• We need to start with definitions of resources and scarcity

  • Resources are things that people want, either for their own sake or to use in production.

  • Scarcity is the notion that the amount resources people want is significantly less than the amount of resources that actually exist.

• Economics, then is the study of how people choose attain their goals in a world of scarcity.

• Considering that nearly everything is a resource, perhaps a simpler definition is:

• Economics is the study of all purposive human action.

• Microeconomics
• Macroeconomics

• Typically focuses on decisions of small (typically) economic units…
  • Individuals
  • Firms
• And how those decisions interact with the decisions of other economic units…
  • Equilibrium
  • Game Theory
  • “Law of Unintended Consequences”
• And what, if anything, to do about the outcomes
  • Free markets/Socialism
  • Regulation
  • Public goods/externalities

• Looks at the economy at the aggregate level…
  • \(C+I+G+NX\)
  • \(\dot {M} + \dot {V} = \dot {P} + \dot {Y}\)
• In an attempt to understand economy-wide phenomena…
  • Unemployment
  • Inflation
  • Recessions/depressions
• And how they might be affected by policy
  • Taxation
  • Central Banking
  • Stimulus

Positive vs. Normative Economics

• Which is more important—being correct factually (positive) or correct morally (normative)?

• Being correct normatively but not positively often leads to the Law of Unintended Consequences.

  • Law of Unintended Consequences: The notion that actions of people, and especially of governments, always have effects that are unanticipated or "unintended.“

• Is there a danger in being too positive?

Understanding the distinction between positive and normative is often seen to be important beyond economics.

• Ideally, you:
  1. Focus on getting the positive economics right, …
  2. … and only then do you use the positive economics to inform your normative economics.
• Going into the other direction leads to disastrous economic policy.
  • Recall the Law of Unintended Consequences.

Economists talk about the margin a lot, and it has a lot of different meanings.

• Most generally, it means “additional.” Some examples in use:
  • Marginal Cost is the change in cost for producing one more thing.
  • Marginal Tax Rate is the change in total taxes owed if your income goes up by a dollar.
  • Marginal Revenue is the extra revenue earned by selling one more unit.

Economic resources are used to produce goods and services. There are many categories of economic resources:

• land: raw materials and natural resources
• labor: workers
• human capital: the experience, education, skills posessed by labor
• physical capital: buildings, machinery, factories, equipment
• time
• ideas: technology, scientific know-how, etc

For the most part, each of the resources exists in a finite, limited quantity.

• Economists assume that people have unlimited wants.
  • There is always something that people want more of.
• How can unlimited wants be satisfied with limited resources?
• This concept is what we define as scarcity and much of economics looks at how people cope with scarcity.

• An implication of scarcity is Opportunity Cost.

• Opportunity Cost refers to the value of the next best opportunity and is how economists think of cost.

• There is a big difference between opportunity cost and how most people think about cost.

“There ain’t no such thing as a free lunch.”

• Another way to think about the ideas of Scarcity and Opportunity Cost together is that they imply that all human action involves tradeoffs.

• Because everybody is different, we all face different tradeoffs and opportunity costs for the things we do, even if we are doing the same thing.

• This fact gives rise to the concept of Comparative Advantage

Comparative Advantage vs. Absolute Advantage

The “normal” concept of being “better than” somebody else at doing things is called Absolute Advantage.

• Absolute Advantage: The ability to produce something more cheaply than someone else, where more cheaply means using less time or resources. This is not opportunity cost.

Comparative Advantage vs. Absolute Advantage

But opportunity cost implies that Comparative Advantage, not absolute advantage, is the more important idea.

• Comparative Advantage: The ability to produce an item more cheaply than someone else, where cheaply means giving up producing fewer other goods. This is opportunity cost.

Comparative Advantage vs. Absolute Advantage

Assume a 2 country, 2 good world in which the only resource needed for production is time.

• Let’s say that in Japan it takes 1 hour to produce a computer or 1 hour to produce a shirt.
• Assume that in Vietnam, it takes 12 hours to produce a computer and 2 hours to produce a shirt.

Comparative Advantage vs. Absolute Advantage

In this example:

• Who has an absolute advantage in making computers? Shirts?
• Who has the comparative advantage in making computers? Shirts?

Comparative Advantage vs. Absolute Advantage

Suppose that both Japan and Vietnam are allocating 12 hours to each task.

Output is:

• Japan produces 12 computers and 12 shirts
• Vietnam produces 1 computer and 6 shirts
• World production is 13 computers and 18 shirts

Comparative Advantage vs. Absolute Advantage

What if each country specializes in what they are good at? Suppose Japan spends 14 hours making computers and 10 making shirts and Vietnam spends 24 hours making shirts.

Total output goes up!

• from 13 computers to 14 computers
• from 18 shirts up to 22.

Comparative Advantage vs. Absolute Advantage

This example highlights some important observations about trade and exchange:

• Trade is nearly always mutually beneficial.
• Trade is not zero-sum.
  • Zero-sum refers to a “game” or situation in which whatever is gained by one side is lost by the other.

As a result, it makes little sense to talk about “winners” and “losers” of trade because both sides tend to win.

The gains from Specialization & Trade here is due to differing innate abilities.

Further gains are likely to come from:

• Learning by Doing
• Economies of Scale
• Competition generated by trade

Each of which will tend to increase the comparative advantage of both countries, increasing the gains from trade.