Chapter 2 Some Tools of the Economist ECO2023 Opportunity Cost Opportunity Cost highest valued alternative sacrificed in order to choose an option Opportunity cost can only be measured by the decision maker It is hard for someone other than the decision maker to make choices on that person s behalf Preferences change with time and circumstances Monetary costs reflect opportunities forgone Monetary costs do not represent the total opportunity cost of an option EX Monetary cost of attending class bus fare parking gasoline costs Failure to consider opportunity cost often leads to unwise decision making Trade Creates Value better off 1 When individuals engage in a voluntary exchange both parties are made An exchange will not occur unless both parties agree to it and they will not do so unless the exchange makes them better off EX Janet loves tomatoes but hates onions and Brad hates tomatoes but loves onions They trade 2 By channeling goods and resources to those who value them most trade creates value and increases the wealth created by a society s resources Trade can create value by moving goods from those who value them less to those who value them more EX If Janet and Brad had never met and were eating their salads alone they would not get as much enjoyment out of their salad and the value would go down By channeling goods and resources toward those who value them most trade creates wealth for both the trading partners and for the nation Transaction Cost A Barrier to Trade Transaction Costs the time effort and other resources needed to search out negotiate and complete an exchange EX You are really hungry late at night and are wishing for a meal from your favorite fast food restaurant You would gladly pay the 4 price for the value meal you have in mind but you feel it is just not worth the time and effort to get dressed and make that drive High transaction costs can barrier a potentially productive exchange Reductions in transaction costs will increase the gains from trade The Middleman As A Cost Reducer Middlemen people who buy or sell goods or services or arrange trades A middleman reduces transaction costs Middlemen provide buyers and sellers information at a lower cost and arrange trades between them Car dealers and grocers are middlemen see page 22 23 Importance of Property Rights Property Rights the right to use control and obtain the benefits from a good or resource Private Property Rights property rights that are exclusively held by an owner and protected against invasion of others Private property can be transferred sold or mortgaged at the owner s discretion Private owners can do anything they want with their property as long as they do not use it in a manner that invades or infringes on the rights of another Because an owner has the right to control the use of property the owner also must accept responsibility for the outcomes of that control Common property ownership occurs when multiple people simultaneously have or claim ownership rights to a good or resource If the resource is open to all none of the common owners can prevent others from using or damaging the property Private ownership provides people with a stronger incentive to take care of things and develop resources in ways that are highly valued by others 1 Private owners can gain by employing their resources in ways that are beneficial to others and they bear the opportunity cost of ignoring the wishes of others Private ownership gives people a strong incentive to use property in a way that will also fulfill the wishes of others 2 Private owners have a strong incentive to care for and properly manage what they own EX If you own a car you are more likely to take care of it EX Berry college purchased 20 bikes to be placed around campus for everyone s use Within 2 months they were in bad condition 3 Private owners have an incentive to conserve for the future particularly if property is expected to increase in value People have a much stronger incentive to conserve privately owned property than they do commonly owned property EX In class Hershey kiss activity EX Overfishing the sea because the sea is common property 4 Private owners have an incentive to lower the chance that their property will cause damage to the property of others Private owners can be held accountable for damage done to others through the misuse of their property EX A chemical company has control over its products but exactly for the reason it is legally liable for damages if it mishandles the chemicals Because private property owners can be held responsible for the damages they cause they have an incentive to use their property responsibly and take steps to reduce the likelihood of harm to others Private Ownership and Markets Private ownership and competitive markets provide the foundation for cooperative behavior amongst individuals When private property rights are protected or enforced the permission of the owner must be sought before anyone else can use the property If you want to use a good or resource you must either buy or lease from the owner Private ownership and markets can play an important role in environmental protection and natural resource conservation Production Possibilities Curve AKA PPF or PPFrontier PPC shows the maximum amount of any two products that can be produced from a fixed set of resources and the possible trade offs in production between them PPC s are about trade offs and making choices Points on the PPC are efficient Points inside the curve are inefficient Points outside the curve are unattainable The PPC can shift SHIFT IN shrink produce less SHIFT OUT growth produce more The Production Possibilities Curve shows all of the maximum combinations of two goods that an economy will be able to produce 1 Given a fixed quantity of resources 2 Holding the level of technology constant 3 Assuming all resources are used efficiently Shifting the Production Possibilities Curve Outward 1 An increase in the economy s resource base would expand our ability to produce goods and services If we have more or better resources we could produce a greater amount of all goods Investment the purchase construction or development of resources including physical assets such as plants and machinery and human assets such as better education Investments expands an economy s resources The process of investment is sometimes called capital formation 2 Advancements in technology can expand the economy s production possibilities Technology
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