AP Macro Unit 1 Notes

Economic Foundations

The 5 Powers of Economic Thinking

The economic cream to your coffee

1. Scarcity
 Scarcity is the basic
imbalance between
relatively unlimited
wants and
relatively limited
resources.
Individual’s Economizing Problem
GLOBAL PERSPECTIVE

Average Income, Selected Nations

Country Per Capita Income 2004
Switzerland $48,230
United States 41,400
Japan 37,180
France 30,090
South Korea 13,980
Mexico 6,770
Brazil 3,090
China 1,290
Pakistan 600
Nigeria 390
Rwanda 220
Liberia 110
Source: World Bank
Theories Principles and Models
 The Scientific Method
 Economic Principle
 Generalizations
 Other-Things-Equal
O 1.4

Assumption (ceteris paribus)

 Graphical Expression
2. Economics - the study of how people
decide to resolve the problem of scarcity.
 Microeconomics  Macroeconomics
studies how studies how
individuals and society as a
firms make whole operates.
these decisions.
3. Opportunity Cost
• Example: Mr.
 The forgone McWenie watching
benefit of the next “Breaking Bad”
instead of grading
best alternative. papers.
The next best
alternative you
give up when you
make a decision.
Resources cost more than you think!
(What does it cost to go to college?)
A) What is the explicit/ accounting costs? It is the costs that you
can see.
Examples: tuition, room and board, parking, transportation, books,
other fees (recreation, lab, etc.)

B) The implicit/ opportunity cost is the cost of the next highest

valued alternative.
Examples: This is the cost that you lose while @ college, for most
it is income from a job

C) The Economic Cost includes both Implicit and Explicit costs.

 4. Types of Opportunity Cost
 A) Dollar: IF you buy one thing, you give up the
opportunity to buy another
 B) Time: When you spend your time on one thing
you give up the ability to spend it on something
else
 C) Resource- If you use resources to produce one
product you give up the opportunity to use them
to produce something else.
5. Economic decisions are made at the
margin.
Marginal Benefit must = Marginal Cost
 Cost/ benefit analysis: We weigh
marginal/additional cost with the
marginal/additional benefits when there is
a change in the current situation.
 Example: The marginal/ extra benefit from
the coin on the ground increases while the
cost stays the same!
 So economic behavior is rational!
 A person’s behavior is
consistent with what they
want.
Example:
 You train for UFC
because you think you
will get more out of it
(benefits) than you put
into it (costs). We weigh
costs versus benefits
People are maximizers.
The best things in life are NEVER free!

 As humans we always try

to get the most out of life,
i.e., we try to maximize
our overall level of
happiness or utility, our
net benefit. Benefits
exceed costs by the
greatest amount.
6. Economy

Mechanism to allocate scarce

resources
7. Every economy must answer 3
basic questions when it is trying to
allocate its resources:

 What to produce?
 How to produce?
 For whom to produce?
8. Every economy has four basic
participants or players who interact
with each other:
 Households/Individuals
 Firms/Businesses
 Government
 Foreign/ International Sector
9. Good
A tangible (physical) economic
product.

Ex. Car, food, and clothing

 10. Service
An intangible (unable to touch) economic
product. Work or labor performed for
someone.

Ex: Hair cut, plumber, mail delivery

 11. Capital Good
Manufactured tool or equipment used in
production.

Ex: A Television used in a classroom. A torch

used to cut steel. A computer used to analyze
sales data.
 12. Consumer Good
An economic product used by consumers
(not producers)

Ex: A television used at home. A house. A shirt.

13. Public Good
G & S provided by the government and
collectively consumed by many individuals.
Ex. Parks, roads, defense, transit, public safety
14. Private Good
G & S provided by the private individuals and
firms and consumed by individuals.
Ex: Any product bought at a store.
15. Households and Firms trade with each
other in markets because they feel they will
be better off, in other words they both benefit.
Their satisfaction or utility has increased.
16. Governments provide services that firms will not
produce. Government pays for these services with
taxes. Government also provides laws which give an
economy a framework or structure within which the
economy operates.
Ex: Copyrights, Patents, Trademarks, Public Utilities (Electricity,
Natural Gas, Cable, Telephone, Water).

World Wrestling World Wildlife Fund WWF was forced to become WWE,
Federation violated what
World Wrestling Entertainment
copyright and trademark?
Texaz Grill
Apple Stores in China???
17. Productive Resources/ Factors of Production -
The components necessary to produce goods and
services. They include natural, human, capital, and
entrepreneurship resources. Also known as Land,
Labor, Capital, and Entrepreneurship resources.

Labor/ Capital
Land/ Human Entrepreneurship
Natural
 Examples of Productive Resources
Natural- Soil, water, oil, gold, rock, crops, metal/ore

Human- Jobs people do; doctors, clerks, salespeople,

teachers

Capital- Tools, equipment, machinery, technology

Entrepreneurship- any idea for a new product;

Facebook, Instagram, Snapchat, WhatsApp, Electric
light, Automobiles, Cell Phones
18. Production Equation
Natural + Human + Capital + Entrepreneurship =
Production of a good or service.
If any of the four components are missing the equation
will not add up. If any one part is decreased then one of
the other two must be increased to keep the same level of
production.

Natural + Human + Capital + Entrepreneurship = Corn!

Production Possibilities
Model
 Full Employment
 Fixed Resources
 Fixed Technology
 Two Goods
 Consumer Goods (Pizzas)
 Capital Goods (Industrial Robots)
Production Possibilities
Model
Production Possibilities Table

Production Alternatives
Type of Product A B C D E

Pizzas 0 1 2 3 4
(in hundred thousands)

Industrial Robots 10 9 7 4 0
(in thousands)

Plot Points to Create Graph…

Production Possibilities
Model
Production Possibilities Curve
A’
14
13
B’ Unattainable G 1.1
12
11
A
10
Economic
Industrial Robots

B C’
9
8
C
Growth
7
6
D’
5
D
4
3 Now Attainable
2 Attainable
1 E E’
0 1 2 3 4 5 6 7 8 9
Pizzas
Production Possibilities Model
Production Possibilities Curve
A’
14
13
B’ Unattainable
12
11
A
10
Law of Increasing
Industrial Robots

B C’
9
8
C Opportunity Cost
7
6
D’
5
D
Shape of
4
3
the Curve
2 Attainable
1 E E’ W 1.2

0 1 2 3 4 5 6 7 8 9
Pizzas
Production Possibilities Model
Production Possibilities Curve
A’
14
13
B’ Unattainable
12
11
10
Industrial Robots

C’
9
8
7
6 U
D’
5
Under or
4 Unemployment
3
2
1 E’
0 1 2 3 4 5 6 7 8 9
Pizzas
Present Choices & Future Possibilities
Compare Two Hypothetical Economies G 1.2
Goods for the Future

Goods for the Future

Future Future
Curve Curve
F

Current P Current
Curve Curve

Goods for the Present Goods for the Present

Presentville Futureville

Implications of International Trade

 19. Production Possibility Curve- A visual way
of illustrating the concept of opportunity cost.
Shows the quantity of a good or service that must
be given up to gain another good or service.
D Point A- NOT using all resources; attainable
C
Capital Goods

B Point B- Using all resources; attainable

Point C- Using all resources; less

consumer goods; attainable
A
Point D- Not enough resources; unattainable

More resources → Shift Outwards

Consumer Goods Less resources → Shift Inwards
 Production Possibility Curve- A visual way of illustrating the
concept of opportunity cost. Shows the quantity of a good or service
that must be given up to gain another good or service. The curve
represents the maximum combination of 2 products that can be
produced with a set amount of resources. Resources are being used in
the most efficient manner possible.
Point A- NOT using all resources; attainable
D
C
Point B- Using all resources; attainable;
Capital Goods

B more capital goods AND more

consumer goods
Point C- Using all resources; attainable;
A More capital goods BUT less consumer
goods

Point D- Not enough resources;

unattainable; beyond the maximum!
Consumer Goods
 More resources → PPC shifts outwards

Less resources → PPC shifts inwards

Capital Goods

Productive Resources
1. Natural
2. Human
3. Capital
4. Entrepreneurship
Consumer Goods 5. Technology
Less resources is often caused by war or
natural disaster
 20. The 4 types of economics systems
Who makes the decisions that answer the 4 questions?
The first 3 systems are ideals, meant to broadly generalize
and describe how systems operate in the real world!!!
1. Traditional- Decisions are made
based on the past. Things are done as
they always have been. Habit, ritual,
and custom all play an important role in
the decision-making process. The
family is the main social group in this
type of system.
Examples: Amish, Aborigines, Native
Americans, Bantu, Bushmen, Amazon
native people, Tarahumara
2. Command- Decisions are made by a central authority.
This could be a king, a dictator, or a group of people.
The government is the primary decision maker in
people's lives. The government owns most or all of the
factors of production in the country and decides the
answers to the questions What, How and For Whom?
Examples: Cuba, Vietnam, China, North Korea,
Soviet Union, Iran, Iraq, Syria
Benefits of Command Systems Costs of Command Systems
1. More equal 1. Lower Quality
distribution of
resources, money, 2. Less variety
products
3. Serious environmental
2. Employment is damage (air and water
guaranteed pollution, land
conversion, habitat
3. Basics are provided loss, plant and animal
to all variety and numbers
decreased)
 Demise of Command Systems

USSR East Germany

Yugoslavia

 Two Insurmountable Problems

 The Coordination Problem
 How can the government possibly organize the
entire economy?
 The Incentive Problem
 There is little or no incentive to excel
 No reward for doing well, no punishment for
doing poorly
3. Market- Decisions are made by private individuals and
private firms. Individuals own all of the (private) property
and decide the answers to the three questions. People can
take part in any economic activity they choose. PRICE
adjustments give individuals and firms the information
necessary to make decisions.

Examples: USA, Canada, Germany,

Japan, Australia, South Africa, Israel,
Great Britain, Mexico, France, South
Korea, Taiwan

Adam Smith, author of The Wealth of

Nations, considered to be the father of
market economies/ Capitalism
In a market system:
A. Property rights- Legal provision that allows ownership, use,
and disposal of property. When individual property rights are
secure indivduals who have made improvements to property are
able to reap the benefits of these improvements. Knowing this
individual property owners have the incentive to maintain and
improve their property.

Examples: Whaling/ Paper Clip harvesting

Rental vs. Owner Occupied Housing

Trash on Campus vs. Trash at home

B. The Profit Motive drives entrepreneurs to
risk starting new businesses and creating new
products.
C. Consumer Sovereignty- The Consumer
is king!
 Consumers decide what gets produced because if they
like a product more gets produced; if they dislike a
product then less gets produced or production may
even stop.

Crystal Pepsi
(1992-1993) Atari Jaguar Apple iPod Hi Fi
(1993-1996) (2006-2007)
D. Increased competition lowers prices,
increases variety, and increases quality.
E. Government is needed to protect
property rights, both physical and
intellectual (patents, copyrights,
trademarks), control cheating by both
consumers and producers, and ensure
competition (by preventing monopolies)
F. Rational Self-Interest and the Invisible Hand-
Entrepreneurs working in their own self-interest
(Profit!) are guided by an invisible hand (Adam
Smith’s idea) to create products that consumers
want at the right price without the need for
government officials deciding what, how, for
whom it gets produced.
Benefits of Market Systems Costs of Market Systems

1. Lower prices 1. Unequal distribution

of resources, money,
2. Higher quality products

3. More variety 2. Employment is NOT

guaranteed

3. Environmental
damage- pollution,
species loss, climate
change
4. Mixed- Decisions are made by a combination of the other
three types of economic systems. In the " real world" all systems
are mixed.
Examples:
Traditional- Draft beer sold by the pint;
Working in the same occupation as a
parent.

Command- Drinking Age of 21 set by

Congress and the State of Arizona; no
sales 2-6 AM, 2-10 AM Sundays.

Market- Freedom to buy and sell almost

anything ; 100’s of brands of beer, other
types of alcohol for sale
21. Nationalization- Trend for most of 20th Century.
The takeover or purchase of private businesses by the
government. This is done for the following reasons:
To try to help consumers, especially the
poor and the middle class, to protect them
from high prices.
To provide a service which might not be
provided without government support.
To prevent foreign control of a strategic
industry.
Examples: U.S. takeover of passenger
rail service (AMTRAK), Mexico
buying up oil companies in 1920’s
(PEMEX)
22. Privatization- Trend since 1980’s. The sale of state
(government) owned businesses to private individuals.
This is done for the following reasons:

Raises money for the government to pay off debts.

Decrease government influence and control over the economy.

Make the economy more efficient and productive.

Examples: Mexico selling off

phone company (TELMEX/
Carlos Slim), City of Phoenix
Garbage Collection is done by
Waste Management Inc.)
23. Absolute advantage- When one country can
produce more of a product than another country .

Examples: U.S. could make more toys than China.

24. Comparative advantage- When one country can
produce a product at a lower opportunity cost than
another country. When one country can produce a
product relatively more efficiently than another country.
Countries should concentrate on making those things
that they are best at.
Examples: U.S. produces movies and prescription drugs while
Mexico produces winter vegetables and clothing; Hatfields and
McCoys worksheet; Bricklayer and Brain Surgeon
25. Division of Labor-
Dividing a large task into a
series of smaller tasks to
increase productivity and
profits.

26. Specialization-
Concentrating on the
production of a few particular
products or tasks to boost
productivity and
profits/standard of living.
 Diapers.com Warehouse 1:45

Amazon.com buys Diapers.com, for $545 Million, 11/2010

Kiva Systems Robots and Zappos.com Warehouse
7:17
Ignore slides
after this
 22.Gross Domestic Product- The total value of all final g
and s produced in an economy in one year
GDP= Consumers (C) + Firms/ Business
Investment(I) + Government(G) + Net Exports
(Nx). GDP= C + I + G + Nx
Remember the Circular Flow (Econo Game)?!
U.S. GDP is currently about $12 Trillion per year.

Business
Consumption Investment Government Net Exports
25. Productivity- The ratio of the amount of output of
goods and services produced per unit of input (amount
of productive resources /factors of production.
26. Interdependence- The linking of people, businesses,
or countries so that they become more productive and
the removal of one of the others makes them less
productive.

Example: Design,
engineering, marketing of iPod
in California, Manufacturing
done in China
27. Total Fixed Costs (TFC)-
Costs of production that do not
vary with output. Examples
include salaried employees,
insurance, and loan payments.

28. Total Variable Costs

(TVC)- Costs of production that
do vary with output. Examples
include wages, cost of materials,
and utilities.
29. Total Costs (TC) = Total Fixed Costs + Total
Variable Costs. TFC + TVC= TC.

30. Average Total Cost (ATC)- ATC equals Total Cost

divided by Output (number of units produced).
Reducing ATC is important for businesses because it
helps to increase production and profits.

Vs. Vs.
Murphy’s Law of Economic Policy
by Alan Blinder
“Economists have the least influence on
policy where they know the most and
are most agreed; they have the most
influence on policy where they know the
least and disagree the most
vehemently”
A. In a market system prices are signals to
Producers and Consumers.

 If P  what happens?
 IT DEPENDS!
 The answer:
Producers produce
MORE while
consumers will buy
LESS.
The Market System Characteristics
 Private Property
 Freedom of Enterprise
 Freedom of Choice

GLOBAL PERSPECTIVE
Free Mostly Mostly Repressed
Free Unfree
1- Hong Kong 22- Belgium 81- Brazil 150- Cuba
3- Ireland 33- Spain 111- China 152- Venezuela
9- United States 44- France 122- Russia 157- North Korea

Source: Heritage Foundation (www.heritagefoundation.com) and The Wall Street Journal

 GLOBAL PERSPECTIVE
The Corruption Perception Index
Corruption Index Value, 2005
0 1 2 3 4 5 6 7 8 9 10
Finland 9.6
New Zealand 9.6
Denmark 9.5
United States 7.6
China 3.2
India 2.9
Moldova 2.9
Madagascar 2.8
Ecuador 2.5
Russia 2.4
Azerbaijan 2.2
Cameroon 2.2
Paraguay 2.1
Nigeria 1.9
Haiti 1.8
Bangladesh 1.7
Source: Transparency International
The Market System
The “Invisible Hand”

U. S. Economy

 1776 Wealth of Nations by Adam Smith

 Efficiency- lower production costs
 Incentives/ Disincentives- positive and
negative!
 Freedom- free to succeed and to fail!
The Market System
Characteristics
2.2
 Self-Interest
 Work to gain for yourself leads to gains for
others
 Competition
 Lower prices, higher quality, more variety
 Markets and Prices
 Allocates scarce resources
The Market System
Characteristics
 Technology and Capital Goods
 Increases efficiency  economic growth
 Specialization
 Increases efficiency  economic growth
 Division of Labor
 Increases efficiency  economic growth

2.3
The Market System
Characteristics
 Geographic Specialization
 Comparative Advantage
 Use of Money
 Medium of Exchange
 Avoids Barter
 Active but Limited Government
 Protection of private property
 Subsidies (money) for improvement
of infrastructure/ education