What is Economics?

Economics: Study of how people make choices in the face of scarcity.
Resources are scarce: Limited availability of resources.
People make choices: Involves tradeoffs due to scarcity.
Production Possibilities Frontier (PPF): A model illustrating choices and tradeoffs.

Opportunity Cost: The value of the next best alternative that must be given up to obtain something.

Marginal Analysis: Examination of the incremental changes resulting from decisions or actions.
- Straw that broke the camel's back.
- Boiling point of water.
- Studying the incremental changes that result from decisions or actions.

PPF Definition: Shows combinations of two goods that can be produced with given resources and the boundary between attainable and unattainable combinations.
Ceteris Paribus: Assumption of holding other factors constant to focus on two goods.
PPF for Cola and Pizza: Example illustrating the tradeoff between producing cola and pizza.
- Various possibilities (A to F) showing different combinations of cola and pizza production.
- Example Data:
  - Possibility A: 0 Pizzas and 15 million cans of Cola
  - Possibility B: 1 Pizza and 14 million cans of Cola
  - Possibility C: 2 Pizzas and 12 million cans of Cola
  - Possibility D: 3 Pizzas and 9 million cans of Cola
  - Possibility E: 4 Pizzas and 5 million cans of Cola
  - Possibility F: 5 Pizzas and 0 million cans of Cola
PPF for Healthcare and Education: Illustrates the tradeoff between social resources allocated to healthcare and education.
- Points on the PPF represent different allocations, from all resources to healthcare (A) to all resources to education (F).
Attainability: Points on the PPF and inside are attainable, while points outside are unattainable.

Production Efficiency Definition: Occurs when it's impossible to produce more of one good without producing less of another.
All points on the PPF (e.g., A, B, C, D, E, F, G) are production efficient.
Inefficiency: Points inside the PPF (e.g., I) represent inefficient production, where more of one good can be produced without reducing the production of the other.
- Resources are either unemployed or misallocated. At I, resources are unemployed or misallocated.

Tradeoffs: Every choice along the PPF involves giving up some of one good to get more of another.
Opportunity Cost: The amount of good Y that must be given up to obtain more of good X.
Example: Moving from D to E.
- Good X increases by 1.
- Good Y decreases by 3.
- Opportunity cost of 1 additional unit of X is 3 units of Y.
Example: Moving from F to E.
- Good Y increases by 3.
- Good X decreases by 1.
- Opportunity cost of 3 units of Y is 1 unit of X.
Inverse Relationship: The opportunity cost of good X is the inverse of the opportunity cost of good Y.
- 1 unit of X costs 3 units of Y.
- 1 unit of Y costs $1/3$ units of X.
Varying Opportunity Costs: Resources are not equally productive in all activities.
- As the quantity of a good produced increases, the opportunity cost changes.

Marginal Benefit: The more we have of any good, the smaller is its marginal benefit, and the less we are willing to pay for an additional unit of it.

Subjective Theory of Value: Value is determined by marginal utility.
- Key Figures:
  - C. Menger, Principles of Economics (1871)
  - W.S. Jevons, Theory of Political Economy (1871)
  - L. Walras, Elements of Pure Economics (1874)

Decision Making: To determine quantity to produce or consume, compare marginal costs and marginal benefits.
Marginal Cost: Incremental cost of producing or consuming one more unit.
- Whatever must be given up to have one more unit of something.
Marginal Benefit: Incremental utility received from producing or consuming one more unit.
- Measured by the amount a person is willing to pay for an additional unit.
Forward-Looking: Marginal costs and benefits are forward looking.
Sunk Costs: Irrelevant to current decisions.

As you move along the PPF, you have to give up more of good Y for each incremental unit of good X.
Example Data:
- From A to B: +1 Good X, -1 Good Y
- From B to C: +1 Good X, -2 Good Y
- From C to D: +1 Good X, -2 Good Y
- From D to E: +1 Good X, -3 Good Y
- From E to F: +1 Good X, -3 Good Y
- From F to G: +1 Good X, -5 Good Y

The more you have of a good, the smaller is the marginal benefit of an additional unit.
We are willing to pay less for an additional unit of it.

Production Efficiency: Cannot produce more of one good without producing less of another good. All points on the PPF are production efficient.
Allocation Efficiency: Cannot produce more of a good without producing less of a good we value more highly. The point on the PPF that is the optimal combination goods that we prefer the most.

Preferences: Description of a person’s likes & dislikes.
- Held by Individuals - reflect subjective values
- Economists look at what people actually value, based on their demonstrated actions, only demonstrated preferences matter.
- Depend upon marginal cost and marginal benefit

Definition: The point on the PPF where marginal benefit (MB) equals marginal cost (MC).
Example: Point D is preferred to points A, B, C, E, F, G; where good X=3 and good Y=11.
Using Resources Efficiently: If marginal benefit exceeds marginal cost, resources are not being used efficiently.
Example: At point C, the marginal benefit exceeds marginal cost. We are producing too much good Y, not enough good X.
Using Resources Efficiently: If marginal cost exceeds marginal benefit, resources are not being used efficiently.
Example: At point E, the marginal cost exceeds marginal benefit. We are producing too much good X, not enough good Y.

Two key factors determine economic growth:
- Technological Change: Development of new products, services, materials, methods.
- Capital Accumulation: An increase in resources allocated to future production.
The Cost of Economic Growth: Economic growth is not free. The cost of economic growth is less current consumption today.

We can produce more tomorrow by consuming less today.
Using some resources today to create new technologies and increase capital shifts the future PPF outward.
Economic Growth as a Tradeoff

Production Possibilities Frontier (PPF): Shows the tradeoffs of goods and services that can be produced.
- All points on the line are equally production efficient; points outside are not possible.
Cost: Opportunity Cost = the next most valuable alternative given up.
Marginal Cost: Incremental cost - Increases as you choose more of something.
Marginal Benefit: Incremental benefit from consuming one more unit.
Principal of Decreasing Marginal Benefit: The more you have of any good, the smaller is the marginal benefit, and the less we are willing to pay.
Allocative Efficiency: Is the point on PPF we value most highly, where MB = MC.
- Allocative Efficiency is dependent on individual preferences.
Economic Growth: Expanding the Production Possibilities Frontier.
- Comes from technological change & capital accumulation.
- More tomorrow, means less consumption today.