Economic Decision MakingWhy can’t you always get what you want?

Why is what we want scarce?

• Our wants always exceed our resources. Even the very rich can’t afford and endless supply of everything.

• Goods = physical objects produced for sale.

• Services = activities done for us by others.

• Resources, like land, labor, materials and machines are scarce.

Shortages are temporary, while scarcity is forever.

• A shortage is a lack of something that is desired. Shortages are caused by fads, wars and natural disasters. New sources of supply end shortages.

Inputs, Outputs and the Production Equation

• Inputs are scarce resources that go into the production process.

• Factors of Production = Land, Labor and Capital.

• Outputs are the goods and services produced using the factors of production.

• Production equation:

• Land+Labor+capital= goods and services.

• Entrepreneurship - The willingness to take risks, a 4th factor of production.

Land Resources• The gifts of nature: air, soil,

minerals, water, forests, plants, animals, birds, fish, solar, wind, geothermal and electromagnetic energy.

• Perpetual resources are in no danger of being used up. Can you think of any?

• Renewable resources are replaced as they are used. Can you think of any?

• Nonrenewable resources are used up and gone forever. Can you think of any?

Labor Resources• Time and effort to produce

goods and services in exchange for wages.

• Human capital is the knowledge and skill people gain from education and experience. Why do airline pilots get paid more than taxi cab drivers?

• There’s a strong correlation between a country’s level of human capital and its standard of living.

Capital Resources

• Consists of tools, machines and buildings used in production of other goods and services.

• Capital can be screwdrivers, machines, supercomputers, robots, factories, warehouses, bakeries, etc.

Entrepreneurs put it all together

• Entrepreneur roles:

• Innovator - Thinking of new ways to turn capital into goods and services that people want.

• Strategist - Supply the vision and make key decisions that set the course.

• Risk taker - Invest time, energy, abilities and money.

• Sparkplug - Supply energy, drive and enthusiasm needed to turn ideas into reality.

Working Smarter Boosts Productivity

• Factors of production are scarce.

• Productivity is a measure of the output of an economy per unit of input (1 of the 3 inputs).

• Productivity= Output / Input

• Productivity can be raised in 2 ways:

1. Getting more output from the same input.

2. Getting the same output from fewer inputs.

• Division of Labor and Specialization - Each worker is assigned a specific task to perform. What are the advantages of specialization?

Maximizing Utility• Utility = The satisfaction one gains from consuming a product

or service.

• Tradeoffs: We always give up something when we choose.

• Opportunity cost - The value of the next best alternative that you could have chosen instead. Eg. A company chooses to produce trucks instead of cars and trucks. The opportunity cost is what the company has given up in car business.

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Thinking at Margin Principle

• Marginal Utility - The satisfaction you will get from an increase of one additional unit of a good or service.

• The marginal utility of something diminishes as we get more of it.

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The Production Possibility Frontier

• The Production Possibility Frontier (PPF) is an economic model that shows how an economy might use its resources to produce two goods. It measures tradeoffs.

• The example graph shows a PPF for a one-person economy. At point A and E, the person has devoted all his time to one product.

• Point C would be splitting time evenly between clams and turnips.

• The line is know as the Production Possibility Curve.

Measuring Opportunity Costs using the PPF

• Consider a hypothetical country that can use its resources to produce two goods: cell phones and bananas.

• The curve indicates that the tradeoffs are not the same at every point on the curve. As a result, the opportunity cost is greater at some points along the curve than at others.

Analyzing PPFs and Efficiency

• A PPF shows what an economy can produce using its resources as efficiently as possible.

• At point G, the economy is not producing as many cell phones or bananas as it could.

• Point H represents a level of production that is not possible for this economy.

Changes in Productivity• Changes in productivity can shift the curve to the right

or left. Banana production has improved because of introduction of trees that bear more fruit. Cell phone production remains the same.

PPFs and Changes in the Economy

• Changes in the economy can shift the entire curve to the right or left.

• A shift to the right is good news. The economy is expanding or growing.

• A shift to the left is bad news. The economy is shrinking and is heading into hard times.