answer 6 questions

Econ 202 Lecture 1

Zach Stangebye

September 26th, 2014

Zach Stangebye () Econ 202 Lecture 1 September 26th, 2014 1 / 24

Outline

1 Decision-making and Opportunity Cost

2 Reading Graphs in Economics

3 Scarcity and Choice

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Decision-making and Opportunity Cost

Example 1

The Hong Kong Hilton

Immense, 26 story, 750 room hotel Highly profitable for over 30 years Torn down in 1995

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Decision-making and Opportunity Cost

Example 1

The Hong Kong Hilton

The answer is because of the opportunity cost of keeping it a hotel It was torn down to build an office complex which brought in an additional $70 million annually

Bill Gates example

Zach Stangebye () Econ 202 Lecture 1 September 26th, 2014 4 / 24

Decision-making and Opportunity Cost

Example 1

The Hong Kong Hilton

The answer is because of the opportunity cost of keeping it a hotel

It was torn down to build an office complex which brought in an additional $70 million annually

Bill Gates example

Zach Stangebye () Econ 202 Lecture 1 September 26th, 2014 4 / 24

Decision-making and Opportunity Cost

Example 1

The Hong Kong Hilton

The answer is because of the opportunity cost of keeping it a hotel It was torn down to build an office complex which brought in an additional $70 million annually

Bill Gates example

Zach Stangebye () Econ 202 Lecture 1 September 26th, 2014 4 / 24

Decision-making and Opportunity Cost

Example 1

The Hong Kong Hilton

The answer is because of the opportunity cost of keeping it a hotel It was torn down to build an office complex which brought in an additional $70 million annually

Bill Gates example

Zach Stangebye () Econ 202 Lecture 1 September 26th, 2014 4 / 24

Decision-making and Opportunity Cost

Opportunity Costs

A decision requires a choice between several alternatives

Definition

The Opportunity (or Economic) Cost of an alternative is the cost of the best foregone alternative

This stands in contrast to what we normally think of as a cost

Definition

The Dollar Cost of an alternative is simply the cost associated with it

Zach Stangebye () Econ 202 Lecture 1 September 26th, 2014 5 / 24

Decision-making and Opportunity Cost

Opportunity Costs

A decision requires a choice between several alternatives

Definition

The Opportunity (or Economic) Cost of an alternative is the cost of the best foregone alternative

This stands in contrast to what we normally think of as a cost

Definition

The Dollar Cost of an alternative is simply the cost associated with it

Zach Stangebye () Econ 202 Lecture 1 September 26th, 2014 5 / 24

Decision-making and Opportunity Cost

Example 2

What is the economic cost of going to college?

First you have all the dollar costs: Tuition, books, laptop, etc. Next you have what you could have earned had you chosen to work instead

Zach Stangebye () Econ 202 Lecture 1 September 26th, 2014 6 / 24

Decision-making and Opportunity Cost

Example 2

What is the economic cost of going to college?

First you have all the dollar costs: Tuition, books, laptop, etc.

Next you have what you could have earned had you chosen to work instead

Zach Stangebye () Econ 202 Lecture 1 September 26th, 2014 6 / 24

Decision-making and Opportunity Cost

Example 2

What is the economic cost of going to college?

First you have all the dollar costs: Tuition, books, laptop, etc. Next you have what you could have earned had you chosen to work instead

Zach Stangebye () Econ 202 Lecture 1 September 26th, 2014 6 / 24

Decision-making and Opportunity Cost

Example 3

What is the economic cost of raising children?

The 2009 USDA estimate of the annual expenses on rearing a child in a two parent, two child home is about $12,000 But parents often forego many hours at work to raise the children. Estimated $11,000 in lost wages

What about the value of raising children, though?

Zach Stangebye () Econ 202 Lecture 1 September 26th, 2014 7 / 24

Decision-making and Opportunity Cost

Example 3

What is the economic cost of raising children? The 2009 USDA estimate of the annual expenses on rearing a child in a two parent, two child home is about $12,000

But parents often forego many hours at work to raise the children. Estimated $11,000 in lost wages

What about the value of raising children, though?

Zach Stangebye () Econ 202 Lecture 1 September 26th, 2014 7 / 24

Decision-making and Opportunity Cost

Example 3

What is the economic cost of raising children? The 2009 USDA estimate of the annual expenses on rearing a child in a two parent, two child home is about $12,000 But parents often forego many hours at work to raise the children. Estimated $11,000 in lost wages

What about the value of raising children, though?

Zach Stangebye () Econ 202 Lecture 1 September 26th, 2014 7 / 24

Decision-making and Opportunity Cost

Example 3

What is the economic cost of raising children? The 2009 USDA estimate of the annual expenses on rearing a child in a two parent, two child home is about $12,000 But parents often forego many hours at work to raise the children. Estimated $11,000 in lost wages

What about the value of raising children, though?

Zach Stangebye () Econ 202 Lecture 1 September 26th, 2014 7 / 24

Decision-making and Opportunity Cost

Measuring Costs

Sometimes the value the alternative is easy to calculate e.g. business decisions, but sometimes it’s not

How do you quantify the value of watching a movie versus using that same time to study? Or read a book?

In order to give an alternative an opportunity cost, we need some way of quantifying a foregone alternative

Economists “cheat” a little here, and attach a dollar value to the foregone alternative; specifically, how much you would be willing to give up to be indifferent

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Decision-making and Opportunity Cost

Calculating Opportunity Cost

The opportunity cost actually is comprised of two parts: The value of the foregone alternative and the difference in the dollar costs

To calculate the opportunity cost of alternative A... 1 Calculate the following for every alternative (alternative B, C, ...)

Value︸ ︷︷ ︸ OC of Time

+ Dollar Cost Difference with A︸ ︷︷ ︸ OC of Money

2 Whichever of these values is the largest is the opportunity cost

Zach Stangebye () Econ 202 Lecture 1 September 26th, 2014 9 / 24

Decision-making and Opportunity Cost

Optimal Decision-Making

So which alternative should we choose?...

A tricky question

It need not be the alternative with the lowest opportunity cost. Why?

Have not talked about benefits at all Optimal choice will involve analyzing both costs and benefits

Zach Stangebye () Econ 202 Lecture 1 September 26th, 2014 10 / 24

Decision-making and Opportunity Cost

Optimal Decision-Making

So which alternative should we choose?...A tricky question

It need not be the alternative with the lowest opportunity cost. Why?

Have not talked about benefits at all Optimal choice will involve analyzing both costs and benefits

Zach Stangebye () Econ 202 Lecture 1 September 26th, 2014 10 / 24

Decision-making and Opportunity Cost

Optimal Decision-Making

So which alternative should we choose?...A tricky question

It need not be the alternative with the lowest opportunity cost. Why?

Have not talked about benefits at all Optimal choice will involve analyzing both costs and benefits

Zach Stangebye () Econ 202 Lecture 1 September 26th, 2014 10 / 24

Decision-making and Opportunity Cost

Example 4

Suppose you can go to see either Katy Perry or Lady Gaga

Tickets to see Katy Perry are $50 and tickets to see Lady Gaga are $75 You get a value of $ 100 of seeing Katy Perry What is the opportunity cost of seeing Lady Gaga?

Suppose you can either enjoy a bowl of yogurt or a bowl of oatmeal for breakfast

You get a value of $5 from the yogurt and $7 from the oatmeal What is the opportunity cost of the yogurt?

Zach Stangebye () Econ 202 Lecture 1 September 26th, 2014 11 / 24

Decision-making and Opportunity Cost

Example 4

Suppose you can go to see either Katy Perry or Lady Gaga

Tickets to see Katy Perry are $50 and tickets to see Lady Gaga are $75 You get a value of $ 100 of seeing Katy Perry What is the opportunity cost of seeing Lady Gaga?

Suppose you can either enjoy a bowl of yogurt or a bowl of oatmeal for breakfast

You get a value of $5 from the yogurt and $7 from the oatmeal What is the opportunity cost of the yogurt?

Zach Stangebye () Econ 202 Lecture 1 September 26th, 2014 11 / 24

Reading Graphs in Economics

How to Read Economic Activity on Graphs

1 Identify axis/space

2 Determine what sort of movement the event would generate

3 Understand whether the event is a shift of the curve, or a movement along the curve

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Reading Graphs in Economics

Linear Functions Refresher

Should be familiar from basic algebra class...but a linear function takes the form

y = mx + b

m is the slope and b is the y-intercept

Will be helpful to recall point-slope form of a line: When m is known and so is a point (x1, y1), then the intercept can be solved for,

y − y1 = m(x − x1)

Then b = y1 − mx1

Zach Stangebye () Econ 202 Lecture 1 September 26th, 2014 13 / 24

Scarcity and Choice

Economics

Definition

Economics is the social science that studies the allocation of scarce resources to satisfy unlimited wants

There is always scarcity, even if it is only a scarcity of time

The need to satisfy these wants is what causes the development of markets and trade

How do we model this scarcity?

Zach Stangebye () Econ 202 Lecture 1 September 26th, 2014 14 / 24

Scarcity and Choice

Economics

Definition

Economics is the social science that studies the allocation of scarce resources to satisfy unlimited wants

There is always scarcity, even if it is only a scarcity of time

The need to satisfy these wants is what causes the development of markets and trade

How do we model this scarcity?

Zach Stangebye () Econ 202 Lecture 1 September 26th, 2014 14 / 24

Scarcity and Choice

Example 1

Tom Hanks is on an island and he only has ten traps, which he can use to catch either fish or rabbits

One trap will catch either three fish or one rabbit

How can we describe his production process?

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Scarcity and Choice

PPF

Definition

A Production Possibilities Frontier is a graphical representation of scarce resources in a quantity-quantity graph. It shows the different maximum combinations of outputs for a given amount of inputs.

On the PPF, more of one good means less of another

The slope of the PPF is the opportunity cost

Any point on the PPF is efficient, any point inside the PPF is inefficient, and any point outside the PPF is infeasible

Illustrate on graph

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Scarcity and Choice

Efficiency

Definition

A combination of outputs is efficient if no resources are wasted in its production.

This means that more of a good cannot be produced without giving up some of the other good

Efficiency does not tell us which point is best or where we should produce; we only know that we do not want to produce inefficiently

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Scarcity and Choice

Shape of PPF

What if catching fish for Tom Hanks gets harder and harder with every fish that is caught?

What does this imply about the opportunity cost of fishing? and about the PPF?

Definition

The Marginal Cost of a good or service is the opportunity cost of producing one more unit of it

It is a fundamental law of economics that marginal costs eventually become increasing, implying concave PPFs

Zach Stangebye () Econ 202 Lecture 1 September 26th, 2014 18 / 24

Scarcity and Choice

Shape of PPF

What if catching fish for Tom Hanks gets harder and harder with every fish that is caught?

What does this imply about the opportunity cost of fishing? and about the PPF?

Definition

The Marginal Cost of a good or service is the opportunity cost of producing one more unit of it

It is a fundamental law of economics that marginal costs eventually become increasing, implying concave PPFs

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Scarcity and Choice

Sample PPFs for an Economy Producing Hats and Jeans

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Scarcity and Choice

Allocative Efficiency

Definition

A combination of outputs is Allocatively Efficient if it efficient and preferred above all other efficient outputs

Definition

The Marginal Benefit of a good or service is the benefit that the last unit provides (measured in dollars, it is how much one is willing to give up to get that last unit)

It is another fundamental economic law that marginal benefits are decreasing

Find graphically where MB = MC to find allocatively efficient point (graph)

Zach Stangebye () Econ 202 Lecture 1 September 26th, 2014 20 / 24

Scarcity and Choice

Example 2

Larry, Curly, and Moe produce whoopee cushions and sledgehammers

Larry can produce either 3 whoopee cushions or 1 sledgehammer in an hour Curly can produce either 1 whoopee cushion or 1 sledgehammer in an hour Moe can produce either 1 whoopee cushion or 4 sledgehammers in an hour

Draw their joint hourly PPF

If the price of a sledgehammer is $10 and the price of a whoopee cushion is $5, how many of each should the three stooges produce and sell?

Zach Stangebye () Econ 202 Lecture 1 September 26th, 2014 21 / 24

Scarcity and Choice

Example 2

Larry, Curly, and Moe produce whoopee cushions and sledgehammers

Larry can produce either 3 whoopee cushions or 1 sledgehammer in an hour Curly can produce either 1 whoopee cushion or 1 sledgehammer in an hour Moe can produce either 1 whoopee cushion or 4 sledgehammers in an hour

Draw their joint hourly PPF

If the price of a sledgehammer is $10 and the price of a whoopee cushion is $5, how many of each should the three stooges produce and sell?

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Scarcity and Choice

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Scarcity and Choice

Growth

Economic growth is an increase in the production of goods and services

There are two ways an economy can grow

1 An increase in the inputs of production 2 An increase in technology or capital goods as a result of investment

PPF today and tomorrow graph with capital and consumption goods

Point on PPF today determines the shape of the PPF tomorrow; the more capital (or investment goods) are produced today, the larger the PPF will be tomorrow

Zach Stangebye () Econ 202 Lecture 1 September 26th, 2014 23 / 24

Scarcity and Choice

Growth

Economic growth is an increase in the production of goods and services

There are two ways an economy can grow 1 An increase in the inputs of production

2 An increase in technology or capital goods as a result of investment

PPF today and tomorrow graph with capital and consumption goods

Point on PPF today determines the shape of the PPF tomorrow; the more capital (or investment goods) are produced today, the larger the PPF will be tomorrow

Zach Stangebye () Econ 202 Lecture 1 September 26th, 2014 23 / 24

Scarcity and Choice

Growth

Economic growth is an increase in the production of goods and services

There are two ways an economy can grow 1 An increase in the inputs of production 2 An increase in technology or capital goods as a result of investment

PPF today and tomorrow graph with capital and consumption goods

Point on PPF today determines the shape of the PPF tomorrow; the more capital (or investment goods) are produced today, the larger the PPF will be tomorrow

Zach Stangebye () Econ 202 Lecture 1 September 26th, 2014 23 / 24

Scarcity and Choice

Growth

Economic growth is an increase in the production of goods and services

There are two ways an economy can grow 1 An increase in the inputs of production 2 An increase in technology or capital goods as a result of investment

PPF today and tomorrow graph with capital and consumption goods

Point on PPF today determines the shape of the PPF tomorrow; the more capital (or investment goods) are produced today, the larger the PPF will be tomorrow

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Scarcity and Choice

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