We have covered a lot of ground in this introductory chapter. It is intended to open up the vista of economics to the new student in the discipline. Economics is powerful and challenging, and the ideas we have developed here will serve as conceptual foundations for our exploration of the subject. Our next chapter deals with methods and models in greater detail.
KEY TERMS
Macroeconomics studies the economy as system in which feedback among sectors determine national output, employment and prices.
Microeconomics is the study of individual behaviour in the context of scarcity.
Mixed economy: goods and services are supplied both by private suppliers and government.
Model is a formalization of theory that facilitates scientific inquiry.
Theory is a logical view of how things work, and is frequently formulated on the basis of observation.
Opportunity cost of a choice is what must be sacrificed when a choice is made.
Production possibility frontier (PPF) defines the combination of goods that can be produced using all of the resources available.
Economy-wide PPF is the set of goods combinations that can be produced in the economy when all available productive resources are in use.
Productivity of labour is the output of goods and services per worker.
Capital stock: the buildings, machinery, equipment and software used in producing goods and services.
Full employment output Yc = (number of workers at full employment) X(output per worker).
Recession: when output falls below the economy’s capacity output.
Boom: a period of high growth that raises output above normal capacity output.
EXERCISES
- An economy has 100 workers. Each one can produce four cakes or three shirts, regardless of the number of other individuals producing each
good. Assuming all workers are employed, draw the PPF for this economy, with cakes on the vertical axis and shirts on the horizontal axis.
- How many cakes can be produced in this economy when all the workers are cooking?
- How many shirts can be produced in this economy when all the workers are sewing?
- Join these points with a straight line; this is the PPF. (d) Label the inefficient and unattainable regions on the diagram.
- In the table below are listed a series of points that define an economy’s production possibility frontier for goods Y and X.
Y10009008007006005004003002001000X01600250033004000460051005500575059006000
- Plot these points to scale, on graph paper, or with the help of a spreadsheet.
- Given the shape of this PPF is the economy made up of individuals who are similar or different in their production capabilities?
- What is the opportunity cost of producing 100 more Y at the combination (X =5500;Y = 300).
- Suppose next there is technological change so that at every output level of good Y the economy can produce 20 percent more X. Compute the co-ordinates for the new economy and plot the new PPF.
- Using the PPF that you have graphed using the data in the preceding question, determine if the following combinations are attainable or not: (X =3000;Y =720), (X =4800;Y =480).
- You and your partner are highly efficient people. You can earn $50 per hour in the workplace; your partner can earn $60 per hour.
- What is the opportunity cost of one hour of leisure for you?
- What is the opportunity cost of one hour of leisure for your partner?
- Now draw the PPF for yourself where hours of leisure is on the horizontal axis and income in dollars is on the vertical axis. You can assume that you have 12 hours of time each day to allocate to work (income generation) or leisure.
- Draw the PPF for your partner.
- If there is no domestic cleaning service in your area, which of you should do the housework, assuming that you are equally efficient at housework?
- Louis and Carrie Anne are students who have set up a summer business in their neighbourhood. They cut lawns and clean cars. Louis is
particularly efficient at cutting the grass – he requires one hour to cut a typical lawn, while Carrie Anne needs one and one half hours. In contrast, Carrie Anne can wash a car in a half
hour, while Louis requires three quarters of an hour.
- If they decide to specialize in the tasks, who should cut the grass and who should wash cars?
- If they each work a twelve hour day, how many lawns can they cut and how many cars can they wash if they specialize in performing the work?
- Illustrate the PPF for each individual where lawns are on the horizontal axis and car washes on the vertical axis. Carefully label the intercepts. Then construct the economy-wide PPF using this information.
- Continuing with the same data set, suppose Carrie Anne’s productivity improves so that she can now cut grass as efficiently as Louis; that is, she can cut grass in one hour, and can still wash a car in one half of an hour. (a) In a new diagram draw the PPF for each individual. (b) In this case does specialization matter if they are to be as productive as possible as a team? (c) Draw the new PPF for the whole economy, labelling the intercepts and kink point coordinates.
- Using the economy-wide PPF you have constructed in Question 7, consider the impact of technological change in the economy. The tools used by Louis and Carrie Anne to cut grass and wash cars increase the efficiency of each worker by a whopping 25%. Illustrate graphically how this impacts the aggregate PPF and compute the three new sets of coordinates.
- Going back to the simple PPF plotted for Question 1 where each of 100 workers can produce either four cakes or three shirts, suppose a
recession reduces demand for the outputs to 220 cakes and 129 shirts.
- Plot this combination of outputs in the diagram that also shows the PPF.
- How many workers are needed to produce this output of cakes and shirts?
- What percentage of the 100 worker labour force is unemployed?
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