Standard Economics

Define opportunity cost and Comparative advantage.

1. Opportunity Cost is defined as the value of the next preferred alternative. In other words, if an asset such as capital is used for one purpose, the “opportunity cost” is the value of the next best purpose the asset could have been used for.

2. Comparative Advantage can be defined as the ability for a business entity or person to produce a product or service at a lower opportunity cost then another business entity or person.

Explain why we buy Mexican oranges, even if we believe that we can produce them as well.

In a macro economic prospective, when we participate in foreign trading and we import items such as Mexican oranges several positive results occur. The first is, given all things constant, the difference in the opportunity cost increases the profitability and the ability to produce in our economy and gives us the ability to meet the consumption or demand levels of our consumers. Secondly participating in an open public market system, we increase the real output and income among our trading partners and their economy. This increase in income and output creates wealth for our trading partners and opens the door to open commerce. The wealth of our trading partners enables them now to buy more of our exported goods which increase our income and enabling us to buy more foreign imports. This “commerce cycle” is the benefit of international trade which is very profitable for any economy. Finally, a simple reason why we would purchase Mexican oranges even if we believe that we can produce them is because it’s simply cost effective. Mexico may very well have better technology then we do (doubt it) and therefore have the ability to produce greater quantities for a cost effective price. This will in turn allow us to invest more capital in other markets.

Who might get hurt in the process?

In international trading there are also disadvantages. The first is the thought of unemployment in the particular market. This reduction of output levels within the particular market will immediately decrease the amount of jobs or need of them. Even though new jobs would be required to now accommodate the international requirements of trade, unemployment may increase for periods of time. Second, if our foreign trading partners begin to impose higher level tariffs they can depress our economy. This depressing will affect our export levels and minimize profitability and even productivity which in turn decrease our GDP (Gross Domestic Product).

Describe the Philips Curve and its implications. What is the relationship between unemployment and inflation.

The “Philips Curve” was created by A.W.H Philips and assumed that the lower the unemployment rate (when employment is high) firms will raise wages to attract scarce labor. In change if the unemployment rate was high (when employment is low) then wages increased slowly or were lower. Economists later applied this rule to the price inflation factor which implied that the lower the unemployment rate the higher the price inflation. Invert, if the unemployment rate was high the lower the price inflation. In a long term view, the economy or market affected by the Philips curve will adapt to the price levels and find themselves at an economical constant.

Exlain how each of the following will affect the consumption and saving shcedules (as they relate to GDP):

A. A large increase in the value of real estate, including private housing. An increase in the value of real estate will effect the GDP positively, due to higher value of real estate this is a sign of a healthy economy and firms are willing to invest more increasing the amount of spendig which will result in a higher GDP.

B. A decline in the real interest rate. A decline in the real interest rate will also effect the GDP positively, due to lower interest rates allowing for more disposible income which in turn will allow families to spend more increasing the GDP.

C. A sharp, sustained decline in stock prices. A sharp decline of stock prices means that the economy may be very volatile and vulnerable, investment will be limited and disposable income will be limited effecting the GDP negatively.

D. An increase in the rate of population growth. An increase in the rate of population growth will effect the GDP positively because higher levels of disposable income will be available,assuming that firms will increase in investment to meet the higher level of demand, which will increase the GDP.

E. The development of a cheaper method of manufacturing computer chips. An development of a cheaper method of manufacturing computer chips will effect the GDP positively because technology has become a necessity in a growing economy which influences investors positively to increase investment therefore allowing and increase in spending which would in turn increase GDP.

F. A sizable increase in the retirement age for collecting Social Security Benefits. This particular change in the retireent age for collecting social security benefits may effect the GDP in a positive or negative way. Considering that individuals of older age continue to work longer will effect the GDP positively because higher income levels in older families will mean higher speding if they remain employeed. In contrast if individuals of older age are not employeed and the time to receive social security has increased means that there will be less disposable income effecting spending negatively which will effect the GDP negatively.

G. An increase in the Federal personal income tax. An increase in the Federal personal income tax, will effect the GDP negatively because most individuals will have limited disposable income which will decrease spending therefore effecting the GDP negatively in the short run, in the long run GDP will balance because in the return of the personal income tax families will be more willing to spend on future investments.