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Basic Economic Concepts, Production Possibilities Curve, Economic Systems, and The Circular Flow Diagram

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Daniel Kim

on 23 August 2016

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Transcript of Basic Economic Concepts, Production Possibilities Curve, Economic Systems, and The Circular Flow Diagram

the study that deals with the problem of how to
allocate
the world's
scarce resources
between the competing and
unlimited wants and needs
of people

A Quick Definition:
Economics IS....
So what does that exactly mean?
Let's break it down
Wants
Needs
Land
Land resources are considered to be the "
gifts of nature
" Soil, wood, oil, gas, minerals, and animals are all scarce because they are desired to produce goods and service but are limited in nature
Labor
Something we desire but is not necessary for survival
Something we cannot survive without
Also known as "Human Resource,"
Labor
is any work people do that creates goods and services
Examples:
Capital
Capital refers to the tools and technologies that are used to produce the goods and services we create using labor
Entrepreneurship
So people always wanting more and more stuff...is this a positive or a negative in regards to our economy? Our society? Culture?
But when do needs turn into wants and desires?
Burberry Sneaker
$450.00 USD
GUCCI Sunglasses
$395.00 USD
Alligator Day Luxe Bag
by Barney's
$39,000.00 USD
Marilyn Monroe's Dress
1,267,500.00 USD
Economics is basically the study of how we use our limited resources to fulfill unlimited wants and needs.
That in itself is impossible.
It creates a problem and that problem is called:
Scarcity
Unless you're this guy and you've got some bread and fish
Something is considered scarce when it is both desired and limited.
Certain supercars are scarce because they are desired and limited
Air is not scarce because it is desired but not limited
Unless you live in parts of China
Malaria is not scarce because it is limited but not desired
Let's quickly differentiate between our wants and needs
We'll find out later that prices on the free market can be determined by scarcity
So basically because of scarcity, people are forced to make choices and need to sacrifice something when they want more of something else.
What is Economics?
Example
The more Chipotle I buy
The less FroYo I can buy
The basic economic problem is how to best allocate scarce resources to meet the wants and needs of society. These scarce resources are called the
Factors of Production
Land
Labor
Capital
Entrepreneurship
Some types of labor are scarcer than others
Factory workers are desirable in huge numbers but they are not very limited in places like India or China; therefore they are not relatively scarce
Medical doctors on the other hand are desired in all parts of the world, yet they are far more limited in numbers than factory workers. Therefore doctors are relatively scarce. Relative to factory workers
More and better tools will enhance our abilities to create more quality and quantities of goods and services
Entrepreneurship is the innovation and creativity applied in the production of goods and services.
The physical scarcity of land, labor, and capital do not apply here. Entrepreneurship is only limited by human ingenuity.
So how do you increase Entrepreneurship?
A better education system should increase the entrepreneurship of a nation's people
Ok so there are basically two types of economic study:
MicroEconomics
and
MacroEconomics
Is the study of individual markets for goods, services, and resources.
Micro examines:
The Supply and Demand for a good or service in a particular market
The relationship between prices and quantities of individual products
is the study of whole nations' economy. An overview, or general outline
Macroeconomics examines
aggregates
, or the total sum, of items examined in Micro.
Macro Examines:
Macro examines the interactions of all of a nation's households, firms, governments, and foreigners.
Macro is used to inform government policy which has three main objectives:
Full employment of a nation's labor force
Stable prices for goods and services
Continual economic growth of the nation
Ok so going back to the problem of scarcity...
Necessitates
Choices
are fundamental to economics!
scarcity
Because there is a limited amount of resources, individuals are forced to make choices about how to best allocate those resources
These choices are called:
Trade-offs
a trade-off is the choice we face when deciding how to use our scarce resources. Economic decisions require making informed choices by weighing the
costs
and
benefits
of the trade-offs we face
There's no such thing as a free lunch!
Even if something's considered, "free" there is always some sort of
implicit cost
with anything.
You might not have had to pay for your lunch, but the cost could be as simple as what you
could have done during the time
it took you to eat it.
So the cost of this
free lunch!
is the
Opportunity Cost
The Opportunity Cost is the consequence of the trade-off made.
Opportunity Costs are not necessarily always monetary. For example when you buy something, the OC would be what you could have done with the money you spent
So if you spend two hours playing video games...
The opportunity cost would be
The two hours you could have spent studying
If you go to college
The opportunity cost would be
What you could have done with the money you spent on tuition, books, and room and board. Also the money you could have made getting a job after HS
Everything we've learned so far:
Scarcity
Factors of Production
Trade-offs
Opportunity Cost
And much more...
Can all be expressed mathematically through what economists call
Models
.
}
No not these models...
These bad boys!
So the first Model we'll be doing is:
The Production Possibilities Curve
The PPC is the simplest economic model that represents
scarcity
,
trade-offs
, and
opportunity costs
. It shows how an individual, firm, government, or entire country allocates resources between two competing activities, goods, or services.
(x)
(y)
Sam's PPC
Hours spent Cooking
Hours spent playing basketball
1
2
3
4
5
0
1
2
3
4
5
Hours spent Cooking
Hours spent playing basketball
0
1
2
3
4
5
5
4
3
2
1
0
Scarcity
Efficiency
Inefficiency
(x)
(y)
Hours spent Cooking
Hours spent playing basketball
1
2
3
4
5
0
1
2
3
4
5
Let's say Sam makes a trade-off
Instead of spending 4 hours cooking, and 1 hour playing basketball, Sam decided to make a trade-off and is now spending 2 hours cooking, and 3 hours playing basketball.
What's the opportunity cost?
In Micro, we examine the sand, rock, and shells. Not the beach
In Macro we examine the beach, not the sand, rocks or shells
We can further differentiate Micro and Macro economics as both contain elements of:
Positive Economics
and
Normative Economics
Positive Economics avoids value judgements
Focuses on facts and cause-and-effect relationships.
Uses scientific statements about economic behaviors
Objectivity
Without Emotion
Incorporates value judgements about what the economy SHOULD be like
Looks at the desirability of certain aspects of the economy
Underlies expressions of support for particular economic policies
"What is"
"What ought to be"
Ethics and Morals
Will Smith accepting this role
The Opportunity Cost would be
Considering he turned down the role as "Neo" in the Matrix to be in Wild Wild West, the opportunity cost would be the money he could have made learning Kung Fu
Will Smith - Wild Wild West - $14 Million
Keanu Reeves - Matrix Trilogy - $260 Million
Opportunity Cost = $246 Million
In any PPC we can assume that the individual, firm, or business is
operating at full employment
with

fixed resources and technology
and only producing two goods
Consumer Goods
Capital Goods
Products that satisfy our wants directly. Like pizzas, clothing, computers, books, and TV's.
Products that satisfy our wants indirectly by making possible more efficient production of consumer goods
So Capital Goods basically help make Consumer Goods
(x)
(y)
Pizza
Calzone
1
2
3
4
5
0
1
2
3
4
5
Any point BEYOND the curve represents an impossible scenario given the present set of inputs. To achieve point C, this individual, firm, or government would have to increase their inputs
2 hours spent cooking
Now not all PPC's are nice and perfectly straight like Sam's
This will introduce the Law of Increasing Opportunity Costs
The law states that as the production of a particular good increases, the opportunity cost of producing an additional unit rises.
Wait what? What does that even mean?
(x)
(y)
Pizza
Robots
7
9
10
0
1
2
3
4
5
Notice that the curve is bowed out from the origin of the graph.
4
This shows increasing opportunity costs!
Hours spent Cooking
Hours spent playing basketball
0
1
2
3
4
5
5
4
3
2
1
0
1
1
1
1
1
1
This is called
Constant Opportunity Cost
If the two goods or services
require similar inputs to produce
the slope of the curve will be straight.
Inputs like:
Land
Labor
Capital
Entr.
All that means is that if the two goods or services you're representing on the PPC
require very DIFFERENT inputs to produce
, the Opportunity Costs will be increasing.
To make Pizzas:
To make Robots:
Land intensive production.
(lots of land to grow ingredients.)
Farmers and Cooks
(Advanced degrees not required)
Land and labor inputs are highly mechanized and sophisticated
Engineers and mechanics require advanced degrees and skills
Mr. Kim
The Factors of Production are also known as
INPUTS
Notice the negative (-) slope of the curve. This represents that there is an inverse relationship between the two variables
(x)
(y)
Pizza
Calzone
1
2
3
4
5
0
1
2
3
4
5
Any point ALONG the curve represents maximum efficiency and represents the best use of all available resources
Any point BENEATH the curve represents an inefficient use of available resources. Typically a sign of an economy in recession
Any point inside the curve also represents a situation where one could increase production of either goods/services without an opportunity cost
To finish Unit 1, we need to talk about Economic Systems, The Circular Flow Model, and finally Comparative Advantage
the system a nation uses to allocate its scarce resources between the competing needs and wants of the nation's government, business firms, and households.
Every society needs to develop their own Economic System. An Economic system is:
In the last 100 years, there have been two dominant systems:
Command System
Market System
What differentiates the two systems is how they answers the Three Basic Economic Questions:
What should be produced
How should it be produced
For whom should it be produced
What are we using inputs to produce?
What types of labor do we employ?
Who gets the outputs of our economy?
Also known as Communism or Socialism, it is the State that answers the Three Basic Q?s.
All resources are centrally owned and distributed by the government. There are
no private ownership or property rights of inputs
, which often creates a problem of incentives.
The lack of private ownership and incentives has caused most command economies to transition to a market system due to enormous inefficiency
Market Systems are predicated on the principles of:
Private ownership of resources, property rights, and the pursuit of self-interests
Resources tend to flow towards the most profitable uses, and goods are allocated to those
willing
and
able
to pay the most for them.
Enter: Adam Smith, the Father of Economics
So Adam Smith was an 18th century Scottish philosopher who wrote the book, The Wealth of Nations.
"It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own self-interest."
This works well within a Market system as resources are allocated and used relatively efficiently because typically the
self-interest of the individual
will ultimately
meet the needs of society
!
Market Systems
Operate on 3 principals
Property Rights
Individuals own their private resources (land, labor, capital)
Ownership is protected by law
Incentives
Goal of Maximizing their utility or profit
In the pursuit of profits, firms will produce the most efficient goods and services for society
Prices
Buyers send signals to producers regarding supply of goods and services demanded
Prices regulate the allocation and use of resources
Another critical component of the Market System is the:
Circular Flow of Money, Resources, and Goods and Services
Households
Firms
Product Market
Resource Market
Expenditures
Goods and Services
Revenues
Goods and Services
Land, Labor, Capital
Rent, Wages, and Interest
Factors of Production
Cost of Production
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