Economics

ECO 2301, Principles of Microeconomics 1

Course Learning Outcomes for Unit I Upon completion of this unit, students should be able to:

1. Discuss the central economic problem. 1.1 Identify the economic problem of resource scarcity and opportunity costs. 1.2 Discuss the circular flow diagram. 1.3 Interpret the economic concepts of opportunity cost, the law of comparative advantage,

production possibilities frontier, and ethics.

Course/Unit Learning Outcomes

Learning Activity

1.1

Unit Lesson Chapter 1, pp. 3–13, 18–23 Chapter 2, pp. 25–35 Chapter 3, pp. 41–54 Video: The Economic Problem Video: Circular Flow Model Video: Opportunity Cost Unit I Assignment

1.2

Unit Lesson Chapter 1, pp. 3–13, 18–23 Chapter 2, pp. 25–35 Video: The Economic Problem Video: Circular Flow Model Video: Opportunity Cost Unit I Assignment

1.3

Unit Lesson Chapter 1, pp. 3–13, 18–23 Chapter 2, pp. 25–35 Article: “Opportunity Cost Overestimation” Article: “Opportunity Cost Consideration” Video: Law of Comparative Advantage Video: Production Possibilities Frontier Unit I Assignment

Required Unit Resources Chapter 1: The Art and Science of Economic Analysis, pp. 3–13, 18–23

• Section 1-1, pp. 3–7

• Section 1-2c, pp. 8–9

• Section 1-2d, pp. 9–10

• Section 1-3, pp. 10–13

• Appendix A1, pp. 18–23 Chapter 2: Economic Tools and Economic Systems, pp. 25–35

• Sections 2-1 through 2-4a Chapter 3: Economic Decision Makers, pp. 41–54

UNIT I STUDY GUIDE

Economics and Economics Decisions

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In order to access the following resources, click the links below. Spiller, S. A. (2011, December). Opportunity cost consideration. Journal of Consumer Research, 38(4), 595–

610. https://libraryresources.columbiasouthern.edu/login?url=http://search.ebscohost.com/login.aspx?direc t=true&db=bsu&AN=67510074&site=ehost-live&scope=site

Weiss, L., & Kivetz, R. (2019, June). Opportunity cost overestimation. Journal of Marketing Research, 56(3),

518–533. https://libraryresources.columbiasouthern.edu/login?url=http://search.ebscohost.com/login.aspx?direc t=true&db=bsu&AN=136893033&site=ehost-live&scope=site

Unit Lesson As you start your journey into microeconomics, you might start to look at everyday mundane tasks in a new way. Microeconomics is at work all around us each and every day of our lives. From a teenager, standing in front of the refrigerator, trying to decide what to eat next, to your deciding to hit the snooze button on the alarm clock one more time in the morning, economics is at work. Take time to enjoy the topics that we will address in this course, and see if you notice them in how you and others live this thing called life. As we begin learning about economics, we have to first learn why economics is important. This importance is found in just one word—scarcity. Scarcity can mean different things to different people. However, McEachern (2019) states that scarcity exists when a resource is not freely available. For example, while drinking water is inexpensive to get out of the tap, it is not free—you pay the utility company for it. That means drinking water is a scarce resource. Flowers to plant in your yard that you purchase at a garden center are not free. That means these flowers are a scarce resource. Some people even pay money to hear investing advice from Warren Buffett. That would mean Warren Buffett’s advice is not free, making it a scarce resource. The problem with scarce resources is that people always prefer more to less. I would like to have $1 million, but I would prefer to have $2 million. I would like to have a new car, but a new luxury car would be nicer. The list goes on and on. In order to have one resource, we usually have to give up another. That is the basis of economics, which “examines how people use their scarce resources to satisfy their unlimited wants” (McEachern, 2019, p. 3). To learn more about scarcity and the economic problem, watch the short video The Economic Problem. As you start to think about resources, consider how these resources flow through an economy:

• Households have the resource of labor to provide to firms.

• These firms pay workers for their labor in the form of wages and use labor resources along with capital, natural, and entrepreneurial abilities to create goods and services.

• These goods and services are sold to households.

• The households pay firms for these goods and services with their earned wages.

The flow of resources continues round and round and is depicted by McEachern (2019) as the Circular-Flow Model for Households and Firms that is presented at right. Each of the resources that are provided to the firms as well as to households are scarce because their price is greater than zero. That means economics can be used to explain how individual households,

(McEachern, 2019, p. 6)

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individual firms, or a collection of households or firms allocate these scarce resources. To learn more about circular flow, watch the short video Circular Flow Model. As you move further into the study of economics, you will see that economists like to make assumptions. Think about it—without assumptions, economists would never be able to draw any conclusions. In fact, everyone makes assumptions anytime they are asked a question. For instance, someone could ask you what you will be doing next week at this exact time. There are many assumptions you will make when answering this question. You may assume that you will not be traveling for work or that someone in your family or a close friend will not be sick and need your attention. Only by making assumptions can you answer most questions. The same holds true for economics, the difference being that economists just get laughed at for the number of assumptions they make. One key assumption that economists make is that consumers look out for their own self-interest (McEachern, 2019). More formally, it is explained that consumers try to maximize the expected benefit from an action at a given cost or minimize the expected cost of the benefit. In other words, it is assumed that consumers exhibit rational self-interest. We do not have to go far back in time to see this assumption at work in society. A prime example occurred when consumers rushed out to purchase as much toilet paper as they could during the COVID-19 (coronavirus) outbreak. Now, calling this decision rational is up for debate. However, consumers were definitely acting in their own self-interest by hoarding toilet paper, thus trying to maximize the expected benefit at a given cost. Now that we have the foundation of economics, we need to address two studies of economics. These studies are microeconomics (which is the class you are taking) and macroeconomics. McEachern (2019) distinguishes between these two fields of study by first suggesting that macroeconomics refers to the study of the economy as a whole. Microeconomics, on the other hand, refers to the study of an individual’s behavior. This individual may be a single person, a household, a community, and so on. However, one way to remember the difference would be when you hear the term microeconomics, think small. When you hear macroeconomics, think large. As we exit Chapter 1, make sure you go over the information about graphs in the Chapter 1 Appendix, between pages 18 and 23. This course will rely heavily on reading and drawing graphs, calculating slope, and performing other minor math functions. Do not worry—you will not be asked to perform any high-level calculus. However, simple addition, subtraction, multiplication, and division will be used. Refresh yourself so you will be ready to dive head-first into this material. Chapter 2 starts off with a concept that is unique to economics. This concept is opportunity cost. An opportunity cost represents the value of the next best alternative when we make a decision (McEachern, 2019). For example, you are sitting here, reading this material. You could be out working and earning additional income instead. Therefore, the income you are giving up right now is the opportunity cost associated with reading this unit lesson. For someone who is taking vacation time off work to read this material and work on this first unit of class, the opportunity cost may be extremely high. For someone who is reading this material at 2:00 a.m. because they could not sleep, the opportunity cost may be extremely low. This is why McEachern (2019) suggests that opportunity costs are subjective. Starting off the discussion of opportunity costs, it was explained that this was a concept unique to economics. Accounting does not recognize opportunity costs because no actual money is changing hands. However, economics places a high level of importance on opportunity costs because consumers make decisions based on opportunity costs all the time. For example, you could be working more hours instead of going to school. The money you are giving up by taking classes is an opportunity cost to you. However, you have weighed the options and believe obtaining a degree will lead to higher pay in the future. That means the prospect of higher pay in the future outweighs the current opportunity cost associated with going to school. For more information regarding opportunity cost, review the short video Opportunity Cost. Opportunity costs are the basis for the law of comparative advantage, which is why we trade goods and services. The economic theory of the law of comparative advantage suggests that an individual, firm, region, or country with the lowest opportunity cost of producing a good should focus on producing that good and trade with other nations (McEachern, 2019).

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As an example, rice needs a warm and relatively wet climate to grow. The average yearly temperature in Louisiana is warm, and rice can be grown outside. However, the average temperature in the state of South Dakota is relatively cold. If rice were grown in South Dakota, it would need to be grown in greenhouses. That means Louisiana has a comparative advantage over South Dakota for growing rice. Louisiana should focus (specialize) on growing rice. Louisiana could then trade rice to South Dakota for a good that South Dakota produces. To learn more about comparative advantage, view the video Law of Comparative Advantage.

Now, we can begin to examine how firms make decisions regarding which goods they can produce and how much they should produce. A graph of the production possibilities frontier shows how resources can be used efficiently to produce two types of goods (McEachern, 2019). The shape of the production possibilities frontier is very important, as it can indicate if the goods are imperfect substitutes, perfect substitutes, or perfect complements. To learn more about production possibilities, watch the short video Production Possibilities Frontier. Be sure to take the time to learn more about the father of our own economic system, Adam Smith, and his notion of the invisible hand, an idea he expressed in his book An Inquiry Into the Nature and Causes of the Wealth of Nations. In his book, Smith (1776) suggests that individuals in society, acting on their own best interests, actually benefit society’s well-being. Smith suggests that there is an invisible hand at work here. Thus, by acting in their own best interests, individuals are directed by the invisible hand to work in the best interests of society as a whole. In his own words:

As every individual, therefore, endeavours as much as he can both to employ his capital in the support of domestic industry, and so to direct that industry that its produce may be of the greatest value; every individual necessarily labours to render the annual revenue of the society as great as he can. He generally, indeed, neither intends to promote the public interest, nor knows how much he is promoting it. By preferring the support of domestic to that of foreign industry, he intends only his own security; and by directing that industry in such a manner as its produce may be of the greatest value, he intends only his own gain, and he is in this, as in many other cases, led by an invisible hand to promote an end which was no part of his intention. Nor is it always the worse for the society that it was no part of it. By pursuing his own interest he frequently promotes that of the society more effectually than when he really intends to promote it. I have never known much good done by those who affected to trade for the public good. (Smith, 1776, Ch. 2, para. 9)

One can see that the invisible hand occurs naturally and essentially guides free markets and capitalism through competition for scarce resources.

Adam Smith (Tassie, 1787)

These two graphics are examples of production possibilities frontier graphs, one for guns and butter, the other for food and computers. (Left: Adapted from Endless Melee, 2006; right, adapted from Thomasmeeks~commonswiki, 2008)

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As you complete this first unit of our course, look at the world around you. See if you can identify at your work the concepts that are covered in this course. Look at your own day-to-day decisions. Whether you hit the snooze button just one more time in the morning, turn off the television an hour early and study, or take a different route home from work or school, you are incurring opportunity costs. Can you identify them? Also, as you fix something to eat, pick out clothes to wear, or use your cell phone, look at where the products you use were made. Think about why the opportunity costs are lower in some locations than others for these goods. Finally, as you encounter businesses you may pass when traveling or online, think about the scarce resources being used to produce the goods or services that are sold. What resources are being used? What makes the resources used scarce? What do the firms’ production possibilities frontiers look like?

References Endless Melee. (2006). Production possibilities frontier diagram [Graphic]. Wikimedia Commons.

https://commons.wikimedia.org/wiki/File:Production_Possibilities_Frontier_diagram.jpg McEachern, W. A. (2019). Micro ECON6: Principles of microeconomics. Cengage Learning.

https://online.vitalsource.com/#/books/9781337671828 Smith, A. (1776). Chapter II: On restraints upon the importation from foreign countries of such goods as can

be produced at home. Marxists Internet Archive. https://www.marxists.org/reference/archive/smith- adam/works/wealth-of-nations/book04/ch02.htm

Tassie, J. (1787). Profile of Adam Smith [Enamel medallion carving]. Wikimedia Commons.

https://commons.wikimedia.org/wiki/File:AdamSmith.jpg Thomasmeeks~commonswiki. (2008). NewPpf small [Graphic]. Wikimedia Commons.

https://commons.wikimedia.org/wiki/File:NewPpf_small.png