Econ 1201 1st Edition Lecture 2Outline of Last Lecture – The Art and Science of Economic AnalysisI. The Economic ProblemA. Scarce ResourcesB. Unlimited WantsC. Decision MakersD. MarketsII. The Art of Economic AnalysisIII. The Science of EconomicsOutline of Current Lecture – Economic Tools and SystemsI. Choice and Opportunity CostII. Comparative AdvantageIII. Economy’s Production PossibilitiesCurrent LectureI. Choice and Opportunity CostOpportunity Cost: the value of the best alternative you gave up. - (Ex. of best alternative: could have slept in instead of walking to an 8 a.m. lecture in the freezing cold)- Effects you daily, but also varies day to day-EXAMPLE: Opportunity cost of college o The factors include the money you make at a job if you don’t go to college ($40,000) AND add the money you would pay for tuition ($45,000), your opportunity cost is $85,000. o Of course, the idea is that this would pay off in the long run.Sunk Cost: A cost that has already occurredThese notes represent a detailed interpretation of the professor’s lecture. GradeBuddy is best used as a supplement to your own notes, not as a substitute.- Ex. If you hate the movie that you already bought a ticket for, you might as well just leave the theater instead of torturing yourself by sitting through the whole movie --- youalready purchased the ticket so whether you leave, you aren’t getting your money backII. Comparative Advantage and ExchangeLaw of Comparative Advantage: Whoever has the lowest opportunity cost should product an item. (***NOT WHOEVER IS BETTER!!***)EXAMPLE: a. Over the course of ONE week, this is what can get done between you and your roommate:You RoommateMeals made 10 mealsOR6 mealsOR Rooms cleaned 4 rooms 2 rooms^^^^ You have the absolute advantage because you can perform both chores more efficientlyb. Opportunity CostYou RoommateMeals Cooked/Week 4/10 = 2/5 rooms 2/6 = 1/3 roomsRooms Cleaned/Week 10/4= 5/2 meals 6/2 = 3 mealsWhere does 4/10 come from? For every 4 rooms that you can clean, you can cook 10 meals. That simplifies to 2/5. Now, for every meal that you cook, you are sacrificing cleaning 2/5 of a room. Likewise, for every room you clean, you are sacrificing the time it would take to make 5/2, or 2.5 meals. (Same follows foryour roommate)  * Meals cooked vs. Rooms cleaned will always be INVERSE of one another. (5/2 is the inverse of 2/5; 1/3 is the inverse of 3/1)Who has the lower opportunity cost in meals?- Your opportunity cost is 2/5 and your roommate’s is 1/3o FIND A COMMON DENOMINATOR!  2/5 = 6/15 ….. 1/3 = 5/15- Since 5/15 is lower than 6/15, your roommate has the lower opportunity cost for cooking meals!C. Specialization- If you each specialize in the chore that you have the lower opportunity cost for, how does it effect the production?You Roommate TOTALMeals Cooked/Week 0 + 6 = 6 mealsRooms cleaned/week 4 + 0 = 4rooms - As you can see, by specializing, we get more!- If we didn’t specialize but rather SPLIT THE TIME, you would make 5 meals and clean 2 rooms, and your roommate would cook 3 meals and clean one room = 8 meals and 3 rooms.- This is probably a good thing because college kids prefer food over clean rooms.Note: Specialization is not only for individuals but for firms, countries, states etc. too. It is also where trading originated (people began to specialize in things they were best at and had the lowest opportunity cost for, then sold the items)D. Partial SpecializationYou Roommate TOTALMeals cooked/week 2.5 6 8.5Rooms Cleaned/week 3 0 3- If you partially specialize, and give up one room (clean 3 rooms instead of for), you create time to make 2.5 meals…. Why? Because the opportunity cost for 1 room is 5/2 or2.5 meals.- Since college kids are hungry, this is the best alternative because now you can have 8.5 meals and 3 clean rooms.- This is better than specialization in this situation because another ½ of a meal will be cooked.III. Economy’s Production PossibilitiesProduction Possibilities Frontier (PPF): Curve showing alternative combination of goods that are produced when resources are used efficiently.- Shows the maximum amount that can be produced withthe given resource at a given time, and given theproduction level of the other resource.- Shows efficiency and opportunity cost*Points and their meanings*- A = Inefficient use of resources- B,C,D = efficient choices BECAUSE on PPF- X = Unattainable at this time- Blue line = PPF- Dotted lines: represent opportunity cost!o There is a trade off, if opportunity cost for making butter increases, OC for making guns decreases and vice versa.o EXAMPLE: if for some reason cows can benefit the manufacturing of guns, less butter will be produced because cows are really good at making butter. Since there will be less cows available to make butter, the opportunity cost for making butter increases* How can we make the unattainable, attainable???- More resources (more people, capital etc.) why most countries go to war- Better Technology- Better Rules of the Game relax human rights standards, pollute air as much as you want (this would all increase production and resources, but not