtsAunitofaccount,oryardstick,forvaluesisessentialWithinaneconomy,itnaturallymakessensetostandardizeonasingleunitofaccount:money!TypesofMoneyCommoditymoneytakestheformofacommoditywithintrinsicvalueFiatmoneyhaslittleornointrinsicvalueoruseinofitself,butisusedasmoneyeitherbecauseofgovernmentdecreeorsocialconventionQuickQuizWhichofthefollowingservedasmoney?Whichofthefollowingwouldbeconsideredfiatmoneyandwhichwouldbeconsideredcommoditymoney?QuickQuizWhatcharacteristicsofthesegoodsmadethemusefulalsoasamediumofexchange?Portability?Durability?Storeofvalue?MetallistFalacyItwasoncebelievedthatthe“value”ofmoneywasderivedfromitsnon-monetaryuses.ThisisknownasthemetallistfallacyItislogicallyessentialformoneytoconsistof,orbe“covered”by,somecommoditysothatthelogicalsourceoftheexchangevalueorpurchasingpowerofmoneyistheexchangevalueorpurchasingpowerofthatcommodity,consideredindependentlyofitsmonetaryrole(Schumpeter1954)AFiatMonetaryStandard:ARecentInventionBefore1971everycurrency(barringbriefinterruptions)wasanchored,whetherdirectlyorindirectly,toacommodityTheworldnowoperatesonafiatmonetarystandard—acurrencywhichisintrinsicallyuselessMoneyontheIslandofYapTheAnthropologistWilliamHenryFurnessIIInotedthestrangeconventionthatismoneyontheislandofYapCurrency—fei—largestonewheelsIstheYapeesesystemreallysostrange?ConventionofMoneyWhydotheislandersofYapusefeiastheirmediumofexchange?WhydidRussiansuseczaristrublesinthepostrevolutionaryperiod?Whydoweusepapermoneytoday?Weacceptmoney,becauseweknowthatotherswill.ByconventionorgovernmentdecreemoneyisuniversallyacceptedHowFragileisthisConvention?Canthisconventionbreakdown?Theconventionorfictionbywhichmoneygetsits“value”isnofragilething,butitcanandhasbrokendownonoccasionExamplesFollowingtheRussianrevolution—oldczaristsnotescirculatedascurrencyDuringtheGermanhyperinflations—foreigncurrenciesservedassubstitutecurrenciesCurrencySubstitutionWhydopeoplestopacceptingoneformofmoneyandsubstitutetoanotherform?Becausemoneynolongerfunctionswellasa:mediumofexchange,meansofpaymentstoreofvalueunitofaccountKeyConceptsWhatarethethreeFundamentalEconomicQuestions?WhatisOpportunityCost?CanOpportunityCostbesomethingotherthanmoney?WhatisMarginalAnalysis?WhatisaProductionPossibilitiesCurve?WhatthreeassumptionsunderlietheProductionsPossibilitiesCurveModel?WhatistheconclusionoftheProductionPossibilitiesCurve?WhatistheOpportunityCostofinvestment?Whatdoesanincreaseininvestmentsmakepossibleinthefuture?Whatconclusioncanwemakeaboutinvestments?Summary

Threefundamentaleconomicquestionsfacinganyeconomyare:

What,How,andForWhomtoproducegoods.TheWhatquestionasksexactlywhichgoodsaretobeproducedandinwhatquantities.TheHowquestionrequiressocietytodecidetheresourcemixusedtoproducegoods.TheForWhomproblemconcernsthedivisionofoutputamongsociety’scitizens.

Opportunitycostisthebestalternativeforegoneforachosenoption.Thismeansnodecisioncanbemadewithoutcost.ScarcityChoiceOpportunityCost

Marginalanalysisexaminestheimpactofchangesfromacurrentsituationandisatechniqueusedextensivelyineconomics.Thebasicapproachistocomparetheadditionalbenefitsofachangewiththeadditionalcostofthechange. Aproductionpossibilitiescurveillustratesaneconomy’scapacitytoproducegoods,subjecttotheconstraintofscarcity.Theproductionpossibilitiescurveisagraphofthemaximumpossiblecombinationsoftwooutputsthatcanbeproducedinagivenperiodoftime,subjecttothreeconditions:

(1)Allresourcesarefullyemployed (2)Theresourcebaseisnotallowedtovaryduringthetimeperiod. (3)Technology,whichisthebodyofknowledgeappliedtotheproductionofgoods,remainsconstant. Inefficientproductionoccursatanypointinsidetheproductionpossibilitiescurve.Allpointsalongthecurveareefficientpointsbecauseeachpointrepresentsamaximumoutputpossibility.ABMilitaryGoodsConsumerGoodsUnattainableInefficientProductionPossibilitiesCurveEfficient Thelawofincreasingopportunitycostsstatesthattheopportunitycostincreasesastheproductionofanoutputexpands.Theexplanationforthelawofincreasingopportunitycostsisthatthesuitabilityofresourcesdeclinessharplyasgreateramountsaretransferredfromproducingoneoutputtoproducinganotheroutput. Investmentmeansthataneconomyisproducingandaccumulatingcapital.Investmentconsistsoffactories,machines,andinventories(capital)producedinthepresentthatareusedtoshifttheproductionpossibilitiescurveoutwardinthefuture.

Economicgrowthisrepresentedbytheproductionpossibilitiescurveshiftingoutwardastheresultofanincreaseinresourcesoranadvanceintechnology.75AComputersPizzasTechnologicalAdvanceBTechnologicaladvanceEconomicgrowthQuiz1.Whichofthefollowingdecisionsmustbemadebyalleconomies?a.Howmuchtoproduce?Whentoproduce?Howmuchdoesitcost?b.Whatistheprice?Whowillproduceit?Whowillconsumeit?c.Whattoproduce?Howtoproduce?Forwhomtoproduce?d.noneoftheabove.C.Regardlessofthesizeofwealthofanation,itmustchooseasystemtoanswerthesethreebasicquestions2.Astudentwhohasoneeveninginwhichtopreparefortwoexamsonthefollowingdayhasthefollowingtwoalternatives:A9580B8090PossibilityScoreinEconomicsScoreinAccounting80Theopportunitycostofreceiving90,ratherthan80,ontheaccountingexamisrepresentedbyhowmanypointsontheeconomicexam?a.15points.b.80points.c.90points.d.10points.PossibilityScoreinEconomicsScoreinAccountingA9580B8090A.Byspendingmoretimestudyingforaccountingandthereforespendinglesstimestudyingfortheeconomicsexam,15pointsontheeconomicsexamaregivenup.813.Opportunitycostisthea.purchasepriceofagoodorservice.b.valueofleisuretimeplusout-of-pocketcosts.c.bestoptiongivenupasaresultofchoosinganalternative.d.Undesirablesacrificerequiredtopurchaseagood.C.Opportunitycostisthatwhichisgivenupinthebestalternative,notthatwhichispaidinmoneyforthegoodbought.82ABMilitaryGoodsConsumerGoodsUnattainableInefficientProductionPossibilitiesCurveEfficient834.Onaproductionpossibilitiescurve,theopportunitycostofgoodXintermsofgoodYisrepresentedbya.thedistancetothecurvefromtheverticalaxis.b.thedistancetothecurvefromthehorizontalaxis.c.themovementalongthecurve.d.alloftheabove.

C.TohavemoreunitsofgoodXapersonwillhavetogiveupunitsofgoodYasrepresentedonthehorizontalaxis.845.Afarmerisdecidingwhetherornottoaddfertilizertohisorhercrops.Ifthefarmeradds1poundoffertilizerperacre,thevalueoftheresultingcropsrisesfrom$80to$100peracre.Accordingtomarginalanalysis,thefarmershouldaddfertilizerifitcostslessthana.$12.50perpound.b.$20perpound.c.$80perpound.d.$100perpound.b.Aslongasthefertilizercostslessthan$20peracre,thefarmerwillgainmorebyfertilizingthenheorshewilllosebytheexpenseofthefertilizer.856.Onaproductionpossibilitiescurve,theopportunitycostofgoodXintermsofgoodYisaproductionpossibilitiescurve;achangefromeconomicinefficiencytoeconomicefficiencyisobtainedbya.movementalongthecurve.b.movementfromapointoutsidethecurvetoapointonthecurve.c.movementfromapointinsidethecurvetoapointonthecurve.d.achangeintheslopeofthecurve.

C.Allpointsontheproductionpossibilitiescurverepresentscombinationsofbothgoodswhileoperatingatthemostefficientlevelpossible.867.Anypointinsidetheproductionpossibilitiescurveisa(an)a.effi