Unit 1 – Basic Economic Concepts

Overview

Unit 1 focuses on basic economic concepts. These concepts account for 8 to 12 percent of the Advanced Placement Microeconomics Examination. More importantly, if you do not understand these concepts, you will have a difficult time throughout the course.

The most important introductory concept is scarcity. In any economy, scarce resources and unlimited wants result in the need to make choices. You must understand scarcity, opportunity cost and trade-offs. You should be able to illustrate these concepts on a production possibilities curve.

Because of scarcity, every economic system must determine which goods to produce, how to produce them and for whom to produce them. We will focus on how specialization and exchange increase the total output of goods and services.

You must be able to differentiate between absolute advantage and comparative advantage. Comparative advantage is the key to specialization and trade. Do not neglect this concept.

Finally, Unit 1 emphasizes an economic way of thinking that is key to ideas that come up over and over again in the course. You should not memorize the concepts; instead, you should use the concepts as a framework for organizing the course.

The Lesson Planner

There are four lessons in this unit:

§  Lesson 1 emphasizes the economic way of thinking. It uses Activity 1 and Visual 1.1.

§  Lesson 2 emphasizes scarcity, opportunity cost and production possibilities curves. It also applies these concepts to organizing an economy. It uses Activities 2, 3, 4 and 5 and Visuals 1.2 and 1.3.

§  Lesson 3 focuses on comparative advantage and uses Activity 6 and Visuals 1.4 and 1.5.

§  Lesson 4 reinforces the activities from the previous lessons by applying them to a variety of conventional and unconventional situations. This lesson uses Activities 7 and 8.

Lesson 1 – The Economic Way of Thinking

Introduction and Description

Advanced Placement Economics has thousands of details that can confuse you. You need a framework to organize these details. This lesson acquaints you with basic economic concepts and methodology. It begins with some key economic ideas, which represent a new set of lenses through which you may view the world.

The lesson ends with a test of economic myths that should get your attention. This exercise should help reinforce the economic concepts taught at the beginning of the lesson.

Objectives

1. Define opportunity cost.

2. Define the economic way of thinking.

3. Apply scarcity concepts to a variety of economic and noneconomic situations.

Time Required

Approximately 90 minutes

Materials

1.  Chapter 1

2.  Reffonomics website

3.  Visual 1.1

4.  Unit 1 Key Ideas

5.  Activity 1

6.  Moodle forum

Your Tasks

1. Observe Visual 1.1 and Unit 1 Key Ideas and consider these points:

Everything has a cost.

This is the basic idea that “there is no such thing as a free lunch,” meaning that every action costs someone time, effort or lost opportunities to do something else. Introduce the term opportunity cost here. Stress the concept that people incur costs when making decisions, even when people appear to pay nothing.

People choose for good reasons.

People always face choices, and they should choose the alternative that gives them the most advantageous combination of costs and benefits. You might stress here that if people have different values, they may make different choices. This might be a good place to discuss normative versus positive economics. Economists tend to be a tolerant lot because they realize people choose for good reasons. Also stress that people choose. Much of the AP Economics course concerns business and government decision-making. But business and government decisions are made by people.

Incentives matter.

This course is really about incentives. It has been said that economics is about incentives and everything else is commentary. Supply and demand analysis is about incentives. The “theory of the firm” and “factor markets” are about incentives. Government decision-making is about incentives. When incentives change, people’s behavior changes in predictable ways.

People create economic systems to influence choices and incentives.

Cooperation among people is governed by written and unwritten rules that are the core of an economic system. As rules change, incentives and behavior change. The success of market systems and the failure of communism are rooted in incentives.

People gain from voluntary trade.

People trade when they believe the trade makes them better off. If they expect no benefits, they don’t trade. Part of the AP Economics course focuses on international trade. However, once again it is people, not countries, that trade. A market system is about trade. Economics is about trade.

1

Economic thinking is marginal thinking.

Marginal choices involve the effects of additions and subtractions from current conditions. Much of this course is about marginal costs and benefits. Marginal thinking will be stressed in Units 3 and 4, where the “theory of the firm” and “factor markets” are discussed. Nevertheless, issues regarding marginal decision-making appear in every unit.

The value of a good or service is affected by people’s choices.

Goods and services do not have intrinsic value; their value is determined by the preferences of buyers and sellers. Because of this, trading moves goods and services to higher-valued uses. This is why trading is so important. The price of a good or service is set by supply and demand.

Economic actions create secondary effects.

Good economics involves analyzing secondary effects. For example, rent controls make apartments more affordable to some consumers. Controls also make it less profitable to build and maintain apartments. The secondary effect of rent controls is a shortage of apartments and houses for rent.

The test of a theory is its ability to predict correctly.

You will consider dozens of theories throughout this course. All these theories have simplifying assumptions. However, “the proof of the pudding is in the eating.” If the theory correctly predicts the consequences of actions, it is a good theory. Nothing is “good in theory but bad in practice.”

2.  Read Chapter 1 of our online Principles of Economics textbook.

3.  Work through What is Economics on the Reffonomics Website.

4.  Complete Activity 1 and submit your response to me. I will respond to your submitted answers as quickly as I can.

5.  After you receive my feedback, discuss your reactions on the Moodle forum for this Lesson. You should provide at least one original entry and respond to at least two separate entries.

Lesson 2 – More on Scarcity, Opportunity Cost and Production Possibilities Curves

Introduction and Description

This lesson deals with opportunity cost, one of the most important concepts in economics. We will start with a lecture on scarcity and production possibilities curves. Then reinforce the lecture by using Activity 2, which develops the central economic problem of scarcity.

Opportunity costs include not only out-of-pocket expenses (explicit costs) but also the value of resources that could be used elsewhere (implicit costs). Understanding explicit and implicit costs will be essential as the students analyze product markets.

Explicit and implicit costs are the focus of Activity 3.

In all societies, people must organize to deal with the basic problems raised by scarcity and opportunity cost. A society must decide which goods and services to produce, how to produce them and how to distribute them. Societies use three systems — tradition, command or market — to solve the basic problems. This is the focus of

Activity 4. It is easier to analyze campus parking than a complex economic system.

Finally, the United States has a mixed market system. The circular flow diagram (Activity 5) describes in a nontechnical way the major flows of goods, services, resources and money in a market economy.

Objectives

  1. Define scarcity, opportunity cost and trade-offs.
  2. Identify the conditions that give rise to the economic problem of scarcity.
  3. Identify the opportunity costs of various courses of action involving a hypothetical problem.
  4. Construct production possibilities curves from sets of hypothetical data.
  5. Apply the concept of opportunity cost to a production possibilities curve.
  6. Analyze the significance of different locations on, above and below a production possibilities curve.
  7. Identify the three questions every economic system must answer.
  8. Analyze the advantages and disadvantages of each of the three economic systems (market, command and tradition).
  9. Describe and analyze the different economic goals of different economies.
  10. Determine the mix of tradition, command and market in different economies.
  11. Analyze a market economy using the circular flow of income.

Time Required

Approximately 180 minutes

Materials

  1. Chapter 1 and Chapter 2, Sections 1, 2 and 3
  2. Khan Academy website
  3. Reffonomics website
  4. Activities 2, 3, 4 and 5
  5. Visuals 1.2 and 1.3

Your Tasks

1.  Review Chapter 1 and read Chapter 2 of our online Principles of Economics textbook.

2.  Watch these three Khan Academy videos:

a.  Production Possibilities Frontier;

b.  Opportunity Cost and;

c.  Increasing Opportunity Cost.

3.  Complete these Reffonomics Interactives:

a.  Production Possibilities Curve 1;

b.  Production Possibilities Curve 2;

c.  Production Possibilities Problem Sets Interactive 1, and;

d.  Production Possibilities Problem Sets Interactive 2.

4.  Consider these ideas:

  1. Wants are unlimited.
  2. Resources are limited and fall into four categories: land, labor, capital and entrepreneurship.
  3. There is a need to make decisions. The cost of choosing one good is giving up another. This is called opportunity cost.

5.  Look at Visual 1.2 of a production possibilities curve (PPC) and consider these points:

  1. What trade-offs are involved?
  2. Why is the PPC concave, or bowed out, from the origin?
  3. What does a point inside the PPC illustrate?
  4. What is an historical example of a point inside the PPC?
  5. What is the significance of a point outside the PPC?
  6. Under what conditions can a point outside the PPC be reached?

6.  Complete and submit Activity 2.

7.  Watch this Reffonomics lesson on the difference between explicit costs and implicit costs.

8.  Complete Activity 3 and submit it.

9.  Watch this Reffonomics lesson on the different economic systems. Every economic system uses some combination of tradition, command and market to answer the questions of what to produce, how to produce and for whom to produce.

10.  Read Activity 4, “Campus Parking.” This case study helps you apply tradition, command and market systems to a real issue. Use the moodle forum to answer the questions at the end of the case study.

11.  Look at Visual 1.3 which shows a circular flow diagram. To make the diagram more concrete, trace a single product through the circular flow.

12.  Watch this Reffonomics lesson on the circular flow diagram, and then complete this Reffonomics interactive on the circular flow diagram.

13.  Reinforce your understanding of the circular flow diagram by completing Activity 5. Submit it.

Lesson 3 – Absolute Advantage and Comparative Advantage, Specialization and Trade

Introduction and Description

Activity 6 introduces absolute advantage and comparative advantage. Although these concepts are covered in more detail in the international-trade unit in Macroeconomics, they explain economic activities intra-nationally as well. You will be tested on them.

People trade because both parties stand to benefit when they engage in voluntary exchanges. Comparative advantage is a powerful concept that helps explain how mutual benefits can occur from exchange.

A nation and an individual have a comparative advantage when they can make one or more products at a lower opportunity cost than another nation or individual. When producers specialize in the lower-cost product, they can make additional goods, which they can trade to other producers for goods that would have been more costly to make.

To determine a comparative advantage, costs must be measured in terms of what other products must be forgone to make a particular product. This relative measure is a subtle, difficult and very important idea for students to understand. A nation's or an individual's comparative advantage will change as the opportunity costs of products made available by different trading partners change.

Objectives

1.  Define comparative advantage and absolute advantage.

2.  Describe and give examples of the law of comparative advantage.

3.  Explain how both parties in a trade gain from voluntary exchange.

4.  Define specialization and exchange.

5.  Use data to determine absolute and comparative advantage. Time Required One class period or 45 minutes

Materials

1.  Chapter 2, Sections 3, 4 and 5

2.  Khan Academy website

3.  Reffonomics website

4.  ACDC Leadership website

5.  Activity 6

6.  Visuals 1.4 and 1.5

7.  Comparative Advantage Cheat Sheet

Your Tasks

1.  Consider the benefits of trade. What do you think life would be like if every person had to be totally self-sufficient and could not specialize and trade? Remember that it is individuals, and not nations, that trade. However, specialization and trade can be accomplished both domestically and internationally. The more we trade, the better off we all are.

2.  Look at Visual 1.4 to distinguish between absolute advantage and comparative advantage. Remember that absolute advantage is easy. Whoever can produce more of something using fewer resources has the absolute advantage. It gets much more complex when determining comparative advantage. Watch these two videos from Khan Academy:

a.  Comparative Advantage Specialization and Gains from Trade, and;

b.  Comparative Advantage and Absolute Advantage.

3.  Look at the Comparative Advantage Cheat Sheet (available as a download or as inline text). This Cheat Sheet is fantastic! If you can know the IOU system and the OOO system, you will succeed in mastering comparative advantage.

4.  Observe Visual 1.5 to illustrate absolute and comparative advantage using outputs. See if you can calculate the opportunity cost of a CD and of a pound of beef; this is similar to what you will do in Activity 6.

5.  Continue working with Visual 1.5. Comparative advantage for each product depends on which country produces the product at the lower opportunity cost. The example assumes Canada and Japan have the same resources, since the table contains output. Canada has an absolute and comparative advantage in beef. Neither has an absolute advantage in CDs, but Japan has a comparative advantage. Can you explain why?