BUSS1040 Notes Semester WEEK 1: GDP and Opportunity Cost

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1 BUSS1040 Notes Semester WEEK 1: GDP and Opportunity Cost What is Economics? The science of choice We need to make choices because of the basic economic problem of scarcity: society has unlimited wants but limited resources to satisfy these wants o What explains the choices we make? Split into two categories o Microeconomics: deals with individuals (consumers/firms) making choices o Macroeconomics: is about the economy as a whole- study of macro aggregates such as GDP, inflation and the unemployment rate and how they are correlated Economics as a science Observe realityà theories/models à predictions Correlation/causation Ceteris paribus: all other things being equal Opportunity Cost The cost of the alternative good foregone (the value of the next best alternative) What you actually choose to consume is your revealed preference Using the production possibility frontier/curve: alternative combinations of production of various goods that are possible, given the economy s resources Increasing opportunity costs: A situation in which producing more of one good requires giving up producing an increasing amount of another good. This is due to the need to use progressively more unsuitable resources for production as production increases. OPPC increases as we desire to produce more of one good Opportunity costs tend to increase because not all resources are equally productive in all activities When we want to move along the PPF, we need to decide which resources are going to be used and for what Efficiency requires to use first the resources that are more productive This explains the shape of the PPF: it is bowed outward Defining GDP Stands for gross domestic product and is the total sum of all final goods and services produced in an economy over a period of time, usually one year

2 BUSS1040 Notes Semester Typically focus on growth of real GDP: i.e. change from one quarter to the next Problem with GDPà some goods are used to produce other goodsà and GDP only measures final goods and services For example, steel used to make cars: Three methods of measuring GDP 1. Expenditure approach 2. Income approach 3. Value-added approach Expenditure Approach: The components: C + I + G + (X-M) C + I + G + NX (net exports)

3 BUSS1040 Notes Semester Income Approach: Each $ spent is income to someone We can add up all the income to find the GDP Income is payments received by households Usually in the form of wages, profits, dividends In the example: o Profit + wages= = 210= GDP The value-added approach Total value of final goods/services is equal to the value added in each stage The difference between the value of inputs and the value of outputs Difference between cost of inputs and final sales revenue From example: o GDP= VA from steel + VA from cars = = 210= GDP GDP does not account for important things: - Income going to foreigners, can be corrected, however o GNP = GDP + net income flows - Equality o Measured using Gini Index (Lorenz Curve) - Health, education, happiness, environment (human development) o HDI, HPI etc Opportunity Cost The value of the next best alternative foregone - Involves trade-off - Scarcity and unlimited wants drive this choice - Opportunity cost of production (producers) - Opportunity cost of consumption (consumers) - Real costs include opportunity costsà also called implicit costs - Real costs do not include unrecoverable or sunk costs o Mary works as an independent accountant. She makes $100,000 a year and has already paid a registration fee of $20,000. She is considering to go to work for an accounting firm for $90,000 a year. What is the real cost of switching jobs? 100,000-20,000= 80,000 o Therefore the real cost is $80,000 Production Possibilities PPF or PPC shows which combinations of goods/services can be produced and which cannot when keeping the resources available constant Describes set of possible output choices This is assuming that all resources are being used to full capacity Operating at a point inside the curve is inefficient Operating at a point outside the curve is impossible Operating at a point on the curve is efficient The entire area within the curve is attainable

4 BUSS1040 Notes Semester The reason opportunity cost is increasing is because not all resources are equally productive at all activities As we move along the PPC, we need to decide which resources will be used for what purpose o Efficiency dictates that we use up first the resources that are most productive/useful This explains the shape of the PPC- it is bowed outwards Economic growth Reflects an economy s expansion in production over time Key factors: Technological change o Better ways of producing g/s

5 BUSS1040 Notes Semester Increase in available resources o Increase in labour (population growth/immigration) o Growth of capital resources such as factories, infrastructure, human capital etc Growth can be reflected in the PPF:

6 BUSS1040 Notes Semester WEEK 2:Comparative Advantage, Bargaining and Negotiations Gains from trade - People, firms or countries may have different resources/skills - They therefore make gains from specialising and trading in what they do not specialise in - What determines the patterns of trade? o Opportunity cost o Comparative advantage - Individuals, firms or countries are better off if they focus/specialise in producing goods in which they have a comparative advantage o This is when a party has a lower opportunity cost of producing another good Bundy can make 2 units of x in an hour, or 3 units of y in an hour Bundy has a comparative advantage in producing X: 3/2 < y x The minimum price of x is 1.5 units of y The maximum price of x is 2 units of y 1.5<x<2 à if they are exchanging in this range of prices, then both parties are better off Fluff can make 4 units of x in an hour, or 8 units of y in an hour Fluff has a comparative advantage in producing Y: ½ < 2/ y x The minimum price of y is 0.5 units of x The maximum price of y is 0.66 units of x 0.5<y<0.66 à if they are exchanging in this range of prices, then both parties are better off Absolute advantage: when a party is able to produce a greater output from a given use of resources. Fluff has an absolute advantage in producing both goods X and Y