Economics

Alan J. Carper Roger Bradley Brad A. Payne Bob Jones University Press 2 nd Edition 2010

Unit 1 Economics The Science Of Choice

Chapter 2 Economic Models

Objectives

• • • • • • • Identify the two purposes of economic models Identify the two common forms of economic models Explain the production possibilities curve List and define the four factors of production List and describe the four factor costs List the participants in the cirular flow model Explain the activities represented in the circular flow model

Biblical Integration

• As Christians we are to be models of Christ. We are to live our lives with the mind set of imitating Him, “to walk, even as He walked” (I John 2:6) • For many, it is not enough to just hear about God—they want to see Him in the lives of those who claim to know Him.

(Carper 23)

Models in Economics:

• A model is a simplified representation of a real situation that is used to better understand real life situations.

• The “other things equal” - assumption = all other relevant factors remain unchanged.

5

•

Trade-offs: The Production Possibility Frontier (PPF)

Production Possibility Frontier (PPF)

– Illustrates the trade-offs facing an economy that produces only two goods. – Shows the maximum quantity of one good that can be produced for any given production of the other.

• PPF improves our understanding of trade-offs by showing it graphically.

6

Production Possibilities Table

 Lists the different combinations between two resources “that can be produced with a fixed quantity of scarce resources.”

Pastries

0 1 2 3 4 5

Pizza Crusts

10 8 6 4 2 0 7 (Dodge 43)

Production Possibilities

• “If the chef wishes to produce 1 more pastry, she must give up 2 pizza crusts. • If she wishes 1 more crust, she must give up one-half of a pastry.”

Pastries

0 1 2 3 4 5

Pizza Crusts

10 8 6 4 2 0 (Dodge 43) 8

Transactions: The Production Possibilities Frontier

 Concepts illustrated by the production possibilities frontier – Efficiency – Opportunity cost – Law of Increasing costs – Economic growth 9

The Production Possibility Model

 Illustrates the concept of: 1. Efficiency: Any point on the frontier represents = feasible and efficient use of resources (Point A or B) Quantity of Pizza Crusts A • D • A point outside the frontier is not feasible given the current amount of resources. (Point D) C • B • The line curve in the figure is not straight but is concave to the origin.

Any combination of goods inside the frontier represent a point of inefficiency, does not use all the resources fully. (Point C) Quantity of Pastries 10

Production Possibility

2. Opportunity costs: The negative slope = an increase in the production of one good and sacrifice of some quantity of the other good.

12 In other words: – The opportunity cost of a pastry is two crusts.

– The opportunity cost of a pizza crust is one-half of a pastry.” (Dodge 43) 10 • 8 6 4 2 0 0 • 1 • 2 • 3 • 4 • 5 6 11

Production Possibility

3. The Law of Increasing Costs

 “more of a good that is produced, the greater its opportunity cost.”  Bowed out = opportunity costs as more of one good is produced - because resources are not easily transferable from the production of one good to another.

- “resources must be reallocated from pizza crusts production to pastry production. Labor, capital, and natural resources must be removed from crust production and moved into pastry production.” 4 2 10 • 8 6 0 • • • 1 2 Pastries 3 • 4 12 (Dodge 43)

Production Possibility

• • 4. Economic Growth: Over time as a society gains more resources, the PPF shifts outward.

- because production possibilities are expanded.

4 2 10 • 8 6 0 • • • 1 2 Pastries 3 • 4 13 (Dodge 43)

Example

• Assume David Ricardo and Ricky Ricardo are going to throw a party in exactly one hour. They decide on serving homemade pizzas and cakes. Assume they have 15 ovens in their apartment and lots of pots and pans. Use the information in the next slide to determine who should produce what.” David Ricardo was an “English economist responsible for promoting comparative advantage as the basis of trade. No relation to Ricky Ricardo” (Lucy’s first husband).

14 (Mayer)

Example

David Ricardo Ricky Ricardo Bakes Cakes 2 cakes/hr.

4 cakes/hr.

Makes Pizza 6 pizzas/hr.

8 pizzas/hr.

(Mayer) 15

Example

David Ricardo Ricky Ricardo Bakes Cakes 2 cakes/hr.

4 cakes/hr.

Makes Pizza 6 pizzas/hr.

8 pizzas/hr.

“Who has the absolute advantage in baking cakes?” “Who has the absolute advantage in making pizza?”

(Meyer) 16

Example

David Ricardo Ricky Ricardo (Mayer) Bakes Cakes 2 cakes/hr.

4 cakes/hr.

Makes Pizza 6 pizzas/hr.

8 pizzas/hr.

Why? Because 4 cakes > 2 cakes & 8 pizzas > 6 pizzas.

17

Example

David Ricardo Ricky Ricardo Bakes Cakes 2 cakes/hr.

4 cakes/hr.

Makes Pizza 6 pizzas/hr.

8 pizzas/hr.

“Who has the comparative advantage in baking cakes?” “Who has the comparative advantage in making pizza?”

(Mayer) 18

Example

Why?

“Ricky only gives up 2 pizzas in order to bake a cake, whereas David gives up 3 pizzas in order to bake a cake.”

(Mayer) 19

Example

“Furthermore, it only cost David 1 / 3 of a cake to make a pizza, whereas it costs Ricky ½ of a cake to make a pizza.”

(Mayer) 20

Example

David Ricky Opportunity Cost Pizza Cakes

6/2 = 3

2/6 = 1/3 8/4 = 2

4/8 = 1/2 “Who has the comparative advantage in baking cakes?” “Who has the comparative advantage in making pizza?”

(Mayer) 21

Specialization

• Individuals and countries can be made better off, if they will produce in the area they have a comparative advantage and then trade with others for whatever else they want or need.

22 (Mayer)

Transactions: The Circular-Flow Diagram

• The circular-flow diagram is a model that represents the transactions in an economy by flows around a circle.

 The diagram helps us to understand how the economy manages to provide jobs for a growing population.

– The number of jobs are not fixed, because it depends on how much households spend.

– The amount households spend depends on how many people are working.

23

Economic Way of Thinking

• The core problem for economic interactions is a array of diverse and even incompatible individual projects • Solution: specialization (division of labor) – results from people’s economizing actions – is necessary to increase production

Activity 1

Scarcity, Opportunity Cost and PPC

National Council on Economic Education, New York, N.Y.

Objectives

• • • • • •

Define scarcity and opportunity cost Apply scarcity and opportunity cost to a number of everyday situation.

Construct production possibilities curves using hypothetical data.

Apply concept of opportunity cost to a production possibilities curve Analyze the different locations of points on, outside, and inside a production possibility curve.

Define absolute advantage and comparative advantage

Activity 2

• • The PPC is drawn assuming that all resources (land, labor, capital, entrepreneurship) are fully employed and technology is constant.

PPC is bowed out or concave to the origin, determines the trade off in the production of the two commodities.

• Other shapes?

Constant Opportunity Cost

Activity 2

Decreasing Opportunity Cost

Activity 2

• • • As the price declines from P to P1, the quantity increases from Q to Q1 Trade-offs: Remember when you want more of one, you have to give-up some of the other.

Activity 2

Opportunity Cost & Comparative Advantage

Activity 2

• Absolute Advantage One individual or nation can produce more output with the same resources as another individual or nation. • Comparative Advantage One individual or nation can produce a good at a lower opportunity cost than another – Examples of Comparative Advantage • Economics professor and secretary (teaching vs. typing) • Auto mechanic and medical doctor (repairing a car vs. caring for the sick and injured)

Activity 2

• For 1 bushel of corn Mexico = ½ gallons of sunscreen (150/300) France = ¾ gallon of sunscreen (150/200) • For 1 gallon of sunscreen Mexico = 2 bushel of corn (300/150) France = 1 ⅔ bushel of corn (200/150) Absolute Advantage - Mexico has the absolute advantage in producing corn - Neither country has the absolute advantage in producing sunscreen Comparative Advantage: - Mexico has the comparative advantage in producing corn - France has the comparative advantage in producing sunscreen

Complete:

Opportunity Cost and Comparative Advantage Activity

HOUSEHOLDS/ PEOPLE The Circular Flow Payment for Goods and Services THE PRODUCT MARKET Finished Goods & Services BUSINESSES/ ENTREPRENEUS Land, Labor, Capital and Entrepreneurship THE FACTOR MARKET Income Wages, Rents, Interest, Profit

Circular Flow Activity Power Point

Graphs Review

–

Objectives

Interpret the graphs used in economic models.

–

Determine the difference between convex and concave.

–

Interpret a constant, zero, decreasing and increasing opportunity cost graph.

–

Interpret a scatter diagram, a time-series graph, and a cross-section graph.

–

Determine a negative vs. positive slope.

–

Define and calculate slope.

–

Graph relationships among more than two variables.

Basic Idea

 A graph enables us to visualize the relationship between two variables.

 To make a graph, set two lines perpendicular to each other: • The horizontal line is called the x-axis. • The vertical line is called the y-axis. • The common zero point is called the origin.

•

Dependent variable is on the vertical axis (Y)

•

Independent variable is on the horizontal axis (X)

Y X (“Leppel”)

Y • “Negative or inverse relations are

downward

sloping from left to right.”

negative slope

Y

positive slope

X • “Positive or direct relations are

upward

sloping from left to right.” X (“ Leppel ”)

“The negative slope is evident in the graph by the fact that the line slopes downward toward the right.” beats mg.

(“ Leppel ”)

Nonlinear Relations Convex

“If a curve looks like the letter U or part of a U, it is convex (from below).” (“ Leppel ”)

“This curve is downward sloping and convex from below.” min.

per mile hrs. slept per day (“ Leppel ”)

wgt calories

Convex Curve

“This curve is upward sloping and convex from below.

(It bulges toward some reference point, usually the horizontal axis or the origin of a diagram.) A curve is convex from below (or convex to something below it) if all straight lines connecting points on it lie on or above it.” (“ Leppel ”)

Nonlinear Relations

Concave

“Picture the opening of a cave. If a curve looks like this or part of this, it is concave (from below).” (“ Leppel ”)

“This curve is upward sloping and concave from below.” wgt calories

Constant Opportunity Cost Graph

Y X

Zero Opportunity Cost Graph

Y X

Decreasing Opportunity Cost or Convex Graph

Y X

Increasing Opportunity Cost or Concave Graph

Y X

Works Cited

Blade, Robin, and Michael Parkin. Foundations of Economics: Instructor’s Manual. 2nd ed. Boston: Pearson Education, Inc., 2004. Carper, Alan. Economics for Christian Schools. Greenville: Bob Jones University Press, 1998. "The New King James Version." Logos Bible Software. CD_ROM. ed. 2004.