Lecture 3 Fundamentals of economics

1. Lecture 3Fundamentals of economics The Production Possibilities Frontier and Circular Flow Model How scarcity, opportunity cost, & factors of production help societies answer the 3 basic questions of economics

2. Scarcity If I tell you something is “scarce” what does that tell you? • There is a limited quantity • There is not enough to go around • It is rare and hard to find Guess what? The answer is none of the above! Rocks and sand are scarce. So is air. So is trash. Scarcityis a condition created by the fact that people have unlimited wants but resources are limited Because of scarcity, when there are multiple uses for a resource people have to decide how to utilize the resource The choice that is made always incurs an opportunity cost!

3. Scarcity case studies: garbage & air B. Why is air scarce if it seems so abundant? What uses do we have for air? A. “Spinning Garbage into Gold” • The USA’s #3 export to China is our trash! • What is the incentive to the USA? • What is the incentive to China? • What are the externalities associated with this exchange?

4. So how do people (including businesses, individuals, and government) answer the 3 questions in the face of scarcity? • Opportunity cost and PPF! Reading instructions • Highlight the sections of text that help you understand what a PPF is and how a PPF is related to the following economic concepts: • Efficient allocation of resources • Inefficient allocation of resources • Opportunity cost • Technological advancements and growth in production • In the margins by the 1st graph, write your own description of what graph points A, B, C , X and Y represent in terms of concepts a-d listed above

5. PPF is a model of opportunity cost Question 1: What to produce--Guns or Butter? • PPF is the curve A Guns B C D 0 Butter

6. What is the opportunity cost of moving from point B to point C? A Guns B C D 0 Butter

7. Points E & F E A B Guns F C G D Point G= Butter

8. Law of Increasing Opportunity Costs A B C D E Why isn’t it an equal exchange (e.g. for every additional car factory produces, factory produces 1 less computer?)

9. 1 2 3 4 Using a production possibilities schedule to predict opportunity costs A B C D E O/C of producing additional car measured in computers What is the opportunity cost of producing 1 car instead of 0? What is the opportunity costs of producing 3 cars instead of 2? Why does it seem that the factory/society has to give up more and more computers just to produce 1 more car as you move from left to right on the schedule?

10. The Circular Flow Model The interactions of individuals and businesses are what keep an economy strong

11. Circular Flow Model This model shows the interdependence of individuals and businesses that creates economic growth * F.O.P. means _________________________________

12. Factors of Production • Land • Capital • Labor • Entrepreneurs

13. Where does the $ come from to buy factors of production? • Total sales $ = REVENUE • Revenue = GROSS earnings • If you receive a paycheck, it will show your Gross and your Net. Gross is always bigger than Net. • Gross is your salary. Net is what you actually get to keep. • For personal income, net is what you have left after you subtract your taxes, health care costs, social security (FICA) from your paycheck • For businesses, net is what they have left after they subtract costs from revenue (earnings) • What is another word for a business’ net?

14. Product Market Goods & Services Money Payment ($) Households Businesses If there were only a Product Market, eventually all goods would end up in the hands of households and all money in the hands of businesses leaving no more market. Of course, the government could just print more money and give it to households to enable them to buy more, but what would be bad about that idea?