Unit 1: Scarcity, Opportunity Costs, Comparative Economic Systems,
Free Enterprise System
Honors Economics
One of my classes at SIAS University, Xinzheng, Henan, China (Fall 2016)
Terms to Know
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economics
need want scarcity good capital good service |
factors of production
land labor capital entrepreneurship utility trade-off |
opportunity cost
cost-benefit analysis diminishing marginal utility production possibilities curve underutilization absolute advantage comparative advantage |
specialization
microeconomics macroeconomics normative economics positive economics |
What are the 4 factors of production?
The Circular Flow of Money model provides a basic relationship between households and firms in the economy. What does the Circular Flow Chart demonstrate about the transfer and transformation of resources?
This model was developed by Frank Knight at the beginning of the 20th century. He was educated at Milligan University and at University of Tennessee, Knoxville. He became a notable professor at the University of Chicago, School of Economics.
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Let's stop for a moment and consider the buying behavior of individuals. As an individual acquires a desired product, the amount or the number of the product they will purchase will decline because the the level of usefulness, or utility, from each additional item will diminish for the individual, diminishing marginal utility. Note the graph to the right. The description and the graph of diminishing utility may sound and look complicated. Think of your favorite food that you have not had for a long while. You are craving to have some. When you finally have the food in front of you, a nice big portion, the first bite tastes so good. If it was a very big portion, the last bite might taste as good as the first bite. However, you are no longer hungry. The last bite does not satisfy, or is not as useful to you as much as the first bite because you are not hungry. So, you not only slow down your consumption of your favorite food, you will stop eating it. How does this apply to Individual buying behavior? Notice the graph at the right, as a person gains more wealth, they may purchase more, but with each additional product purchased, the utility of that product decreases, diminishing marginal utility. Businesses advertise to convince consumers that they have not reached satisfaction and to keep buying their products. The application of these concepts to individuals and firms is the study of microeconomics, Unit 2.
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Suppose a country looks at their scarce resources and realize that they can only make two products. If fact, they can't make the maximum number of either product without sacrificing producing all of the other product. They are in a situation where they must trade-off making some of one product to make some of the other product. The quantity they give up of one product is the opportunity cost of making the other product.
To the left is a Production Possibilities Frontier (PPF). Within the PPF is the Production Possibility Curve (PPC). All along the PPC are the maximum quantities of producing both products A and B if the resources are used efficiently. If the quantity of B is to be increased from E1 to E2, then it will cost the opportunity of a specific quantity of product A. If the resources are used inefficiently or are wasted, quantities of A and B produced would be inside the production potential represented along the PPC at points I or W. Resources are being underutilized. Any attempt to produce outside of the PPC at point N is simply not possible. It is beyond what can be produced with the scarce resources. |
Note the production possibilities frontiers of the two countries to the right and left. Each country happen to make the same two products with their scarce resources. Gearhead Republic produces more cars and computers than Geeklandia. Gearhead Republic has absolute advantage over Geeklandia in producing both products.
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Now, which country has comparative advantage in producing cars and computers. Stated another way, which country experiences the least opportunity cost producing a car or a computer.
When you calculate comparative advantage for production output, set it up like the example, and place the "other over" to calculate the opportunity costs. "Other over" refers to the other product that could be produced if you hadn't put all your resources into producing the the product you are making. For instance, here we have placed the number of computers over the number of cars to determine how many computers are given up to make one car. Or, we have placed the number of cars over the number of computers to determine how many cars are given up to make one computer. "Other over". Notice that Gearhead Republic only gives up 3 computers to produce a car compared to Geeklandia who gives up producing 5 computers to produce a car. Gearhead Republic has comparative advantage over Geeklandia in producing cars. Notice that Geeklandia only gives up producing a 1/5th of a car to produce a computer, where Gearhead Republic gives up 1/3rd of a car to produce a computer. Geeklandia has comparative advantage over Gearhead Republic in producing computers. |
On a PPC that is straight, the ratio of giving up the manufacture of one product to the gain of the alternative product is the same any where along the curve. It is said that opportunity costs are constant along the PPC.
In the example to the right, moving from point A to B, or B to C, or even A to D, The ratio of giving up product Beta to gain more of product Alpha is the same. If we gave up Alpha to gain Beta, the ratio would be the same between points along the PPC. Anytime you are given a scenario that refers to constant opportunity costs, you need to draw a straight line for the PPC. |
economic system traditional system
market system mixed economy command system |
centrally planned economy socialism
democratic socialism authoritarian socialism communism proletariat bourgeoisie political capital |
infrastructure
public goods public transfer payment subsidy safety net positive externality negative externality free enterprise system |
market
capitalism profit profit motive |