MicroeconomicsEconomics 0105 Dr. McGahagan

Course web page:

http://www.pitt.edu/~upjecon

Textbook: Principles of Microeconomics

by

Robert Frank and Benjamin Bernanke

(New York, McGraw Hill, 2000)

At the UPJ bookstore now

Scarcity ... the fundamental problem of economics

White Sands, New Mexico in the1950s, during a water shortagephoto from National Park Service

Resources are limited ... wants are not

Projected water scarcity (R. Svadlenka, "The emerging water crisis")

Color codes: Green => "little or no scarcity" Red => "Physical water scarcity" Orange => "Economic scarcity"

In economics, ALL COUNTRIES face economic scarcity

This photo illustrated an article on water scarcity on the island of Corfu (Greece).

No physical scarcity of water ... but no USABLE water.

Scarcity is always relative to human wants, hence it is always with us.

Is West Nile Virus “Scarce”?

In US in 2002 (to Aug.23) – 371 cases, 16 deaths http://www.cdc.gov/od/oc/media/wncount.htm

“Scarcity” means scarcity of “goods”;West Nile Virus is “rare”, but not “scarce”

Resources are limited; wants are unlimited

Scarcity = not enough resources to produce the goods to satisfy our wants.

Resources: Adam Smith in his Wealth of Nations (1776) divided resources into land, labor and capital.

http://www.adamsmith.org/smith/won-intro.htm

Adam Smith’s 3 resources: Land, Labor and Capital

1. LAND: used as shorthand for any natural resource,not simply for agricultural land.

2. LABOR: manual power + skill ("human capital")

3. CAPITAL: produced means of production for example, hammers, drill presses, computers ...

or even flint arrowheads of American Indians, which Smith used as an example.

Although money is used to BUY all the above, money is not itself a productive resource.

Capital grows through investment – and requires foregoing current consumption. The Indian must take time away from gathering berries to make the arrowheads.

Identify the resources:

Buena Vista Farm, Kern County, CA, around 1885 (Library of Congress)

Identify the resources:

Barthelemy L'Anglais, Le Livre des Proprietes des Choses15th century. Bibliotheque Nationale, France.

Identify the resources: land, labor, capital

Trawling for shrimp (NOAA website)

Identify the resources: land, labor, capital

Gathering coal from a slag heap, Nanty Glo, 1937(Photo by Ben Shahn, Library of Congress website)

Identify the resources: land, labor, capital

Electric furnace, Allegheny Ludlum (1941)

Scarcity means that choices are necessary.

When you can’t have all you want of everything, you must make choices.

Microeconomics is the study of how to make the best possible ( or the optimal) choice under the constraint of limited resources.

Choices always involve tradeoffs

Because of the scarcity of resources, we can have more of one thing only if we are willing to do with less of another.

The tradeoffs are very evident in wartime –the following slide shows Cadillacs from 1944 and 1946.

The productive resources in the lower pictures could be used to make either tanks or cars.

Cadillacs ... 1944 and 1946

M5 Tank Cadillac Coupe

Opportunity cost of tank = 10 passenger autos

Tradeoffs and the Production Possibility Frontier

Economists would want to develop a more precise model of the tradeoffs involved –

And that model can be represented graphically by a “Production Possibility Frontier”, showing the choices which are-- possible (on or within the frontier)

-- efficient (exactly on the frontier) -- inefficient (within the frontier) -- impossible (beyond the frontier)

500

M5 tanks

Autos

5,000

The tank-auto trade-off:an economist's view using the

Production Possibility Frontier

500

M5 tanks

Autos

5,000

The tank-auto PPF:one POSSIBLE point is(2000 autos, 300 tanks)

another POSSIBLE point is

(4000 autos, 100 tanks)300

2,000

500

M5 tanks

Autos

5,000

The tank-auto PPF:

an IMPOSSIBLE point is(4000 autos, 300 tanks)

300

4,000

500

M5 tanks

Autos

5,000

an INEFFICIENT point is(1000 autos, 200 tanks)

200

1,000

500

M5 tanks

Autos

5,000

The tank-auto equation:TANKS = 500 – 0.1 AUTOSCheck out a few values:

AUTOS TANKS 0 500 1000 400 2000 300 2001 299.9

500

M5 tanks

Autos

5,000

Equation in general form:

TANKS = a + b AUTOS

How to find the equation from the graph:

1. a = Y-INTERCEPT = 500

2. b = SLOPE = rise over run = - 500 divided by 5000 = - 0.1

500

M5 tanks

Autos

5,000

What the intercept means:

TANKS = 500 – 0.1 AUTOS

IF we produced zero autos, we could produce up to 500 tanks, since

TANKS = 500 – 0.1 (0) = 500

500

M5 tanks

Autos

5,000

What happens when the intercept changes:TANKS = 600 – 0.1 AUTOS

IF we produced zero autos, we could produce up to 600 tanks, sinceTANKS = 600 – 0.1 (0) = 600

The PPF would shift OUT and parallel to itself.

600

6000

This might be due to an increase in the resources available for production – for example, an increase in the labor force, and a new assembly line in the factory

500

M5 tanks

Autos

5,000

What the slope means:TANKS = 500 – 0.1 AUTOS

IF we were producing 2000 autos and 300 tanksand if we decided to produce one more auto, we

would have to reduce tank production to 299.9 The OPPORTUNITY COST of an auto is

one-tenth of a tank.

500

M5 tanks

Autos

10,000

What happens when the slope changes:TANKS = 500 – 0.05 AUTOS

If autos = 0, TANKS = 500If autos = 5,000, TANKS = 250If autos = 10,000, TANKS = 0

The possibility exists of producing more autos – perhaps some way of producing auto transmissions (but NOT tank transmissions) more rapidly has been discovered.

5000

Costs and benefits

The Production Possibility Frontier shows us the economically efficient possibilities, butdoes not help us choose among them.

To choose, we must weigh costs and benefits:

take an action (move along the PPF)if and only if the EXTRA benefits of the action are at least as great as the EXTRA costs.

Scarcity and use of time

Exercise: Draw PPF for

1.Studying/Partying

2. Studying/Working

Think about intercepts, actual point chosen.

Opportunity cost

Consider the last slide:

1. What is the opportunity cost of studying?

2. What is the opportunity cost of working?

3. Why do rational people make different choices?