economics eco001 jan2014 lecture 1

8/12/2019 Economics ECO001 Jan2014 Lecture 1

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Diploma in Management Studies

Microeconomics ECO001

Lecture 1- Introduction to Economics

Definition and Scope of Economics

Factors of Production

Opportunity Cost

Marginal Analysis

Production Possibility Frontier Economic Growth

Ref: Parkin, Chapters 1 and 2

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Learning Outcomes

After this lecture, students should be able to:

Define economics and its scope

Define factors of production

Explain marginal analysis

Calculate opportunity cost

Analyze production possibilities frontier (PPF)

Explain economic growth using PPF


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Definition of Economics

All economic questions arise because we want morethan we can get.

Our inability to satisfy all our wants is called scarcity.

Because we face scarcity, we must make choices.

The choices we make depend on the incentives weface.

A positive incentiveis a reward that encourages anaction

A negative incentiveor disincentiveis a penalty thatdiscourages an action.

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Definition of Economics

Economicsis the social science thatstudies the choicesthat individuals,businesses, governments, and entiresocieties make as they cope with scarcityand the incentives that influence andreconcile those choices.


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Scope of Economics

Microeconomics

Microeconomicsis the study of choices thatindividuals and businesses make, the way thosechoices interact in markets, and the influence ofgovernments.

Macroeconomics

Macroeconomics is the study of the performanceof the national and global economies.

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Positive and Normative Analysis

Economists distinguish between two types ofstatement:

What is - positive statements

What ought to be - normative statements

- A positive statement can be tested by checking itagainst facts.

Example: Higher tax reduces income of people

- A normative statementcannot be tested.

Example: Higher tax is bad for the economy


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Goods and Services

Goods and servicesare the objects thatpeople value and produce to satisfy humanwants.

Goods and services are produced usingproductive resources called factors ofproduction.

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Factors of Production

Factors of production are grouped intofour categories:

Land

Labor

Capital Entrepreneurship


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Factors of Production The gifts of nature that we use to produce goods and

services are land.

The work time and work effort that people devote toproducing goods and services is labour. The quality oflabor depends on human capital, which is theknowledge and skill that people obtain from education,on-the-job training, and work experience.

The tools, instruments, machines, buildings, and otherconstructions that are used to produce goods and

services are capital.

The human resource that organizes land, labor, andcapital is entrepreneurship.

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Opportunity Cost

Because of scarcity, we need to make choices.Whenever we make a choice, there is a tradeoff.

Thinking about a choice as a tradeoffemphasizes cost as an opportunity forgone.

The highest-valued alternative that we give up toget something is the opportunity cost of theactivity chosen.

Example: Opportunity cost of the three hourslecture is the next best alternative use of thesethree hours


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Marginal Analysis Choosing at the Margin

People make choices at themargin, whichmeans that they evaluate the consequences ofmaking incremental changesin the use of theirresources.

The benefit from pursuing an incrementalincrease in an activity is its marginal benefit.

The opportunity cost of pursuing anincremental increase in an activity is itsmarginal cost.

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Marginal Analysis

Responding to Incentives

Our choices respond to incentives.

For any activity, if marginal benefit exceedsmarginal cost, people have an incentive to do

more of that activity. If marginal cost exceeds marginal benefit,

people have an incentive to do less of thatactivity.

Incentives are also the key to reconciling self-interest and the social interest.


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Product ion Possibil ities Frontier The production possibilities frontier(PPF)

is the boundary between those combinationsof goods and services that can be producedand those that cannot.

To illustrate the PPF, we focus on two goodsat a time and hold the quantities of all othergoods and services constant.

That is, we look at a model economy in whicheverything remains the same (ceteris paribus)except the two goods were considering.

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Production Possibilities

The figure shows the PPFfor two goods: CDs andpizza.

Any point on the

frontier such as E andany point inside thePPF such as Z areattainable.

Points outside the PPFare unattainable.


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Product ion Efficiency

We achieve productionefficiencyif we cannotproduce more of onegood without producingless of some other good.

Any point on thefrontier are production

efficient.

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Product ion Inefficiency

Any point inside thefrontier, such as Z, isinefficient.

At such a point, it is

possible to producemore of one goodwithout producingless of the othergood.

At Z, resources areeither unemployed ormisallocated.


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PPF and Opportunity Cost

Tradeoff Along the PPF

Every choice alongthe PPF involves atradeoff.

On this PPF, wemust give up someCDs to get more

pizzas or give upsome pizzas to getmore CDs.

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PPF and Opportunity Cost

The PPF makes theconcept of opportunitycostprecise.

As we move downalong the PPF, weproduce more pizzasbut the quantity of CDswe can producedecreases.

The opportunity cost ofa pizza is the CDsforgone.


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PPF and Opportunity Cost In moving from Eto F,

the quantity of pizzasproduced increases by1 million.

The quantity of CDsproduced decreases by5 million.

The opportunity cost of

producing the fifth 1million pizzas is 5million CDs.

One of these pizzascosts 5 CDs.

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PPF: Increasing Opportunity Cost

Because resourcesare not all equallyproductive in allactivities, the PPFbows outwardisconcave.

The outward bow ofthe PPFmeans thatas the quantityproduced of eachgood increases, sodoes its opportunitycost.


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PPF: Using Resources Efficiently All the points along the PPF are production

efficient.

To determine which of the alternative efficientquantities to produce, we compare costs andbenefits.

The PPF and Marginal Cost

The PPF determines opportunity cost.

The marginal costof a good or service is theopportunity cost of producing one more unit of it.

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PPF: Using Resources Efficiently

The figure illustratesthe marginal cost ofpizza.

As we move alongthe PPFin part (a),

the opportunity costof pizza increases.

The opportunity costof producing onemore pizza is themarginal cost of apizza.


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Increasing Opportunity Cost In part (b) of the figure, the bars illustrate theincreasing opportunity cost of pizza.

The black dots andthe line labeled MCshow the marginalcost of pizza.

The MC curve

passes through thecenter of each bar.

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Preferences and Marginal Benefit

Preferencesare a description of a persons likesand dislikes.

To describe preferences, economists use theconcepts of marginal benefit and the marginalbenefit curve.

The marginal benefitof a good or service is thebenefit received from consuming one more unit ofit.

We measure marginal benefit by the amount thata person is willing to payfor an additional unit of agood or service.


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Marginal Benefit Curve It is a general principle that the more we have of

any good, the smaller is its marginal benefit andthe less we are willing to pay for an additionalunit of it.

We call this general principle the principle ofdecreasing marginal benefit.

The marginal benefit curveshows the

relationship between the marginal benefit of agood and the quantity of that good consumed.

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Marginal Benefit Curve

The figure shows amarginal benefitcurve.

The curve slopesdownward to reflect

the principle ofdecreasing marginalbenefit.

At pointA, with pizzaproduction at 0.5million, people arewilling to pay 5 CDsfor a pizza.


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Decreasing Marginal Benefit

At point B, withpizza production at1.5 million, peopleare willing to pay 4CDs for a pizza.

At point E, withpizza production at

4.5 million, peopleare willing to pay 1CD for a pizza.

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Combining Marginal Benefit and

Marginal Cost

Price/Cost

Quantity

Marginal Cost

Marginal Benefit

Q*

Optimal quantity Q*

Marginal Benefit equalsMarginal Cost


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Product ive and Allocative Effic iency

When we cannot produce more of any one goodwithout giving up some other good, we have achievedproduction efficiency.

Production efficiencyProducing at a point onthePPF (Marginal Cost Curve).

When we cannot produce more of any one goodwithout giving up some other good that we value morehighly, we have achieved allocative efficiency.

Allocative efficiencyProducing at thepoint on thePPF that we prefer above all other points (MarginalBenefit equals Marginal Cost)

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Economic Growth The expansion of production possibilitiesand

increase in the standard of livingis calledeconomic growth.

Two key factors influence economic growth:Technological change and Capital accumulation

Technological changeis the development ofnew goods and of better ways of producinggoods and services.

Capital accumulationis the growth of capitalresources, which includes human capital.


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Cost of Economic Growth To use resources in research and

development and to produce new capital,we must decrease our production ofconsumption goods and services.

So economic growth is not free.

The opportunity cost of economic growth isless current consumption

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Economic Growth

The figure illustratesthe tradeoff we face.

We can producepizzas or pizza ovens

along PPF0. By using some

resources to producepizza ovens today,the PPFshiftsoutward in the future.


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Economic Growth in USA and HK In 1966, Hong Kongs

production possibilities(per person) were aquarter of those in theUnited States.

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Economic Growth in USA and HK

By 2006, Hong Kongsproduction possibilities(per person) were 80percent of those in theUnited States.

Hong Kongs PPFshifted out morequickly than did theU.S. PPFbecauseHong Kong devotedmore of its resources tocapital accumulation.


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Exercise 1.1 All of the following are examples of normativestatements EXCEPT:

A) Reducing cost should not be done atthe expense of inferior quality.

B) The government must act decisively toreduce pollution.

C) The company should employ lessworkers and use more machines in theproduction.

D) In this year, the companys profitincreases by 5%. E) The market price of car is too high in

Singapore.

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Exercise 1.2

Amy is thinking about going to the moviestonight to see Jurassic Park 2. A ticket costs$7 and she will have to cancel her tuition jobthat pays $30. The opportunity cost ofseeing the movie is

A) $7. B) $30.

C) $37.

D) $37 minus the benefit of seeing the movie.

E) indeterminate.


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Exercise 1.3David is considering pursuing a one-year full-timepostgraduate program in a local university. The tuitionfee of the postgraduate program is $6,000 andexpenses of $3,000 for study-related activities, suchas buying textbooks and stationery will have to beincurred. In addition, to pursue the program, Davidwill have to give up his current job as a salesassistant which pays $20,000 per year. His expenses

on non-study related activities are $15,000 per year.What is his opportunity cost of pursuing the one-yearfull-time postgraduate program?

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Exercise 1.4 Jay has estimated that the additional benefit of writing 50

more lines of computer programming code is $20 and theadditional cost is $10. He should:

A) not write the code because it would not be arational choice.

B) write the code because it would be a rational

choice and an optimal quantity. C) write the code because it would be a rational

choice but it is not an optimal quantity.

D) not write the code because it would not be arational choice but it would be an optimal quantity.

E) not write the code because it would not be arational choice, nor would it be an optimal quantity


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Exercise 1.5What happen to the PPF model that produces2 goods X and Y if:

a) All resources are perfect substitutes inproducing the two products?

b) There are unemployed resources in theeconomy?

c) Previously unused resources are now beingutilized?

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Exercise 1.6An economy produces two goods, car and rice.Illustrate the effects of the following incidents on theproduction possibility set.

a)There is an influx of workers who are more skilledin producing cars.

b)An earthquake destroys factories and farmlandsacross the country.

c)There is an improvement in technology in theproduction of cars.

d)Some workers migrates to nearby countries insearch of better employment opportunities.

economics eco001 jan2014 lecture 1

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