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How do
individuals make
economic
decisions
Four Economic Questions
Society ( we) must figure out..,
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Number of Space Missions Per Year
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The Principle of Opportunity Cost
•The primary concern of
economics is the problem of
RELATIVE SCARCITY -
resources are scarce relative
to wants and therefore
CHOICES must be made
The Principle of Opportunity Cost
•Production of one good means
foregoing the production of another
good.
•Similarly, consuming one good or
service reduces our purchasing power
and prevents us from consuming
another good or service
The Principle of Opportunity Cost
•Opportunity cost is the term
used to represent THE TRUE
COST OF AN ECONOMIC
DECISION and can be defined as
the VALUE OF THE NEXT BEST
ALTERNATIVE FOREGONE
The Principle of Opportunity Cost
•For example, $ 20 spent on a
CD could have been used to
buy a T-shirt. The monetary
cost is $ 20 but the
opportunity cost is the T-
shirt.
The Principle of Opportunity Cost
•The concept of opportunity cost can be
easily illustrated using a model called
the PRODUCTION POSSIBILITY
FRONTIER.
The model is a graph which shows all the
combinations of goods and services that can be
produced by an economy given the available
resources and level of technology .
Static Model
•This model is called a
‘static model’
because it refers to
one point in time.
Static Model
•It is assumed;
1. That an economy’s resources are
fixed in both quantity and quality.
2. Technology is fixed.
3. The economy can only produce 2
types of goods.
Static Model
•For example - assuming the economy can
produce consumer and capital goods, a
production possibility schedule may look as
follows:
Consumer
100 80 60 40 20 0
Goods
Capital Goods
0 15 30 45 60 75
Static Model
•The schedule can be
shown graphically and is
known as ‘A Production
Possibility Frontier’ or
‘Production Possibility
Constant
Opportunity Cost
Production Possibility Frontier or Curve
•The production possibility
frontier or curve shows all
the combinations of output
an economy can produce.
Production Possibility Frontier or Curve
•The slope of the curve reflects
the law of increasing
opportunity cost - indicating
that resources are not equally
suited to different types of
production.
The Principle of Opportunity Cost
•No matter what we do, there are
always tradeoffs.
•Scarcity -- limited resources -- is the
reason.
“The opportunity cost of something
is what you sacrifice to get it.”
3 E’s of Economy
•ECONOMY
The careful , thrifty
management of resources ,
such as money materials,
or labor
3 E’s of Economy
•EFFICIENCY
A level of performance that
describes a process that uses the
lowest amount of inputs to create
the greatest amount of outputs.
“ dong the thing right”
3 E’s of Economy
•EFFECTIVENESS
The degree to which
objectives are achieved and
the extent to which targeted
problems are solved.
“ doing the right thing”
Positive Economics Normative Economics
Studies facts as they are and not as they Studies things as they ought to be
ought to be
Makes critical analysis of the existing Judge whether it is socially justified or not
facts and draw conclusions