AP ECONOMICSUNIT 1

BASIC TERMS & CONCEPTS

How people choose to use scarce resources

ECONOMICS

MICROECONOMICS MACROECONOMICSHow businesses and individuals choose to use scarce resources

How resources are used in the aggregate

Unlimited Wants v. Limited Resources

SCARCITY

CHOICEThe good or service selected

Because we choose, we necessarily must leave something behind.

ECONOMIC CONTINUUMCOMMAND ORCENTRALLY PLANNED

MIXED MARKET

Gov’t or sm. groupof gov’t advisorsown & operate theFOP’s

Buyers and sellers ownand operate the FOP’s

Buyers & sellers togetherwith the gov’t own & operate the FOP’s Self-interest

Profit motivatedSelf regulatingInnovationCompetitionPricing SystemIncentivesPrivate Property

PRIVATE PROPERTY is the key distinguishing factorbetween a market and command economy.

1. What to produce.

2. How to produce.

3. Who gets the product.

3ECONOMIC QUESTIONS

Economists are concerned with what happens at the MARGIN.

MARGIN: one more of something

MARGINAL COST: how much more does it cost to produce one more product

MARGINAL BENEFIT: how much more benefit is received from one more product

MARGINALISM

At this point, know that demand will increase when more benefit is received.

The marginal cost is what it takes to get one more unit of a product.

MARGINALISM Con’t

PRIC

E

QUANTITYMB

MC

Economy functions whereMC and MB meet.

What is left behind!

Formally defined as

THE NEXT BEST ALTERNATIVE!

Opportunity Cost

FINDING THE OPPORTUNITY COST ON THE PRODUCTION POSSIBILITIES CURVE

Pretzels

Chee

se

24

6

1 2 3 4

8

AB

CD

E Pt. On PPF

Cheese

Pretzels

Op Cost

A 0 4B 2 3 2:1C 4 2 2:1D 6 1 2:1E 8 0 2:1

CONSTANT Opportunity Cost

FINDING THE OPPORTUNITY COST ON THE PRODUCTION POSSIBILITIES CURVE

Chee

se

Pretzels

INCREASING Opportunity Cost

Pt. On PPF

Cheese

Pretzel

Op Cost

A 2 11 2:11B 5 10 5:10C 8 8 8:8

A2

5

8

8 10 11

B

C

Land AKA Natural Resources: oil, water, gold, natural gas, property

Labor: people

Capital: things that allow more to be made in the future

FACTORS OF PRODUCTION

Human Capital: knowledge, skills, education, and talent

Physical Capital: Buildings, tools, transportation, conveyor systems

CAPITAL: 2 Kinds

Comparison of the production of 2 goods/services given the resources available

-----Consumer Goods

-----Capital Goods: Poor countries will want capital goods before consumer goods because capital allows them to make more in the future

PRODUCTION POSSIBILITIES CURVE

Consumer Goods

Capi

tal G

oods

A

A’

Production Possibilities Frontier

GROWTH: 1. Technology 2. QTY of Resources 3. QLTY of Resources

UNDERUTILIZATION: Resourcesare available but not being used

This PPC is a constant production possibilities curve. As production moves up the curve from A to A’, the cost of A is constant.

All points on the PPF representEfficiency.

Consumer Goods

Capi

tal G

oods

A

A’ PPF: CONCAVE to the origin Shape is concave to the origin because of the Law of Increasing Costs

Law of Increasing Costs: as more of one good is produced, increasing amounts of a second good are given up

4 ASSUMPTIONS OF A PPC:

1. The graph compares the production of 2 goods given the resources available.

2. When on the curve, there is an efficient use of all resources available.

3. Resources in quantity and quality and technology do not change when on the curve.

4. Production techniques do not change.

Capi

tal G

oods

Consumer GoodsA

A’

UNDERUTILIZATION

When you are inside the area of underutilization:

1. Unemployment (Remember that labor is a resource and under- utilization is not using your resources efficiently. If labor isn’t being used, it is underutilized and the position on the graph relative to the curve is placement under the curve.)

2. Idle resources such as strip malls with empty stores

Capital Goods

Consumer GoodsA

A’

B

B’

When do you shift the PPF:

Anytime there is an elimination of resources. Think about a country that has a declining birth rate or a resource destroyed by a natural disaster or war.

Leftward OR Downward shift of the PPF is always a decrease.

Capital Goods

Consumer Goods A

A’

B

B’

When the PPF shifts from AA’ to BB’, the new curve moved into the

area of growth!Therefore, the reasons you shift the curve are technology, an increase in the quantity of resources &/or an increase in the quality of resources.

Rightward OR Outward OR Upwardshift of the PPF is always an INCREASE

When do you shift the frontier?

Consumer Goods Consumer Goods

Capi

tal G

oods

Capi

tal G

oodsA B

What is happening in Graph A?

What is happening in Graph B?

Movement on the PPF

Capi

tal G

oods

Consumer Goods A

A’

∙

E∙∙

B

CD

When to move on the curve and what is that saying:Moving from point to point on the curve is just a matter of reallocating resources to the production of more of one good and less of another.

Any point on the curve is technically efficient; HOWEVER, depending onthe circumstances, it may be better to be closer to consumer goods orcloser to capital goods.

Explanations of the PPC should contain the phrase

GIVEN THE AVAILABLE RESOURCES

REMEMBER*

David Ricardo theory that extended Adam Smith’s theory

Concept explains the need for and value of trade

Concept of Absolute & Comparative Advantage

PRODUCTIVELY EFFICIENT: Produce using the fewest resources at the least cost.

ALLOCATIVELY EFFICIENT: Produce what people want

EFFICIENT

Voluntary exchange—NO coercion

All parties MUST benefit or trade will not occur

A country may have the absolute advantage and still not have the comparative advantage.

Trade is based on comparative advantage

Evaluation of the least opportunity cost

TRADE

Trade is based on use of the least resources because resources are scarce.

If a country has the lowest opportunity cost, that country is producing the most with the least amount of resources.

A country producing more with less is most efficient. If countries are most efficient, they should produce to get the greatest yield and waste the least.

DO WHAT YOU ARE BEST AT! SPECIALIZATION!

The Logic of Trade

The country that produces the most given the available resources

ABSOLUTE ADVANTAGE

The country with the least opportunity cost in the production of a good or service given the available resources.

COMPARATIVE ADVANTAGE

Output questions relate the amount of a good or service produced.

Answers the questions: How Much Produced

It’s better to produce more at a lower cost!

OUTPUT QUESTIONS

Input questions relate to the amount of the resource used to produce the product.

It’s better to use fewer resources!

INPUT QUESTIONS

Answers are always based on an evaluation of the OPPORTUNITY COST.

Answers must acknowledge the Opportunity Cost as a calculated number or ratio.

Answers must indicate that the conclusion is based on the available resources.

ANSWERING OUTPUT & INPUT QUESTIONS

CA/AA ProblemGUNS BUTTER

SPARTANVILLE 20 10 lbs.WOLVES COVE 5 20 lbs.

How to read the chart:

Spartanville and Wolves Cove make guns and butter with resources available.

Spartanville can make 20 guns or 10 lbs. of butter with the resources available to them.

Wolves Cove can make 5 guns or 20 lbs. of butter with the resources available to them.

GUNS BUTTERSPARTANVILLE 20 10 lbs.WOLVES COVE 5 20 lbs.

This is an OUTPUT question.

Step 1: Determine who has the absolute advantage. The absolute advantage lies with the country that makes the most product GIVEN THE AVAILABLE RESOURCES.

For Guns: Spartanville makes 20 Wolves Cove makes 5

Spartanville makes more so they have the absolute advantage in guns GIVEN THE AVAILABLE RESOURCES.

For Butter: Spartanville makes 10 lbs. Wolves Cove makes 20 lbs.

Wolves Cove makes more so they have the absolute advantage in butter GIVEN THE AVAILABLE RESOURCES.

GUNS BUTTERSPARTANVILLE AA 20 10 lbs.WOLVES COVE 5 AA 20 lbs.

Step 2: Determine the comparative advantage. The comparative advantage lies with the country that experiences the LOWEST OPPORTUNITY COST GIVEN THE AVAILABLE RESOURCES.

For Guns: Spartanville loses 10 lbs. of butter for 20 guns. The loss OR COST is 10:20 OR ½ butter.

Wolves Cove loses 20 lbs. of butter for 5 guns. The loss OR COST is 20:5 OR 4 butter.

Therefore, because Spartanville loses only 1/2 butter while Wolves Cove loses 4 butter it has the lower opportunity cost GIVEN THE AVAILABLE RESOURCES and thus the comparative advantage inguns.

GUNS BUTTERSPARTANVILLE AA 20

CA 10 lbs.

WOLVES COVE 5 AA 20 lbs.

For Butter: Spartanville loses 20 guns for 10 lbs. of butter. The loss OR COST is 20:10 lbs. OR 2 guns.

Wolves Cove loses 5 guns for 20 lbs. of butter. The loss OR COST is 5:20lbs. OR 1/4 guns.

Therefore, because Wolves Cove loses only ¼ butter while Spartanville loses ½ butter Wolves Cove has the lower opportunity cost GIVEN THE AVAILABLE RESOURCES and thus the comparative advantage in butter.

GUNS BUTTERSPARTANVILLE AA 20

CA 10 lbs.

WOLVES COVE 5 AA 20 lbs.CA

Step 3: State who should produce which product.

Since Spartanville has the lowest opportunity cost andtherefore the comparative advantage, Spartanville shouldproduce guns.

Since Wolves Cove has the lowest opportunity cost andtherefore the comparative advantage, Wolves Coveshould produce butter.The production decision for both products was determined GIVEN THE AVAILABLE RESOURCES.

GUNS BUTTERSPARTANVILLE AA 20

CA 10 lbs.

WOLVES COVE 5 AA 20 lbs.CA

Step 4: Determine terms of trade.Terms of trade is the final step in determining if trade is in thebest interest of both countries. REMEMBER: Trade MUST be beneficialto both parties involved or it will not occur.

This step will be discussed during the Macroeconomics portion ofthe course as this topic will recur.

CA/AA PROBLEMGUNS BUTTER

SPARTANVILLE 20 hrs. 10 lbs./hr.WOLVES COVE 5 hrs. 20 lbs./hr.

How to read the chart:

Spartanville and Wolves Cove make guns and butter with the resources available.

Spartanville can make 1 gun every 20 hours or 10 lbs. of butter every hour with the resources available to them.

Wolves Cove can make 1 gun every 5 hours or 20 lbs. of butter every hour with the resources available to them.

GUNS BUTTERSPARTANVILLE 20 hrs. 10 lbs./hr.WOLVES COVE 5 hrs. 10 lbs./hr.

This is an INPUT question.

Step 1: Determine who has the absolute advantage. The absolute advantage lies with the country that uses the least amount of resources to make a product.

For Guns: Spartanville uses 20 hours (of labor or capital) Wolves Cove uses 5 hours (of labor or capital)

Wolves Cove uses the least number of hours to produce guns so they have the absolute advantage in guns GIVEN THE AVAILABLE RESOURCES.

GUNS BUTTERSPARTANVILLE 20 hrs. 10 lbs./hr.WOLVES COVE AA 5 hrs. 10 lbs./hr.

Step 1 Continued:

For Butter: Spartanville uses 1 hour (of labor or capital) to make10 lbs. of butter Wolves Cove uses 1 hour (of labor or capital) to make10 lbs. of butter Since both countries use the same amount of resources

to produce butter, there is no absolute advantage in butter.

Step 2: Determine the comparative advantage. The comparative advantage lies with the country that experiences the LOWEST OPPORTUNITY COST GIVEN THE AVAILABLE RESOURCES.

GUNS BUTTERSPARTANVILLE 20 hrs. 1 lbs./hr.WOLVES COVE AA 5 hrs. 1 lbs./hr.

For Guns: Spartanville can make 1lbs. of butter in an hour OR make 1 guns in 20 hours. The loss OR COST is 20:1 OR 20 butter.

Wolves Cove can make 1 lbs. of butter in an hour OR make 1 gun every 5 hours. The loss OR COST is 5:1 OR 5 butter. Therefore, because Wolves Cove loses only 5 butter while Spartanville

loses 20 butter it has the lower opportunity cost GIVEN THE AVAILABLE RESOURCES and thus the comparative advantage in guns.

GUNS BUTTERSPARTANVILLE 20 hrs. 1 lbs./hr.WOLVES COVE AA 5 hrs. CA 1 lbs./hr.

For Butter: Spartanville can make 1 lb. of butter in 1 hour OR 1 gun every 20 hours. The loss OR COST is 1:20. OR 1/20 guns.

Wolves Cove can make 1 lb. of butter in 1 hour OR 1 gun every 5 hours. The loss OR COST is 1:5 OR 1/5 guns.

Therefore, because Spartanville loses only 1/20 guns while Wolves Cove loses 1/5 butter Wolves Cove has the lower opportunity cost GIVEN THE AVAILABLE RESOURCES and thus the comparative advantage in butter.

GUNS BUTTERSPARTANVILLE 20 hrs. 1 lbs./hr. CAWOLVES COVE AA 5 hrs. CA 1 lbs./hr.

Step 3: State who should produce which product.

Since Spartanville has the lowest opportunity cost andtherefore the comparative advantage, Spartanville shouldproduce butter. Since Wolves Cove has the lowest opportunity cost andtherefore the comparative advantage, Wolves Cove shouldproduce guns.

The production decision for both products was determined GIVEN THE AVAILABLE RESOURCES.

The comparative and absolute advantage question may be placed inside a story. Given the data in the story, create the chart and work the problem the same way.

Example: Spartanville and Wolves Cove are two different countries on the coast of the continent of Michilvania. Each country makes guns and butter. Spartanville can make 20 guns or 10 pounds of butter. Wolves Cove can make 5 guns or 20 pounds of butter.

A DIFFERENT WAY TO SEE THE SAME QUESTION

Remember that comparative and absolute advantage are determined using opportunity cost AND production of 2 goods is analyzed on a production possibilities curve AND opportunity cost can be determined using the data gathered from a PPC.

Therefore, this question could appear as a PPC. Use the data from the graph and create the chart. Work the problem the same way.

AGAIN A DIFFERENT WAY TO SEE THE SAME QUESTION

EXAMPLE:

Guns

Butter

20

5

10 20

Spartanville

Wolves Cove

http://www.youtube.com/watch?v=8JYP_wU1JTUKahn Academy explanation of Economics, Microeconomics, Macroeconomicshttp://www.youtube.com/watch?v=7LVRxTmVRbIKahn Academy explanation of production possibilitieshttp://www.youtube.com/watch?v=nwEihKsiz4sKahn Academy explanation of calculating opportunity costhttp://www.youtube.com/watch?v=qFi12NnZB6U &http://www.youtube.com/watch?v=7_pZ0ZxEPO4Kahn Academy explanation of comparative and absolute advantagehttp://www.youtube.com/watch?v=SJQ56vJoy3YACDC Economics explanation of production possibilitieshttp://www.youtube.com/watch?v=FpTBjRf8lGsACDC Economics explanation of comparative/absolute advantagehttp://www.youtube.com/watch?v=z9SAzSm24qgACDC Economics explanation of input and output questions for comparative/absolute advantage

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