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Scarcity
Economics is the study of how individuals and economies deal with the fundamental problem of scarcity. As a result of scarcity, individuals and societies must make choices among competing alternatives.
Opportunity Cost
The opportunity cost of any alternative is defined as the cost of not selecting the "nextbest" alternative. Example: Suppose that you own a building that is worth $100,000 today and is expected to be worth $100,000 one year from today. If the interest rate is 10%, what is the opportunity cost of using this building for one year?
Example II
the cost of tuition, books, and supplies, foregone income (this is usually the largest cost associated with college attendance), and psychic costs.
Example III:
Marginal analysis
Marginal benefit = additional benefit resulting from a one-unit increase in the level of an activity Marginal cost = additional cost associated with one-unit increase in the level of an activity
Net benefit
Individuals are not expected to maximize benefit; nor are they expected to minimize costs. Individuals are assumed to attempt to maximize the level of net benefit (total benefit minus total cost) from any activity in which they are engaged.
Marginal analysis
MB > MC expand the activity MB < MC contract the activity optimal level of activity: MB = MC (Net benefit is maximized at this point)
Marginal benefit
MB generally declines as the level of an activity rises, ceteris paribus. Consider the MB of time spent studying:
Marginal cost
For most activities, marginal cost rises as the level of the activity increases.
Assumptions:
A fixed quantity and quality of available resources A fixed level of technology Efficient production (i.e., no unemployment and no underemployment)
4 hours left to study for two exams: economics and calculus Output = grades on each exam Fixed resources? Fixed technology? No unemployed nor underemployed resources?
Law of diminishing returns: output will ultimately increase by progressively smaller amounts when the use of a variable input increases while other inputs are held constant. Does this apply in this example? What are the fixed inputs?
Marginal opportunity cost = the amount of another good that must be given up to produce one more unit of a good.
In the interval between points A and B, the marginal opportunity cost of 1 point on the economics exam is 1/3 of a point on the calculus exam.
In the interval between points B and C, the marginal opportunity cost of one point on the economics exam equals 4/3 of a point on the calculus exam.
Law of increasing cost marginal opportunity cost rises as the level of an activity increases
Law of diminishing returns Specialized resources (heterogeneous labor, land, capital, etc.)
Some land, labor, and capital is better suited for wheat production and some is better suited for corn production
Economic growth
Adam Smith economic growth is caused by increased specialization and division of labor.
specialization in areas that match the skills and talents of workers learning by doing increase in productivity from task repetition less time lost while switching from task to task
As noted by Adam Smith, specialization and trade are inextricably linked. Adam Smith and David Ricardo used this argument to support free trade among nations.
Absolute advantage an individual (or country) is more productive than other individuals (or countries). Comparative advantage an individual (or country) may produce a good at a lower opportunity cost than can other individuals (or countries).
Suppose the U.S. and Japan produce only two goods: CD players and wheat.
Absolute advantage?
Comparative advantage?
Opportunity cost of CD player in U.S. = 2 units of wheat Opportunity cost of CD player in Japan = 4/3 unit of wheat If Japan produces and trades each CD player to the U.S. for more than 4/3 of a unit of wheat but less than 2 units of wheat, both the U.S. and Japan gain from trade and can consume more goods than they could produce by themselves.
Note that the U.S. has a comparative advantage in producing wheat. Countries always expand their consumption possibilities by engaging in trade (since they acquire goods at a lower opportunity cost than if they produced them themselves).
Free trade?
If each country specializes in the production of those goods in which it possesses a comparative advantage and trades with other countries, global output and consumption in increased.