Learning Objectives At the end of the lecture class, students will be able to: Define the meaning of economics and several economics terms Illustrate the Production Possibility Curve Provide comparison between different type of economic system
WHAT IS E-C-O-N-O-M-I-C-S?
The term "economy," from which we get "economics," comes most directly from the Old French word "economie," meaning "management of a household."
The French adopted the term from the Latin word "oeconomia," which was in turn derived from the Greek word "oikonomia." Oikonomia came from the word "oikonomos," which separates into "oikos," meaning house, and "-nomos" meaning managing.
The oldest recognized written work in the field of economics is Oeconomicus, a book on farming and household management, written by the Greek philosopher Xenophon.
In short, “one who manages a household.”
Microeconomics vs Macroeconomics
Microeconomics is the branch of economics that examines the individual economics units or particular parts of the economy
Macroeconomics is the branch of economics that examines the behavior of economicaggregates — income, output, employment, and so on—on a national scale
Definition of Economics
Concerned with the efficient use of limited or scarce resources to achieve maximum satisfaction of human materials wants.
Human wants are unlimited, but the means to satisfy the wants are limited. Thus, economics is the study of the use of scarce resource to satisfy unlimited human wants.
Definition of Economics
Or economics is the study of how individuals and societies choose to use the scarce resources that nature and previous generations have provided. In large measure it is the study of how people make choices.
Land: gifts of nature that we use to produce goods and services. eg. Water, tree, mineral, etc.
Labor: time and effort that we devote to produce goods and services. Both physical and mental.
Capital: the goods that we have produced and that we can now use to produce other goods and services. Physical capital such as factory and human capital consists of knowledge and skill.
Entrepreneurship: the resource that organizes other factors of production.
Resources Categories Resources/Input Goods Commodities Production Services Consumption Value the goods & services
Economists call such resources as inputs or factors of production because they are used to produce things what people desire.
The things produced are called commodities. Commodities may be divided into goods and services. Goods are tangible (e.g cars or shoes), and service are intangible (e.g haircuts or education).
People use goods and services to satisfy many of their wants (needs). The act of making goods and services called production, and the act of using them to satisfy wants is called consumption.
Goods are valued for services they provide. An automobile, for example, helps to satisfy its owner’s desires for transportation, mobility and possibility status.
Scarcity, Choice and Opportunity Cost Scarcity: the central economic problem Scarcity. . . means that society has limited resources and therefore cannot produce all the goods and services people wish to have.
Human wants are unlimited, but resources are not!! Choices
Because resources are scares, all societies
face the problem of deciding what to produce and how to produce and divide the products among their members.
Societies differ in who makes the choices and
how they are made, but the need to choose is common to all. Just as scarcity implies the need for choice, so choice implies the existence of cost.
The best alternative that we forgo, or give up, when we make a choice or a decision.
Every decision means giving up something. Economists are fond of trade-offs as a way of thinking about decision making. Taking one action usually means giving up something else.
Opportunity costs arise because resources are scarce. Resources are scarce because human wants exceed what we can produce from our current resources.
Nearly all decisions involve trade-offs. The cost of something is what you give up to get it. Rational people think at the margin. People respond to incentives.
“There is no such thing as a free lunch!”
People Face Tradeoffs To get one thing, we usually have to give up another thing. Whether to go to college or to work? Whether to study or go out on a date? Whether to go to class or sleep in? Decisions require comparing costs and benefits of alternatives. The opportunity cost of an item is what you give up to obtain that item. Making decisions requires trading off one goal against another.
Consider This … Free for All? Products provided for “free” to an individual are not free for society because of the required use of scarce resources to produce them. Companies provide “free” goods as a marketing strategy to promote brand awareness. Products that are promoted as “free” to the individual may actually be bundled with another good for which the consumer must pay. Because a purchase is required to obtain them, these products are not really free to the buyer.
0 The principles of HOW PEOPLE MAKE DECISIONS
0 Principle 1: People Face Tradeoffs All decisions involve tradeoffs. Examples: Going to a party the night before your midterm leaves less time for studying. Having more money to buy stuff requires working longer hours, which leaves less time for leisure. Protecting the environment requires resources that could otherwise be used to produce consumer goods. 20
Principle 1: People Face Tradeoffs 0 Society faces an important tradeoff: efficiency vs. equality Efficiency: when society gets the most from its scarce resources Equality: when prosperity is distributed uniformly among society’s members Tradeoff: To achieve greater equality, could redistribute income from wealthy to poor. But this reduces incentive to work and produce, shrinks the size of the economic “pie.” 21
Principle 2: The Cost of Something Is What You Give Up to Get It Making decisions requires comparing the costs and benefits of alternative choices. The opportunity cost of any item is whatever must be given up to obtain it. It is the relevant cost for decision making. Examples: The opportunity cost of… …going to college for a year is not just the tuition, books, and fees, but also the foregone wages. …seeing a movie is not just the price of the ticket, but the value of the time you spend in the theater. 22
Principle 3: Rational People Think at the Margin Rational people systematically and purposefully do the best they can to achieve their objectives. make decisions by evaluating costs and benefits of marginal changes– incremental adjustments to an existing plan. Examples: When a student considers whether to go to college for an additional year, he compares the fees & foregone wages to the extra income he could earn with the extra year of education. When a manager considers whether to increase output, she compares the cost of the needed labor and materials to the extra revenue. 23
Principle 4: People Respond to Incentives Incentive: something that induces a person to act, i.e. the prospect of a reward or punishment. Rational people respond to incentives. Examples: When gas prices rises, encourages people to carpool and take public transportation. When cigarette taxes increase, teen smoking falls. 24
0 The principles of HOW PEOPLE INTERACT
Principle 5: Trade Can Make Everyone Better Off Rather than being self-sufficient, people can specialize in producing one good or service and exchange it for other goods. Countries also benefit from trade & specialization: Get a better price abroad for goods they produce Buy other goods more cheaply from abroad than could be produced at home 26
Principle 6: Markets Are Usually A Good Way to Organize Economic Activity Market: a group of buyers and sellers (need not be in a single location) “Organize economic activity” means determining what goods to produce how to produce them how much of each to produce who gets them A market economy allocates resources through the decentralized decisions of many households and firms as they interact in markets. 27
Principle 6: Markets Are Usually A Good Way to Organize Economic Activity Famous insight by Adam Smith in The Wealth of Nations (1776): Each of these households and firms acts as if “led by an invisible hand” to promote general economic well-being. The invisible hand works through the price system: The interaction of buyers and sellers determines prices. Each price reflects the good’s value to buyers and the cost of producing the good. Prices guide self-interested households and firms to make decisions that, in many cases, maximize society’s economic well-being. 28
Principle 7: Governments Can Sometimes Improve Market Outcomes Important role for govt: enforce property rights(with police, courts) People are less inclined to work, produce, invest, or purchase if large risk of their property being stolen. Market failure: when the market fails to allocate society’s resources efficiently Causes: Externalities, when the production or consumption of a good affects bystanders (e.g. pollution) Market power, a single buyer or seller has substantial influence on market price (e.g. monopoly) In such cases, public policy may promote efficiency. 29
Principle 7: Governments Can Sometimes Improve Market Outcomes Govt may alter market outcome to promote equity If the market’s distribution of economic well-being is not desirable, tax or welfare policies can change how the economic “pie” is divided. 30
0 The principles of HOW THE ECONOMY AS A WHOLE WORKS
Principle 8: A country’s standard of living depends on its ability to produce goods & services. Huge variation in living standards across countries and over time: Average income in rich countries is more than ten times average income in poor countries. The U.S. standard of living today is about eight times larger than 100 years ago. The most important determinant of living standards: productivity, the amount of goods and services produced per unit of labor. Productivity depends on the equipment, skills, and technology available to workers. Other factors (e.g., labor unions, competition from abroad) have far less impact on living standards. 32
Principle 9: Prices rise when the government prints too much money Inflation: increases in the general level of prices. In the long run, inflation is almost always caused by excessive growth in the quantity of money, which causes the value of money to fall. The faster the govt creates money, the greater the inflation rate. 33
Principle 10: Society faces a short-run tradeoff between inflation and unemployment In the short-run (1 – 2 years), many economic policies push inflation and unemployment in opposite directions. Other factors can make this tradeoff more or less favorable, but the tradeoff is always present. 34
Why Study Economics?
An important reason for studying economics is to learn a way of thinking. It is an essential part of the study of society.
Most political problems have an economic aspect, whether it is balancing the budget, fighting over the tax structure, welfare reform, international trade, or concern for the environment.
Economic decisions often have enormous consequences.
Why Study Economics?
THE ECONOMIST is like A SCIENTIST to the economy. Involves thinking analytically and objectively.e.g. what sort of formula is the best for the country or maybe firm. [The pegging of RM to US$ (RM3.80 = US$1)]. Was it the best option?
An understanding of economics is essential to an understanding of global affairs. e.g. the impact of 1997 crisis, 911 and the world oil prices increase.
The study of economics helps to develop an individual’s analytical skills and allows students to better predict the logical consequences of their actions.
Why Study Economics?
Economics can help individuals make better buying decisions, better employment choices and better financial investments.
Economics is however, mainly an academic, not a vocational subject. Its primary objective is to examine problems and decisions from a social rather than personal point of view. It is not a series of “how to make money” examples.
Evan Lau for EBE1053 (CHAP 1)
One of the most important generalizations in economics is ceteris paribus
Ceteris Paribus Other-Things-Equal
ceteris paribus, or all else equal, assumption, economists study the relationship between two variables while the values of other variables remain constant.
The Latin phrase "ceteris paribus" and its use in economic commentary are centuries older than the formal discipline of economics.
Ceteris Paribus Other-Things-Equal
The first recorded use of the phrase in an economic context was in "De Officiis," written by Cicero in 44 B.C. Cicero (106-43 B.C.) wrote that "the proper way to render aid is - if cetera are paria - to bring it to one who needs it most, and not to one whom we expect to be useful for us."
The production possibility curve
Production possibilities curve: a curve that showing alternative combinations of goods when available resources are used fully and efficiently.
1. Full employment level 2. Level of technology is fixed 3. Only two goods can be produced 4. Resources are fixed in quantity and quality.
Produce and sell goods and services Hire and use factors of production
Buy and consume goods and services Own and sell factors of productionfirms and households
Markets for Goods and Services
Firms sell Households buy
Markets for Factors of Production
Households sell Firms buy
Factors of Production
Inputs used to produce goods and services Land, labor, and capital
Economic systems are the basic arrangements made by societies to solve the economic problem.
1. Capitalist system. This is also known as laissez- faire, market economy, free enterprise, and price mechanism, free market economy. 2. Command economy. This is also known as planned economy system, centrally planned economy, controlled economy or totalitarian economy. 3. Mixed economy system. A combination between both capitalist and command economy system. 4. Traditional Economy system (extreme case) 5. Economies Based on Custom or Religion (extreme case)
Laissez-faire economy Characteristics
Individuals and firms pursue their own self interest without any central direction or regulation. Also implies a complete lack of government involvement in the economy.
Existence of consumer sovereignty. i.e. consumers are the ones who would determine and influence the types and quantities of goods to be produced. In other words ‘consumers decision would influence the producers’ decision of what to produce. The consumer is said to be a ‘King’.
Price mechanism (market) answer the economic questions and demand and supply decisions. The invisible hand works in the economy. If demand shortage price rises while surplus price falls and settle at equilibrium price where demand equals supply.
What is invisible hand
Term used by Adam Smith to describe the natural force that guides free market through competition for scarce resources.
According to Adam Smith, in a free market each participant will try to maximize self-interest, and the interaction of market participants, leading to exchange of goods and services
No regulation of any type would be needed to ensure that the mutually beneficial exchange of goods and services took place, since this "invisible hand" would guide market participants to trade in the most mutually beneficial manner.
Problems of a free-market economy Competition may be limited Inequality - wide gap between the rich and the poor. This will result in a pyramid-shaped income distribution pattern in the economy. Environment and social goals may be ignored Monopoly By-product Do not produce “public goods” No central authority to protect property rights, enforce contracts
2. The command economy Characteristics
An economy in which a central government planning either directly or indirectly sets output targets, incomes, and prices. The three basic economic problems will be solved by the government.
Consumer’s sovereignty does not exist in this system. Consumers have no choice but to except all the decision made by the government or the central authorities.
2. The command economy
High investment, high and stable growth
There is no different in society socially or economically - no different between the rich and the poor. However, in practice, there is still a gap between the two groups although the gap is not as apparent as in a capitalist system.
Theoretically, unemployment does not exist in a communist economy, because every potential worker available will be given a job by the government. However, in practice, this is not possible because of the scarce resources. Government will not be able to provide job opportunities for everyone.
2. Problems of a command economy
Problems of gathering information (e.g. getting reliable data)
inefficient allocation of resources - government may produces goods that are not required by the public. no system of prices shortages and surpluses lack of response to consumer demand
less freedom for the society in making economic choice choice of occupation
3. The mixed economy Characteristics
There are both public and private sectors working hand in hand so to ensure economic growth of the economy.
The role of the public sector is to complement the private sector by providing the infrastructure so that economic activities can be carried out effectively and efficiently.
The government will try to reduce income inequality by imposing a progressive tax system where higher income earners are taxed more than the lower income earners. In this way, the gap between the rich and the poor will be narrowed.
3. The mixed economy
The government will also control the existence of monopolies and regulate the power of monopolists.
Since markets are not perfect, governments intervene and often play a major role in the economy. Some of the goals of government are to
Minimize market inefficiencies
Provide public goods
Stabilize the macro foundation of the economy
Promote low levels of unemployment
Promote low levels of inflation
4. Traditional Economy system Characteristics Situation in which individuals produce commodities primarily for their own use. (a) No market (b) No money (c) Low level of technology (d) Low standard of living (e) Primitive transportation system 5. Economies Based on Custom or Religion
Positive economics studies economic behavior without making judgments. Positive economics can be referred to as “What is, what was, and what probably will be” economics.
Positive economics is based on sound economic theory, probability, and statistical methods. (e.g. study and determines the probable outcomes from an increase or decrease in taxes)
Normative economics, also called policy economics, analyzes outcomes of economic behavior, evaluates them as good or bad, and may prescribe courses of action. It tends to be subjective, value laden, and emotional in its presentation.
Normative economics is often referred to as “What ought to be” economics. “We ought to do this,” or “we ought to do that.”
(e.g. during political elections, candidates claims have the answer to all the country’s economic problems. “We should raise taxes.” “We should lower taxes.” “The rich do not pay enough taxes”).
The Method of Economics
Theoretical economics: The systematic arranging of facts, interpretation of the facts, making generalizations.
Empirical economics refers to the collection and use of data to test economic theories. Many data sets are available to facilitate economic research. They are collected by both government agencies and private companies, Theories involve models, and models involve variables.
A model is a formal statement of a theory. It is usually a mathematical statement of a presumed relationship between two or more variables. (e.g. DD=f(P,Y,Y*,PRE)
A variable is a measure that can change from observation to observation. Economists use the scientific method to establish theories, laws, and principles.
Scientific Method The scientific method consists of: The observation of facts (real data). The formulations of explanations of cause and effect relationships (hypotheses) based upon the facts. The testing of the hypotheses. The acceptance, rejection, or modification of the hypotheses. The determination of a theory, law, principle, or model.
Uses abstract models to help explain how a complex, real world operates develops theories, collects, and analyzes data to evaluate the theories.
Economists use models to simplify reality in order to improve our understanding of the world. Makes use of the scientific method e.g. econometrics model to evaluate the impact of oil price increase to the economy. Economists make assumptions in order to make the world easier to understand.
The art in scientific thinking is deciding which assumptions to make. Economists use different assumptions to answer different questions.
Economic Concepts Define the following terms: Free goods Economic goods Public goods Merit goods Consumption Production Utility