Econ 100
Lecture 2.4
Essential Concepts and Terms
1-15-2009
Defining Economics
• Economics studies (Wikipedia):
– 1) the production,
– 2) distribution, and
– 3) consumption of goods and services.
• The term economics comes from the
Greek for oikos (house) and nomos
(custom or law), hence "rules of the
house(hold).“
Production of Goods and Services
• How do we decide which goods and services get
produced?
– How much is produced?
– Who/which firms produce it?
– Which resources are used to produce it?
• A couple of approaches:
– Decentralized – Adam Smith’s invisible hand
• Market demand determines which goods (and how much)
gets produced
– Centralized – planned economy
• Government planners determine production
Distribution of Goods and Services
• How are the goods and services distributed?
– To which consumers?
– How much to each consumer?
• A couple of approaches
– Decentralized: goods are allocated to consumers
based on their willingness-to-pay
– Centralized: allocated or rationed to consumers
• WW II: rationing food/clothing by coupons
Another Way of Looking At It
• Lionel Robbins (1932):
• "the science which studies human behaviour as
a relationship between ends and scarce means
which have alternative uses."
• Scarcity means that available resources are
insufficient to satisfy all wants and needs.
• Absent scarcity and alternative uses of available
resources, there is no economic problem. The
subject thus defined involves the study of
choices as they are affected by incentives and
resources.
Scarcity
• There are not enough resources to
produce and consume all of the goods and
services we desire
– An example: production possibilities frontier
(PPF)
• Federal Government: guns and butter (or child
health care and the Iraq war)
• Detroit: SUVs/Humvees and smaller/fuel-efficient
cars
Production Possibilities Frontier
• Tradeoff between producing computers and food in a two
good economy
Paul’s example
• Two brewers
• Two beers: Stout or Lager
– What is the opportunity cost?
• “Next” best alternative
Brewer
Gal of Gal of Opp Cost
Stout Lager of Stout
Jones
5
10
Brown
4
3
Opp Cost
of Lager
Opportunity Cost
• Jones
– Can produce either:
• 5 gals of stout or 10 gals of lager
– Or any “linear” combination in between
• What is the cost of producing 1 more gal of stout
– Start at 0 gal of stout & 10 gal of lager
– Next: produce 1 gal of stout -> can only produce 8 gal of
lager -> had to give up 2 gal of stout to produce 1 more
gal of lager: opp cost of 1 more g of stout = 2 gal of lager
• Or alternatively
– Cost of producing 1 gal of lager = ½ gal of stout
» (8->10 g lager) -> (1->0 g of stout)
Paul’s example
• Two brewers
• Two beers: Stout or Lager
– What is the opportunity cost?
• “Next” best alternative
Brewer
Gal of Gal of Opp Cost
Stout Lager of Stout
Opp Cost
of Lager
Jones
5
10
2 g lager
½ g stout
Brown
4
3
¾ g lager
4/3 g stout
Gains From Trade
Both
Stout
Gallons of Beer Produced
Wealth through Exchange
Scenario
14
12
Jones Lager
10
8
6
4
2
0
1
2
3
4
5
6
Stout
Jones
Brown Lager
Lager
Lager
8
0
8
2
6
4.75
4
7.5
2
10.25
0
13
Brown
Stout
Lager
Both Stout
0
5
0
Both Lager
2
4
0
4
3
0.75
6
2
1.5
8
1
2.25
10
0
3
PPF for Stout and Lager
Individually
Gallons of Stout Produced
PPF for Jones and Brown
12
10
8
Jones
6
Brown
4
2
0
5
4
3
2
1
Gals of Lager Produced
0
The Combined PPF
Gains from Trade
Jones
Brown
Lager
Stout
Both
Lager
Stout
Lager
0
5
0
2
4
0
8
2
4
3
0.75
6
4.75
6
2
1.5
4
7.5
8
1
2.25
2
10.25
10
0
3
0
13