MIS 111 Ch01 F07

Chapter 1Economics and the Economy : Chapter 1 Economics and the Economy MIS 111 Economics I 2007 Fall


What is Economics? : What is Economics? ECONOMICS ... is the study of how society decides: What For whom How to produce...


What is Economics?(2) : What is Economics?(2) Society consists of households consume goods and services firms produce goods and services government


What is Economics? (3) : What is Economics? (3) Goods are physical comodities steel, food, Services are activities banking, education, hellth economics is about human behavior in the production exchange use of goods and services


What is Economics?(4) : What is Economics?(4) People have unlimited desires for goods and services resources are scares labor, machinery, raw materials economics explain how scare resources are allocated between competing claims on their use


What is Economics?(5) : What is Economics?(5) Economists develop theories about human behavior and to test them against the facts


The price of oil : The price of oil Tripled in 1973-74, and doubled again in 1979-80 … and affected people all over the world.


Oil : Oil provides fuel for heating, transport, machinery basic input petrochemicals, household products plastics, polyester clothing in 1973 OPEC raised the price of oil Poil quantity demanded  very slowly (Q) Why ?


Oil Price Shock : Oil Price Shock What is special about oil? almost no substitutes Poil Q  revenue or profits  when Poil  How the economy produces goods and services firms reduces use of oil based products electricity by coal artificial substitutes oil inputs efficient engines


Oil Price Shock : Oil Price Shock What is being produced? Firms and households reduce their use of oil-intensive products buy smaller cars move closer to the city Poil   demand for oil related comodities  purchase substitute commodities Psubstitutes  and their production 


Oil Price Shock : Oil Price Shock For whom OPEC revenues  spent on goods produced in industrialised nations buying power of OPEC  buying power of oil-importing countries 


Exercise : Exercise Try to answer the three questions when there is a fall in oil price What goods the world economy produces How they are produced For whom they are produced


Exercise : Exercise Chose a commodity or service whose price changes (increase or decrease) by a reasonable event Try to answer the three questions when there is a fall in the price of that good or service What goods the economy produces How they are produced For whom they are produced


Allocation problem of a single farmer : Allocation problem of a single farmer Condider a single farmer With a land of 10 acers He can cultivate Wheat (W) or barley (B) 1 tone of wheat requires 1 acers of land 1 tone of barley requires 2 acers of land


Allocation problem of a single farmer : Allocation problem of a single farmer The following area constraint has to be satisfied Notice that land is a reasource used in producing wheat or barlay But it is scares 10 acers is availiable for the farmer 2*B + 1*W <= 10 Where B tons of barlay, W tons of wheat cultivated 2*B acers of land for barley production 1*W acers of land for wheat production


Slide16 : W B 10 5 Production possibility frontier fisability set G 2 2 J C D Points G, C, D are fisable Point J is not fisable Points C and D are on the PPF 4 3 8 G: 2,2 C:4,3 D:8,1 J:9,2


Inefficient points : Inefficient points Producing at G he is not using all of his reasorse: land At G 2 tons B and 2 tons W so 2*1+2*2 = 6 acers of land 10 – 6 = 4, acers are free not used in production Therefore point G is an ineffeicent point


Infisable points : Infisable points Producing at J is impossible At J 2 tons B and 9 tons W so 9*1+2*2 = 13 13 acers are required but he has only 10 acers of land therefore point j is infisable or unattainable


Efficient points : Efficient points Points C and D are on PPF The farmer use all of his land of 10 acers At C: 3 tones B and 4 tones of W 2*3+1*4 =10 At D: 1 tones B and 8 tones of W 2*1+1*8 =10


Slide20 : When producing in the PPF he can increase his wheat production without decreasing barley production Or visa versa Or he can increase both wheat and barley production simultaneously


Slide21 : When producing on the PPF İn order to increase wheat production he has to decrease barley production Or visa versa Specificly at point C he produces 3 tones of B and 4 tones of W To produce one additional tone of W Move from C to right he has to sacrifise 1/2 tons of B


Opportunity Cost : Opportunity Cost Opportunity cost a crucial concept in economic analysis the quantity of other goods that must be sacrificed to obtain another unit of a good


Opportunity Cost of wheat : Opportunity Cost of wheat İn this particular example the opportunity cost of wheat is 1/2 tones of barlay producing on the PPF Ask the specific question How many units of barley he has to sacrifice to increase wheat production by one more unit Since PPF is a straight line opportunity cost of wheat is constant every where on the PPF Notice that the opportunity cost of wheat is the slope of PPT


Slide24 : Opportunity Cost of barley Or the opportunity cost of barley is 2 tones of wheat on PPF at C or D He has to sacrifice 2 units of wheat to produce one additional tone (unit) of barlay Notice that the opportunity cost of barlay is the inverse of the slope of PPF


Slide25 : Opportunity Cost Notice that opportunity cost of a good or service depends on the current production What is the opportunity cost of wheat at G inside PPF? Zero


Slide26 : A subjective question If you were the farmer how would you allocate your land between W and B For ther three cases Price Wheat Barley A) 1 1 B) 1 2 C) 1 3


Slide27 : Another allocation problem: A four worker economy An economy with four workers two products: food and films Film industry Food industry Workers output Workers output 0 0 0 0 1 9 1 10 2 17 2 17 3 24 3 22 4 30 4 25


Slide28 : Another allocation problem: Low of diminishing returns Low of diminishing returns each additional worker adds less to industry output than the previous additional worker added what is the reason of diminishing return? For the film industry say equipment is fixed each additional worker use the same equipment productivity of additional workers are less and less


Slide29 : Another allocation problem: A four worker economy Film industry Food industry Workers output Workers output 0 0 0 0 1 9 1 10 2 17 2 17 3 24 3 22 4 30 4 25 employment in output employment in output film ind. film food ind. Food


Slide30 : Another allocation problem: A four worker economy Film industry Food industry Workers output Workers output 0 0 0 0 1 9 1 10 2 17 2 17 3 24 3 22 4 30 4 25 employment in output employment in output film ind. film food ind. Food A 0 0 4 25 B 1 9 3 22 C 2 17 2 17 D 3 24 1 10 E 4 30 0 0


Slide31 : Another allocation problem: trade off between food and film When a worker transfers from food to film the economy can produce more film but only at the expense of producing less food there is a trade off between food production and film production moving from A to E society is trading food for film


The production possibility frontier : The production possibility frontier For each level of the output of one good, the production possibility frontier shows the maximum amount of the other good that can be produced. Film output Food output Production possibility frontier A B C D E G H


Opportunity cost of films : Opportunity cost of films Moving from A to B One worker transfers to film industry 9 units of film is produced for 3 units of food 3 units of food is sacrificed for 9 units of film 3/9 units of food is sacrificed for 1 unit of film the opportunity cost of film is 3/9=1/3 units of food


Opportunity cost of films : Opportunity cost of films Moving from B to C One worker transfers to film industry 8 units of film is produced for 5 units of food 5 units of food is sacrificed for 8 units of food 5/8 units of food is sacrificed for 1 unit of film the opportunity cost of film is 5/8 units of food


Slope of PPF : Slope of PPF The slope of the PPF gives us the opportunity cost of film in terms of food the inverse slope of PPF gives us the opportunity cost of food in terms of film Notice that the slope of PPF is not constant in this example


İmportent note : İmportent note The definifion of opportunity cost is not about how many units of food is secrified when one worker is transfered from food to film industry But how many units of food is secrified to increase film production by one unit


Opportunity cost of food : Opportunity cost of food Moving from D to C One worker transfers to food industry 7 new units of food is produced for 7 units of films 7 units of films is sacrificed for 7 units of food 7/7 units of food is sacrificed for 1 unit of film the opportunity cost of food is 1 units of films


Exercise on opportunity costs : Exercise on opportunity costs What is the opportunity cost of film when 3,2,1 and 0 workers are employed in the food industry what is the opportunity cost of food at E, D.C,B and A can you see a pattern in the opportunity cost figures Why the opp. Cost of film is increasing as we move from A to E Why the opp. Cost of food is increasing as we move from E to A


Inefficient points : Inefficient points Point G is inefficient 3 workers are emplyed: one in food, two in film industries 1 worker is unemployed Food production = 10 Film production = 17 Notice that employing the forth worker in food (film) industry, İt is possible to increase the output of the food (film) industry without sacrificing any film (food) Therefore G is inefficient


Efficient points : Efficient points Points on the PPF are efficient because more output of the one good can be obtained only by sacrificing output of the other good


Unattainable points : Unattainable points Point H is unattainable With the given 4 workers and given technology Is it ever possible to attain point H ? produce at the outside of PPF PPF can shift to right or expends by Population increase Advences in technology Productivity of labour increases Trade with other economies


The three questions : The three questions What to produce film and food How to produce allecating workers into the two industries For whom to produce not enough information How does society decide where to produce on the PPF government decides?


Your opportunity cost : Your opportunity cost What is your opportunity cost of studing in MIS department for 4 years What do you sacrifise to get an MIS diploma To increase your education by one unit


The operation of markets : The operation of markets Market a shorthand expression for the process by which households’ decisions about consumption of alternative goods firms’ decisions about what and how to produce and workers’ decisions about how much and for whom to work are all reconciled by adjustment of prices Economics studies how markets and prices enables society to solve the what, how, and for whom to produce


Slide45 : Households Firms money Goods or services Wage or profits Labour Operation of markets


Text book market (1) : Text book market (1) A student has two alternatives Buying a new text book from bookstore price is high but quality is better or buying a used book from the counters price is low but may be lower quality Sellers if price of new books are high more people open counter some bookstores are closed can not pay rent other expenses


Text book market (2) : Text book market (2) Workers if price of new books are low bookstores pay higher wage more people want ot work in bookstores some counters close if price of new books are high bookstores pay lower wages few people want to work in bookstores new counters open price of used books bids up if the price of new books are low more resources are allocated to bookstores


Resource allocation : Resource allocation Resource allocation is crucial for a society and is handled in different ways in different societies, e.g.: Command economy Mixed economy Free market


Command Economy : Command Economy Command economy the government makes all decisions about production and consumption a planning office


Free Market (1) : Free Market (1) No government intervention Adam Smith Wealth of Nations self-interest without any central direction could produce a coherent society making sensible allocative decisions


Free Market (2) : Free Market (2) Does free market work well? Sometimes it does not lead society to allocate resources efficiently


The Mixed Economy : The Mixed Economy Government and private sector interact government taxation transfer payments setting prices provision of goods and services defence, education, health


Market orientation : Market orientation Cuba China Hungary Sweden UK USA Hong Kong Command economy Free market economy


Normative and Positive Economics : Normative and Positive Economics Positive economics deals with objective explanation e.g. if a tax is imposed on a good its price will tend to rise Normative economics offers recommendations based on value judgements e.g. a tax SHOULD be imposed on tobacco to discourage smoking


Micro and Macro : Micro and Macro Microeconomics offers a detailed treatment of individual economic decisions about particular commodities Macroeconomics emphasizes the interactions in the economy as a whole Gross domestic product GDP The aggregate price level Unemployment rate


Exercise : Exercise Consider an economy producing only food and cars. Total number of workers is four. The first two workers’ contribution to the output of both cars and food industries is zero. Each additional worker(third and fourth) can make either two cars or three units of food.


Slide57 : a)Draw societies production possibility frontier.(3 pnt) b)What is the opportunity cost of food when the economy is producing three units of food? (1 pnt) c)What is the opportunity cost of cars when three workers are employed in the cars industry?(1 pnt)


Exercise : Exercise Consider an economy producing only food and cars. Total number of workers is four. The first worker’s contribution to the output of both cars and food industries is zero. The second and third workers can produce two cars or three units of food. The fourth worker’s contribution to the output of both industries is again zero.


Slide59 : a) Tabulate output of each industry as a function of number of workers. b) Draw societies production possibility frontier.(2 pnt) c) What is the opportunity cost of food when all workers are employed in the car industry? d) What is the opportunity cost of cars when the economy is already producing two cars? (1 pnt)