The desire for food is limited in every man by the narrow capacity of the human stomach; but the desire for the conveniences and ornaments of building, dress, equipage, and household  furniture, seem to have no limit or boundary.

		Adam Smith, 1776

The Economic Problem

	Unlimited Wants
	but
	Scarce Resources

Key Definitions*

	Goods
		Anything that satisfies a human want
	Resources
		Land, Labor, Capital
	Consumption
		Use Goods to satisfy wants
	Production
		Combine resources to create goods

Nine Principles

	4 Principles of Individual Choice
	5 Principles of Markets

Individual Choice Principle:
Scarcity

	Result of Economic Problem
	Both Resources & Time are Scarce

Individual Choice Principle:
Opportunity Cost

	Measured by value of best alternative given-up
	What could have been if this choice were not made

Individual Choice Principle:
Marginal Decisions

	Marginal: the next unit, or the incremental unit
	Quantities are chosen marginally by comparing marginal benefits vs. marginal costs

Individual Choice Principle:
Rational Decisions

	“Self-Interest”
	Individuals try to maximize the expected benefit, given constraints
		Assumed Rationality
		Voluntary, not Coerced

Market Principle:
Trade is Win-Win

	Diversity creates opportunities for “gains from trade”
	Voluntary trade ONLY occurs if both parties gain

Market Principle:
Equilibrium

	Given conditions, everybody is doing the best they can
	No incentive to change
	more precise definition later

Market Principle:
Social Goal: Efficiency

	Making the most of limited resources
	Economic Efficiency
		“Pareto Optimal”
		“Allocation” efficiency
	Efficient Production
		Max Output, Given Current Resources
		What about Equity?

Market Principle:
Markets are Efficient

	Competitive markets achieve greatest efficiency
	Exceptions:
	monopoly
	externalities
	public goods

Market Principle:
Government Role

	Sets the “rules”
	Enforce Contracts
	Public goods
	Correct market “failures”

Question:

	Bastiat’s Fallacy of the Window:
	A child throws a brick though a window.  The owner pays a glazier to replace the window.
		Who gains?
		Who loses?
		Was there economic “growth” and production?
		Examples of the fallacy?

 Methodology:
How Do Economists Think?

	“What is often called sound economics is very often what mirrors the needs of the respectably affluent”. J.K. Galbraith (Money, 1975)

 Economic Theories: Models

	Simplied
	“If…..then….”
	Predict Behavior
	Key Factors Only
	Too Many Details      è Unwieldy
	Aim to Explain
		Stories, Graphs, Data, Math

Economic Activities & Interactions

	Economic Agents:
		Households
		Firms
	Where they interact:
		Markets for goods and services
		Markets for factors of production

Positive vs. Normative Economics

	Theory & Positive Economics
		Evidence Supports/Denies
		Conditional Forecasts
			“ceteris paribus”
		How things work/ What “is”
	Policy & Normative Economics
		Change Rules
		What to do / What “should”

Economic “Systems”

	How to answer 4 questions?
		What to produce?
		How much to produce?
		How to produce?
		Who gets to consume?

Questions for our 1^st model:

	What to produce?
	How much to produce?
	What’s possible?
	What’s a fantasy?
	What’s most we can make?

PPF:
Production Possibilities Frontier

	Model of Economic Problem & Choice
		Max. Production Quantities Possible of 2 Goods
		All Resources Used Efficiently
	Assumptions
		Two Goods
		Fixed Time Period
		Resources available:
			Fixed Quantity
			Fixed Quality
		Technology does not change

Factors Affecting PPF

	Shift curve (right/out or left/in)
		Changes in Resource Quantity / Quality
		Increase Capital Stock
		Technological Change
	Shape curve
		Comparative Advantage & Trade
		Law of Increasing Costs

Example

	Homer & Ned Stranded on Two Islands

PPF Model Illustrates

	Opportunity Costs
	Gains from Trade and Specialization

Who makes what & who trades?

	Comparative advantage:
		opportunity cost of is lower than for other people.
		Determines trade patterns
	Absolute advantage:
		physical resource cost is least

In the next unit:

	When trade happens….
		How is price determined?
		How is the quantity traded determined?