AP
Macroeconomics Unit 2
Lesson 1:
Key Idea: The study of economics exists because of scarcity. Scarcity
forces us to choose between various alternatives (trade-offs). All choices
have costs (opportunity cost). Incentives guide our choices.
Scarcity- the basic condition that exists when unlimited wants exceed limited
productive resources. **Scarcity is NOT a shortage! A shortage can be
fixed.
Trade-off- possible options that we can choose from when we face scarcity
Opportunity Cost – the next best alternative given up when a choice is made
Incentive- a reason for doing something.
Lesson 2:
Key Idea: Economics recognizes certain factors of production that are
scarce. Since these factors of production are scarce, we must choose how we
allocate them between various alternatives.
Factors of Production: Building blocks of the economy
Capital Goods- man-made tools used to make other things (tractors,
factories)
Entrepreneurship- willingness to combine all factors and start a
business to
provide goods and services
Land – natural resources such as oil, coal, natural gas, timber, iron
ore, etc.
Labor- human workers; this can also be reflective of human capital
which is the
knowledge and skills workers have
Allocate – to distribute. In economics, we must decide how to distribute our
scarce factors of production. Will it be based on price, first-come, firstserve?
Lesson 3:
Key Idea: Not all decisions are “all or nothing”. With some decisions, we
must decide whether we should do a little more or a little less. (Should I
sleep ten more minutes? Should I eat another piece of pizza?) This is
referred to as making decisions “at the margin”. A rational decision will
occur where the marginal benefit is greater than or equal to the marginal
cost of a decision.
Marginal- additional
Rational Decision – marginal benefit is greater than or equal to marginal
cost
Lesson 4:
Key Idea: The concepts of scarcity, trade-offs, opportunity cost, and
decision making at the margin can all be observed on a production
possibilities curve.
Production Possibilities Curve/Frontier:
Trade-offs: Refrigerators or cars
Opportunity Cost: If I move from Point A to Point B,
I give up refrigerators. If I move from Point C to
Point B, I give up cars.
Scarcity: The curve is the limit of resources. Points
A, B, and C are productively efficient.
Point X: All resources are not being used (during a
recession)
Point Y: Unattainable using current resources
Lesson 5:
Key Ideas: Specialization and voluntary exchange increase satisfaction of
both parties.
Specialization: Focusing on one particular area of expertise to increase
productivity. (One should specialize where they have their comparative
advantage.)
Comparative Advantage: Specialization should always occur where an
individual, business, or country has the comparative advantage. To have the
comparative advantage means to be able to produce at a lower opportunity cost
than another producer. This is different than the absolute advantage, which
is the ability to produce more than another producer using the same
resources.
To determine comparative advantage, you must determine whether the problem is
an input problem or an output problem. For input problems, use the method:
Input, Other, Under. (IOU). For output problems, use the method Output,
Other, Over (OOO).
Example of an Input Problem:
** The data below represents the number of hours needed to produce one of the
following:
Hours to Produce One Car
Hours to Produce One
Airplane
United States
8
(8/16=1/2)
16
Canada
10
(10/25 =2/5)
25
(16/8 = 2)
(25/10 -5/2 =2 1/2
In this example, the US has the absolute advantage in both cars and airplanes
because it takes them fewer hours to produce one. To determine comparative
advantage, you use the input, other goes under method. Using this method,
you see that Canada should make cars and the US should make airplanes. This
is where the respective opportunity costs are lower.
Appropriate terms of trade will fall between the opportunity costs.
acceptable term would be one airplane to 2 ¼ cars.
An
Example of an Output Problem:
** The data below represents output given a set number of inputs.
Bushels of corn per acre
Bushels ofTomatoes per
acre
United States
30
30
(30/30=1)
Mexico
20
10
(20/10 = 2)
(30/30 = 1)
(10/20=1/2)
In this example, the US has the absolute advantage in both. They can produce
more corn and tomatoes per acre than Mexico. To determine comparative
advantage, use the Output, other goes over method. Using this method, the US
should specialize in tomatoes and Mexico should specialize in corn. This is
where the opportunity costs are lower.
An acceptable term of trade will lie between opportunity costs. For example,
an acceptable trade term would be 1 bushel of tomatoes to 1 and ½ bushels of
corn. Another acceptable term would be 1 bushel of corn to ¾ bushel of
tomatoes.
Voluntary Exchange: Willingness to trade.
it benefits you!
You will only make an exchange if
Lesson 6:
Key Ideas: Productivity is increased through specialization, technology,
investment in capital goods, and investment in education (human capital).
Productivity:
relationship of inputs to outputs
An increase in productivity will shift the production possibilities frontier
to the right.
Lesson 7:
Key Ideas: All societies must decide how to produce and distribute goods and
services. When they do this they form an economic system.
Three Basic Economic Questions: What will we produce?
produced? For whom will it be produced?
How will it be
Types of Economic Systems:
Market Economy – three basic questions are answered by individuals
Command Economy- three basic questions are answered by government
Mixed Economy- three basic questions are answered by individuals and
government
Lesson 8:
Key Ideas: All societies form economic systems based on their social and
economic goals. These goals are often in conflict with one another. Because
of this, most countries have some level of a mixed economy so that they can
balance the interest between these competing goals.
Economic Growth- increasing output/ increasing real Gross Domestic Product
Economic Freedom- ability to start a business, work where you want, purchase
what you want, sell to whom you want, etc.
Economic Efficiency- using all resources to make things that people want with
very little waste
Economic Equity- distributing resources, goods, and services in a way that is
fair
Economic Security- providing an economic safety net to prevent unemployment,
homelessness, etc.
Economic Stability- avoiding large fluctuations in prices
Goals Best Achieved in a Market
Economy
Goals Best Achieved in a Command
Economy
Economic Growth
Economic Equity
Economic Freedom
Economic Security
Economic Efficiency
Economic Stability
A MIXED ECONOMY helps societies achieve a balance of all these goals.
Lesson 9:
Key Idea: In the Soviet-style command economy, lack of information for
consumers and warped incentives led to extreme inefficiency with resources.
People were left with little freedom and poor-quality products.
Lesson 10:
Key Ideas: Market economies are characterized by private ownership, profit
motive, consumer sovereignty, and competition.
Private Ownership: The ability to own and control your resources and goods.
You own and control your labor as well as private property. This gives you
the incentive to be as efficient as you can with your resources so that you
do not waste them.
Profit Motive: The incentive to improve your material well-being. This is
why people go to work, start businesses, and further their education. This
is part of the idea of Adam Smith’s “invisible hand.” No one needs to direct
the economy. People will act in their own self-interest, and this will lead
to a functioning economic unit.
Consumers Sovereignty: “Consumers Rule”- This is the idea that consumers
ultimately decide what gets produced. Due to profit motive, entrepreneurs
only want to make things that people are willing to buy. Therefore, they
will make what consumers want!
Competition: This is the regulating force in a market economy. When many
firms compete with one another, firms that are not the best tend to go out of
business. This helps to ensure low prices, high quality, and the greatest
efficiency possible with our scarce resources.
Lesson 12:
Key Ideas: A market economy can be illustrated through a circular flow
diagram. This shows the interaction between households and businesses in the
factor or resource market and the product market. The exchange of resources,
goods, and services takes place through the exchange of money.
Factor or Resource Market: Households sell their factors of production
(especially labor) to businesses in exchange for income. You participate in
this market when you go to work.
Product Market: Businesses sell final consumers goods and services to
households. These are created using the factors of production the business
purchases in the factor market.
Medium of Exchange: Money is our medium of exchange. It facilitates the
flow of goods, services and resources throughout the economy. If we did not
have money, we would have to rely upon barter which would be much less
efficient.
Lesson 13:
Key Ideas: There are no pure market economies left in the world. There are
problems with a laissez-faire style economy, and therefore there are certain
reasons for government to get involved, leading to a mixed economy.
Laissez-Faire: pure free market; government “hands-off”
Regulation: A rule or law placed on businesses by government. More
regulation tends to increase costs for producers and prices for consumers.
However, there tends to be increased safety, quality, or product clarity when
regulations are in place.
Deregulation: Removal of laws placed on business.
Reasons for Government Involvement in a Market-based Economy
1. Redistribution of Income- This is one way a market-based economy seeks
to achieve more equity and security. They tax the population and give
money to specific individuals and programs. This includes Social
Security, Temporary Aid to Needy Families (Welfare), Food stamps, etc.
2. Protection of Private Property Rights- Since private ownership is key
to a market, there must be rule of law to protect that property. In
addition, government serves to protect intellectual property by giving
patents and copyrights. This gives individuals the incentive to go out
and innovate so that they can expand their own material well-being, and
help us in the process!
3. Provide Public Goods and Services- There are certain goods and services
that would be under-produced if left to the market. These include
roads, fireworks, etc. They would be under-produced due to the freerider problem, which means that people can use and enjoy a good or
service and not have to pay for it. To fix this problem, the
government taxes everyone and provides the service to all.
4. Correcting Market Failures (Externalities)- Sometimes the market does
not distribute costs efficiently. People wind up bearing external costs
from the actions of others. These are called negative externalities.
Examples of this include pollution, second-hand smoke, loud music, etc.
The role of government is to come in and place regulations or taxes on
the groups involved in the behavior to reduce the spill-over costs.
(**Actions that provide external benefits are often provided as public
goods, such as education.)