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Isues in economics today 6th by guell chapter01

Chapter 01
Economics:
The Study of
Opportunity
Cost

McGraw-Hill/Irwin

Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.


Chapter Outline
• Economics And Opportunity Cost
• Modeling Opportunity Cost Using A
Production Possibilities Frontier
• Attributes Of The Production
Possibilities Frontier
• The Big Picture
• Thinking Economically
• Kick It Up A Notch: Demonstrating
Constant And Increasing Opportunity

Cost on a Production Possibilities
Frontier

1-2


Economics and Opportunity Cost
• Economics: the study of the
allocation and use of scarce
resources to satisfy unlimited
human wants

1-3


Choices Have Consequences
• Opportunity Cost

• The forgone alternative of the
choice made
Or
• What you would have done had
you not done what you did.

1-4


Modeling Opportunity Cost Using a
Production Possibilities Frontier Definitions
• PPF: a graph which relates the amounts of
different goods that can be produced in a
fully employed society
• Model: a simplification of the real world
that we can manipulate to explain the real
world
• Simplifying Assumption: an assumption
that may, on its face, be silly but allows for
a clearer explanation
• Scarce: not freely available and infinite
• Resources: anything we either consume

directly or use to make things that we will
ultimately consume
1-5


Soda

Figures 1-4 Building The Production
Possibilities Frontier
S

X

Y
M
Z
P

0

Pizza
1-6


Soda

A Fully Labeled Production Possibilities
Frontier: The Case When People are Different
S

Unattainable

X
Y
Attainable

M
Z

Unemployment
0

P
Pizza
1-7


Soda

Figure 5
Unattainable
(outside the curve)

Unemployment
(just inside the curve)

0

Attainable
(on the curve and on the inside)

Pizza
1-8


Soda

A Fully Labeled Production Possibilities
Frontier: The Case When People are the Same
S
X
Y
Attainable

Unattainable
M
Z

Unemployment
0

P
Pizza
1-9


Soda

Figure 6
Unattainable
(outside the curve)

Unemployment
(just inside the curve)

0

Attainable
(on the curve and on the inside)

Pizza
1-10


Increasing and
Constant Opportunity Cost
• Increasing Opportunity Cost
• Exists when the additional resources required
to produce an additional unit grows as more
output is produced.
• Likely to occur when people are different in
their skills.

• Constant Opportunity Cost
• Exists when the additional resources required
to produce an additional unit remains the
same as more output is produced.
• Likely to occur when people are identical in
their skills.
1-11


The Big Picture
• circular flow model: A model that
shows the interactions of all
economic actors

• Markets are where the
interactions take place
• Actors are the entities
interacting

1-12


Markets in a Circular Flow Diagram
• Market: Any mechanism by which
buyers and sellers negotiate an
exchange
• Factor Market: A mechanism by which
buyers and sellers of labor and financial
capital negotiate an exchange.
• Goods and Services Market: A
mechanism by which buyers and sellers
of goods and services negotiate an
exchange.
• Foreign Exchange Market: A
mechanism by which buyers and sellers
of the currencies of various countries
negotiate an exchange.
1-13


Actors in a Circular Flow Diagram
• Households
• Firms
• Government

1-14


The Circular Flow Diagram

1-15


Thinking Economically: Marginal
Analysis
• Optimization Assumption: an
assumption that suggests that the
person in question is trying to
maximize some objective
• Marginal Benefit: the increase in the
benefit that results from an action
• Marginal Cost: the increase in the
cost that results from an action
• Net Benefit: the difference between
all benefits and all costs
1-16


Positive and Normative Analysis
• Positive Analysis: a form of
analysis that seeks to understand
the way things are and why they
are that way
• Normative Analysis: a form of
analysis that seeks to understand
the ways things should be

1-17


Economics Incentives
• Incentive: something that influences
the decisions we make

• Examples: prices influence the
amount we buy; taxes influence
how much we work and save

1-18


Logical Flaws
• Fallacy of Composition: the mistake
in logic that suggests that the total
economic impact of something is
always and simply equal to the sum
of the individual parts
• Correlation = Causation: the
mistake that suggests that because
two variables are correlated that
one caused the other to happen.

1-19


Kick it Up a Notch
Demonstrating Increasing
and Constant Opportunity
Cost

1-20


Soda

Figure 7 Illustrating Increasing Opportunity
Cost
Opportunity Cost of going from 0 units of
Pizza to 1 unit of pizza

10
9
8
7
6
5
4
3
2
1
0

Opportunity Cost of going from 1 unit of
Pizza to 2 units of pizza

Production Possibilities Frontier
Opportunity Cost of going from 2
units of Pizza to 3 units of pizza

1

2

3

Pizza
1-21


Soda

Figure 8
Illustrating Constant Opportunity Cost
Opportunity Cost of going from 0 units of
Pizza to 1 unit of pizza

9
8
7
6
5
4
3
2
1

Opportunity Cost of going from 1 unit of
Pizza to 2 units of pizza

Production Possibilities Frontier

Opportunity Cost of going from 2
units of Pizza to 3 units of pizza

0

1

2

3

Pizza
1-22



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