Download 15 fundamental concepts

15 FUNDAMENTAL
CONCEPTS
BEGINNING WITH THE END IN
MIND
SCARCITY

SCARCITY OF RESOURCES
 LAND
SCARCITY

LABOR
SCARCITY

CAPITAL
SCARCITY

THE ECONOMIC PROBLEM
 LIMITED RESOURCES VS. UNLIMITED
WANTS AND NEEDS
 SCARCITY NECESSITATES CHOICE
OR
TRADEOFFS/OPPORTUNITY
COSTS

ALL CHOICES INVOLVE TRADEOFFS
– YOU MUST CHOOSE A OR B
“THERE IS NO SUCH THING AS A FREE
LUNCH”
 SLEEP OR SCHOOL? WORK OR FRIENDS?

OR

A DOLLAR SPENT ON VACTION IS A
DOLLAR NOT SPENT ON RETIREMENT
TRADEOFFS/OPPORTUNITY
COSTS

GUNS VS. BUTTER
OR

CLEAN ENVIRONMENT VS. HIGHER
INCOMES
OR
TRADEOFFS/OPPORTUNITY
COSTS
 EFFICIENCY VS.
EQUITY
 GETTING THE MOST OUT OF
SCARCE RESOURCES VS.
FAIRNESS OF DISTRIBUTION
TRADEOFFS/OPPORTUNITY
COSTS

REDISTRIBUTION OF INCOME
THROUGH UNEMPLOYMENT AND
WELFARE REDUCES INCENTIVE TO
WORK HARD
 MORE EQUAL SLICES BUT SMALLER
PIE
TRADEOFFS/OPPORTUNITY
COSTS

ALL TRADEOFFS INVOLVE
OPPORTUNITY COSTS
– THE COST OF THE NEXT BEST
ALTERNATIVE USE OF TIME, MONEY OR
RESOURCES

SLEEPING IN SATURDAY MORNING
COSTS $35?!?!?!?!?
TRADEOFFS/OPPORTUNITY
COSTS

EXPLICIT + IMPLICIT COSTS
 TRUE COST OF COLLEGE??
– EXPLICIT=TUITION AND BOOKS
– IMPLICIT=LOST WAGES ($10/HOUR =
~$20,000/YEAR

SHOULD TOP ATHLETES STAY IN
COLLEGE?
RATIONAL PEOPLE THINK
AT THE MARGIN

MUST WEIGH ADDITIONAL COSTS
WITH ADDITIONAL BENEFIT
 MARGINAL COST IS THE ADDITIONAL
COST OF AN ADDITIONAL UNIT
 MARGINAL BENEFIT IS THE
ADDITIONAL BENEFIT FROM AN
ADDITIONAL UNIT
RATIONAL PEOPLE THINK
AT THE MARGIN

NEVER LET YOUR MARGINAL COSTS
EXCEED YOUR MARGINAL BENEFITS
 MC=MR
PROFIT MAXIMIZATION
 SHOULD THE AIRLINE SELL THE $500
TICKET FOR $100 TEN MINUTES
BEFORE TAKEOFF???
PEOPLE RESPOND TO
INCENTIVES

DECISIONS MADE TO GAIN BENEFIT
OR PROFIT AND TO AVOID LOSS OR
PAIN
 KNOWING PEOPLE RESPOND
PREDICTALBLY TO INCENTIVES
SHOULD BE KEPT IN MIND WHEN
SETTING PUBLIC POLICY
PEOPLE RESPOND TO
INCENTIVES

SUV TAX BREAK
 TAXES, UNEMPLOYMENT BENEFITS
 SOCIAL SECURITY
 LATE SLIPS
RELATIVE SCARCITY

DEMAND FOR A GOOD OR SERVICE
IN RELATION TO THE SUPPLY OF
THAT GOOD
 1000 < 10
 BALLPLAYERS VS. TEACHERS
 RELATIVELY SCARCE GOODS = $$$$$
VOLUNTARY EXCHANGE

BOTH PARTIES EXPECT TO BE
BETTER OFF AFTER THE EXCHANGE
 WIN/WIN SITUATION
 COMPETITION BETWEEN
BUYERS/SELLERS
 NET GAIN IS POSITIVE FOR BOTH
PARTIES
SPECIALIZATION LEADS TO
INTERDEPENDENCE

SPECIALIZATION: CONCENTRATION
OF PRODUCTIVE EFFORTS…LEADS
TO GREATER EFFICIENCY
 BASED ON COMPARATIVE
ADVANTAGE…WHO HAS THE
LOWEST OPPORTUNITY COST?
 FORCES RELIANCE ON OTHERS TO
LIVE
PRICE=SUPPLY + DEMAND

SUPPLY
 SUPPLY
PRICE
PRICE

PRICE
PRICE
DEMAND
 DEMAND
PRICE=SUPPLY + DEMAND

SUPPLY
DEMAND
PRICE

SUPPLY
DEMAND
PRICE

DEMAND
SUPPLY
PRICE

DEMAND
SUPPLY
PRICE
PRICE=SUPPLY + DEMAND

HIGH DEMAND
AND LOW
SUPPLY=HIGH
PRICES
PRICE=SUPPLY + DEMAND

MARKET SYSTEM DEPENDS ON
PRICES AND SELF-INTEREST TO
GUIDE RESOURCES
PRICES=SUPPLY+DEMAND

HOUSEHOLDS (DEMAND) AND FIRMS
(SUPPLY) INTERACT

ADAM SMITH…INVISIBLE HAND,
LAISSEZ FAIRE
ADAM SMITH

“…IT IS NOT THE
BENEVOLENCE OF
THE BUTCHER,
THE BREWER, OR
THE BAKER THAT
WE EXPECT OUR
DINNER, BUT
FROM THEIR
REGARD TO THEIR
OWN INTEREST…”
PRICE = SUPPLY+ DEMAND
COMMAND ECONOMY…DECISIONS
MADE BY GOVERNMENT
 CENTRALLY PLANNED

– WHAT IS PRODUCED?
– HOW MUCH IS PRODUCED?
– FOR WHOM? WHO SHOULD PRODUCE?
PRICE = SUPPLY+ DEMAND

COMMAND ECONOMIES
– DO NOT MAXIMIZE SOCIAL WELFARE IF
RESOURCES ARE NOT GUIDED
EFFICIENTLY

COMMAND ECONOMIES MAY
PROVIDE FOR RAPID SHIFTS IN
ECONOMIC ACTIVITY BUT PERFORM
POORLY IN THE LONG RUN
COMPETITION DRIVES
EFFICIENCY

EFFICIENCY
– ALLOCATIVE OR ECONOMIC
 GETTING WHAT THE ECONOMY WANTS
– TECHNICAL
 PRODUCING THE MOST WITH THE FEWEST
AMOUNT OF RESOURCES

COMPETITION INCREASES BOTH
LEVELS OF EFFICIENCY
COMPETITION DRIVES
EFFICIENCY

SPORTS
 ACADEMICS??? DRIVE BEHIND
VOUCHERS
 WALMART VS KMART
 MUSIC INDUSTRY
 INTERNET ACCESS AND SERVICES
PUBLIC GOODS AND
MARKET FAILURES

PRIVATE GOODS
– EXCLUDABLE
– RIVAL
 CLOTHING, FOOD, DVD PLAYERS…

PUBLIC GOODS
– NON-EXCLUDABLE
– NON-RIVAL
 DEFENSE, ROADS, PUBLIC PARKS
Types of Goods
Rival?
Yes
Private Goods
Yes
Excludable?
No
 Ice- cream cones
 Clothing
 Congested toll roads
No
Natural Monopolies
 Fire protection
 Cable TV
 Uncongested toll
roads
Common Resources Public Goods
 Fish in the ocean
 The environment
 Congested nontoll
roads
 National defense
 Knowledge
 Uncongested nontoll
roads
PUBLIC GOODS AND
MARKET FAILURES

PRIVATE MARKETS HAVE NO
INCENTIVE TO PROVIDE FOR PUBLIC
GOODS…THIS NECESSITATES
GOVERNMENT INVOLVEMENT
 COMMON POOL RESOURCES
– NON-EXCLUDABLE
– RIVAL (DEPLETABLE)
PUBLIC GOODS AND
MARKET FAILURES

EXTERNALITIES…ECONOMIC SIDE
EFFECT THE IMPOSES COSTS OR
BENEFITS ON SOMEONE OTHER
THAN THE PRODUCER AND THE
CONSUMER
EXTERNALITIES

NEGATIVE…POLUTION

POSITIVE…RESEARCH, EDUCATION
PUBLIC GOODS AND
MARKET FAILURES
MARKET POWER…THE ABILITY TO
UNDULY INFLUENCE MARKET
PRICES
 LITTLE OR NO
COMPETITION…MONOPOLIES
 MARKET AWARDS THOSE
ACCORDING TO ABILITY TO
PRODUCE

PRODUCTIVITY/STANDARD
OF LIVING

STANDARD OF LIVING: QUALTIY OF
LIFE MEASURED BY MATERIAL
POSSESIONS
 PRODUCTIVITY: AMOUNT OF GOODS
AND SERVICES PRODUCED PER
HOUR
 DIRECT RELATIONSHIP
PRODUCTIVITY/STANDARD
OF LIVING
UNITED STATES
$29,000
MEXICO
$8,000
NIGERIA
$900
STANDARD OF LIVING AND
PRODUCTIVITY
PRODUCTIVITY/STANDARD
OF LIVING

REMEMBER THE RULE OF 72!!!
 ALL ABOUT PRODUCTIVITY
– INVESTMENT NEEDED
 CAPTIAL
 TECHNOLOGY
 EDUCATION

HISTORICAL, PERSONAL OR
NATIONAL COMPARISONS
PRODUCTIVITY/STANDARD
OF LIVING

IMPACT OF GOVERNMENT DEFICIT
– DEFICIT: AMOUNT BY WHICH
EXPENDITURES EXCEED REVENUE
(YEAR TO YEAR)
– DEBT: CUMULATIVE EFFECT OF PAST
DEFICITS (OVER TIME)

DEBATE OVER IMPACT
PRODUCTIVITY/STANDARD
OF LIVING

GOVERNMENT
DEFICITS LEAD TO
CROWDING OUT
 HIGHER INTEREST
RATES FOR ALL
 LESS INVESTMENT
IN HUMAN AND
PHYSICAL
CAPITAL

CUTTING TAXES
WILL SPUR MORE
GROWTH…MORE
INCENTIVES
 MORE GROWTH
MEANS MORE
REVENUE
 GROW OUT OF THE
DEFICIT
PRODUCTIVITY/STANDARD
OF LIVING

IF DEFICITS DO “CROWD OUT”
– LOWER INVESTMENT TODAY MEANS
LOWER PRODUCTIVITY TOMORROW

DO DEFICITS LEAD TO LOWER
STANDARDS OF LIVING IN THE LONG
RUN???
UNEMPLOYMENT VS
INFLATION

TWO MAJOR PROBLEMS IN
MACROECONOMY
 TRADEOFF IN THE SHORT RUN
 PHILLIPS CURVE
I
U
UNEMPLOYMENT VS
INFLATION

PUBLIC POLICY
– FISCAL POLICY
 TAX AND/OR SPEND
– MONETARY POLICY
 CONTROL OF MONEY SUPPLY
LENDERS HURT BY
INFLATION
INFLATION…GENERAL RISE IN PRICE
LEVELS
 VALUE OF DOLLAR DECREASES
 IF UNEXPECTED WITH A FIXED
INTEREST RATE THEN LENDERS GET
PAID BACK IN CHEAPER DOLLARS

INTEREST RATES GUIDE
THE ECONOMY
INTEREST RATES…PRICE OF
BORROWING MONEY
 SAVINGS RATE VS BORROWING RATE
 FEDERAL RESERVE BOARD
CONTROLS MONEY SUPPLY

INTEREST RATES GUIDE
ECONOMY





MORE MONEY
LOWER RATES
MORE
BORROWING
MORE SPENDING
ECONOMY HEATS
UP





LESS MONEY
HIGHER RATES
LESS BORROWING
LESS SPENDING
ECONOMY SLOWS
DOWN
INVESTMENT IS NEEDED
FOR GROWTH

NO PAIN NO GAIN
 INVESTMENT OF TIME MONEY OR
RESOURCES NEEDED FOR GROWTH
 CAPITAL GOODS
 TECHNOLOGY
 HUMAN CAPITAL/EDUCATION
INVESTMENT IS NEEDED
FOR GROWTH

RULE OF 72
 AMOUNT OF TIME IT TAKES FOR
“INVESTMENT” TO DOUBLE
 72/7=10 YEARS TO DOUBLE
 72/2=36 YEARS TO DOUBLE