ECONOMICS 11
Markets and The State
The Central Concepts
of Economics
Reference:
Economics – 19th Edition (Samuelson and Nordhaus, 2009)
The Central Concepts of Economics
Q1:
In economics, what do we mean by scarcity?
➢ Scarcity is the situation in which resources and a given state of technology to produce goods
and services are limited to satisfy unlimited human wants and needs
➢ Relative scarcity ⟶ limited resources vis-à-vis unlimited desires
➢ Economics is the study of how societies use scarce resources to produce valuable goods
and services and distribute them among different individuals
Q2:
If one alternative is chosen, another must be sacrificed. This sacrifice is called the
_________ of the alternative chosen.
A. Comparative advantage
B. Choice expenditure
C. Opportunity cost
D. Economic profit
➢ Opportunity cost is the value of the next best alternative given/foregone to make a choice or
a decision because resources are scarce
➢ People face trade-offs ⟶ no such thing as free lunch!
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The Central Concepts of Economics
Q3:
In economics, we assume that an individual knows what he/she wants and has a plan
on how to attain it. In other words, we assume that an individual is:
A. Thrifty
B. Rational
C. Visionary
D. Emancipated
➢ Assumption of near-perfect rationality ⟶ Homo economicus
➢ Individuals employ rational calculations (costs vis-à-vis benefits) to make rational
choices based on their preferences and that are aligned with their own personal
objectives
➢ Maximizing his/her self-interest to provide himself/herself with the greatest benefit and
satisfaction given the limited options or resources available
➢ Examples:
➢ Agents in the economy and their pursuit of different goals:
➢ Consumers ⟶ utility maximization given a budget constraint
➢ Producers ⟶ profit maximization given costs constraints
➢ Government ⟶ welfare maximization given several constraints (economic, political,
social)
➢ Real-life situations:
➢ Use of discounts, coupons, and promos to maximize purchase but at the cheapest
possible cost
➢ Cost-benefit analysis in policy-making
3
The Central Concepts of Economics
Q4:
Economics is also a mental skill that incorporates a special view of human behavior
characteristic of economists.
➢ A skill that can be applied to questions and issues of everyday life, not only those that we think
of as hard-core economic questions or issues
➢ Study of mankind in the ordinary business of life according to Alfred Marshall (father of
microeconomics)
Q5:
If the government puts a tax on cigarettes which raises its price to dissuade people
from smoking, this tax is an economic incentive.
➢ An incentive is something (such as the prospect of a punishment or reward) that induces a
person to act
➢ Changes the cost and benefits people face, and as a result alter their behavior
➢ Some examples of incentives in economics:
➢ Tax/ financial incentives
➢ Subsidies
➢ Negative incentives
➢ Behavioral nudges
4
The Central Concepts of Economics
5
The Central Concepts of Economics
➢ Incentive vs mandate:
➢ When something is mandated, an individual really has no choice (except an existential
one of perhaps going to jail or not for non-compliance)
➢ If the government mandates no smoking and does not allow the production or
importation of cigarettes, the individual has no choice but not to smoke
➢ Mandatory wearing of face masks in public or face legal consequences
➢ An incentive assumes the individual has a choice as the incentive tries to induce the
individual to choose to behave in a particular way:
➢ A ‘sin’ tax on cigarettes raises the price of cigarettes and induces people to reduce
cigarette consumption especially among the youth
➢ Information campaign and distribution of in-kind goods (e.g., gas cards for TODA
drivers) by OVP to encourage vaccination
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The Central Concepts of Economics
Q6:
The definition of economics can be summarized in three basic questions: what, how,
and for whom goods are to be produced.
➢ Common textbook definition of economics:
➢ A social science that studies how societies choose to use scarce productive resources
that have alternative uses, to produce goods of various kinds, to distribute them among
different groups now or in the future
➢ This definition arises from the three basic questions:
➢ What goods will be produced:
➢ Type, quantity, and quality of commodities and services to produce
➢ Example:
Consumption goods or capital goods?
Doctors or lawyers?
Guns (war) or butter (social services)?
➢ How goods will be produced
➢ Who will do the production? ⟶ Government or private firms?
➢ What resources are to be used? ⟶ Taxpayer’s money or private funds?
➢ What technology will be used?
➢ For whom goods will be produced?
➢ Distributional aspect based on society’s norms
➢ Based on fairness and equity
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The Central Concepts of Economics
Q7:
As a farmer, you believe that a bumper crop this year will give you more money. Hence,
if all farmers have a bumper crop this year, then all farmers will make more money as
well. What kind of fallacy does this statement exhibit?
A. Fallacy of composition
B. Post hoc ergo propter hoc fallacy
C. Failure to hold things constant
D. This statement does not exhibit a fallacy
➢ Fallacy of composition
➢ Mistake of assuming that what holds true for a part of a system also holds true for the
whole
➢ Post hoc ergo propter hoc fallacy
➢ Latin expression for ‘after this, therefore necessarily because of this’
➢ Occurs when we assume that because one event occurred before another event, the first
event caused the second event
➢ Failure to hold things constant
➢ Important assumption in economics ⟶ ceteris paribus
➢ Example: Consumer demand
➢ In drawing a consumer’s demand curve, we illustrate changes in quantities of the
good demanded by the consumer for every change in the price of the good, but
holding income constant
8
The Central Concepts of Economics
Refer to the table below that shows how many hours of labor are needed to produce a 1 kilo of
rice and 1 kilo of fish in Vietnam and the Philippines. Assume that in both countries, both goods
can be produced using labor hours only:
Rice
Fish
Vietnam
5 hours
5 hours
Philippines
20 hours
15 hours
➢ Absolute advantage
➢ The ability to produce a good using fewer inputs than another producer:
➢ Vietnam has an absolute advantage over the Philippines in both rice and fish
production
➢ Does that mean we should leave the production of both rice and fish to Vietnam alone?
➢ NO ⟶ We should base it on their relative productivities (i.e., opportunity costs)
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The Central Concepts of Economics
Q8:
What is the opportunity cost of fish in terms of rice in Vietnam?
Rice
Fish
Vietnam
5 hours
5 hours
Philippines
20 hours
15 hours
➢ If Vietnam produces 1 kilo of fish using 5 labor hours, it gives up producing the equivalent of
1 kilo of rice (which also takes 5 labor hours to produce)
➢ Hence, the opportunity cost of fish in Vietnam is 1 kilo of rice
Q9:
What is the opportunity cost of fish in terms of rice in the Philippines?
➢ If the Philippines produces 1 kilo of fish using 15 labor hours, it gives up producing the
equivalent of 𝟏𝟓Τ𝟐𝟎 = 𝟑Τ𝟒 = 𝟎. 𝟕𝟓 kilo of rice
➢ Hence, the opportunity cost of fish in the Philippines is 0.75 kilo of rice
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The Central Concepts of Economics
Q10:
Vietnam has a comparative advantage in _____ and the Philippines has a comparative
advantage in _____ .
➢ Comparative advantage
➢ Ability to produce a good at a lower opportunity cost than another producer
➢ We construct a table of opportunity costs:
Table of Opportunity Costs
Rice
Fish
Vietnam
1 kilo of fish
1 kilo of rice
Philippines
1.33 kilos of fish
0.75 kilo of rice
➢ We complete the table above by providing the opportunity costs of producing rice for each
country:
➢ If Vietnam produces 1 kilo of rice using 5 labor hours, it gives up producing the
equivalent of 1 kilo of fish (which also takes 5 labor hours to produce)
➢ Hence, the opportunity cost of rice in Vietnam is 1 kilo of fish
➢ If the Philippines produces 1 kilo of rice using 20 labor hours, it gives up producing the
equivalent of 𝟐𝟎Τ𝟏𝟓 = 𝟒Τ𝟑 = 𝟏. 𝟑𝟑 kilos of fish
➢ Hence, the opportunity cost of rice in the Philippines is 1.33 kilos of fish
11
The Central Concepts of Economics
Q10:
Vietnam has a comparative advantage in _____ and the Philippines has a comparative
advantage in _____ .
➢ Comparative advantage
➢ Ability to produce a good at a lower opportunity cost than another producer
➢ We construct a table of opportunity costs:
Table of Opportunity Costs
Rice
Fish
Vietnam
1 kilo of fish
1 kilo of rice
Philippines
1.33 kilos of fish
0.75 kilo of rice
➢ From the table of opportunity costs, we can conclude that:
➢ Vietnam has a comparative advantage in producing rice:
➢ Opportunity cost equal to 1 kilo of fish in Vietnam is less than the opportunity cost
equal to 1.33 kilos in the Philippines
➢ Philippines has a comparative advantage in producing fish:
➢ Opportunity cost equal to 0.75 kilo of rice in the Philippines is less than the
opportunity cost equal to 1 kilo in Vietnam
12
The Central Concepts of Economics
➢ If the two countries decide to trade, how much will each gain?
➢ First, consider the situation that the two countries do not exchange:
➢ From the table of opportunity costs:
Table of Opportunity Costs
Rice
Fish
Vietnam
1 kilo of fish
1 kilo of rice
Philippines
1.33 kilos of fish
0.75 kilo of rice
➢ The rates of exchange in each country (without trade) will be:
➢ In Vietnam:
1 kilo of fish = 1 kilo of rice
1 kilo of rice = 1 kilo of fish
➢ In the Philippines:
1 kilo of rice = 1.33 kilos of rice
1 kilo of fish = 0.75 kilo of fish
➢ These rates of exchange can be interpreted as the price of one good in terms of
the other good in each respective countries in a situation without exchange or
trade
13
The Central Concepts of Economics
➢ If the two countries decide to trade, how much will each gain?
➢ By the principle of comparative advantage:
➢ Specialization will take place:
➢ Vietnam will specialize in and solely produce rice
➢ Philippines will specialize in and solely produce fish
➢ A mutually beneficial exchange (trade) will happen between Vietnam and the
Philippines:
➢ Vietnam can exchange a kilo of rice it produces for 1.33 kilos of fish from the
Philippines (which is the before-trade price of rice in the Philippines) with
trade
➢ In contrast, the same kilo of rice in Vietnam can only be exchanged for 1
kilo of fish in Vietnam without trade
➢ Philippines can exchange a kilo of fish it produces for 1 kilo of rice from
Vietnam (which is the before-trade price of fish in Vietnam) with trade
➢ In contrast, the same kilo of rice in the Philippines can only be
exchanged for 0.75 kilo of rice in the Philippines without trade
➢ As such, each country can increase its consumption of the good it has
comparative disadvantage in producing by exchanging with the country that has
comparative advantage in that good
➢ The increase in consumption that can be obtained by each country is a
manifestation that trade makes everyone better off
14
The Central Concepts of Economics
➢ If the two countries decide to trade, how much will each gain?
➢ We can summarize the gains from trade each country obtains as:
Producer
Country
After trade
(B)
Gains from
Trade
(B − A)
1 kilo of fish
1.33 kilos of fish
0.33 kilo of fish
1 kilo of fish
0.75 kilo of rice
1 kilo of rice
0.25 kilo of rice
1 kilo of rice
1.33 kilos of fish
Goods
Before trade
(A)
1 kilo of fish
1 kilo of rice
1 kilo of rice
Vietnam
Philippines
➢ Each producer country can increase its consumption of the good it has comparative
disadvantage in producing with trade:
➢ Vietnam gains 0.33 additional kilo of fish
➢ Philippines gains 0.25 additional kilo of rice
15
The Central Concepts of Economics
Consider the statement: A PPF is only an array of technically feasible outputs. This does not
mean a society will actually be operating on its PPF.
Based on this statement, consider a society that only produces either guns or butter.
16
Production Possibility Frontier
Butter
150
A
B
C
120
D
90
60
E
30
F
0
30
60
90
120
150
Guns
The Central Concepts of Economics
➢ Production possibility frontier (PPF)
➢ Graphical illustration of the maximum quantity of goods that can efficiently produced by
an economy given its fixed technological knowledge and quantity of available inputs
➢ Depicts a society’s menu of choices (i.e., what goods society can produce)
➢ Any points along the PPF are points of productive efficiency:
➢ That is, the economy cannot produce more of one good without producing less of
another good
➢ Moving along the PPF requires some trade-offs to society
➢ Rate at which the good on one axis is sacrificed to obtain more of the other good is
given by the slope of the PPF
➢ If PPF is linear (straight line), slope is the same for all points on the PPF
➢ If PPF is non-linear (curved), slope is different for any point on the PPF
➢ Operating inside the PPF indicates one or both of two situations:
➢ Unemployment
➢ Inefficiency in the use of resources
➢ Any point outside the PPF is infeasible
➢ A PPF can shift either inward or outward:
➢ Outward if there is economic growth or improvement in technology and resources
➢ Inward if there are market failures and regressions in the economy
18
Linear Production Possibility Frontier
Butter
150
A
From B to C:
Slope =
𝑹𝒊𝒔𝒆 −𝟑𝟎
=
= −1
𝑹𝒖𝒏
𝟑𝟎
B
120
−30
C
90
From D to E:
+30
Slope =
D
60
𝑹𝒊𝒔𝒆 −𝟑𝟎
=
= −1
𝑹𝒖𝒏
𝟑𝟎
−30
E
30
+30
F
0
30
60
90
120
150
Guns
Non-linear Production Possibility Frontier
Butter
From B to C:
150
A
Slope =
B
𝑹𝒊𝒔𝒆 −𝟐𝟎
=
𝑹𝒖𝒏
𝟑𝟎
=−
𝟐
𝟑
−20
C
120
+30
From D to E:
D
90
Slope =
𝑹𝒊𝒔𝒆 −𝟒𝟎
𝟒
=
=−
𝑹𝒖𝒏
𝟑𝟎
𝟑
−40
60
E
+30
30
F
0
30
60
90
120
150
Guns
Inefficient Production Inside the Production Possibility Frontier
Butter
150
A
B
C
120
D
90
G
60
E
30
F
0
30
60
90
120
150
Guns
Infeasible Production Outside the Production Possibility Frontier
Butter
150
A
B
H
C
120
D
90
60
E
30
F
0
30
60
90
120
150
Guns
Shifts in the Production Possibility Frontier
Butter
150
Outward shifts in the PPF are
caused by economic growth
and improvements in
technology and resources.
A
B
C
120
D
90
60
Inward shifts in the PPF are
caused by market failures
and regressions in
technology and resources,
among others.
E
30
F
0
30
60
90
120
150
Guns
The Central Concepts of Economics
Consider the statement: A PPF is only an array of technically feasible outputs. This does not
mean a society will actually be operating on its PPF.
Based on this statement, consider a society that only produces either guns or butter. Given the
following situations, select your answer from among choices A to E below:
Q13:
Where would society be relative to its PPF in the event of a war?
A. Inside the PPF
B. On the PPF (with more butter)
C. On the PPF (with more guns)
D. On the PPF (with equal amounts of guns and butter)
E. Outside the PPF
24
Production Possibility Frontier
Butter
150
A
B
C
120
D
90
60
E
30
F
0
30
60
90
120
150
Guns
The Central Concepts of Economics
Consider the statement: A PPF is only an array of technically feasible outputs. This does not
mean a society will actually be operating on its PPF.
Based on this statement, consider a society that only produces either guns or butter. Given the
following situations, select your answer from among choices A to E below:
Q14:
Where would society be relative to its PPF in the event of an economic recession?
A. Inside the PPF
B. On the PPF (with more butter)
C. On the PPF (with more guns)
D. On the PPF (with equal amounts of guns and butter)
E. Outside the PPF
26
Production Possibility Frontier
Butter
150
A
B
C
120
D
90
G
60
E
30
F
0
30
60
90
120
150
Guns
The Central Concepts of Economics
Consider the statement: A PPF is only an array of technically feasible outputs. This does not
mean a society will actually be operating on its PPF.
Based on this statement, consider a society that only produces either guns or butter. Given the
following situations, select your answer from among choices A to E below:
Q15:
Where would society be relative to its PPF in the event of an economic boom?
A. Inside the PPF
B. On the PPF (with more butter)
C. On the PPF (with more guns)
D. On the PPF (with equal amounts of guns and butter)
E. Outside the PPF
28
Production Possibility Frontier
Butter
150
A
B
C
120
D
90
60
E
30
F
0
30
60
90
120
150
Guns
The Central Concepts of Economics
Suppose the current administration expects to earn additional revenue from its tax reform
program. Assume that it faces the figure as its production possibility frontier (PPF) where it
considers producing either classrooms or roads using the revenues generated by the government.
➢ At point A, the government intends to build 10,580 new classrooms and 12,000 kilometers of
new roads.
➢ However, some officials prefer to build 14,000 classrooms instead (point B).
Q11:
Based on the figure, what is the opportunity cost of producing the additional
classrooms preferred by some government officials?
➢ Point B on the PPF with 14,000 classrooms corresponds to 8,000 kilometers of roads on the
horizontal axis
➢ Moving from point A to point B on the same PPF requires giving up 4,000 kilometers of roads
➢ Hence, the opportunity cost of the additional classrooms preferred by government officials is
4,000 kilometers of roads
30
Production Possibility Frontier
Number of Classrooms
15,000
B
14,000
A
10,580
10,000
5,000
0
Kilometers of Roads
5,000
10,000 12,000
15,000
Production Possibility Frontier
Number of Classrooms
15,000
B
14,000
+3,420
A
10,580
10,000
−4,000
5,000
0
Kilometers of Roads
5,000
8,000 10,000 12,000
15,000
The Central Concepts of Economics
Suppose the current administration expects to earn additional revenue from its tax reform
program. Assume that it faces the figure as its production possibility frontier (PPF) where it
considers producing either classrooms or roads using the revenues generated by the government.
➢ At point A, the government intends to build 10,580 new classrooms and 12,000 kilometers of
new roads.
➢ However, some officials prefer to build 14,000 classrooms instead (point B).
Q12:
Consider a situation in which government officials instead insist on building 14,000
classrooms and 12,000 kilometers of new roads. Is this feasible given the current
revenue situation of the government? Under what circumstances will this be possible?
➢ The situation of building 14,000 classrooms and 12,000 kilometers of new roads is not feasible
because it is outside of the government’s PPF which depicts is current revenue situation.
➢ This production combination, however, can be achieved by shifting the government’s current
PPF outward:
➢ This will happen under the following scenarios:
➢ Actual tax collections exceed additional revenues needed to finance the
construction of additional roads
➢ The cost of laying out new roads is significantly reduced
➢ The cost of constructing new classrooms is significantly reduced
33
Production Possibility Frontier
Number of Classrooms
15,000
B
14,000
A
10,580
10,000
5,000
0
Kilometers of Roads
5,000
10,000 12,000
15,000
Production Possibility Frontier
Number of Classrooms
15,000
B
14,000
A
10,580
10,000
5,000
0
Kilometers of Roads
5,000
10,000 12,000
15,000