Basic Economic Concepts:
Micro, Macro, PPC and
Comparative Advantage
Mr. Bordelon
University High School
AP Economics
What is Economics?
• Economics. Social science concerned with the efficient use of
limited or scarce resources to achieve maximum satisfaction
of human economic wants.
• Scarcity and choice—these are your economic friends.
• Every economic issue involves individual choice.
• Why do we have to choose?
Market and Command
Economies
• Market Economy. Production and consumption are the result
of decentralized decisions by many firms and individuals.
• Command Economy. Industry is publicly owned and there is a
central authority making production and consumption
decisions.
• Most countries have adopted a market economy. Command
economies typically and spectacularly fail miserably. Why?
Market and Command
Economies
• Why do command economies fail?
• 1. Incentives. Prices make for a powerful incentive.
• Stupid question: why?
• 2. Property rights. In command economies, the government
owns all resources and property.
• How is this a problem?
Factors of Production
• Land
• Labor
• Capital
• Physical capital
• Human capital
• Entrepreneurship
Scarcity
• Economic resources are limited/scarce, which means that
goods/services produced must be limited.
• Scarcity requires choices to be made.
• Choices require that something must be given up.
Opportunity Cost
• Opportunity cost. The opportunity cost is the best alternative
given up as a result of a decision. The sacrifice you make
when you make a choice.
• When you make a choice, you are giving up the opportunity to do
something else.
Opportunity Cost
• Awesome. What about free stuff? Is it actually free?
Opportunity Cost
• No. Think of this in terms of resources, not marketing tactics.
• Resources were used to make these “free” items (land,
labor, capital) and because those resources do not have
alternative uses, society gives up something else to produce
the “free” items you get at no cost.
Opportunity Cost and
Marginal Analysis
• Opportunity Cost. The real cost of something is what you
must give up to get it.
• Decisions are often made on an incremental basis. Bit by bit,
step by step.
• Video games vs. studying.
Opportunity Cost and
Marginal Analysis
• Marginal Analysis. If the person believes that the additional
benefits received from an activity outweigh the additional
costs incurred, then the person will continue with that
activity.
• Marginal Benefits. The additional benefits.
• Marginal Costs. The additional costs.
• If MB ≥ MC, do it. If MB < MC, do not.
Micro- and Macroeconomics
• Microeconomics. The branch of economics concerned with
how individuals make decisions and how these decisions
interact. Microeconomics focuses on choices made by
individuals, households, or firms.
• Macroeconomics. The branch of economics that sutdies the
overall ups and down of the economy. Macro focuses on
economic aggregates that summarize data across many
different localized markets.
Positive and Normative
Economics
• Positive Economics. Economic analysis used to answer
questions about how the world actually works.
• Normative economics. Economic analysis that involves saying
how the world should work.
Macroeconomics
• Macroeconomics. The branch of economics that sutdies the
overall ups and down of the economy. Macro focuses on
economic aggregates that summarize data across many
different localized markets.
Business Cycle
• Business Cycle. Alternation between economic
downturns and upturns in the macroeconomy.
• Peak. Business activity reaches temporary maximum
with full employment and near capacity output.
Unemployment rate at lowest level.
• Recession. Decline in total output, income,
employment, and trade lasting six months or more.
Unemployment rate rising.
• Trough. Bottom of recession period. Unemployment
at highest level.
• Recovery. Output and employment expanding toward
full-employment. Unemployment rate falling.
• Cycle measured by time between peaks in the cycle.
Employment, Unemployment,
Business Cycle
• Measured by Bureau of Labor Statistics.
• Under 16 or institutionalized (military/jail) not surveyed.
• Labor force = employed + unemployed
• Those not in labor force.
Employed and Unemployed
• Employed: those who work at a job with pay for at least one
hour or without pay for at least 15 hours (family
business/farm).
• Unemployed: no job, or temporarily laid off but actively
looking for work.
Labor Force and
Unemployment Rate
• LF = E + U
• UR% = 100 x (#U)/(#LF)
• Unemployment Rate. Percentage of labor force not
employed.
Aggregate Output and
the Business Cycle
• Aggregate Output. Economy’s total production of g/s for a
given time period, usually a year.
• Relation to Unemployment
• Economy is strong, many g/s produced, firms need to hire
workers, employment is high, unemployment rate is low.
• Economy is weak, fewer g/s produced firms need to lay off
workers, employment low, unemployment rate is high.
Inflation, Deflation,
and Price Stability
• Inflation. A rise in the overall price level.
• Reduces ability to purchase g/s.
• Deflation. A fall in the overall price level.
• As prices fall, consumers hold onto money and wait for lower and
lower prices.
• Why could this be a problem?
Ceteris Paribus
• Ceteris Paribus. In order to figure out the effect one variable
has on another, we have to hold other contributing factors
constant. This is the idea of ceteris paribus, or “other things
equal.”
Production Possibilities Curve
Production Possibilies Curve
• Efficient in production. All points along the curve are efficient
in production. Can not increase production of one without
giving up production of the other.
• Efficient in allocation. What society wishes to have more
than anything else. If society wants more of one thing than
another, that point in the PPC would be efficient in production
but not allocation.
Production Possibilities Curve
Production Possibilities Curve
• Opportunity cost. What is the opportunity cost
between pizza and bulldozers?
• Opportunity cost of the good graphed on x-axis is
ALWAYS slope of PPC.
• Opportunity cost of the good graphed on y-axis is
ALWAYS the inverse of the slope of PPC.
• Does it matter where you start out on the PPC in
determining the opportunity cost?
• The opportunity cost (slope) is constant. What
does this tell you about the substitutability of
the resources used to produce pizza and
bulldozers?
Production Possibilities Curve
Law of
Increasing Opportunity Costs
• When switching from one item of production to another,
more and more resources are necessary to incrase
production of the second item.
• 1. Amount of other products forgone to obtain more of any given
product is the opportunity cost.
• 2. More of a product produced, greater is its (marginal)
opportunity cost.
• 3. Slope of PPC becomes steeper, demonstrating increasing
opportunity cost (which gives curve its concave look).
Law of
Increasing Opportunity Costs
• Why?
• Economic resources are not completely adaptable to alternative
uses.
• To get increasing amounts of bulldozers, resources that are not
particularly well suited for that purpose must be used. Workers
accustomed to producing pizza may not be good bulldozer
builders. Gee, go figure.
• Pizza ovens are physical capital, and not very adaptable to
building bulldozers.
Economic Growth
• Economic growth means an expansion of the economy’s
production possibilities. The economy can produce more of
everything.
Shifts in PPC
Shifts in PPC
Shifts in PPC
Shifts in PPC
Summary PPC
• Efficiency. PPC represents combinations of output that are
possible, given economy’s resources and tech.
• Scarcity. Given stock of resources and tech, economy can
produce only so much.
• Economic Growth. Rightward shift or rotation of PPC.
• Choice.
Comparative Advantage and
Trade
• Why do we trade?
• How do you think this might affect the PPC?
Comparative Advantage and
Trade
• Milton Hershey is
famous for making
chocolate.
• And going bankrupt
twice.
• What does it take to
make chocolate?
• Land
• Labor
• Capital
Comparative Advantage and
Trade
• How much chocolate do you think Hershey personally
produced?
Comparative Advantage and
Trade
• Reality is if Hershey got his hands dirty at all, it was with filthy
stacks of obscene amounts of cash.
• Why hire all these people to work for him creating chocolate?
Comparative Advantage and
Trade
• Specialization. Each person specializes in the task that he or
she is good at performing.
• Gains from trade. By diving tasks up and trading, people can
each get more of what they want than they could get by being
self-sufficient.
• Key: The economy can produce more when each person
specializes in a task and trades with others.
Comparative Advantage
• Comparative Advantage. Individual has
comparative advantage in producing
something if hte opportunity cost of that
production is lower for that individual than
for other people.
• Basic Idea: There are differing opportunity
costs of producing various g/s. Trading
partners benefit if they specialize and trade
based upon comparative advantage. There
are gains from trade even if one of traders
isn’t particularly specialized.
Tom and Hank
Reading the PPC
• According to PPC, Tom can catch 40 fish, but only if no
coconuts. He could get 30 coconuts, but only if no fish.
• What’s the slope?
Reading the PPC: Tom
• According to PPC, Tom can catch 40 fish, but only if no
coconuts. He could get 30 coconuts, but only if no fish.
• What’s the slope? -3/4
• Opportunity cost of 1 fish is ¾ of a coconut.
• What’s the opportunity cost of 1 coconut to fish?
Reading the PPC: Hank
• Hank’s PPC has a slope of -2.
• Opportunity cost of 1 fish is 2 coconuts.
• What’s the opportunity cost of 1 coconut to fish?
Opportunity Cost
Gains from Trade
Can Tom and Hank Make a Deal?
Gains from Trade
• Tom and Hank are better off when they specialize in what they
are good at and trade for each other.
• Tom should catch fish. Why?
• Hank should get coconuts. Why?
Here’s the Deal
• Tom gives 10 fish to Hank.
• Tom consumes two more fish per week and one more coconut
per week.
• Hank gives 10 coconuts to Tom.
• Hank consumes four more fish per week and two more coconuts
per week.
Effect on Production Possibilities
Limits on Trade
• Why did Tom and Hank agree to a deal of 10 fish for 10
coconuts? Was there another deal to be made?
• Hank will not accept a deal where he must give up more than 2
coconuts per fish.
• Tom will not accept a deal where he must give up more than 4/3
of a fish per coconut.
• Why?
Limits on Trade
• A trading partner engages in trade ONLY IF the price of the
good being obtained from the trade is less than the
opportunity cost of producing the good himself.
Okay, so what?
• Specialization. By agreeing to specialize and provide goods to
each other, Tom and Hank can produce more; both are better
off than being self-sufficient.
• Comparative Advantage. As long as people have different
opportunity costs, everyone has a comparative advantage in
something, and everyone has a comparative disadvantage in
something.
Wait, wasn’t Tom better at producing
both fish and coconuts?
• Absolute Advantage. Individual has absolute advantage in
producing a good or service if he can make more of it with a
given amount of time and resources.
• How is this different from comparative advantage?
• FRQ Happy Points: Comparative advantage is the basis for
mutual gain, not absolute advantage. Only the opportunity
cost is what matters ultimately.
A More Realistic Example