Objectives After studying this chapter, you will be able to:Define economics and distinguish betweenmicroeconomics and macroeconomicsExplain the two big questions of economicsExplain the key ideas that define the economic wayof thinkingExplain how economists go about their work associal scientists
Definition of EconomicsAll economic questions arise because we wantmore than we can get.Our inability to satisfy all our wants is calledscarcity.Because we face scarcity, we must make choices.The choices we make depend on the incentiveswe face.An incentive is a reward that encourages anaction or a penalty that discourages an action.
Definition of EconomicsEconomics is the social science that studies thechoices that individuals, businesses, governments, andentire societies make as they cope with scarcity andthe incentives that influence and reconcile thosechoices.Economics divides in to main parts: Microeconomics Macroeconomics
Two Big Economic QuestionsTwo big questions summarize the scope ofeconomics:How do choices end up determining what, how,and for whom goods and services get produced?When do choices made in the pursuit of self-interest also promote the social interest?
Two big economic questions: What, How and For whomWhat?What we produce changes over timeWhat determines the quantities and all the othermillions of items that we produce?How?Goods and services are produced by usingproductive resources that economists call factors ofproduction.
How? continues..Factors of production are grouped into fourcategories:- Land- Labour- Capital -Entrepreneurship
How continues.. The ―gifts of nature‖ that we use to produce goods and services are land. The work time and work effort that people devote to producing goods and services is labour. The quality of labour depends on human capital, which is the knowledge and skill that people obtain from education, on-the-job training, and work experience. The tools, instruments, machines, buildings, and other constructions that businesses use to produce goods and services are capital. The human resource that organises land, labour, and capital is entrepreneurship.
Two Big Economic Questions: For Whom?Who gets the goods and services depends on theincomes that people earn. Land earns rent. Labour earns wages. Capital earns interest. Entrepreneurship earns profit.
Two Big Economic Questions: When is the Pursuit of Self- Interest in the Social Interest?Every day, 49 million South Africans and 6.6 billionpeople in the rest of the world, make economic choicesthat result in What, How, and For Whom goods andservices are produced.Do we produce the right things in the rightquantities?Do we use our factors of production in the best way?Do the goods and services go to those who benefitmost from them?
Two Big Economic Questions: When is the Pursuit of Self-Interest in the Social Interest? Continues.. You make choices that are in your self-interest— choices that you think are best for you. Choices that are best for society as a whole are said to be in the social interest. An outcome is in the social interest if it uses resources efficiently and distributes goods and services fairly. Is it possible that when each one of us makes choices that are in our self-interest, it also turns out that these choices are also in the social interest?
Two Big Economic Questions: When is the Pursuit of Self-Interest in the Social Interest? Continues..Five topics that generate discussion and thatillustrate tension between self-interest and socialinterest are Privatisation Globalisation HIV/Aids Water storages Unemployment
The Economic Way of Thinking: Choices and Trade-offs Because of scarcity we must make choices, we select from the available alternatives. You can think about every choice as a tradeoff—an exchange—giving up one thing to get something else. The classic tradeoff is ―guns versus butter.‖ ―Guns‖ and ―butter‖ stand for any pair of goods.
The Economic Way of Thinking: What, How and For Whom Trade-offsWhat Trade-offsWhat goods and services get produced depends onchoices made by each one of us, when governmentschoose how to spend their tax revenues, and whenbusinesses choose what to produce.How Trade-offsHow goods and services get produced depends onchoices made by the businesses that produce them.
The Economic Way of Thinking: What, How and For Whom Trade-offs Continues..For Whom Trade-offs For whom goods and services are produced depends on the distribution of buying power. Government redistribution of income from the rich to the poor creates the big tradeoff - the tradeoff between equality and efficiency.
The Economic Way of Thinking: Choices Bring Change The quantity and range of goods and services available today in the US are much greater than those in Africa. The Economic condition of the world today is much better than it was a generation ago. The quality of economic life depends on many of the choices made by each one of us and these choices involve trade-off.
The Economic Way of Thinking: Choices Bring Change Continues..One choice is that of how much of our income toconsume and how much to save. If we save more, we canbuy more capital and increase our production.A second choice is how much effort to devote toeducation and training. If we take less leisure time, we caneducate and train ourselves to become more productive.A third choice is how much effort to devote to researchand development of new products and productionmethods. If businesses produce less and devote resourcesto research and developing new technologies, they canproduce more in the future
The Economic Way of Thinking: Opportunity Cost The opportunity cost of something is the highest- valued alternative that we give up to get it. In other words it is the value of the NEXT BEST opportunity that is sacrificed by the exercise of a choice For instance if you have three items in front of you, namely: a chocolate, a toffee and jelly babies. Arrange these items according to you preference (what you like most to what you like least). Example chocolate, jelly babies and toffee. Chocolate is your first choice hence you will sacrifice the NEXT BEST opportunity which is ONLY jelly babies
The Economic Way of Thinking: Choosing at the Margin You can allocate the next hour between studying and emailing your friends. You must decide how many minutes to allocate to each activity. you compare the benefits of a little bit more study time with its cost – you make your choice at the margin. The benefit that arises from the increase in the activity is called marginal benefit. The cost of an increase in an activity is called marginal cost.
The Economic Way of Thinking: Responding to Incentives Our choices respond to incentives. For any activity, if marginal benefit exceeds marginal cost, people have an incentive to do more of that activity. If marginal cost exceeds marginal benefit, people have an incentive to do less of that activity. Incentives are also the key to reconciling self-interest and the social interest.
The Economic Way of Thinking: Human Nature, Incentives and Institutions Economists take human nature as given and view people as acting in their self-interest. Self-interested actions are not necessarily selfish actions. But if human nature is given and people pursue self- interest, how can the social interest be served? Economists answer by emphasizing the role of institutions in creating incentives to behave in the social interest. Private property protected by a system of laws and markets that enable voluntary exchange are the fundamental institutions.
Economics: A Social Science Economists distinguish between two types of statement: What is—positive statements What ought to be—normative statements A positive statement can be tested by checking it against facts. A normative statement cannot be tested.
Observation and Measurement The first step toward understanding how the economic world works is to observe it. Economists observe and measure data of all aspects of economic behaviour.
Model Building The second step toward understanding how the economic world works is to build a model. An economic model is a description of some aspect of the economic world that includes only those features that are needed for the purpose at hand.
Testing Models The third step is testing models. A model’s predictions might correspond to the facts or be in conflict with them. A model is tested by comparing its predictions with the facts
Obstacles and Pitfalls Unscrambling cause and effect Ceteris Paribus is a Latin term that means ―other things being equal‖. By changing one factor at a time and holding all the other factors constant we isolate the factor of interest and are able to investigate its effects in the clearest possible way.