When you finish this chapter, you should: Define the key terms of economics and opportunity cost and understand how a production possibilities frontier exemplifies the trade-offs that exist in life, distinguish between increasing and constant opportunity cost and understand why each might happen in the real world, analyze an argument by thinking economically, while recognizing and avoiding logical traps. | CHAPTER 1 ECONOMICS: THE STUDY OF OPPORTUNITY COST CHAPTER OUTLINE ECONOMICS AND OPPORTUNITY COST MODELING OPPORTUNITY COST USING A PRODUCTION POSSIBILITIES FRONTIER ATTRIBUTES OF THE PRODUCTION POSSIBILITIES FRONTIER DEMONSTRATING CONSTANT AND INCREASING OPPORTUNITY COST THINKING ECONOMICALLY Economics and Opportunity Cost Economics: the study of the allocation and use of scarce resources to satisfy unlimited human wants Choices Have Consequences Opportunity Cost The forgone alternative of the choice made Or What you would have done had you not done what you did. Modeling Opportunity Cost Using a Production Possibilities Frontier Definitions PPF: a graph which relates the amounts of different goods that can be produced in a fully employed society Model: a simplification of the real world that we can manipulate to explain the real world Simplifying Assumption: an assumption that may, on its face, be silly but allows for a clearer explanation Scarce: not freely available and infinite Resources: anything we either consume directly or use to make things that we will ultimately consume Figure 1 Production Possibilities Frontier: The Starting Point S P Soda Pizza 0 Figure 2 PPF: Moving Pizza Chefs to Their Rightful Place S P Soda Pizza 0 X Figure 3 PPF Moving to Even More Pizza Production S P Soda Pizza 0 X Y Figure 4 All Points on a Production Possibilities Frontier S P Soda Pizza 0 X Y Z M Figure 5 A Fully Labeled Production Possibilities Frontier: The Case When People are Different S P Soda Pizza 0 X Y Z M Unemployment Attainable Unattainable Figure 6 A Fully Labeled Production Possibilities Frontier: The Case When People are the Same S P Soda Pizza 0 X Y Z M Unemployment Attainable Unattainable Increasing and Constant Opportunity Cost Increasing Opportunity Cost Exists when the additional resources required to produce an additional unit grows as more output is produced. Likely to occur when people are different in their skills. Constant Opportunity Cost Exists when the additional resources required to produce an additional unit remains the same as more output is produced. Likely to occur when people are identical in their skills. Figure 7 Illustrating Increasing Opportunity Cost Pizza Soda 0 1 2 3 OC01 OC12 OC23 Production Possibilities Frontier Figure 8 Illustrating Constant Opportunity Cost Pizza Soda 0 1 2 3 OC01 OC23 OC12 Production Possibilities Frontier Thinking Economically Marginal Analysis Optimization Assumption: an assumption that suggests that the person in question is trying to maximize some objective Marginal Benefit: the increase in the benefit that results from an action Marginal Cost: the increase in the cost that results from an action Net Benefit: the difference between all benefits and all costs Positive and Normative Analysis Positive Analysis: a form of analysis that seeks to understand the way things are and why they are that way Normative Analysis: a form of analysis that seeks to understand the ways things should be Economics Incentives Incentive: something that influences the decisions we make Examples: prices influence the amount we buy; taxes influence how much we work and save Logical Flaws Fallacy of Composition: the mistake in logic that suggests that the total economic impact of something is always and simply equal to the sum of the individual parts Correlation = Causation: the mistake that suggests that because two variables are correlated that one caused the other to happen.
