AP Econ – Unit 1

Topic 1.1 – Scarcity

Scarcity

• Scarcity in Microeconomics:
• Resources, both physical (land, water, oil) and intangible (time, skills, attention), are limited.
• Choices must be made on how to allocate these resources.
• Types of Scarcity:
• Absolute Scarcity: Physical limitations of resources.
• Relative Scarcity: The value society places on resources, even if not physically scarce (e.g., diamonds).
• Foundation of Microeconomics:
• Scarcity is fundamental to microeconomics.
• Understanding how people make decisions when faced with limited resources.
• Opportunity Cost:
• The value of what is given up when choosing one option over another.
• A crucial concept in decision-making under scarcity.
• Price and Resource Allocation:
• Prices play a role in allocating resources.
• When resources are scarce, prices tend to rise, encouraging efficiency and the search for substitutes.
• Economic Systems and Scarcity:
• Capitalist System: Relies on prices and market forces for resource allocation.
• Planned Economy: Government intervention in resource allocation decisions.
• Incentives in the Face of Scarcity:
• Prices, taxes, subsidies, and regulations are incentives used to influence resource usage.
• Encouraging efficient resource utilization.
• Interaction of Supply and Demand with Scarcity:
• Scarce resources lead to price increases.
• Prices, in turn, affect supply and demand dynamics.

Introduction to economics

• Adam Smith's quote emphasizes self-interest leading to unintended societal benefits, a foundational idea in capitalism.
• Microeconomics studies individual actors' decisions with a focus on allocating scarce resources like money, time, and labor.
• Macroeconomics examines the aggregate impact on the economy and addresses policy-related questions.
• Modern economics divides into microeconomics and macroeconomics, aiming for mathematical rigor.
• Mathematical models in economics simplify complex human interactions but must be interpreted cautiously due to inherent assumptions.
• Alfred Knopf's quote humorously critiques economists who express the obvious in incomprehensible terms.
• Lawrence J. Peter's quote highlights the challenge of economic predictions, particularly in macroeconomics, where uncertainties abound.

Scarcity (video)

• Economics is built on the notion of scarcity, implying insufficient availability of goods, services, or resources.
• Scarcity necessitates economic study to understand how limited resources are allocated in response to demand.
• Free resources, in contrast to scarce ones, are seemingly abundant and do not diminish with increased usage.
• The video uses examples like caviar, labor, a picturesque town, and air to illustrate scarcity or lack thereof.
• Caviar is a scarce resource, requiring significant effort to obtain, while labor is also considered scarce as people expect compensation for their work.
• The scarcity of resources is evident in desirable locations like a town with a scenic view, where not everyone can live.
• The perception of resources, such as water and air, can shift from free to scarce based on factors like human intervention or extraterrestrial living conditions.
• While oxygen on Earth is currently considered a free resource, the video suggests scenarios where it could become scarce, such as in a space station or a world without photosynthetic plants.
• Scarcity is highlighted as the central idea in economics, driving the need for economic principles to allocate resources and understand the trade-offs involved.
• Future studies in micro and macroeconomics will delve into methods of resource allocation and the implications of different allocation models.

Four factors of production

• The four factors of production: land, labor, capital, and entrepreneurship.
• Land includes natural resources like water, air, and energy.
• Labor involves the human effort needed for production, evident in activities such as planting and harvesting crops.
• Capital, in an economic context, refers to tools, buildings, and machinery produced to facilitate the production of other goods.
• Entrepreneurship involves organizing the factors of production to achieve efficient and productive output.
• Technology is sometimes interchangeably used with entrepreneurship in the context of factors of production.
• The trade-off between producing capital goods (for future production) and consumption goods (for immediate use) is crucial in economic decision-making.

Scarcity and rivalry

• Scarcity in economics refers to the limited availability of goods or services due to potentially unlimited wants from people.
• Scarce resources, such as oil, land, or housing, require allocation strategies to meet the demands of competing individuals.
• Rivalry in economics involves competition for a resource, where one person's use limits the ability of others to use it.
• Examples of rival goods include housing in tight markets, where multiple people compete for the same property.
• The video introduces a spectrum from highly rivalrous (rival goods) to non-rival (non-rival goods) to illustrate the degree of rivalry for different resources.
• Air is used as an example of a non-rival good, as one person's use (breathing) does not impede another's simultaneous use.
• The concept of simultaneity is crucial in determining whether a good is rivalrous or non-rivalrous.
• Roads are presented as an example of rival goods during rush hour, were increased usage limits simultaneous access for others.
• However, roads at 3:00 a.m. in most places are closer to being non-rival goods, as one person's use doesn't hinder others' simultaneous use.

Normative and positive statements

• Normative Statements:
  • Express opinions or ethical beliefs.
  • Cannot be tested for accuracy.
  • Examples include statements about what is right or wrong, fair or unfair.
• Positive Statements:
  • Are testable and can be proven true or false.
  • Examples include statements that can be examined through experimentation or analysis.
  • Focus on what can be observed or measured rather than personal opinions.
• Examples:
  • Normative Statement: "Paying people who aren't working, even though they could work, is wrong and unfair."
    • Expresses an opinion, cannot be tested.
  • Positive Statement: "Programs like welfare reduce the incentive for people to work."
    • Can be tested through observation and comparison.
  • Positive Statement: "Raising taxes on the wealthy to pay for government programs grows the economy."
    • Can be tested through simulations or case studies.
  • Positive Statement: "Raising taxes on the wealthy slows economic growth."
    • Testable despite potential bias, can be examined through real-world data.
  • Normative Statement: "The government should raise taxes on the wealthy to pay for helping the poor."
    • Expresses an opinion, not testable.

Topic 1.2 – Resource allocation and economic systems

Property rights in a market system

• Property rights are essential for the proper functioning of a market-based economy.
• Property rights involve defining ownership and determining what individuals can do with their property.
• Strong property rights provide clarity in transactions and prevent disputes over ownership.
• The video presents a thought experiment using houses to demonstrate how property rights impact market dynamics.
• Properly functioning property rights led to effective market signals, influencing production and consumer choices.
• In a world with weak or disputed property rights, market signals break down, leading to potential market failures.
• The video contrasts the market-based system with command economies, highlighting the incentive problems associated with the latter.
• Command economies lack the efficiency and innovation incentives present in market-based systems.
• The speaker encourages viewers to consider the infrastructure in society that enforces property rights and promotes economic stability.

Topic 1.3 – Production possibilities curve (PPC)

Production possibilities curve

• The hunter-gatherer faces a trade-off between hunting rabbits and gathering berries, assuming a fixed amount of time for both activities.
• Scenarios A through F are presented, each representing a different allocation of time between hunting and gathering, leading to varying quantities of rabbits and berries.
• The term "ceteris paribus" is introduced, meaning all other things are held equal when examining changes in variables.
• The points representing different scenarios are plotted on a graph with the number of rabbits on one axis and the number of berries on the other.
• These points form a curve known as the production possibilities frontier, illustrating all possible combinations of rabbits and berries given the constraints.
• Points on the frontier are considered efficient, representing the maximum use of resources, while points inside or outside the frontier are deemed inefficient or unattainable, respectively.

Opportunity cost

• Scenario E: In this scenario, the average is catching one rabbit or gathering 280 berries.
• Trade-off for More Rabbits: If the decision is made to catch one more rabbit (moving from scenario E to D), there is an opportunity cost of giving up 40 berries.
• Opportunity Cost Definition: The opportunity cost of catching one more rabbit is defined as giving up 40 berries, specific to scenario E.
• Marginal Cost: The opportunity cost of producing one more unit (in this case, rabbit) is referred to as the marginal cost.
• Scenario E to Scenario F Trade-off: If the goal is to eat more fruit and give up rabbits (moving from scenario E to F), the opportunity cost of 20 more berries is giving up one rabbit.
• Marginal Cost Calculation: If expressed as a marginal cost, 1 more berry in scenario E is equivalent to 1/20 of a rabbit, assuming linearity in the cost curve.
• Encouragement for Analysis: Viewers are encouraged to analyze the opportunity cost at different points on the curve in various scenarios, considering the data from the constructed table.

Increasing opportunity cost

• Scenario F (Starting Point):
  • Vegetarians focusing on berries.
  • Opportunity cost of going after one rabbit is 20 berries.
• Scenario E:
  • Already hunting one rabbit a day.
  • Going for a second rabbit costs 40 berries.
• Scenario D:
  • Transitioning into carnivores, wanting more rabbits.
  • Giving up 60 berries for three rabbits a day.
• General Trend:
  • Increasing the number of rabbits pursued leads to a proportional rise in opportunity cost.
  • Pursuing five rabbits a day results in giving up 100 berries, leading to no berries at all.
• Explanation:
  • The phenomenon of increasing opportunity cost is illustrated through the hunter-gatherer's decision-making.
  • Initially, easy-to-get rabbits are chosen over harder-to-reach berries.
  • As the pursuit intensifies, faster and smarter rabbits are targeted, requiring more time and sacrificing easier-to-reach berries.
  • The obsession with hunting rabbits leads to ignoring nearby berries, emphasizing the increasing opportunity cost.
• Graphical Representation:
  • Presented on a production possibilities frontier, showing a bow-shaped curve.
  • The negative slope increases as more units are pursued, indicating rising opportunity costs.
• Relevance to Economic Models:
  • Explains why increasing opportunity cost is a recurring phenomenon in economic models.
  • Simplifies choices to two variables (rabbits and berries) to illustrate the concept.
• Conclusion:
  • The concept of increasing opportunity cost is visually represented through the bow-shaped curve, emphasizing the trade-offs in economic decision-making.

PPCs for increasing, decreasing, and constant opportunity cost

• Increasing Opportunity Cost (Bowed Out Curve)
  • Describes a scenario where catching each additional rabbit leads to a higher opportunity cost in terms of berries.
  • Illustrated by a bowed-out PPC.
  • Example: As more rabbits are caught, the berries sacrificed increase progressively (20, 40, 60, 80, 100).
• Decreasing Opportunity Cost (Bowed In Curve)
  • Represents a situation where catching additional rabbits results in a lower opportunity cost for berries over time.
  • Demonstrated by a bowed-in PPC.
  • Example: With experience and improved skills, the opportunity cost decreases for each successive rabbit (100, 80, 60, 40, 20).
• Constant Opportunity Cost (Straight Line Curve)
  • Indicates a consistent opportunity cost for catching rabbits in terms of berries.
  • Shown as a straight-line PPC.
  • Example: Each rabbit caught results in a fixed sacrifice of 60 berries, regardless of the number of rabbits caught or berries already obtained.

Production possibilities curve as a model of a country’s economy

• The PPC represents the potential combination of goods a country can produce efficiently.
• Efficient resource use is depicted on the curve, while inefficient use is within the curve, and points beyond are unattainable without changing inputs.
• A recession can led to inefficient resource use, placing a country behind the PPC.
• Economic growth is shown by an outward shift of the PPC, indicating increased resources like land, capital, labor, or improved technology.
• Economic contraction is illustrated by an inward shift of the PPC due to factors like war, loss of resources, or reduced technology.
• Shifting the PPC requires changes in inputs such as more land, capital, labor, or technology.

Topic 1.4 – Comparative advantage and trade

Comparative advantage, specialization, and gains from trade

• Charlie can produce 30 cups or 10 plates, and Patty can produce 10 cups or 30 plates.
• Opportunity cost for Charlie to produce 1 plate is 3 cups, while for Patty, it's 1/3 of a cup.
• Patty has a comparative advantage in plates, and Charlie has a comparative advantage in cups.
• Through specialization and trade, both Charlie and Patty can achieve outcomes beyond their individual production possibilities.
• They agree to trade at a rate of 1 cup for 1 plate, which is lower than their respective opportunity costs.
• By specializing in their comparative advantages and trading, they can reach a scenario where each has 15 cups and 15 plates, surpassing their individual production limits.

Comparative advantage and absolute advantage

• Patty had a comparative advantage in plates, while Charlie had a comparative advantage in cups, based on their differing opportunity costs.
• Comparative advantage is not to be confused with absolute advantage, which depends on productivity with the same inputs.
• Even if Charlie has an absolute advantage in both cups and plates due to increased productivity, specialization based on comparative advantage remains beneficial.
• The video introduces Production Possibilities Frontiers (PPF) to depict the trade-offs and opportunities for both Patty and Charlie.
• Patty's comparative advantage in plates and Charlie's in cups persist, even when Charlie achieves an absolute advantage in both products.
• The concept of opportunity cost is crucial in determining comparative advantage and trade decisions.
• Trade between Patty and Charlie, where the exchange is cheaper than their opportunity costs, results in outcomes beyond their individual PPFs.
• The video emphasizes the importance of specialization, comparative advantage, and trade for achieving outcomes beyond individual production capabilities.

Opportunity cost and comparative advantage using an output table

• The video discusses the relationship between opportunity cost, comparative advantage, and production possibility curves for two countries.
• An output table is introduced to represent the maximum production of basketballs and shoes per worker per day in each country.
• The opportunity cost table is created to calculate the trade-off between producing basketballs and shoes in terms of each country's comparative advantage.
• Opportunity cost is calculated by comparing the production extremes on the production possibility curves and inputting the data into tables.
• The opportunity cost of producing basketballs is determined in terms of pairs of shoes, and vice versa.
• Country A is found to have a lower opportunity cost for producing basketballs, giving it a comparative advantage in basketball production.
• Country B has a lower opportunity cost for producing shoes, indicating a comparative advantage in shoe production.
• The tutorial emphasizes the importance of focusing on comparative advantage rather than absolute advantage for efficient resource allocation.
• Trade implications and benefits of specialization based on comparative advantage are briefly discussed.

Terms of trade and the gains from trade

• Production Possibility Curves:
  • Each country has production possibility curves for pants and shirts, representing the maximum output per worker per day.
  • Country A can produce a maximum of 20 pants or 10 shirts per worker per day, while Country B can produce 30 pants or 45 shirts.
• Opportunity Costs Calculation:
  • Opportunity cost is calculated based on the constant opportunity cost assumption and the given production possibilities.
  • Country A's opportunity cost of producing a pant is 1/2 a shirt, and the opportunity cost of producing a shirt is 2 pants.
  • Country B's opportunity cost of producing a pant is 3/2 of a shirt, and the opportunity cost of producing a shirt is 2/3 of a pant.
• Comparative Advantage:
  • Country A has a comparative advantage in producing pants due to its lower opportunity cost.
  • Country B has a comparative advantage in producing shirts due to its lower opportunity cost.
• Trade and Gains:
  • By specializing in their comparative advantage and trading, both countries can go beyond their production possibility curves.
  • Country A can trade pants for shirts, and Country B can trade shirts for pants, resulting in both countries being better off.
  • The gains from trade allow them to reach points beyond their individual production possibilities.
• Key Takeaway:
  • Comparative advantage facilitates mutually beneficial trade, leading to outcomes beyond individual production possibilities, demonstrating the value of specialization and trade.

Input approach to determining comparative advantage

• The video introduces an input approach to determining comparative advantage, shifting from the traditional output-based perspective.
• Worker hours per item per country are presented in an input table, emphasizing the time it takes to produce a unit of a product.
• The input data is then converted into an output table, considering the assumption of eight working hours per day in each country.
• Opportunity cost is calculated for toy cars and belts in both countries, comparing the efficiency of production.
• Despite one country having an absolute advantage in producing a particular item, the comparative advantage is determined based on opportunity costs.

When there aren’t gains from trade

• Two countries, A and B, capable of producing apples and bananas in varying quantities.
• Comparative advantage is determined by analyzing the opportunity cost of producing each good in each country.
• Opportunity cost is illustrated by the trade-off between apples and bananas in terms of production quantity.
• If two countries have the same opportunity costs for both goods, there is no comparative advantage, leading to no gains from trade.
• The graphical representation of production possibilities for both countries helps visualize the equal opportunity costs and the absence of gains from trade.
• The lesson acknowledges that in some scenarios, there might not be gains from trade even if there is a comparative advantage, highlighting the complexities of real-world trade situations.

Comparative advantage worked example

• Absolute Advantage in Charms: Johto has the absolute advantage in producing charms, being more efficient and producing more charms per day compared to Kalos.
• Opportunity Cost in Kalos of Charms:
  • Kalos trades off 20 berries to produce 10 charms.
  • Opportunity cost: 2 berries per charm in Kalos.
• Opportunity Cost in Johto of Charms:
  • Johto trades off 75 berries to produce 25 charms.
  • Opportunity cost: 3 berries per charm in Johto.
• Comparative Advantage in Berries:
  • Johto has the comparative advantage in producing berries, with a lower opportunity cost (1/3 charms per berry) compared to Kalos (1/2 charms per berry).
• Specialization for Trade:
  • Kalos specializes in producing charms due to its comparative advantage.
  • Johto specializes in producing berries due to its comparative advantage, despite having the absolute advantage in charms.
• Trading Price:
  • A trading price of 2.5 berries per charm is suggested, benefiting both Kalos and Johto.
  • Trade allows both countries to obtain goods at a price lower than their respective opportunity costs, resulting in mutual gains.
• Benefits of Comparative Advantage:
  • Comparative advantage leads to gains from trade for both countries, contrary to the misconception that one country benefits more than the other.

Topic 1.5 – Cost-benefit analysis

Optimal decision-making and opportunity costs

• Rational decision-making involves maximizing the difference between benefits and costs.
• Benefits and costs can be quantified, with explicit costs having a monetary value.
• Implicit costs, such as opportunity costs, are associated with the next best alternative to a decision.
• Opportunity cost is the most well-defined implicit cost and represents the cost of forgoing the next best alternative.
• An example is presented where the opportunity cost of going to a movie for three hours is calculated based on potential earnings from alternative activities.
• Total cost is the sum of implicit costs (opportunity cost) and explicit costs (e.g., the price of a movie ticket).
• Optimal decision-making involves comparing the total cost with the quantified benefit to determine the best course of action.

Accounting profit vs economic profit

• Sally's business sells 5,000 hamburgers at $5 each per month, resulting in a total revenue of $25,000.
• Explicit costs include $10,000 for supplies, $5,000 for employee salaries, and $500 for utilities, totaling $15,500.
• Accounting profit is calculated as $25,000 (revenue) - $15,500 (explicit costs) = $9,500 per month.
• To determine economic profit, implicit costs (opportunity costs) are considered. Sally could rent her building for $5,000 per month and work as an accountant for $6,000 per month, resulting in total opportunity costs of $11,000.
• Economic profit is calculated as $9,500 (accounting profit) - $11,000 (implicit costs) = -$1,500 per month.
• The analysis suggests that it may not be rational for Sally to continue running her burger business as her economic profit is negative, indicating a net loss when implicit costs are considered.

Introduction to utility

• Utility in Economics is a measure of usefulness, worth, value, or even happiness.
• Total Utility is demonstrated using the example of scoops of ice cream, with Utility units measured in utils.
• The instructor introduces the concept of Marginal Utility (mu) and its role in incremental units of a good or service.
• Marginal Utility tends to decrease as more units of a good or service are consumed, illustrated by the ice cream example.
• The video emphasizes the importance of understanding Utility, Total Utility, and Marginal Utility for making rational decisions to optimize overall satisfaction.

Topic 1.6 – Marginal analysis and consumer choice

Marginal utility and total utility

• Utility Definition: Utility is the measure of benefit, satisfaction, or value obtained from goods or services.
• Marginal Utility: The video emphasizes marginal utility, representing the satisfaction gained from the next incremental unit of a good or service.
• Absolute Measurement: Instead of using dollars or other goods as a measure, the video introduces an arbitrary unit for utility measurement.
• Comparison of Preferences: The presenter compares the marginal utility of chocolate bars and fruit to demonstrate relative preferences.
• Introduction of Prices: Prices are assigned to chocolate bars ($1 per bar) and fruit ($2 per pound) to analyze marginal utility per dollar spent.
• Bang for Buck: The analysis explores how individuals allocate their money based on the satisfaction gained per dollar, illustrating rational decision-making in purchasing choices.
• Decision Process: Using the assigned prices, the video walks through a decision-making process, showing how three chocolate bars and one pound of fruit are chosen when given a budget of $5.

Visualizing marginal utility and total utility

• Marginal Utility (MU):
  • Represents the additional satisfaction or utility gained from consuming one more unit of a good.
  • Illustrated using a table for tennis balls, with abstract units denoting utility.
  • Demonstrates the diminishing marginal utility: the second ball provides 80% of the utility of the first, and the trend continues downward.
• Graphing Marginal Utility:
  • Plots the marginal utility values on a graph, creating a downward-sloping curve.
  • Describes how the law of demand aligns with the diminishing incremental benefit of each additional unit.
  • Connects the discrete points to visualize the continuous nature of marginal utility curves.
• Total Utility (TU):
  • Represents the overall satisfaction or utility derived from the total quantity of a good consumed.
  • Explains that total utility starts at the same point as marginal utility when consumption begins.
  • Uses a table to calculate total utility as the sum of marginal utilities for each unit consumed.
• Graphing Total Utility:
  • Illustrates the upward-sloping nature of the total utility curve as long as positive marginal utility exists.
  • Points out the diminishing rate of increase in total utility due to decreasing marginal utilities.
  • Notes the maximum point on the total utility curve when marginal utility reaches zero, beyond which negative marginal utility leads to a negative slope.
• Connection to Law of Demand:
  • Relates the concepts of marginal and total utility to the principles of the law of demand in economics.
  • Emphasizes that the diminishing marginal utility aligns with consumers being willing to pay less for additional units.
• Graphical Representation:
  • Emphasizes the graphical representation of marginal and total utility curves as essential tools in understanding consumer behavior.
  • Shows the connection between marginal utility as the slope of the total utility curve.
• Example with Tennis Balls:
  • Uses a discrete case of tennis ball consumption to explain the concepts.
  • Highlights the point of indifference when marginal utility is zero, and negative marginal utility results in a decrease in total utility.
• Generalization to Continuous Examples:
  • Encourages thinking about more continuous examples where units are not discrete.
  • Suggests connecting the dots to represent a more granular quantity, like pounds of chocolate.

Utility maximization: equalizing marginal utility per dollar

• The initial allocation decision is made by evaluating the marginal utility per price for each product (bang for the buck).
• The video introduces a continuous case, allowing for the purchase of very small increments of each product.
• A graphical representation is used, with the vertical axis representing marginal utility per price and the horizontal axis representing dollars spent.
• The diminishing utility of each product is illustrated through curves, emphasizing that as more of a product is purchased, the marginal utility decreases.
• The analysis shows that initially, the entire budget is spent on the product with the highest marginal utility per price (product A).
• As spending continues, a point is reached where the marginal utility per price for product B becomes comparable to that of product A.
• At this threshold, money is divided between the two products to maximize utility.
• The general principle derived is that for the last increment of spending, the marginal utility for price for one product equals that of the other.
• The principle doesn't imply overall equality in marginal utility for price between the two goods, but rather a specific point where they become equal for the last increment of spending.
• The importance of considering marginal utility in decision-making and adjusting spending to optimize utility is highlighted throughout the analysis.