Sandbox:Econ 101 - Microeconomics

Economics Issues and Concepts

The Complexity of the Modern Economy

The Self-Organizing Economy

• The economy is self-organizing due to the thousands of millions of transactions people make which is motivated by self-interest and not so much benevolence

Efficient Organization

• The free-markets behaves like it is guided by an "Invisible Hand" (Smith) because the decision-makers act on the same set of prices determined by overall conditions of national scarcity or plenty.
  • This means that the economic order is relatively efficient.

Main Characteristics of Market Economies

There are four characteristics of market economies that produce the "spontaneous self-organization" of the economy

1. Self-Interest
   • People buy and sell what seems best for them and their families (Pursuing their own self-interest)
2. Incentives
   • People respond to incentives (Sell more when prices high, buy more when prices low)
3. Market Prices and Quantities
   • Buyers & sellers negotiate exchange of goods&services in markets via prices
4. Institutions
   • "Rules of the game"
   • Freedom of Contract
   • Manners,customs,conventions

Planned Alternative = Command Economy = Communism

• Another way an economy can work would be a command economy where resources are allocated and income is distributed for efficiency.
• This alternative fails mainly due to misplaced incentives (Why work when I'm going to get paid anyway?), and quality control.

Scarcity, Choice, and Opportunity Cost

Economics is the study of the management of scarce resources to satisfy unlimited human wants

Resources

Society's resources divided into three categories

1. Land
   • Includes all natural endowments
     • arable land
     • forests
     • lakes
     • crude oil
     • minerals
2. Labour
   • Includes all mental & physical human resources
3. Capital
   • "PIER"
     • Plant
     • Inventory
     • Equipment
     • Residential Const.

These resources are called factors of production, what is used to produce things people desire.

There are Five factors of Production(Inputs), "Lt. Ken"

• L Land = natural resources, natural capital
• T Technology = change in productive process
• K Capital - PIER
• E Entrepreneurship = Innovation&Invention
• N Labour = Human resource&capital

The act of making Goods&Services is called Production and using them up is called Consumption

Production to Consumption

Inputs -> Outputs -> Satisfaction

Scarcity & Choice

• Existing resources and factors of production are limited while human desires are unlimited
• Economics manages the scarcity to satisfy, and Politics' decides among the desires
• Scarcity implies that we must make choices, and choice implies cost
• A scarce good means that there is a limited supply and a free good means there is an unlimited supply

• Look at figure 1-1 in textbook

Opportunity Cost

Opportunity Cost is the value of what you give up for something.

• OC of going to Guatemala at Christmas is the price of the ticket AND lost income from a PT job
• If a slice of pizza is $2, and a beer is $4, then the OC of one pizza is half a beer and OC of a beer is two pizzas.

Opportunity Costs only include costs affected by the choice

• This means we exclude sunk cost which is cost incurred in past which cannot be recovered, thus irrelevant

Aside: The Opportunity Cost of Your University Degree

Suppose that a bachelor's degree requires four years of study and that each year you spend $6000 for tuition fees and tack on another $1500 for books&materials. This is a total of $30,0000 spent on the degree. But the opportunity cost of going to University is much greater. Suppose you would of taken the best alternative of attending university and got a job that received $20,0000 after tax per year for a total of $80,0000 in four years. The opportunity cost shoots up to $110,0000 <-- Make sure you make the best out of this sacrifice!

Production Possibilities Curve/Boundary/Frontier

The PPC is a concave curve illustrating three concepts.

1. Scarcity
   • Indicated by unattainable combination outside of boundary
   • Cannot produce beyond your input capacity
2. Choice
   • The need to choose among alternative attainable points along boundary
   • Production Efficiency - cannot produce more of one without less of other.
   • Inside the PPC is "Production Inefficiency"
3. Opportunity Cost
   • The negative slope of the boundary
   • Cost of one more gun is to give up 2 butters(A ratio)

• Look at Figure 1-2 in Textbook
  • The concave shape indicates that the OC of either good increases as we increase production of it.
  • High Comparative Advantage inputs used first
  • Assume most efficient factors used first & most inefficient resources are switched out first
  • Law of Increasing Marginal Opportunity Cost OC of X increases and production of X increases. Least to Most efficient resources switched out to produce more of X. eg. switch farmers & tractors into health care
  • Increasing productivity shifts PPC outward
  • We want to be on the curve where MC = MB
    • MC = Marginal cost, OC of producing one more unit
    • MB = Marginal benefit, extra benefit one receives from consuming one more unit of good

Four Key Economic Problems - For ANY Economy

Microeconomics

1. Production - What is Produced and How - Resource Allocation

• Resources are scarce, therefore we need to figure out how to use them efficiently
• Choosing a method of production to produce a certain quantity of goods means choosing a particular allocation of resources
• So we must figure out how to allocate our scarce resources of land, labour, and capital efficiently.

2. Consumption - What is Consumed and By Whom? - Income Distribution

• Who gets a lot, who gets a little, and why?
• How much will the economy consume?
• Will trade allow us to consume more variety?

Macroeconomics

3. Why are Resources Sometimes Idle?

• Why is the economy below the PPC?
• Sometimes workers cannot find jobs even if they want to work, or factories are not operating at their best.
• Should Gov't worry about these idle resources?
• Is this idleness sometimes a good thing?
• What can the Gov't do to reduce such idleness?

4. Is Productive Capacity Growing?

• Is the capacity to produce goods&services growing?
• Such growth allows the PPC to shift outward and attain the unattainable points
• What determines this growth?
• Are there side effects to such growth?
• What can Gov't do to influence this growth?

Who Makes the Choices and How?

Flow of Income & Expenditure

• flows of income & expenditure pass through markets
• Individuals who sell services of the factor that they own are collectively called factor markets
• Producers selling their outputs of goods & services in what are collectively called goods markets
• Prices determined by these markets (price of each type of factor service receives in factor markets)
  • People who get high prices for their factor services earn high

incomes, and those who get low prices earn low incomes. This is called distribution of income

Consists of:

1. Households
   • they live under one roof and make joint financial decisions
     • Assumed to act consistently as one unit, is a maximizer, exchange factors for income, and spend income and goods&services
2. Firms
   • Employs factors(inputs) to produce goods&services
     • Assumed to act consistently as one unit, maximizer for profits, exchange G&S for income, spend income on factors
3. Government
   • Anyone under control of the fed, provincial, municipal government
     • Assumed to not act consistently, and not maximize anything except for votes lol
4. Rest of World
   • Export/Import markets
     • Assumed to act like rational consumers & producers

Maximizing Decisions

• Consumers&Producers are decisionmakers in a market economy
  • These people are assumed to be maximizers; that is they make decisions to get what is best for them like maximizing profit

Marginal Decisions

• Consumers&Producers who are maximizers make marginal decisions by weighing out the benefits vs cost to see if what they're giving up is worth it.

The Complexity of Production

Production is a very complex process in any modern economy. For example, a typical car manufacturer assembles a product out of thousands of individual parts. It can make some of these parts itself and most of hte other ones are subcontracted to parts manufacturers and these manufacturers can subcontract to smaller firms like a chain. This displays two characteristics:

1. Specialization
   • Jobs like Artisan, soldier, priest, and more are specialized occupations allocated to different people. This is called Specialization of Labour.
   • Two reasons that specialization is efficient:
     1. Individual abilities differ and specialization allows each person to do what they are good at which increases production for not only individual, but entire countries.
     2. "learning by doing" principle, meaning that the more someone does soemthing, the better they get at it which further increases production.
2. Division of Labour
   • Instead of specializing in whole products, modern methods of production now break the production process into a series of specialized tasks, each done by a different worker. This is called Division of Labour
   • Mass Production is where a factory divides highly specialized tasks by using specialized machinery.
   • Artisans & Flexible Manufacturing
     • Individual artisans have recently reappeared in some lines of production which are responding to a revival in the demand for individually crafted products
     • Flexible Manufacturing/lean production is a new reorganization of production where employees work as a team; each employee is able to do every team member's job.

Markets and Money

• Specialization must be accompanied by trade. People who produce only one thing must trade most of it to obtain all the other things they want.
• Early trading was by means of barter, where goods & services are traded directly for other goods & services
• Money helps facilitate specialization and trade immensely

Globalization

• Globalization is caused by advancements in transportation and communication
• As a result, globalization of demand(markets) and supply(transnational corporations - mcdonalds)
• also increased international trade

Side: Globalization Debate

Anti-Globalization activists:

• Increases in flow of international trade & investment have been responsible for increasing global income inequality and worsening poverty in developing countries
• Organizations such as WTO, World Bank, and the IMF operate in undemocratic fashion and hold their meetings behind closed doors out of view of and without critical input from people whose lives their polices are so dramatically influencing.

Pro-Globalization:

• Argue that globalization is the best bet for reducing the poverty the anti-globalization believes it is causing.
• Argue that free trade between countries have been responsible for advancements in living standards of developing countries
• Argue that the WTO and other organizations are voluntary meetings held by democratically elected leaders and thus democratic.

Is There an Alternative to the Market Economy?

There aren't any alternatives to the market economy because the modern economy has no practical alternative to reliance on market determination for many of its transactions. But not all transactions take place in free markets even in the most market-oriented societies.

Types of Economic Systems

1. Traditional Economies
   • Allocation & distribution based on custom
   • effective in an unchanging environment
   • feudal system - traditional prices offered to all
   • young men follow their fathers occupations, women do what their mothers did. Not much change.
2. Command Economies
   • Allocation & distrubition based on central planning authority
   • old russian communist 5-year plans
   • requires forecasting - which means lots of planning and adapting to changes in trends. Very difficult to keep up with the sheer amounts of data required for central planning of an entire modern economy.
   • Today, possibly Cuba and North Korea
3. Free Market
   • Allocation & distribution - private households and firms
   • free-market or free-enterprise economy
   • decisions decentralized
   • price system acts to coordinate buyers and sellers, which pretty much means a free-market system
4. Mixed
   • Allocation & distribute - by private and public sectors, sometimes government

The Great Debate: Market v. Command Economy

• Maybe command economies are good for transition from traditional economies
• Mixed may trump command; but free may not trump mixed.
• Market economies have difficulties with monopolies,externalities,publicgoods,etc.
• Don't confuse efficient allocation with equitable distribution
• Don't confuse free economy w/ democratic politics.
• Best choice is a MIXED economy

Failure of Central Planning

1. Failure of Coordination
2. Failure of Quality Control
3. Misplaced Incentives
4. Environmental Degradation