(Solution Manual) Principles of Economics

Case,Fair,Oster, 13

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Solution Manual for Principles of Economics, The downloadable file consists of 695 pages, and the total size of the file is 18.8 MB. Purchase now only for highly discounted price.

Author(s): Case, Fair, Oster

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1 Copyright © 2020 Pearson Education, Inc. by Tony Lima, California State Un iversity, East Bay, Hayward, CA CHAPTER OUTLINE AND LEARNING OBJECTIVES Why Study Economics? p. 2 Identify three key reasons to study economics. Think of an example from your life in which understanding opportunity costs or the principle of efficient markets could make a difference in your decision making. The Scope of Economics p. 5 Describe microeconomics, macroeconomics, and the diverse fields of economics. The Method of Economics p. 8 Think about an example of bad causal inference leading to erroneous decision making. Identify the four main goals of economic policy. An Invitation p. 12 Economic Skills and Economics as a Career p. 12 Describe economics as a career and the key skills you can learn from studying economics. Appendix: How to Read and Understand Graphs p. 15 Understand how data can be graphically represented. Visit www.MyLabEconomics.com for current examples, news articles, and teaching tips. 2 Principles of Microeconomics Copyright © 2020 Pearson Education, Inc. DETAILED CHAPTER OUTLINE I. Introduction, page 1 The authors show students how economics relates to their everyday lives. Case, Fair, and Oster discuss the interactions between the United States and other countries, while also comparing the United States to other countries. Along the way m acroeconomics is introduced with the notions of employment, production, and GDP (although the authors don’t use that term). Foreign trade is also mentioned at the level of U.S. exports and imports. The section concludes with a definition of economics that emphasizes the two fundamental economic problems: scarcity and choice. Economics is the study of how individuals and soci eties choose to use the scarce resources that nature and previous gene rations have provided.  TEACHING TIP: The opening sentence, “The study of economics should begin with a sense of wonder,” is very true. Mention to your class that some peopl e actually make a living te aching economics. Developed economies are truly highly specialized. Unique Economics in Practice Use the opening example on pages 1 and 2 to introduce the subject of globalization. Ask your students what “made in the United States” means. Many will respond that the good has to be manufactured in the United States. Raise the issu e of where the parts were made. Quite a few goods that carry the “made in the United States” la bel are actually assembled in the United States with the components manufactured in other countries. Then move on to a discussion of what it would mean for the U.S. or any developed econom y to consume only what we make. The general answer is higher prices and less choice for consum ers, but try to get the students to focus on specific goods (bananas and BMWs are two that ar e easy to understand). If you’re ambitious, you can introduce value added as a percentage of market value to measure the extent of local contribution to a final product. Question: Apple’s iPhones are assembled by Foxc onn Industries in China. But the various parts come from many different countries. Should the iP hone be labeled “Made in China?” Shouldn’t those other countries get some of the credit? Suggested answer: This is stamped or printed on every iPhone: “Designed by Apple in California. Assembled in China.” That’s about as clear as you can get. You might mention to your class that complicated “rules of origin” are part of intern ational trade agreements. These rules specify the conditions under which a product can be labeled “Made in the United States” (for example). One common rule is a minimum percenta ge of value added must be in the country in which origin is claimed.  TEACHING TIP: Each chapter of the book includes a feature entitled Economics in Practice that helps students apply the concepts of the chapter to a real-wor ld observation or news story. Each chapter of this Instructor’s Manual includes one or more Unique Economics in Practice to use in class. œ Chapter 1: The Scope and Method of Economics 3 Copyright © 2020 Pearson Education, Inc.  TEACHING TIP: To help break firs t-day tensions, try getting your st udents involved from the start. Ask them why they are taking the course. Be persuasive —this is a good chance to show the class that you’re really a nice person. You will get a variety of an swers, from the serious—“To understand the world,” “To help me get a good job when I graduate,” “I’m thinking about becoming an economics major”—to the humorous—“My father made me,” “Intro Politics was full”. Some of these answers can prompt further questions: Why might learning economics help you get a job? Why do you think your father wanted you to take this course? The answers can help acquaint the re st of the class with the breadth and practicality of economics. œ  TEACHING TIP: Try to get the class thinking in terms of substitutes. Ask them to think about substitutes for water. Most will say there are no substitutes for water. A few will say beer or wine, but point out that these start as water so they don’t count. Things that can be used in place of water incl ude plastic bottles of water placed in a toilet tank (reduces volume per flush); shor ter showers; and brown lawns. Then point out that if there are substitutes for something as basic as water th ere almost certainly are substitutes for just about every other economic good. Wants exceed quantity available for any economic good. You might want to mention the 2012–2016 California drought in this context. Californi ans managed to reduce water consumption by 27 percent. But water deliveries to farmers have been cu t. What impact will that have on, say, the price of lettuce?œ II. Why Study Economics? pages 2–5 Learning Objective: Identify three key reasons to study economics. Think of an example from your life in which understanding opportunity costs or the principle of efficient markets could make a difference in your decision making. There are three main reasons to study economics: A. To Learn a Way of Thinking. Also described as a way to make decisions, the economic way of thinking involves understandi ng three fundamental concepts  TEACHING TIP: Point out to students that economists use common everyday words to describe very specific ideas. The word cost is one example. How is the word used in everyday usage? One example is the common conflation of cost and price. Economists use the word to mean opportunity cost, the cost of choosing one alternative over another. Another example is efficiency. People generally use efficiency to describe any process that’s accomplished with skill and dexterity. Economists mean producing the most output possible from given quantities of resources ( productive efficiency ). A related concept, allocative efficiency is probably too advanced for the first day (or week) of your class. œ 1. Opportunity Cost is the best alternative that we forgo, or give up, when we make a choice or a decision. Every decision means giving up something. a. Economists are fond of trade-offs as a way of thinking about decision making. Taking one action usually m eans giving up something else. As the text states, “The full ‘cost’ of making a specific choice includes [the value of] what we give up by not making the best alternative choice.” b. Opportunity costs arise because resources are scarce. Scarce means limited. Resources are scarce because human wants exceed what we can produce from our current resources.  TEACHING TIP: This example will be familiar to many faculty. Suppose your professional organization is holding the annual meeting in Honolulu. You are fortunate enough to be sele cted to attend. After considering alternatives, you decide to take a week’s vacation on Maui after the conference. You did this because you realized the marginal cost of travelling to Maui from Honolulu is relatively small. People often use marginal analysis without realizin g what they are doing! œ 4 Principles of Microeconomics Copyright © 2020 Pearson Education, Inc. Unique Economics in Practice Show your students this list of countries: Chin a, France, Germany, Japan, Norway, and the United States. Ask them to rank these countries fro m highest to lowest per capita income. (You may have to explain what per capita income me ans. Income per household may work better for your class.) Many will put China first. Show them actual data: The point, of course, is that China is the wo rld’s second-largest economy. But they have the largest population, making their per capita income fairly small. (The Excel workbook includes a tab where the countries are sorted by total GNI.) Tip: Data for this example is in the Excel wor kbook for this chapter. Also included is the full dataset from the World Bank for those who want to use different countries or compare different years. Both total and per capita GNI are included starting in 1960 (subject to data availability). Note that between 2011 and 2013, Germany passed Japan. Chapter 1: The Scope and Method of Economics 5 Copyright © 2020 Pearson Education, Inc. Economics in Practice: Rainfall and Schooling in India, page 3 Rural India remains an agricultural society. Children join their parents working in the fields. Irrigation is common. And total output depends critically on annual rainfall. When there is a large quantity of rain, the harvest is large. The opportunity cost of a child attending school (and not working in the field) is also large. The opposite is true when there is a drought. Sure enough, the data shows that children tend to miss more days in class during years with larger rainfalls. As the opportunity cost of schooling rises, there is lower class attendance.  TEACHING TIP: Use the following exercise to quickly get across several points concerning opportunity costs. Ask students to think about what they would be doing if they were not in class. (Don’t let them think about this too long or you may find y ourself facing an empty classroom!) Make a list of the many suggestions you will receive: Go back to sleep, sunbathe, read a book. Answers will vary because tastes vary. Then ask each student to think about the value of that alternative. That value is the opportunity cost of attending class. (Clearly the benefits of attending your class always outweigh the cost!) Point out that measuring opportunity cost is subjective and depends on th e perspective of the person making th e choice. Conclude by noting that each student cannot have the whole list. Opportunity cost is not the value of all the alternatives forgone. It is the value of the single second best alternative. œ Economics in Practice: Majoring in Economics Makes You Less Vulnerable to a Recession!, page 4 Getting a college degree increases lifetime income on average by about 70 percent. Two fields with high wage premia are engineeri ng and economics. Recent work concludes that a degree in economics also protects graduat es from the effects of graduating during a recession. During a recession, unemployment is high and wages are low. Getting a job under those circumstances places individuals on a lower rung of the job ladder and can keep them from advancing to the levels e xpected if they graduated when the economy was at full employment. The exceptions include those who hold degrees in economics. You might add that the unemployment rate among those with degrees in economics is usually very low. TOPIC FOR CLASS DISCUSSION: Have students discuss the costs of atte nding college. Most will usually name the explicit costs of tuition, fees, books, and room and board. Some may note the implicit cost of not working full time. Explore the idea that cost is not always an explicit payment but also a loss. Have students consider what full-time jobs they might have if they were not in college. Make sure the st udents understand that opportunity costs are real costs. If they had not chosen to attend college, the opportunity co st would have been their net economic gain or loss. You may want to add a comment that this analysis only looks at the 4 years of college. Over a lifetime, the benefits of college are far greater than the costs.   2. Marginalism: Marginalism is the process of analyzing the additional or incremental costs or benefits arising from a choice or decision. Marginal means a small change. The text uses marginal cost , the cost of increasing production by one unit. This can be illustrated by putting added miles on a car; the change in the odometer reading is the marginal mileage. TOPIC FOR CLASS DISCUSSION: Hotel managers use marginal cost all the time. As th e training manager for Hilton once noted, “We are selling a very perishable product.” A hotel room not rented tonight cannot be rented twice tomorrow night. Pose this question to the class: You are the night mana ger at the EZ-Sleep hotel. You are approached at 10:00 PM by a traveler looking for a room. The traveler says, “I can only spend $50.” The standard rate for your 6 Principles of Microeconomics Copyright © 2020 Pearson Education, Inc. cheapest room is $150. You know the hotel currently has half a dozen empty rooms. Should you rent the room for $50? Many students will say no. They are not thinking marginally. Ask them what the marginal cost of one more occupied room will be. Answers should include electr icity, water, amenities, and housekeeping services. Warn them to be careful: only the cost of the time to make up one room should be included in housekeeping services. It’s difficult to raise the marginal cost to $50.    TEACHING TIP: To drive home the importance of ma rginal analysis, one example can come from the testing requirements you’ve outlined on your syllabus . Ask students to look into the future and imagine they’ve taken three exams and their average is a 78, say two points from a B. Given that their goal is to earn a B, the relevant grade is their grade on the final (fourth) ex am; that is, the relevant grade is the marginal grade. At the end of semester, they have no control over what they earned on the first three exams (a sunk cost at this juncture), but they do have so me control over their final exam grade. œ 3. Efficient Markets −No Free Lunch: An efficient market is a market in which profit opportunities are eliminated almost instan taneously. In efficient markets, profit opportunities are eliminated rapidly by the actions of those seeking the profits. Use the text’s example of checkout lines at a grocery store to make the point that it is the people seeking the shortest line (express lines not included!) whose actions result in all the lines being of about the same length.  TEACHING TIP: The text repeats an old joke about a $20 bill lying on the sidewalk. Believers in perfectly efficient markets will argue that the $20 can’t be there because, if it was, someone would have picked it up already. If you decide to repeat this joke in class, make it a $100 bill to drive the point home. The point, of course, is that no market is perfectly efficient. œ  TEACHING TIP: This is a good point to introduce the economics of information. One of the main factors that causes profit opportunities to persist is slow di ssemination of information. Use the stockbroker example from the text to illustrate the other extreme. If a st ockbroker calls with a hot tip, what should you do? The answer in the text—do nothing—is correct. Expand on this answer to point out that a phone call from your stockbroker is way, way too late. By the time you ge t the phone call, the information has already been disseminated via the Internet and other electronic trading networks. The current price of the stock will already reflect the information, eliminating any chance you might have to earn a profit. œ B. To Understand Society 1. Economic decisions shape the physical environment and influence the character of society. The text cites the examples of the Industrial Revolution of the late eighteenth and early nineteenth centuries and the e-revolution of the late 1990s. The Industrial Revolution was the period in England during the late eighteenth and early nineteenth centuries in which new manufacturing technologies and improved transportation gave rise to the modern factory system and a massive movement of the population from the countryside to the cities. 2. The authors point to the market-drive n miracle of millions of workers, each pursuing his or her own self-interest, producing output efficiently while also earning a living. These decisions have an enormous influence on the direction in which societies evolve. The text’s example of the shrinking agricultural labor force is even more extreme today. At the same time, employment in technology-related industries has been booming. The text mentions internet companies. Biotech firms are also important. In each case, the main thrust of the change has been the desire of entrepreneurs to build new businesses and earn a profit. TOPIC FOR CLASS DISCUSSION: Near the top of the “dot-com” stock market bubble, Milt on Friedman said he was absolutely sure some dot- com companies would be successful and worth their cu rrent valuations, but he was also quite certain he didn’t know which. Ask the class to discuss the impact of the stock market bubble on consumer spending and consumer behavior generally. This is a good time to introduce the differe nces between inco me and wealth. Chapter 1: The Scope and Method of Economics 7 Copyright © 2020 Pearson Education, Inc. You might also point out that the fraction of income spent on consumption is much , much larger than the fraction of wealth spent on consumption.    TEACHING TIP: Using a news website, point out that th e future of society depends on informed voters. The website merely reports what has happened. An understanding of econom ics is vital for understanding why things happen and can enable us to make better decisions in solving important social problems. List some of those problems and indicate where they may be covered in more detail later in your course (or other courses). œ  TEACHING TIP: Demonstrate to students that economics is relevant. Go to the front page of a news website (not the business page), and show it to the class. Br iefly state how economics can shed light on each of six stories. This will be easy to do for stories about national heal th policy, budget deficits, and inflation. But with a little imagination (and good class participati on!), you can show how economics rela tes to virtually any news story. A cocaine bust? Economics explains why cocaine costs so much and why selling it can be such a lucrative activity for lawbreakers. A war in a faraway region of the world? Economics can help us understand the origins of the conflict, as well as the true cost—the opportunity cost—of a possible U. S. military intervention. œ  TEACHING TIP: Ask the students what percentage of the U.S. labor force is employed in agriculture. Few will guess the correct answer (less than two percent). œ C. To Be an Informed Citizen: Many politi cal issues citizens vote fo r deal with economic issues. The authors mention government pa yments for public schools and roads, the Obama health care plan, and ticket scalping as three examples. Without a basic understanding of economics, citizens are likely to vote for policies that are not in their best interests. III. The Scope of Economics, pages 5–7 Learning Objective: Describe microeconomics, macroeconomics, and the diverse fields of economics. A. Microeconomics versus Macroeconomics 1. Microeconomics is the branch of economics th at examines the functioning of individual industries and the behavior of individual decision-making units—that is, firms and households. 2. Macroeconomics is the branch of economics that examines the economic behavior of aggregates—income, employment, output, and so on—on a national scale.  TEACHING TIP: Table 1.1 on page 7 in the text is an excellent summary of the differences between macro and micro. œ Economics in Practice: iPod and the World, page 6 Even though iPods are assembled in China a nd parts are produced everywhere, about 80 percent of the retail price is captured in the United States. Tosh iba makes the most expensive component, the hard drive. But the largest fraction of the iPod’s price is the value added paid to Apple, various U.S. di stributors, and domestic component makers. The true value of the iPod is its design and conception, not the parts that go into it. Similarly, Mattell’s Barbie doll was designed in the United States . The plastic used in the doll was made in Taiwan, the hair was ma de in Japan, and the clothes are made in China. The final doll assembly is also done in China. But of the $10 retail price, $8 is captured by the United States as Mattell’s gross margin on each doll. 8 Principles of Microeconomics Copyright © 2020 Pearson Education, Inc. B. The Diverse Fields of Economics: Table 1.2 on page 7 of the text lists some fields of specialty in economics (analogous to specialties in medicine).  TEACHING TIP: Students often think of economics as a ra ther narrow field. Stress its applicability to the analysis of a wide range of intere sts and its usefulness in preparing fo r a variety of graduate degrees. Try discussing the “economic approach” to the pollution probl em. Many students and scientists believe pollution control is strictly an issue of regulation and have never thought of the economics that cause pollution in the first place. Drawing on the analogy to medicine, explain why in the current context of managed health care even a premed student would find an economics course helpful! Students who still find the list of topics in the text uninteresting may be intrigue d by sports economics (refer them to the Journal of Sports Economics ) and studies of the wine industry (the Journal of Wine Economics ).œ Web Resources Most fields of economic research ha ve at least one web site . The American Association of Wine Economists is at http://www.wine-economics.org/ . The Journal of Sports Economics (http://jse.sagepub.com/ ) is published in association with the North Am erican Association of Sports Economists (http://www.byuresearch.o rg/naasportseconomists/ ). IV. The Method of Economics, pages 8–12 Learning Objective: Think about an example of bad causal inference leading to erroneous decision making. Identify the four main goals of economic policy. A. Positive and Normative Economics 1. Positive economics is an approach to economics that seeks to understand behavior and the operation of systems without making judgments. It describes what exists and how it works. 2. Normative economics is an approach to economics that analyzes outcomes of economic behavior, evaluates them as good or bad, and may prescribe courses of action. Also called policy economics . When economists disagree, the points they argue about are often normative points (differences of opinion and values).  TEACHING TIP: One of the main contributions of econom ics to public debate is a clear distinction between positive and normative differences. This separation is of ten obscured in the media and some other social sciences. Using a news website, find an economic issue on whic h government leaders disagree (e.g., the cause of the government budget deficit). Ask students: What sort of positive disagreement might be responsible for the dispute? There is disagreement over the appropriate si ze of the budget and the related size of government. This is a good chance to explore the c oncept of forecasts and the role of assumptions in making them. Next, make an arbitrary positive assumption. Say, about the future course of the economy. Could a normative difference still explain the policy di spute? One side believes that govern ment is needed to provide more services, the other believes that people should spend their own money not have it spent for them by the government. œ B. Theories and Models:  TEACHING TIP: This is a good place to describe the scientific method in econ omics. Economists develop mathematical models of some aspect of the world. They use those models to make predictions (called hypotheses ). These predictions are then tested using real-w orld data. Models whose predictions have passed many such empirical tests become accepted as theories . Emphasize that economic theory is based on real- world data, not just mathematics. And warn them against saying, “Well, that's OK in theory, but …” œ 1. A model is a formal statement of a theory, usually a mathematical statement of a presumed relationship between two or more variables. 2. A variable : a measure that can change from time to time or from observation to observation. Chapter 1: The Scope and Method of Economics 9 Copyright © 2020 Pearson Education, Inc. 3. Ockham’s Razor is the principle that irrelevant detail should be cut away. Of course, be sure it’s irrelevant! Formally, Ockham’s Razor says that when there are two equally good explanations of a phenomenon, the simpler of the two should be used. 4. All Else Equal : Ceteris Paribus is a device used to analyze the relationship between two variables while the values of other variables are held unchanged. (Ceteris paribus is often abbreviated cet. par. ) 5. Expressing Models in Words, Graphs , Equations: Economists use graphs and mathematics to make it more difficult to overlook some effects. One obvious example is income and substitution effects in consumer theory.  TEACHING TIP: Relate models to how a coach or choreographer might diagram a play or dance routine on a chalkboard to illustra te how the play or routine shoul d work on the field or on stage. œ TOPIC FOR CLASS DISCUSSION: The text uses the example of what determines total m iles driven during a time period. The factors listed there are the number of drivers (driving age, population growth , changes in state laws); the price of gasoline (a complement); household income; number and ages of children; commute distance; location of shopping areas; and availability and quality of public transportation. Make this more specific by using months as the measure of time. Then ask the class for some other factors that might affect average miles driven per month by a household. Two obvious factors are airfares (the price of a substitute) and special events such as September 11, 2001.    TEACHING TIP: The text mentions obesity and soda consumption. Former New York City Mayor Michael Bloomberg has tried to ban sodas larger than 16 ounces, believing that will cure obesity. But all we have is correlation. It is far more likely that both obesity a nd high soda consumption are caused by a third factor. œ  TEACHING TIP: Here’s an interesting exercise to tr y. Announce a new soft drink, Mocha-Cola, that you intend to market. Which variables do students think will be important in determining the amount of Mocha-Cola that people will want to buy? You will quickly compile a long, but not exhaustive, list. This gives you an excellent excuse to in troduce abbreviations. Ask in which way each variable will impact on the consumption of Mocha-Cola. Observe that a specific cause-and-effect pattern is being postulated in each case. If you choos e, introduce functional notation at this point, distinguishing between dependent and independent variables, and labeling each independent variable with a positive or negative sign, according to the direc tion of its effect. (You can introduce the use of graphs here. See the note below under the Appendix to this chapter.) Students have now unknowingly cons tructed a model of consumer be havior. Use this opportunity to underline the point that not all variables have been incl uded in the model and that an all-inclusive list would be cumbersome and distract from the major elements of the model. The values of the variables that you have compiled in your list will be continually changing. Bring out the point that to isolate the effect of any one on the consumption of Mocha-Cola, the ceteris paribus assumption can be invoked. You might suggest the analogy to ex periments in the natural sciences, where tightly controlled environments actually make the ceteris paribus assumption a reality. œ  TEACHING TIP: Use the Mocha-Cola ex ample above to introduce graphs. You can draw a separate graph of the number of bottles purchased versus two or three of the independent variables that influence consumption. Be sure to select at least one in dependent variable with a positive re lationship to quantity and one with a negative relationship, saving price for last. Explain what it means to move along each of these curves, and what ceteris paribus means in each case. œ 6. Cautions and Pitfalls: What Is Really Causal? a. Just because event A happened befo re event B does not mean A caused B. Examples of this sort of thinking are everywhere. Confusing correlation with causation has become a cottage industry for much of the media. 10 Principles of Microeconomics Copyright © 2020 Pearson Education, Inc. b. Post hoc, ergo propter hoc means literally “after this (in time), therefore because of this.” A common error made in thinking about causation: If Event A happens before Event B, it is not necessarily true that A caused B. The post hoc fallacy is the incorrect belief that because event B occurs after event A then A caused B. This is closely related to correlation and causation. Correlation refers to things happening together. Just because two variables move closely together doesn’t mean one causes the other. c. Testing Theories and Models: Empirical economics is the collection and use of data to test economic theories. Researchers look at data collected over time and across different categor ies or conditions (e.g., age groups, locations) and try to draw conclusions. Controlled experiments are difficult in economics (and other social sciences), but are not impossible.  TEACHING TIP: A few years ago, I taught 8:00 AM classes five days a week. I got out of bed at 5:30 AM. Every morning when I got up, the sun would be rising. Obviously the act of getting out of bed caused the sun to come up. This exam ple shows two things. First, just be cause two actions happen together does not mean one caused the other. A theory must be developed that explains why one might cause the other. Second, make sure you have gathered enough data. All I need ed to do was include some weekend mornings to refute my hypothesis. œ Economics in Practice: Does Your Roommate Matter for Your Grades?, page 10 Two studies seem to indicate that peer eff ects are real and significant. The lesson for students: you will become who you hang out with.  TEACHING TIP: Can students find examples of these p itfalls in the model of consumer behavior they constructed for Mocha-Cola? For example, do consumers in the aggregate behave as one individual consumer might? One individual consumer may pur chase on impulse, but that is not true in the aggregate. This is a good opportunity to explain what it means to aggregate. œ  TEACHING TIP: The text mentions Ph.D. economists empl oyed by firms working with “big data.” Perhaps the best-known example is Hal Varian, formerly of U.C. Berkeley, now at G oogle. Recently Peter Coles (Ph.D., Stanford, 2005, formerly at the Harvard Business School) accepted a job at eBay as their Director of Global Strategy in charge of designing new marketplaces for them. œ Web Resources Go to a Web site for data about the economy. The text mentions the Bureau of Labor Statistics, for example. Other good sources are the Bureau of the Census, the Fe deral Reserve, the Bureau of Economic Analysis, and (more exotically) the CIA’s Wo rld Factbook available at https://www.cia.gov/library/publicat ions/the-world-factbook/index.html .  TEACHING TIP: Mention that the statistical techniques used by economists often implicitly assume each independent variable changes while the others are held constant. These statistical techniques can be used to overcome some of the problems caused by our in ability to construct controlled experiments. œ C. Economic Policy: Without objectives it’s impossible to come up with policies. Economists have looked at four different criteria for judging outcomes: efficiency, equity, growth, and stability. Using these criteria to evaluate a policy often leads to conflicting recommendations. This is especially true for the first two (efficiency and equity). 1. Efficiency is the condition in which the ec onomy is producing what people want at the least possible cost. As the text notes, this is allocative efficiency. Chapter 1: The Scope and Method of Economics 11 Copyright © 2020 Pearson Education, Inc.  TEACHING TIP: The text discusses voluntary exchange as an activity that increases efficiency. It's impossible to stress this idea too much. Voluntary exchange makes both parties to the transaction better off. If one party would be made worse off they will walk away from the transaction. This is also a key reason why international trade improves economic welfare. œ 2. Equity means fairness. This is impossible to define universally. An allocation that seems fair to one person will be viewed by another as highly skewed.  TEACHING TIP: Mention the “law of unintended conseque nces.” Rent control is a good example. This is a good spot to point out that rent control often hurts the very people it was intended to help. œ TOPIC FOR CLASS DISCUSSION: Fairness is in the eye of the beholder. My favorite exer cise to provoke a discussion of fairness is to suggest a grading system for the course in which students with A’ s, B+’s, and B’s at the end of the course will have points taken away from them and redistri buted to those with C’s, D’s, and F’s. In the end everyone receives a C+. (There is always at least one student who says, “ I’ll take it!”) Outline the issues involved. Compare this to the issues involved in income redistribution.   TOPIC FOR CLASS DISCUSSION: Ongoing congressional debates over tax po licy provide a good platform to discuss equity. Is it fair that those with high incomes receive most of the dollars of a tax cut? Point out that these people also pay most of the taxes. (If you have the time, a brief discussion of the earned income tax credit and the concept of negative income taxes will often be persuasive.)   3. Economic growth is an increase in total output of an economy. Growth occurs when a society acquires new resources or when it learns to produce more using existing resources. a. Economists often define growth as an increase in output per capita. b. Government policies can encourage or discourage growth. 4. Stability is a condition in which national out put is growing steadily, with low inflation and full employment of resour ces. The causes of instability and the various techniques governments have used to try to improve stability are the core of macroeconomics. TOPIC FOR CLASS DISCUSSION: The text refers to an increase in output per capita as if it automatically becomes an improvement in the standard of living. Ask the class wh ether they can think of circumstances in which higher output per capita would cause their standard of living to fall. They should come up with higher pollution levels, increased crowding and higher crime rates as items that reduce the standard of living but are not measured in output per capita.  Unique Economics in Practice Voluntary exchange makes both parties better off. But what if the exchange is not entirely voluntary? Consider the minimum wage. Under minimum wage laws, employers must pay each employee a minimum amount per hour. That means employees working for the minimum wage are not engaged in voluntary exchange because the employer is coerced into paying a certain amount. Since this exchange is not entirely voluntary, it is possible that the parties are not made better off. Employers will hire fewer workers than they might hire if the wage was lower. Some workers will find themselves unemplo yed as a result. Economists call th e cost of this inefficiency the deadweight loss caused by the transaction. Question: Ask for a show of hands. Who supp orts raising the minimum wage to $15/hour? 12 Principles of Microeconomics Copyright © 2020 Pearson Education, Inc. Answer: This is your first chance to introduce students to the unpleasant realities economists face every day. Use it wisely. V. An Invitation, page 12: Remember what you’v e learned in previous chapters. You’ll use this material in future chapters. VI. Economic Skills and Economics as a Career, page 12 Learning Objective: Describe economics as a career and the key skills you can learn from studying economics. A. During this course you’ll learn economic principles that will help you understand the economy and business. These tools will also help you make life decisions such as what career to pursue. B. Business managers use economic principles to make pricing and investment decisions. C. Government policymakers use economic prin ciples to allocate research funds and make decisions about environmental issues. Web Resources Economic data is widely available on the web. I always try to download the data in spreadsheet format. For U.S. data students should visit http://www.bea.gov , http://www.bls.gov , and http://www.census.gov . Global data is available from http://www.oecd.org , http://www.worldbank.org/ , http://www.imf.org/ , and http://www.un.org/en /databases/#stats . Real statistics aficionados will want to try their hand at Eurostat (http://epp.eurostat.ec.europa.eu/ ). U.S. monetary statistics are at http://www.federalreserve.gov while Eurozone statistics are at http://www.ecb.eu . APPENDIX: HOW TO READ AND UNDERSTAND GRAPHS, PAGES 15–20 Learning Objective: Understand how da ta can be graphically represented. You may find the Unique Economics in Practice on the following page useful. It introduces students to the ways economists use data in the real world. (The values for disposable personal income differ slightl y. Data for Table 1A.1 was taken from the textbook. Data for 1A.3 was downloaded from the Bureau of Economic Analysis September 22, 2018. As usual, there have been revisions.)  TEACHING TIP: You must face the unpleasant choice of either boring those who know this material or skipping the material and losing those who have forgo tten it. If possible, try to hold a special half-hour section of class and invite those w ho feel “rusty” with graphs to come for a short review. Passing out an assignment that requires basic gra phing skills will encourage those who need the review to attend. Whatever you decide, it’s usually better to include at least a brief review of graphs somewhere in the course. œ  TEACHING TIP: Emphasize that the “45 ˚ line” is simply a graph of y = x. This is especially important in macroeconomics. Unique Economics in Practice Tables 1A.1 and 1A.3 give you the opportunity to work with real world data. The Excel workbook for this chapter includes the data, graph, and a simple regression of disposable personal income versus the year. (The graphs below can be increased in size by simply dragging a corner.) That’s not particularly interesting, but having the data may be useful. For Table 1A.3, the data is annual from 1970 through 2017. There is a graph: Chapter 1: The Scope and Method of Economics 13 Copyright © 2020 Pearson Education, Inc. While that’s fun, there is also a lin ear regression of a consumption function: Don’t explain the details of regression analysis to your class. Instead, note that the straight line is the best fit to the data. Also note that there are a number of points (the blue dots) that do not lie precisely on the line. The equation for this regression is Point out that the coefficient of YD (disposable personal income ) means that for every dollar more in income, consumption expenditure ( C) increases by $0.91. Question: This analysis is done for the entire U.S. economy. Do you think it implies that every household spends 91 percent of their disposable income? Answer: Of course not. Use this as a jumping-off point for the life-cycle model of consumption. Many of your students are spending more than their income. They accomplish this by getting funds from other sources (parents, financial ai d) and/or acquiring debt (student loans). Copyright © 2020 Pearson Education, Inc. 14 by Tony Lima, California State University, East Bay, Hayward, CA CHAPTER OUTLINE AND LEARNING OBJECTIVES Scarcity, Choice, and Opportunity Cost p. 24 Understand why even in a society in which one pe rson is better than a second at all tasks, it is still beneficial for the tw o to specialize and trade. Economic Systems and the Role of Government p. 36 Understand the central difference in the way co mmand economies and market economies decide what is produced. Looking Ahead p. 38 Visit www.MyLabEconomics.com for current examples, news articles, and teaching tips. Principles of Microeconomics 15 Copyright © 2020 Pearson Education, Inc. Detailed Chapter Outline I. Introduction, pages 22–23 This chapter explores the questions of what, how, and for whom to produce. Human wants are unlimited, but resources are not . This creates scarcity. Scarcity, in turn, forces us to make choices. The chapter stresses positive and descrip tive economics, postponing normative questions until the students have acquired analytical tools.  TEACHING TIP: Stress the idea that any society must answer the three fundamental questions regardless of its political organization. One reason command econom ies don’t work well is the immense number of calculations that would be required to answer th ese questions correctly. œ A. Resources, used in its broadest sense, incl udes everything from natural resources (timber, minerals, energy), capital (buildings, machines), labor (human capital), and entrepreneurship. Resources are also called factors of production , inputs , or simply factors . Output is what is produced, goods and services of value to households. B. Key definitions: 1. Capital includes things that are produced and then used in the production of other goods and services. As used by economists, capital means physical capital, including buildings and machines. 2. Factors of production (factors ) are the inputs into the process of production. Another term for resources. 3. Production is the process that transforms scarce resources into useful goods and services. 4. Inputs or resources include anything provided by na ture or previous generations that can be used directly or indirectly to satisfy human wants.  TEACHING TIP: Many goods are used to produce other goods. Some of these goods are counted as intermediate goods (“parts”) while others are counted as capital. In the national income accounts, the distinction is simple: Anything that firms expect to us e for more than 1 year is capital. Examples include a computer, office furniture, or an assembly line. If firms expect to use something for less than 1 year, it is an intermediate good. For example, quick-release bolts are common in bicycles. Because the bicycle maker expects to use many of these bolts within a year th ey are intermediate goods, not capital goods. Even though they are goods used to make another good, they are no t capital. Think of them as parts instead. This is especially useful for thos e teaching macroeconomics. œ 5. Producers are those who transform resources into outputs (final goods and services). 6. Outputs are goods and services of value to households. 7. Households are the consumers in the economy. They purchase output. II. Scarcity, Choice, and Opportunity Cost, pages 24–35 Learning Objective: Understand why even in a so ciety in which one person is better than a second at all tasks, it is still beneficial for the two to specialize and trade. A. Scarcity and Choice in a One-Person Economy 1. Bill must make choices about how to a llocate resources, what to produce, and how to produce it. Bill’s situation is “constrained choice.” His main constraint is available time. Other constraints are his physical condition, his knowledge and skills, and the resources and climate of the island. Bill must decide what goods and services he wants to produce, what he is able to produce, and how to use the resources to produce what he wants. Principles of Microeconomics Copyright © 2020 Pearson Education, Inc. 16  TEACHING TIP: The text correctly notes that Bill has wants , not needs . Discourage your students from using the word “needs.” There are two reasons for this . First, “needs” is value-loaded, implying that the product in question is a necessity, possibly with a ve rtical demand curve. Second, “needs” may encourage students to ignore price rationing. œ TOPIC FOR CLASS DISCUSSION: What are some of the more useful skills Bill might wa nt? Students will come up with things like building a fire, primitive construction, and being able to tell whic h berries are not poisonous. More subtle answers might include weather forecasting and knowledge of airline and shipping routes.    TEACHING TIP: This is a good place to follow the text’s lead and discuss the cost of leisure time. As the text notes, Bill can use as much time as he wants to lie on the beach. Howeve r, the cost of that leisure time is lost production. œ 2. Opportunity cost is the best alternative that we give up, or forgo, when we make a choice or decision. If Bill spends more time hunting he will have less time to build shelter. Similarly, time he spends on the beach also has an opportunity cost.  TEACHING TIP: Instructors sometimes rush through their discussion of indivi dual versus societal opportunity cost because the point seems obvious. But the idea of opportunity cost makes a deep impression on students. They often find it valuable in their pers onal lives and remember it long after class is over. Remind students that opportunity cost is relevant to so cietal as well as individual choices. A good way to drive the concept home is to find some social goal that virtually everyone in the class thinks is “good.” National health insurance for all? A pristine environment? Completely safe streets? Point out that achieving the goal requires resources, which must be pulled out of producing something else. How much “other production” would class members be willing to sacrifi ce to accomplish the goal? A cut in their material standard of living of 10 percent? How about 50 percent? Or 90 percent? Public policy debates suffer when opportunity cost is ignored or calculated incorrectly. A major contribution of economists is to keep opportunity cost—correctly measured—part of policy debates. œ B. Scarcity and Choice in an Economy of Two or More 1. Now there are two decision makers—Bill and Colleen. Their preferences, skills, and abilities probably differ. They will have to decide how much of each product each person should produce. They will pr obably benefit from specialization and trade.  TEACHING TIP: Students often have difficulty remembering that opportunity cost and comparative advantage are intertwined. Try using the term comparative opportunity cost advantage when calculating who should specialize in what. It helps st udents to remember that comparative advantage is what matters when calculating who should produce which good to maximize the gains from trade. œ Economics in Practice: Frozen F oods and Opportunity Costs, page 26 Over the last 60 years, the frozen f ood market has boomed. In 2012, sales were $44 billion, about 44 times what they we re in the mid-1950s. Increased labor force participation by women has increased the opportunity cost of their time. In other words the cost of preparing meals “f rom scratch” has risen. A second factor complementing this is a technological improvement, the introduction of the microwave oven. In fact, the widespread acceptance of microw ave ovens occurred because of the increasing opportunity cost of time for housework. Entrepreneurs look for areas in which opportunity cost is rising to get some ideas about new technology. Chapter 2: The Economic Probl em: Scarcity and Choice Copyright © 2020 Pearson Education, Inc. 17 TOPIC FOR CLASS DISCUSSION: Related to Economics in Practice , page 26. Ask the class to list other de vices that were developed in response to higher opportunity costs of time. One example is iRobot, a company that makes a line of home cleaning robots ( http://www.irobot.com ). The company has recently broadened their product line to include robotic mops and swimming pool cleaners.   2. Specialization, Exchange, and Comparative Advantage: a. David Ricardo formulated the theory of comparative advantage , the idea that specialization and free trade will benefit all trading partners, even those that may be “absolutely” more efficient producers. (As we know today, this must be true of any voluntary exchange.) Ricardo’s most important point is that everyone—eve ry individual, firm, and country— has a comparative advantage at something even if another has an absolute advantage at produc ing all goods and services . Trade and specialization allow the most effi cient producer to produce each good. This increases productivity and aggregate output. b. A producer has an absolute advantage over another in the production of a good or service if he or she can produce that product using fewer resources (a lower absolute cost per un it). In the text’s example, Colleen has an absolute advantage at both cutting logs and gathering food. c. Comparative advantage is the advantage in the production of a good enjoyed by one country over another when that good can be produced at lower cost (in terms of other goods th at must be foregone) than it could be in the other country. d. Trade means both parties can consume at points outside their individual PPFs. This demonstrates the gains from specialization and trade.  TEACHING TIP: Comparative advantage is extremely important. It is the economic motivation for exchange between individuals (roommates, workers within an offi ce, etc.); groups of indivi duals (divisions within a company, firms that specialize in productive tasks with in an economy); and nations (international trade). Ask students to give examples from their own experiences. For example, who does which chores in their families and why? œ  TEACHING TIP: The data and graphs for Figure 2.3 are in the Excel workbook for this chapter. œ  TEACHING TIP: The numbers in Figure 2.2.a can be confusing. Remember each person is producing equal quantities of each good. For Colleen the solution is simp le because her opportunity cost of 1 more log is 1 more bushel of food. But Bill's PPF has a slope of −0.5. In fact, the equation of Bill’s PPF is L = 4 – 0.5F. Setting L = F gives L = F = 2–2/3. Bill will spend 2/3 of a day producing logs and 1/3 of a day producing food.œ  TEACHING TIP: Walk through the example on pages 25–27 in the text in class. Do the calculations of opportunity costs. Show how Figure 2.3 on page 27 is cons tructed. It’s worth the time. If you don’t like the example in the text, try the followi ng alternative exam ple. Suppose Colleen and B ill subsist on fish and coconuts. Catching fish requires pati ence and good vision. Picking coc onuts requires climbing ability and manual dexterity. Colleen can catch 18 fish per day or pick 36 coconuts. It costs her 36/18 = 2 coconuts per fish or 18/36 = 0.5 fish per coconut. Bill can catch 9 fish per day or pick 27 coconuts. It costs him 27/9 = 3 coconuts to catch a fish or 9/27 = 0.33 fish to pick a coconut. Colleen has a compar ative advantage at fishing since one fish costs her only 2 coconuts compared to 3 for Bill. Bill has a comparative advantage at picking coconuts since it costs him 0.33 fish per coconut while it costs Colleen 0.5 fish per coconut. Colleen should specialize in fishing while Bill sp ecializes in picking co conuts. Be sure the students understand how these calculations are done and why the numbers are opportunity costs. œ Principles of Microeconomics Copyright © 2020 Pearson Education, Inc. 18 3. Weighing Present and Expected Future Co sts and Benefits: There is a trade-off between present and future benefits and costs. The simplest example of trading present for future benefits is saving part of our income, which allows us to consume more in the future. Even Bill, alone on his island, must choose between gathering food for immediate consumption and constructing tools that he can use to produce more in the future.  TEACHING TIP: This is a good place to introduce the tim e value of money. Make the point that the interest rate is the marginal opportunity cost of consum ption today and the marginal benefit for saving. œ 4. Capital Goods a nd Consumer Goods: Consumer goods are goods produced for present consumption. When a society devotes a portion of its resources to investment in capital, it is trading present benefits for future benefits. Investment is new capital additions to a firm’s cap ital stock. Although capital is measured at a given point in time (a stock), invest ment is measured over a period of time (a flow). The flow of investment increases the capital stock.  TEACHING TIP: Emphasize that econom ists are quite specific when de fining investme nt and capital. Capital means physical capital—buildings and machines. Investment is the process of creating new capital, often involving the construction industry. This is especially important when teaching macroeconomics. œ TOPIC FOR CLASS DISCUSSION: Introduce the idea of human capital. Explain that educat ion is an investment in human capital. Draw on the analysis of the cost of going to college (from Chapter 1) to consider it as invest ment. Is it a trade-off of current benefits for future bene fits? What are those benefits?   C The Production Possibility Frontier (PPF) 1. The PPF can be used to show the prin ciples of constrained choice and scarcity. a. A production possibility frontier (ppf) is a graph that shows all the combinations of goods and services that can be produced if all of society’s resources are used efficiently. b. All points on the curve are combinations of output produced using full resource employment and production efficiency. c. Production efficiency means producing a given mix of outputs at least cost. This implies producing the maximum quantities of both goods given society’s resources and technology. d. Points inside the curve are achievabl e but are not efficient. Points outside the curve are unattainable unless the quantities of resources increase or there is a technological improvement. e. Different points on the PPF show the quantities of each of the two goods. At point F in Figure 2.4 the economy is producing more capital goods and less consumer goods than at point E. In subsequent years, the PPF will shift out further from point F than E. Chapter 2: The Economic Problem: Scarcity and Choice Copyright © 2020 Pearson Education, Inc. 19 Unique Economics in Practice One measure of inefficiency is th e unemployment rate, the percentage of the labor force that can’t find work. The unemployment rate fluctuates. During recessions output falls and the unemployment rate rises. Wh en the economy is expanding, output rises and the unemployment rate fa ll. This process is usually called a business cycle . (The data and graph for this example are in the Excel workbook for this chapter.) Question: The unemployment rate is often called a countercyclical variable. Can you figure out why? Answer: A countercyclical variable moves in the opposite direction from the economy. During an expansion output rises and the unemployment rate falls. During a recession, output falls and the unemployment rate rises. The two variables generally change in opposite directions.  TEACHING TIP: The presentation of the PPF is an exce llent time to reinforce the way in which one should detail and use an economic model. Lay out the assumptions , being sure all variables are clearly defined, and use the model to explain what it is designed to explain (or predict). Advise students who are hesitant to work with graphs that the appendix to Chapter 1 provides a good review. œ 2. Negative Slope and Opportunity Cost a. When resources are used efficiently the only way to produce more of one good is to produce less of the other. The opportunity cost of increasing production of good X by one unit is the number of units of good Y that must be sacrificed. b. The marginal rate of transformation (MRT ) is the slope of the production possibility frontier (ppf). 3. The Law of Increasing Opportunity Cost a. The “bowed out” shape of the PPF tells us that the more society tries to increase production of one good, the more costly it becomes (in terms of the number of units of the other good that must be given up). b. In effect, the law of increasing oppor tunity cost says the absolute value of the slope of the PPF will increas e as the quantity on the x-axis increases.  TEACHING TIP: The text discusses climate differences between Ohio and Kansas as well as the impact of a law forcing farmers to plant more wheat in Ohio and more corn in Kansas (p. 32). You may want to bring up the corn ethanol mandate. The government has, in effect, told farmers to grow more corn. The inefficiency is identical to that described in the text. See the Unique Economics in Practice below.œ Principles of Microeconomics Copyright © 2020 Pearson Education, Inc. 20  TEACHING TIP: Suppose LeBron James, a well-known prof essional basketball player, was forced to teach economics. Presumably that would not be his most pr oductive activity. Similarly, if you (or I) was assigned the job of playing center in the NBA, our productivity would be low. We know that because of revealed preference and comparative advantage. œ 4. The Efficient Mix of Output a. To be efficient, an economy must produce what people want. b. All points on the PPF are efficient in production. But the economy must also be at the correct point on the PPF ( output efficiency ).  TEACHING TIP: Figure 2.5 on page 34 shows a PPF for corn and wheat production. The specialized resource is climate. Ohio has a wetter climate, better suited to growing corn. Kans as is drier, better for growing wheat. Growing corn in Kansas or wheat in Oh io will be more costly because of the specialized resource (climate). You may find the table below helpful. It expands Tabl e 2.1 to include the MRT. With wheat on the horizontal axis, the correct measure of MRT is ΔC/ΔW. Again, do some examples in class showing how the slopes are calculated. (Technically you are calculating the slope of a secant, the straight line connecting two points on a curve.)  TEACHING TIP: Figure 2.5 and Table 2.1 are included in the Excel workbook for this chapter. œ 5. Economic growth is an increase in the total outpu t of an economy. Growth occurs when a society acquires new resources or when it learns to produce more using existing resources. Growth causes an outward shift of the PPF. Growth is an increase in the total output of an economy. TOPIC FOR CLASS DISCUSSION: Growth is what happens when you relax the restrictiv e assumptions (fixed resources and technology) used to draw the first PPF. Have students c onsider what happens if a change in resources or technology affects society’s ability to produce one product but not the other. This can lead into a discussion of how the Internet has changed productivity in different industries.   Unique Economics in Practice Sometimes, government contributes to allocative in efficiency. Under current U.S. law, ethanol intended for use as vehicle fuel must be made from corn. Part of this law imposes a tariff of $0.54 on every gallon of ethanol imported into the United St ates. This tariff is aimed squarely at Brazil, which produces ethanol from cane sugar at about 20 percent of the cost of producing ethanol from corn. Technologically, producing ethanol from sugar needs only water and yeast, while corn needs to be cooked before fermentation. The r esult has been high corn prices leading to high prices of many other foods, such as beef a nd chicken because those animals feed on corn. Producing ethanol from sugar in the United Stat es is economically unattractive because the government restricts sugar imports. The price of sugar in the United States is about twice the world price due to these import restrictions . While the U.S. economy may be productively efficient, it is not allocatively efficient, largel y because of these policies. Figure 2.6 on page 34 in Chapter 2: The Economic Probl em: Scarcity and Choice Copyright © 2020 Pearson Education, Inc. 21 the text can be used as an example of this with very few changes. In fact, the ongoing example of increasing opportunity cost as the quantity of co rn increases fits this example perfectly. Question: Why does the government impose tariffs on ethanol and sugar imports? Answer: Special interest groups seek ways to in crease their incomes. One method they use is lobbying Congress to restrict imports and other forms of competition. In this case, those groups have been quite successful.  TEACHING TIP: Extreme examples can help students s ee the difference between allocative efficiency and productive efficiency. Suppose all of the land, labor, and capital in the country were used to produce something students might fi nd undesirable, say Brussels sprouts or turnips. As long as the economy is producing the maximum amount possible of that good, then productive efficiency is achieved. However, the economy is not producing the best mix of outputs becau se it is not producing the goods people want. That means the mix of goods is not allocat ively efficient. Make it clear to students that points on the curve represent a productively efficient combination of resources, but not necessarily an allocatively efficient combination of resources. Productive efficiency means all resources are being fully used. Allocative efficiency means the economy is producing the combination of goods and services consumers want to buy. œ 6. Sources of Growth and the Dilemma of the Poor Countries a. Historically, the two most important sources of growth have been the accumulation of capital and technological advance. b. For poor countries, taking resour ces out of the production of consumer goods is very difficult because they are living so close to subsistence levels. This lack of saving can make it difficult for them to accumulate capital, pay for research and development, and grow. c. The paper by Robert Jensen cited in the footnote on p. 34 is an excellent example of how a seemingly minor technological improvement can lead to large welfare gains.  TEACHING TIP: There are several directions you can go from here. It appears that poor countries are destined to remain poor based on this analysis. However, recent research by Lucas and Romer seems to show that accumulation of human capital is more important than either physical capital or technology. And Lawrence Summers has estimated the rate of return on educating women in less deve loped countries is more than 20 percent. œ D. The Economic Problem: How do different economic systems answer the three basic questions? Economics in Practice: Trade-Offs among the Rich and Poor, p. 36 Poor countries are very poor. Consumers spend we ll over half their income on food. But they still make choices. About 10 percent of income is sp ent on sugar. About the same amount is spent on weddings, funerals, and other festivals. Even poor economies find the time and income for entertainment. Principles of Microeconomics Copyright © 2020 Pearson Education, Inc. 22 Unique Economics in Practice This example shows how an increase in productiv ity in one sector of the economy can actually raise the opportunity cost of production in other sectors. During the mid-1980s, the lumber industry announced that a cord of wood (a 4-by-4-by-8 foot pile) could be converted into 942 one-pound books, 2,000 pounds of paper, 61,370 num ber 10 envelopes, or 7,500,000 toothpicks. Measure the opportunity cost of books in terms of “toothpicks forgone.” Given the data above, the opportunity cost of a book is 7,500,000/942 = 7,961 toothpicks per book. Suppose that a technological advance in the toothpick industry (perhaps a waste-reducing technique) enables more toothpicks, say 9,000,000, to be created from a cord of wood. Question: What happens to the opportunity cost of producing a book when productivity increases in the toothpick manufacturing industry? Answer: The opportunity cost of producing a book increases! Now, one book “costs” 9,000,000/942 = 9,554 toothpicks, even though there has been no change in book-producing technology. III. Economic Systems and the Role of Government, pages 36–37 Learning Objectives: Understand the central difference in the way command economies and market economies decide what is produced. There are different types of economic systems: A. Command Economies are those in which a central government either directly or indirectly sets output targets, incomes, and prices. Th ere are few true command economies left in the world. Even China has become a “magne t for private capital and entrepreneurship.” TOPIC FOR CLASS DISCUSSION: Ask the class if they can name any countries that are pure (or almost pure) command economies. Three examples are Venezuela, Cuba, and North Korea. Y ou can get a cheap laugh by referring to the People’s Republic of Santa Monica (Ca lifornia) as a third example.   Unique Economics in Practice Venezuela is the latest country to try to control inflation with price ceilings. And the results are as predictable as the long lines and empty shelves in Caracas. Prof. Steven Hanke has become the de facto monitor of hyperinflation (the Troubled Currencies Project at the Cato Institute, https://www.cato.org/research/troubled-currencies ). As of September 23, 2018, Prof. Hanke estimates the annual infl ation rate for Venezuela at 48,072 percent. Question: Why are there long lines and empty shelves? And, more important, how can inflation be so high if prices are fixed by the government? Answer: This is a great opportunity to introduce the idea of price rationing. Point out that when a price is set too low, people will want to buy more of that product than sellers are willing to sell. That simple fact creates long lines and empty shelves. The second question is a bit more complicated. Just point out that high inflation rates are always caused by excessive growth in the qua ntity of money in circulation. B. Laissez-Faire Economies: The Free Market 1. A laissez-faire economy is an economy in which individuals and firms are free to pursue their own self-interest without any government direction or regulation. Chapter 2: The Economic Probl em: Scarcity and Choice Copyright © 2020 Pearson Education, Inc. 23 (“Laissez-faire” is from the French: “allow [them] to do.”) Laissez-faire economies rely on markets , institutions through which buyers and sellers interact and engage in exchange. Its characteristics include: 2. Consumer sovereignty is the idea that consumers u ltimately dictate what will be produced (or not produced) by choosing what to purchase (and what not to purchase). The mix of output produced is dictated by the tastes, preferences, and incomes of consumers. 3. Individual Production Decisions: Free Enterprise: a. Free enterprise is the freedom of individuals to start and operate businesses in search of profits. This increases output and develops new production techniques. b. In market systems, prices are signals of relative scarcity. These price signals to consumers and producers guide them in making decisions. This is Adam Smith’s “invisible hand.” c. Markets promote competition and efficiency. 4. Distribution of Output: Also determined in a decentralized way, the distribution depends on a household’s income and wealth.  TEACHING TIP: Income is the amount the household earn s in a year. Wealth is the households accumulated saving (assets) out of income. œ 5. Price Theory: Prices are the basic coordinating and signaling mechanism. Wage rates are the prices of various kinds of labor. From page 38: C. Mixed Systems, Markets, and Governments 1. All real-world economies are mixed, with differing degrees of government intervention. Market systems have advantages, but are not perfect. 2. In the United States, governments at a ll levels accounted for about 20 percent of total output. They directly employ about 14 percent of all workers. Governments redistribute income via taxes and social welfare spending. Finally, they regulate many aspects of economic activity. 3. Remember the “law of unintended c onsequences.” Government intervention may make things worse instead of better. Go vernment sets and enforces the rules for an economy. Two important rules are the protection of private property and the enforcement of laws governing intellectual property. TOPIC FOR CLASS DISCUSSION: Have students research countries in transition and consider the problems and challenges faced in the process.   Principles of Microeconomics Copyright © 2020 Pearson Education, Inc. 24 IV. Looking Ahead, page 38 The next chapter discusses how markets work. EXTENDED APPLICATION Application 1: The Rising Cost of Services Consider how the cost of services tends to ri se over time. Why do items like haircuts, medical care, and education keep getting more and more expensive, both absolutely (they cost more dollars) and relatively (they require a larger and larger portion of our incomes)? Using the concept of opportunity cost, the production possi bilities frontier, and a little common sense, we can come up with a realistic answer. The three items mentioned above are examples of services. A service is, by definition, provided by workers directly to consumers. (One of th e fastest-growing service sectors in the United States is meals eaten away from home.) A service is always consumed the moment it is produced. It cannot be brought home in a shopping bag or r esold to someone else. Services can’t be inventoried. To keep the analysis simple, le t us assume that a nation can produce only one good (T-shirts) and one service (haircuts). The nation’ s production possibilities frontier is shown in the following graph: Initially, at Point A, the economy is producing 100 haircuts and 300 T-shirts per day. Between points A and B the opportunity of producing 50 more T-shirts (increasing from 300 to 350) requires the sacrifice of 25 haircuts (decreasing from 100 to 75). The marginal rate of transformation is thus 50/25 = 2.00. Now (as students who are taking microeconomics will see later on) relative prices in a market economy us ually correspond quite cl osely to opportunity costs. That is, if producing 50 more T-shirts uses resources that could otherwise produce 25 haircuts, then a haircut should cost about two tim es the cost of a T-shirt. Let us suppose that for this economy at Point A, each T-shirt costs $5 and each haircut costs $10. Many economists believe that the growth of pr oductivity (output per hour) is much slower for services than for goods. This is easy to see in the case of T-shirts versus haircuts. Over the past 50 years, the number of T-shirts a worker can produ ce in an hour has increased dramatically due to technological advances in cotton-picking, weav ing, and assembly-line production techniques. Over the same period, however, the number of ha ircuts a barber could perform in an hour has probably increased very little, if at all. The effect of this asymmetrical change in productiv ity is illustrated in the diagram. Note that the vertical (T-shirt) intercept of the production possibilities frontier has in creased, reflecting an increase in the maximum quantity of T-shirts that could be produced—after the productivity Chapter 2: The Economic Probl em: Scarcity and Choice Copyright © 2020 Pearson Education, Inc. 25 change—if all resources were devoted to T-shirt pr oduction. But the horizontal (haircut) intercept remains the same, as there has been no productivity change in this industry. Suppose that the economy ends up at Point C on the new PPF. The economy is producing more T-shirts (160) and more haircuts (400). In add ition, the opportunity cost has increased. As the economy moves from Point C to Point D (after the productivity change) it could produce 100 additional T-shirts with a sacrifice of 25 haircu ts. The opportunity cost is now 4.00 instead of 2.00. In other words, even though there has been no change in haircut technology or productivity, the opportunity cost of haircuts has risen! One ha ircut should now cost the same as 10 T-shirts. If T-shirts continue to cost $5 each, then haircuts should rise in price to $50. Alternatively, if T-shirts fall to $1.50 each, haircuts should remain priced at $15. Either way, the relative price of haircuts will rise, as the opportunity cost of haircuts has risen. This simple analysis has far-reaching implications. It explains why college tuition rises faster than the general price level, as providing an educa tion relies heavily on services (teaching, building maintenance, administrative services) rather than goods. Similarly, it suggests that ongoing efforts to reform health care may be only pa rtially successful. We can certainly choose, as a nation, to provide better health care to more of our population. But if manufacturing productivity continues to increase faster than productivity in medical services , then the relative price of health care like the relative price of haircuts, will rise. If your class seems to enjoy this material, point out that global competition mostly has no effect on services such as haircuts because they are nont raded goods. Then note that technology is moving more and more goods from the “nontraded” category into “traded.” Education is a good example. There are several consortiums 0f unive rsities and a number of private companies hoping to exploit the trend toward online education.