OUTLINE -- CHAPTER 2
The Economizing Problem: Making Choices

I. The Necessity of Choice -- Production Possibilities

A. The Economizing Problem -- The Necessity of Choice
The choices necessitated because society's material wants for goods and services are unlimited but the resources available to satisfy these wants are limited.

1. Unlimited Wants
2. Limited resources

B. Production Possibilities -- Demonstrating the Necessity of Choice

1. Production Possibilities Table
a. shows the MAXIMUM POSSIBLE LEVELS OF PRODUCTION given the assumptions
b. assumptions
1) fixed resources
2) fixed technology
3) productive efficiency
4) full employment
5) only two goods

c. the necessity of choice -- Unattainable combinations

2. Production Possibilities Curve

a. the necessity of choice -- Unattainable combinations
b. opportunity costs
1) ALL costs in economics are opportunity costs
2) definition

The amount of other products which must be forgone or sacrificed to produce a unit of a product.

3) examples

  • coming to class today
  • a Big Mac
  • attending NIU
  • "free" trip
  • life?

4) calculating opportunity costs

c. law of increasing costs

1) definition

As the production of a good increases the opportunity cost of producing an additional unit rises.

2) shape of the PPC -- concave

3) rationale

4) example: Pizza restaurant

d. unemployment

e. productive inefficiency

f. economic growth

1) definition
(a) "Chapter 2 Definition:

An outward shift in the production possibilities curve which results from an increase in resource quantity or quality or an improvement in technology

(b) Common Definition:

an increase either in real output (gross domestic product) or in real output per capita.

2) causes

  • more resources
  • better resources
  • better technology

3) graphically
4) "ABILITY"
5) a shrinking PPC?
6) non-proportional growth

g. present choices, future possibilities

h. optimum product mix? (allocative efficiency?)

C. Other Applications

1. going to war
2. discrimination
3. growth: Japan vs. U.S.
4. international trade
5. other

II. The Necessity of Choice -- HOW?

pp. 4-5, "Rational Behavior", Marginalism: Benefits and Costs"
pp. 27-28, "Allocative Efficiency Revisited" (especially fig 2.2),
p. 12, "Fast Food Lines: An Economic Perspective"
pp. 324-325 "Society's Optimal Amount of Externality Reduction"

A. Benefit-Cost Analysis: "the economic perspective"

1. definition
the selection of ALL possible alternatives where the marginal benefits are greater than the marginal cost

select all where: MB > MC
up to where: MB = MC
but never where: MB < MC

TEXTBOOK: Comparing the marginal benefits of a government project or program with the marginal costs to decide whether or not to employ resources in that project or program and to what extent.

2. marginal benefits and marginal costs

marginal benefit

The extra (additional) benefit of consuming one more unit of some good or service; the change in total benefit when one more unit is consumed.

marginal cost

The extra (additional) cost of producing one more unit of output; equal to the change in total cost divided by the change in output (and in the short run to the change in total variable cost divided by the change in output).

3. Marginal Benefit = Marginal Cost Rule

The point at which the size or scope of production is optimized. The activity, scope, or output of a project should be increased until it reaches this point - or comes very close to it. This point will yield the maximum net benefit to society.

If marginal benefit exceeds marginal cost, then the project is too modest, and could be increased thereby increasing the net benefit to society.

If the marginal cost exceeds the marginal benefit, then the project will decrease the net benefit to society and should be decreased in scope.

For example, if the cost of a proposed government program exceeds its benefits, then it would be unwise to undertake it, but if the benefits exceed the cost, then it would be uneconomical, or "wasteful" not to spend on that government program.

4. ignore fixed or sunk costs

any cost that does not change as a result of the decision

TEXTBOOK: A fixed cost is any cost which in total does not change when the firm changes its output; the cost of fixed resources.

5. examples

a. Should I go to class today?
  • What are the MB?
  • What are the MC?
  • Ignore fixed costs = tuition

    What happens if the MB change?

    • An increase in MB will encourage the activity
    • A decrease in MB will discourage the activity

    What happens if MC change?

    • An increase in MC wil discourage the activity
    • A decrease in MC will encourage the activity

b. How many guards should be hired?

c. How many bridges should be built?

d. Should I wear a Ski Helmet ?

e. Should I drive fast?

f. Should I wear a helmet while skiing?

 

f. Others

Think of a decision that you currently have to make. What are the marginal benefits and the marginal costs? Are there any sunk costs that do not matter?

5. GRAPHICALLY [mcmb.jpg]

  • as you do more of something what happens to the additional costs (MC)?
    • law of increasing costs
    • opportunity costs and marginal utility

     

  • as you do more of something what happens to the additional benefits (MB)?
    • diminishing marginal utility

     

B. Microeconomic Applications

1. optimal quantity of a good: MSB = MSC
(allocative efficiency) Ch. 3, 10, 11, 12)

2. utility maximizing rule: MUa/Pa = MU b/Pb (Ch. 8)

3. profit maximization: MR = MC (Ch. 10, 11, 12)

4. rule for employing resources: MRP = MRC (Ch. 14, 15)

C. REVIEW

1. Study Guide pp. 5, # 2, 3, 4 and pp. 203-205: #9, 18, 19, 20

2. Multiple Choice Problems

 

III. Economic Systems -- the "isms"

A particular set of institutional arrangements and a coordinating mechanism for solving the economizing problem; a method of organizing an economy; of which the market economy command economy and traditional economy are three general types.

A. Criteria
1. who owns?
2. who decides?

B. Types

1. pure capitalism

An economic system in which property resources are privately owned and markets and prices are used to direct and coordinate economic activities.

2. command economy

An economic system (method of organization) in which property resources are publicly owned and government uses central economic planning to direct and coordinate economic activities.

3. mixed systems

4. traditional economy

An economic system in which traditions and customs determine how the economy will use its scarce resources.

C. All modern economic systems are mixed systems

IV. The Circular Flow Model

The flow of resources from households to firms and of products from firms to households. These flows are accompanied by reverse flows of money from firms to households and from households to firms.

A. Two Markets
1. product market

A market in which products are sold by firms and bought by households.

a. how much to buy
b. how much to produce

2. resource market

A market in which households sell and firms buy resources or the services of resources.

a. how many to hire
b. how much we earn

B. Two Flows

1. real flow
2. money flow

C. Reversal of Roles
D. Limitations

E. Diagram