Fundamental
Economic
Concepts
What is Economics?
- The study of mankind’s unlimited
desires in a world of limited resources.
-Economics is a social science, dealing with how people
react to changing variables.
-Economists form theories, based on economic models in
which they manipulate variables.
-These theories, models and variables are used to
describe what is (Positive Economics) and what ought to
be (Normative Economics).
Microeconomics deals with individual decisions,
Macroeconomics looks at the economy as a whole
What is the Economy?
Why Do We Study It?
1. Description
2. Analysis
3. Explanation
4. Prediction
What? or How Much?
How? or Why?
When?
OR…
Why do we study Economics?
So
we
don’t
get
screwed.
Book Auction

What economic concepts were
demonstrated by the book auction?
◦
◦
◦
◦
◦
Scarcity
Value
Choices
Rationing
Equity vs. Efficiency
 Which was the sealed auction?
◦ Consumer surplus
Stay
Tuned!
Scarcity
Situation that occurs when wants are greater than
available resources.
Scarcity is the fundamental problem in economics.
In this classroom, is/are _________ scarce?
Wants are satisfied by available resources
Desks?
But not in the hallway…
 Water?
 Books?
No want for it in classroom, but outside… yes
 Gasoline?
Wants exceed available resources
 Jolly Ranchers?
…


Good looking economics instructors?
Good looking economics instructors?
We always assume….

People make decisions based upon
RATIONAL SELF-INTEREST
We must consider…
Examples: Shelter is a need, a mansion is a want.
Food is a need, a large pizza is a want.
Scarcity forces us to ask the
following questions…

WHAT to produce?

HOW to produce?

FOR WHOM to produce?
Imagine a scenario where…
…we take an all-expensespaid class trip to…
Australia!
Our plane is forced to make a “water landing,” and we
are able to swim to an uncharted island.
You are in charge. Prioritize 3-5 things we’ll have to do
to survive and how (and with who) we should
accomplish these tasks.
Specialization
• Allocating resources toward production for
which they are best suited.
FACTORS OF PRODUCTION
•
•
•
•
Land – all gifts of nature
Labor – human efforts and abilities
Capital – tools, equipment, space
Entrepreneurship – risk taking, ideas
– **The “spark” or driving force of the
economy**
EXAMPLES:
Adam Smith

“Wealth of Nations”
◦ 1776

Invisible hand
◦
◦
◦
◦
Meat
Bread
Candles
How do we decide to provide these?
CIRCULAR FLOW
Utility

The satisfaction that consumption of a
good or service provides
DIMINISHING MARGINAL UTILITY
As you consume additional units of a good, at some
point each additional unit will begin providing less
utility than the one before it.
Paradox of Value
Water vs. Diamonds
 Monetary Value

◦ Must be scarce
◦ Must give utility
Are diamonds scarce?
 Do they give utility?


Conspicuous consumption
◦ Examples?
Cost – Benefit Analysis
Question? :
What do you want
RIGHT NOW?
Cost – Benefit Analysis
Follow up question? :
Why don’t you go
get it?
Cost – Benefit Analysis
• We all make decisions in our own self-interest
• All decisions come with certain trade-offs and
alternatives
• THERE IS NO SUCH THING AS A FREE LUNCH!!!
Seinfeld example
• Opportunity Cost: the next-best alternative given
up when making a choice
Opportunity Cost
VS.
VS.
VS.
Marginal Cost
Marginal = Additional, next
Additional cost vs. additional benefit
We constantly engage in
marginal analysis
Production Possibilities Model
 Illustrate
production choices
 Assumptions:
◦ Full employment
◦ Fixed resources
◦ Fixed technology
◦ Two goods
1-31
Production Possibilities Frontier
All possible combinations of two products that can be produced when
employing 100% of available resources.
Guns (thousands)
80
75
60
30
0
Butter (tons)
0
150
300
400
450
Production Possibilities Frontier
Production Possibilities Table
Production Alternatives
Type of Product
Pizzas
A
B
C
D
E
0
1
2
3
4
10
9
7
4
0
(in hundred thousands)
Industrial Robots
(in thousands)
Plot Points to Create Graph…
1-35
Industrial Robots
Production Possibilities Curve
A’
14
13
12
11
10
9
8
7
6
5
4
3
2
1
B’
Unattainable
A
Economic
Growth
C’
B
C
D’
D
Now Attainable
Attainable
E’
E
0
1
2
3
4
5
6
7
8 9
Pizzas
1-36
Industrial Robots
Production Possibilities Curve
A’
14
13
12
11
10
9
8
7
6
5
4
3
2
1
B’
Unattainable
A
Law of Increasing
Opportunity Cost
C’
B
C
D’
Shape of
the Curve
D
Attainable
E’
E
0
1
2
3
4
5
6
7
8 9
Pizzas
1-37
Quick Quiz

Why is the PPF bowed out from the
origin?
◦ Law of increasing opportunity
costs…
◦ …due to specialization of resources
What is the marginal opportunity
cost of the 2nd unit of pizza?
◦ 2 thousand robots
 Which point(s) on the curve
represent full employment of
resources?
◦ All points ON the curve

The Future Economy
 Consequences
of unemployment
 Economic growth
◦ More resources
◦ Better quality resources
◦ Technological advances
1-39
Future
Curve
Current
Curve
P
Goods for the Present
Presentville
Goods for the Future
Goods for the Future
Future Possibilities
Future
Curve
F
Current
Curve
Goods for the Present
Futureville
1-40
Specialization
 Shift
resources to export industry
 Achieve higher overall output and
income
 Absolute advantage
◦ Higher output per worker for a good
 Comparative
advantage
◦ Lower domestic opportunity cost for a
good
5-41
Comparative Advantage
Mexico’s Production Possibilities Table (in Tons)
Product
Production Alternatives
A
B
C
D
E
Avocados
0
20
24
40
60
Soybeans
15
10
9
5
0
**Optimal domestic production occurs at point C
• Opportunity cost of 1 ton of
Soybeans is 4 tons of Avocados
• Opportunity cost of 1 ton of
Avocados is .25 tons of Soybeans
5-42
Comparative Advantage
U.S.’s Production Possibilities Table (in Tons)
Product
Production Alternatives
A
B
C
D
E
Avocados
0
30
33
60
90
Soybeans
30
20
19
10
0
**Optimal domestic production occurs at point C
• Absolute advantage in both goods
• Opportunity cost of 1 ton of
Soybeans is 3 tons of Avocados
• Opportunity cost of 1 ton of
Avocados is .33 tons of Soybeans
5-43
Comparative Advantage
 Mexico
will produce avocados
 U.S. will produce soybeans
 U.S. gives up 3 A for 1 S
 Mexico gives up 4 A for 1 S
 Terms of trade
◦ 3.5 A for 1 S
◦ Both countries benefit
5-44
Comparative Advantage
 Gains from trade
 Mexico starts at C
(24 A and 9S)
◦ Move to E (60 A and 0 S)
◦ Trade 35 A for 10 S
 U.S. starts
at T (33 A and 19 S)
◦ Move to R (0 A and 30 S)
◦ Trade 10 S for 35 A
 Overall
gains?
5-45
Comparative Advantage
Terms of Trade – 1s : 3.5a
Trade: 10 tons soybeans for
35 tons avocados