AP Micro Unit 1

Scarcity

-We have limited resources but unlimited wants

-People always want more goods and services than can be produced with the resources available

-That gap is the Fundamental economic problem

-True in every system

-No country can escape scarcity

Factors of Production

Factors of production are the scare resources

-Capital are tools and equipment used to produce other goods. Ex: factories, machines, and computers (physical capital, not money)

-Labor Human effort, physical and mental. Workers, engineers, and teachers.

-Entrepreneurship is the risk-taking and innovation that organizes land, labor, and capital.

-Natural Resources/Land are all natural resources: oil, water minerals, farmland, and forests

Why are resources scare

-Physical limits:there is only so much oil, land, or labor hours available.

-Time is limited: everyone gets 24 hours a day

-Technology limits production: at any moment, we can only produce what our current technology allows. Ex. U.S factories shifted from consumer goods to military production. The same factories couldn’t fully produce both at once

Rival Resources

-Most factors of production are rival

-If one person uses a machine, someone else cannot use it at the same time

-Scarcity is unavoidable because most productive resources are rival and limited

Non Rival Resources

-Some knowledge is non-rival

-A mathematical formula or coding language can be used by million at once without running out

-Established knowledge can spread widely without becoming scarce in the same way physical resources are

Trade offs

-A trade off is all the alternatives you give up when you choose something

-Ex. if the government increases military spending, it may reduce funding for education

Opportunity Cost

-The value of the next best alternative you give up

-It is only the second best option, not every option

-It is measured in whatever you value most

The three economic questions

What to produce?

-Consumer goods or capital goods?

-Military goods or civilian goods?

How to produce?

-Labor intensive or capital intensive

-Old technology or new

For whom to produce?

-Based on income? Need? Equal shares?

Traditional economy

Customs guide decisions

Market Economy

Prices and profit guide decisions

Command economy

Central planners decide

Mixed economy

Combination of market and command(U.S)

Why Scarcity Matters

Scarcity → Trade-offs → Opportunity Cost → Decision-making → Supply and Demand

If resources were unlimited:

-No trade offs

-No opportunity cost

-No prices

-No economics

Positive Economics

Economics is the study of how to allocate scare resources among competing ends

-Positive economics describes the way things are (fact)

Normative Economics

Economics is the study of how to allocate scare resources among competing ends

-Normative economics describes the way things should be (judgement)

What to produce?

This means which goods and services and how much of each

-Choose more of one means less of another.

-In a market economy, producers respond to consumer demand.

-In a command economy, central planners decide output targets.

How to produce

-Labor intensive: more works and fewer machines

-Capital intensive: more machines and fewer workers

-High tech vs low tech

-large coporations vs small firms

For whom to produce

-In market system it is based on ability to pay

-In command systems it is based on government decisions, equality, goals, or need

-In traditional systems it is based on family, status, or customs

Resource Allocations

Economic system influences:

-Incentives

-Efficiency

-Equity (command and mixed systems often redistribute income)

-innovation

-Stability

Production Possibilities Curve

-Efficiency: points on the curve represent full employment of resources

-Inefficiency: points inside the curve indicate underutilized resources or unemployment

-Unattainable: points outside the curve are impossible with current resources

-Growth: an outward shift represents growth through better technology or more resources.

-Outward shift on the y-axis means that the economy gained the ability to produce more of the good on the y-axis, while the maximum production for the good on the x-axis stays the same. This will increase the opportunity cost for the x-axis goods, since more of the y-axis’s goods are being sacrificed to produce x-axis’s goods.

-Outward shift on the x-axis decreases the opportunity cost for producing x-axis’s goods, while it increases the opportunity cost for y-axis’s goods.

PPC

Shows the max combinations two goods an economy can produce with:

-fixed resources (land, labor, capital, and entrepreneurship)

-fixed technology

-Only two goods

Opportunity cost on the PPC

-Opportunity cost is measured by the slope of the curve

-Opportunity cost= What one Sacrifice/What One Gain

Absolute Advantage

An individual, firm, or country has absolute advantage when it can:

-produce more output with the same resources

-Use fewer resources to produce the same output

An country can have absolute advantage in:

-one good

-both goods

-neither goods

How to spot it:

-In output table (max quantities) look for the larger number

-In input table (hours per unit), look for the smaller number.

Comparative advantage

This means producing a good at a lower opportunity cost

In a two country, two-good model:

-every country will have comparative advantage in one good only

-even if one country has absolute advantage in both goods, trade can still benefit both

Specialization According to Comparative Advantage

Countries should specialize in the good where they have comparative advantage, then trade

-Export what you have comparative advantage in

-Import what you do not

Even if one country has absolute advantage in both goods, specialization still increases total output

-Specialization is the process of focusing one’s time, skills, or resources on a specific task, product, or area of expertise

Specialization in Graph Form

After specializing in the good with comparative advantage and trading at a mutually beneficial rate such as 1:1, the country consumes at a point label “after trade” that is outside its on ppc.

-With specialization and trade consumption can occur outside the PPC

-That represents gains from trade

Terms of Trade

The rate at which one good exchanges for another and for trade to be mutually beneficial:

-The trading must fall between the two opportunity cost

Gains from Trade

A country gains if:

-Export price> its opportunity cost

-Import price< its opportunity cost

When this occurs, both countries consume beyond their PPC and total surplus rises

Explicit cost

-are the traditional out of pocket costs associated with making a decision

-Out of pocket monetary payments (the actual cash expense made by firms or individuals)

-recorded in accounting

Implicit Cost

-are the opportunity costs of making a decision

-Value of forgone alternatives (no money paid)

-not recorded in accounting

Two common mistakes on tests

-Only include costs that change because of the decision. If you’ll pay for food either way, that’s not part of the opportunity cost

-The opportunity cost is the highest-valued alternative, not every alternative combined

Total Benefits

-For consumers

-Measured in utility (satisfaction)

-For firms, it is measure as total revenue

Total cost

-Total economic cost of producing or consuming that quantity

Net Benefit

Net Benefit=Total Benefit-Total Cost

-The rational choice is the one that maximizes total net benefits

Cost Benefit Analysis

Greatest difference between Total Benefit-Total Cost

Marginal benefit

-If the marginal (additional) benefit of an action is greater than (or equal to) the marginal (additional) cost, do it

Marginal Cost

-If the marginal cost of an action is greater than the marginal benefit, don’t do it.

Law of Diminishing Marginal Utility

-As you consume more of a good, marginal benefit eventually falls

-Eventually MB can hit zero or even become negative. That’s the law of diminishing marginal utility, and it explains why the MB curve slopes downard

When to use marginal analysis

-The decision can be adjusted by unit

-Marginal analysis is making decisions based on increments and analyzing benefits and additonal costs

When to use total analysis

-The decision is all or nothing

Utility Max

Marginal Utility1/Price1=Marginal Utility 2/Price 2

Total Utility

-Total Satisfaction obtained when consuming a good

Marginal utility

-The change in total utlity when consumption of a good changes by one unit

Marginal Utility= Change in Total Utility/ Change in quantity

Extra marginal utility info

-Marginal utility is the change in total utility when an extra unit is consumed

-If the marginal utility from the extra unit is positive then total utility increases

-If the marginal utility from the extra unit is zero, then total utility does not change

-If the marginal utility from the extra unit is negative, then total utility decreases

-Marginal Utility=Marginal Benefit

The Optimal Quantity

MB=MC and Total net Benefit (TB-TC) is maximized

-in a table it’s the last unit where marginal benefit is great or equal to marginal cost

Marginal Utility Per Dollar

-The additional Satisfaction a consumer receives from spending one more dollar on a good or service

-Marginal Utility Per Dollar=Marginal Utility/Price

How to calculate max use of utility

1. Calculate marginal utility per dollar for each category

2. Pick the product that gives you the most marginal utility per dollar until you reach your spending limit