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AP Econ: Unit I: Basic Economic Concepts

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Andrew Arnold

on 26 August 2016

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Transcript of AP Econ: Unit I: Basic Economic Concepts

UNIT 1:
BASIC ECONOMIC CONCEPTS

scarcity
choice
production
possibilities

A. Scarcity, choice, and opportunity cost
B. Production Possibilities Curve
C. Comparative advantage, specialization, and trade
D. Economic Systems
E. Property rights and role of incentives
F. Marginal analysis

Sections:
SECTION A:
scarcity, choice, and opportunity cost
Economics:
the study of scarcity and choice
"But what is scarcity?"
Scarcity:
2 Fields:
Microeconomics:
Macroeconomics:
concerned with individual units (individuals, families, firms, etc)
concerned with the nation as a whole
2 Types:
Positive:
Normative:
Based on scientific method. Describes the way things ARE
Based on individual values. Addresses the way things SHOULD be
"If a families income increases, their spending will increase"
"We should be spending money on space exploration, not welfare"
a scarce resource is not available in sufficient quantities to satisfy all the various ways a society wants to use it
But I forgot something!
"forgot what?"
what are the wants and desires of all individuals, according to economics?
To better understand scarcity, we must answer the question:
EVERYTHING!!!!
WE WANT EVERYTHING!
OUR WANTS ARE UNLIMITED!
But wait! You can't have everything!
"aww...but I wanted everything"
Resources are scarce!
Unlike our wants, resources have limits
4 Types of Resources*:
*sometimes called factors of production
Land:
refers to all resources that come from nature, such as minerals, timber, and petroleum
Labor:
human effort and talent, physical and mental.
Capital:
manufactured goods that can be used in the production process, including tools, equipment, buildings, and machinery
Entrepreneurship:
the effort and know-how to put the other resources together in a productive venture.
how are these scarce?
how are these scarce?
how are these scarce?
how are these scarce?
Pizza Shop Example:
Consider the resources needed for a pizza shop?
land?
labor?
capital?
entrepreneurship?
(but this is only the beginning)
Economics Expanded:
"the study of how individuals and society, facing unlimited wants, chooses to allocate scarce resources to satisfy those wants"
how was this shown in the pizza shop example?
Next on "Economics"
Trade off
vs
Opportunity Cost
what's the difference?
Trade Off:
an exchange for one thing in return for another
Opportunity Cost:
the value of the next-highest-value alternative or forgone cost
$2 and DELICIOUS
$1 and HEALTHY
Let's Clarify:
You want to go out on Friday night. You have to make a
choice
from the following:
Going out with friends
Studying Economics
Going on a date
Watching Adventure Time
Let's choose going on a date:
Going out with friends
Studying Economics
Going on a date
Watching Adventure Time
The rest are
trade offs
but we can't do EVERYTHING
(time is scarce)
But
opportunity cost
is the next best thing, not ALL the next best things
So of course you pick studying! No wonder you are all so smart!
But what is the cost?:
Studying Economics:
Going on a date:
You GET:
Fun
Dinner
Relaxation
Snuggle-time
But LOSE:
Good grades
College credit
Mr. Arnold's good graces
Let's look at another example:
If you have one scarce hour and you could either work for $6 or take a restful nap, the opportunity cost of working is the nap, which certainly has value. How can we place a dollar value on the nap? What if your employer offers you $10 instead of $6? Is that enough? What about $15? The price in which you choose to work over a nap is your value!
"Does EVERYTHING have to have a dollar figure attached to it? Can't we just enjoy something without slapping a price tag on it?"
On a final note:
To figure the value of opportunity cost, we must also take into account the value of what we chose to do in comparison to the value of what we could have GAINED. For example, if you chose to spend $10 on a date instead of working for a few hours and gaining $20, your opportunity cost is $30 ($10 from the date + $20 from your next best alternative).
A note on
ceteris paribus:
http://www.investopedia.com/video/play/ceteris-paribus/
SECTION B:
production possibilities curve/frontier (PPC/PPF)
Production Possibilities:
Shows the trade-offs facing an economy that produces only two goods. It shows the maximum quantity of one good that can be produced for each quantity of the other good produced.
"that sounds complicated"
Let's look at it this way:
In order to produce something, we must give up something else. When we make chairs, we cannot use the same resources to make birdcages. So our opportunity cost of making more chairs would be the birdcages we DIDN'T produce.
"but what's this PPC mumbo-jumbo?"
What does this graph tell us?
Chart it out!
Let's chart out an example:
Calzones
Pizzas
0
1
2
3
4
4
3
2
1
0
This is the same information presented in different ways
Efficiency:
Economy is using resources productively.
points
ALONG
the curve are efficient
Inefficiency:
Economy is not using resources productively.
points
WITHIN
the curve are inefficient
Not Possible:
points
OUTSIDE
the curve are not possible without expanding the PPC
"how do you move the PPC curve?"
PPC curve expands when:
1. Increase in resources*
2. Improved technology
if the curve moves outwards, we have had economic growth!
Back to Graphs!
What could have caused this economic growth?
"Sir, do you know how fast you were increasing your opportunity costs back there?"
Law of Increasing Costs:
PPC Shapes:
Why are some PPCs curved while others are straight?
the law of increasing opportunity costs!
Law of Increasing Opportunity Costs:
The more of a good that is produced, the greater it's opportunity cost. Makes the PPC bow outward.
some resources are better suited for one product and not another.
Constant OC
Increasing OC
resources NOT specialized
resources ARE specialized
SECTION C:
comparative advantage, specialization, and trade
Calculating OC from a PPC:
Formula for Opportunity Cost:
OC =
what you give up
what you get
Let's make it practical:
Formula for Opportunity Cost:
OC of
guns
=
change in
butter
change in
guns
Guns
Butter
0
3
6
9
12
30
25
20
15
10
15
5
OC of
butter
=
change in
guns
change in
butter
=
=
5
5
3
3
is this PPC constant or increasing in OC?
Absolute Advantage:
An individual has an absolute advantage in producing a good if he/she can make more of it with a given amount of time and resources.
Comparative Advantage:
An individual has a comparative advantage in producing a good or service if the opportunity cost of producing the good is lower for that individual than for other people.

More Practice:
What does point C represent?
-Inefficient use of resources
What do points A and B represent?
-Resources are used efficiently
-Fully employed
What does point D represent?
-Not possible without improved technology or increase in resources
-Unemployment
What would cause a shift inward?
-Decrease in resources
-Loss of technology
*Unemployment is NOT an increase in labor. It is an inefficient use of resources!
Which country has an absolute advantage in cotton shirts?
Which country has an absolute advantage in Malaria Medicine?
United States
United States
Since the U.S. can produce both better, should it make both?
Not necessarily!
4 Steps to Comparative Advantage:
Step 1:
Know the definition of Comparative Advantage:
Means one entity can produce something at a lower opportunity cost than another entity

Step 2:
Prepare a table to assist you:
United States
Bangladesh

Step 3:
Figure Opportunity Cost:
OC(shirts)=
1000 medicine
1000 shirts
United States
1 shirt= 1 medicine
OC(medicine)=
1000 shirts
1000 medicine
1 medicine= 1 shirt
OC(shirts)=
250 medicine
750 shirts
Bangladesh
1 shirt= 1/3 medicine
OC(medicine)=
750 shirts
250 medicine
1 medicine= 3 shirt

Step 4:
Plug the numbers into chart from Step 2:
OC(shirts)=
1000 medicine
1000 shirts
United States
1 shirt= 1 medicine
OC(medicine)=
1000 shirts
1000 medicine
1 medicine= 1 shirt
OC(shirts)=
250 medicine
750 shirts
Bangladesh
1 shirt= 1/3 medicine
OC(medicine)=
750 shirts
250 medicine
1 medicine= 3 shirt
Which should produce shirts?
Which should produce medicine?
Bangladesh
United States
WHY?
Country A

Why should we trade?
Especially since we have an Absolute Advantage!
It only costs the United States 1 shirt to produce 1 medicine
It only costs Bangladesh 1/3 medicine to produce 1 shirt
The United States has a COMPARATIVE advantage in medicine production
Bangladesh has a COMPARATIVE advantage in shirt production
Medicine
Shirts
United States
Bangladesh
Medicine
Shirts
1m= 1s
1s= 1m
1m= 3s
1s= 1/3m

United States
Bangladesh
Medicine
Shirts
1m= 1s
1s= 1m
1m= 3s
1s= 1/3m
Which should produce shirts?

Terms of Trade
We know that we should specialize and trade, but what are the terms of trade?

United States
Bangladesh
Medicine
Shirts
1m= 1s
1s= 1m
1m= 3s
1s= 1/3m
United States
should not trade 1 med for less than 1 shirt
should not trade for more than 3 shirts
Bangladesh
United States
should not trade 1 shirt for more than 1 medicine
should not trade for less than 1/3 medicine
Bangladesh

United States
Bangladesh
Medicine
Shirts
Output vs. Input Method
4 units
2 units
10 units
8 units
Output= Other goes over (OOO)

United States
Bangladesh
1 Medicine
1 Shirts
4 hrs
2 hours
10 hours
8 hours
Input= Other goes under (IOU)
SECTION D:
Economic Systems
Command Economy:
An economy in which the 3 questions are answered by gov. officials
Output= Other goes over (OOO)
Input= Other goes under (IOU)
SECTION F:
Marginal Analysis
Marginal Analysis:
Most decisions are based upon a change in the status quo. You have one cup of coffee (status quo) and are deciding whether to have another. These decisions are said to be made on the margin.
Marginal:
"the next one," or "additional," or "incremental."
the next one brings ADDITIONAL costs and ADDITIONAL benefits
Marginal Cost (MC):
The additional cost incurred from the consumption of the next unit of a good
Example:
$
#of sodas per day
MC= $1
MB
MB>MC, consume
MB<MC, don't consume
Market Economies:
An economy in which the 3 questions are answered by firms and the free market
3 Questions Every Society must Answer
What
do we produce?
How
do we produce it?
Who
do we produce it for?
SECTION E:
Property Rights and the Role of Incentives
Private Property:
Individuals, not government, own most economic resources. Encourages innovation, investment, growth, and trade
EX:
If the state owned the bakery ovens, mixers, and even the building itself, how much of an incentive would our entrepreneur have to maintain the equipment, the inventory, or even the quality of the product? Knowning that the state could take these resources with very little notice, our chef might just do the bare minimum.
Self-Interest and Incentives:
Individuals are motivated by self interest in their use of resources. Entrepreneurs seek to maximize profit while consumers seek to maximize happiness
EX:
Our bakery owner, motivated by profit, seeks to offer products that appeal to her customers. Customers, seeking to maximize their happiness, consume these bakery products only if they satisfy their personal tastes and wants
Marginal Benefit (MB):
The additional benefit received from the consumption of the next unit of a good or service
economists assume that people try to maximize their benefit
each additional unit that people consume gives them less benefit than the previous unit
economists assume that people try to minimize their cost
each additional unit that people produce costs more than the previous unit because of the
law of increasing opportunity cost
Allocative Efficiency:
happens when the amount of a good or service produced is most beneficial to society
maximizes society's total benefit
point where
MB = MC
Example:
Price
Quantity
MC
MB
Allocative Efficiency
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Full transcript