Some Tools of Economic Analysis

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Some Tools of Economic Analysis
Chapter Two
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Choice and Opportunity Cost

• Opportunity Cost the value of the next best
  alternative forgone when a choice is made
• Subjective- value is not always quantifiable
• Varies with circumstances
• Sunk Cost- A cost that has already been incurred,
  thus irrelevant to the present and future
  decisions

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Law of Absolute Advantage

• The Individual, firms, or countries that have the
  lowest opportunity cost of production should
  specialize in producing a good.
• Absolute Advantage- The ability to produce
  something using fewer resources and other
  producers use.

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Law of Comparative Advantage

• Comparative Advantage- The ability to produce
  something at a lower opportunity cost than other
  producers
• That is, you give up less to produce a good or
  service than someone else

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Comparative Advantage Maximizing Output
You- ½ hour type a paper/ 10 minutes to iron a
shirt Roommate- 1 hr to type a paper/5 minutes to
iron a shirt

• Case 1 You are a faster typist and your roommate
  is a faster ironer.
• Output per Hour
• Each Does Own Each Specializes
• Typed Ironed Typed Ironed Papers Shirts Pap
  ers Shirts
• You 1 3 2 0
• Roommate 1 0 0 12
• Total 2 3 2 12

Priority Paper
5
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ComparativeAdvantage Maximizing Output
You- ½ hour type a paper/ 10 minutes to iron a
shirt Roommate- 1 hr to type a paper/12minutes to
iron a shirt

• Case 2 You are a faster typist and a faster
  ironer, but you are a comparatively faster
  typist.
• Output per Hour
• Each Does Own Each Specializes
• Typed Ironed Typed Ironed Papers Shirts P
  apers Shirts
• You 1 3 2 0
• Roommate 1 0 0 5
• Total 2 3 2 5

Priority Paper
6
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Gains from Division of Labor

• Organize production into a series of separate
  tasks
• Specialization- Focus on a specific task
• Why it works
• Can do what you like
• Can use specialized equipment
• Can reduce training costs
• Reduce time between specific tasks

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Gains from specialization are not absolute and
infinite
Productivity
Units of Output
More Specialization
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Production Possibilities

• Assumptions
• There is a limited number of resources available
  in the economy
• To make more of one good, results in a tradeoff
  of one good for another
• The only thing that can allow you to make more of
  each, is an increase in available technology

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Exhibit 2 The Economys Production
Possibilities Frontier
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(Increase in Available Resources)
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(Decrease in Available Resources)
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(Increase in Resources or Technological Advance
that Benefits Consumer Goods)
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(Increase in Resources or Technological Advance
that Benefits Capital Goods)
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Three Questions any Economic System Must Answer

• What goods should be produced?
• How will goods and services be produced?
• For whom will goods and services be produced?

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Economic Systems

• Pure market- Private ownership of resources,
  prices answer question of allocation of goods
• Pure Command- Public ownership of resources,
  government allocates goods on the basis of need
  of the many
• Mixed Systems- public and private ownership of
  goods and services