Chapter 1 What is Economics 1 1 Scarcity and Individual Choice Economics is the study of choice under conditions of scarcity Scarcity is a situation in which the amount of something available is insufficient to satisfy the desire for it 1 1a The Concept of Opportunity Cost The opportunity cost of any choice is what we must forego when we make that choice Most complete and accurate concept of cost Only the best alternative out of all available alternatives is considered when calculating opportunity cost e g if your next best alternative to studying microeconomics is going to the movies and if your next best alternative to going to the movies is playing Call of Duty then the opportunity cost of studying microeconomics is only going to the movies because you can t play CoD and go to the movies at the same time Explicit vs Implicit costs explicit cost is 1 Explicit is the money actually paid out for a choice e g if a Hershey s bar costs 1 then the Implicit is the value of something sacrificed e g if I could make 5 in the time it takes to walk to CVS to buy the Hershey s bar then the implicit cost is 5 The Opportunity Cost of College per year Two Year Public College Type of Institution Tuition and fees Books and supplies Room and board Transportation and other expenses 7 605 1 137 8 535 3 062 Room board and transportation are usually not included in the opportunity cost because you would have to pay for these regardless of your status Assume that instead of going to college you could make 18 000 working full time Explicit cost Tuition and fees Books and Supplies 8 742 Implicit cost Forgone income 18 000 Total opportunity cost 26 742 Resources the labor capital land including natural resources and entrepreneurship used to produce 1 2 Scarcity and Social Choice goods and services 1 2a The Four Resources 1 Labor the time human beings spend producing goods and services 2 Capital any long lasting tool that is itself produced and helps us make other goods and services Physical capital machinery and equipment factory buildings computers hammers screwdrivers must be long lasting therefore something like flour used to bake bread is NOT Human capital skills and knowledge possessed by workers Capital stock total amount of capital at a nation s disposal at a point in time 3 Land the physical space on which production takes place natural resources crude oil iron capital coal fertile soil etc enterprise 4 Entrepreneurship the ability and willingness to combine other resources into a productive Can be an innovator invents an original idea or a risk taker provides his own funds or time to nurture a project with uncertain rewards Resources vs Input An input is anything used to make a good or service includes the four resources as well as many other inputs like cement and electricity 1 2b Opportunity Cost and Society s Trade offs Virtually all production carries an opportunity cost to produce more of one thing society must shift resources away from producing something else e g for better healthcare society may have to move resources away from national security 1 3 The World of Economics 1 3a Microeconomics and Macroeconomics Microeconomics the study of individual households firms and governments the choices they make and their interaction in specific markets Macroeconomics the study of the behavior of the overall economy total output total employment etc 1 3b Positive and Normative Economics Positive economics explains how the economy works whether true or not e g Government policy has no effect on our standard of living is a positive statement even though it is false Normative economics prescribes solutions to economic problems requires us to make judgments If we want to reduce greenhouse gas emissions our society will have to use less gasoline is a normative statement 1 4 The Methods of Economics A model is an abstract representation of reality should be as simple as possible to accomplish its purpose Every model makes a simplifying assumption and a critical assumption A simplifying assumption makes a model simpler without affecting important conclusios e g for a road map the statement There are no trees is a simplifying assumption because this won t affect decisions based on using the map A critical assumption affects the conclusions of a model in important ways e g for a road map the statement All roads are open is a critical assumption because this could affect decisions based on When studying business firms economists make the critical assumption that all business try to earn using the map the highest profit possible Practice Problems 1 For each of the following state whether economists would consider it a resource and if they would identify which of the four types of resources the item is a A computer used by an FBI agent to track the whereabouts of suspected criminals b The office building in which the FBI agent works c The time that an FBI agent spends on a case d A farmer s tractor e The farmer s knowledge of how to operate the tractor f Crude oil g A package of frozen vegetables h A food scientist s knowledge of how to commercially freeze vegetables i The ability to bring together resources to start a frozen food company j Plastic bags used by a frozen food company to hold its product 2 Suppose that you are considering what to do on an upcoming weekend Here are your options from least to most preferred a study for upcoming midterms b fly to Colorado for a quick ski trip c go into seclusion in your dorm room and try to improve your score on a computer game What is the opportunity cost of a decision to play the computer game all weekend Your answer will not be in dollars 3 Use the information in the table below as well as the assumption about forgone income a student can make 18 000 working full time if he does not attend college to compare the opportunity cost of attending a year of college for a student at a two year public college under each of the following special assumptions a The student receives free room and board at home at no opportunity cost to the parents b The student receives an academic scholarship covering all tuition and fees in the form of a c The student works half time while at school assume for this problem that the leisure or study grant not a loan or a work study aid time sacrificed has no opportunity cost Type of Institution Tuition and fees Books and supplies Room and board Transportation and other expenses Total out of pocket costs Two Year Public College 2 713 1