Spring 2010 I. FOUNDATIONS OF ECONOMICS A. Scarcity, Production Possibilities, Efficiency and Exchange Section I.A Learning Objectives: • Define or explain a number of basic economic terms and concepts. • Explain, illustrate, and apply marginal analysis. • Explain, illustrate, and apply the production possibilities model. • Explain, illustrate, and apply the law of comparative advantage. 1. “Life is Economics” Q: Is this statement true or false? Why? 2. Economic Goals and Priorities of Society, or, “What does society want out of its economy?” • • • • • Economic growth/rising living standards Low unemployment/high employment Low inflation/stable prices Economic equity Economic efficiency
Remark: On the individual decision-making level, the incentives that motivate economic activity and choices are utility maximization for consumers, profit maximization for producers/firms, and social welfare maximization for government units. 3. Economics Defined a) Economic Scarcity DEF: Economic scarcity exists when human needs and wants exceed an economy's ability to satisfy them given available resources and current technology. DEF: The four basic economic resources are labor, capital (a capital good is a produced good that is used as an input in the production of other goods and is not available for current consumption), land (energy, natural resources, raw materials and other “gifts of nature”) and entrepreneurial ability (the ability to recognize and exploit economic opportunities, develop and produce new goods/services and organize economic resources). Technology refers to the ability (based upon a body of knowledge or set of skills) to transform resources into goods and services.
DEF: An economic good (bad) is something that increases (decreases) an individual’s “utility”, the economic term for well-being, happiness, satisfaction or welfare. Examples: Economic goods: kringle, DVDs and shoes. Economic bads: garbage and pollution. CLAIM: Economics is based on two axioms (self-evident truths): (i) society's material wants and needs are unlimited or insatiable;
(ii) economic resources and current technology are limited.
Remark: Physical scarcity alone does not cause economic scarcity. Economic goods are both physically and economically scarce. Economic bads, such as pollution, toxic wastes and garbage, are physically scarce but they are not economically scarce. CLAIM: Economic scarcity implies that (i) people must compete for scarce goods and resources, (ii) goods and resources must be rationed by some rationing device or mechanism, (iii) choices must be made and when choices are made, other opportunities and alternatives must be sacrificed.
Remark: Economic scarcity is most easily seen when a person has to give up or sacrifice something (in the form of money or time) in order to obtain more of something else. Price is a clear indicator or signal of economic scarcity. Remark: People and society in general are confronted with the following problem: The Economizing Problem: Attain the greatest or maximum fulfillment of a person's or society's unlimited wants (the goal of production) given limited resources and technology (the means of production). Question: How does one make the “best” or “optimal” choice? DEF: Economics is the study of economic scarcity and how individuals and society allocate their limited resources and technology to try to satisfy their unlimited needs, wants and desires; i.e., economics is the study of how best to solve the Economizing Problem. b) Opportunity Cost Claim: To solve the “Economizing Problem,” the decision-maker must make choices or decisions and so must know the value or cost of alternatives. DEF: The opportunity cost of a choice or decision is the value of the next best alternative that is forgone or sacrificed when the choice or decision is made. What is the opportunity cost of (or sacrifices required by) the following? • taking Econ...