What is Economics? Two important terms: 1. Choice 2. Scarcity Study of choice under conditions of scarcity Scarcity Situation in which the amount of something available is insufficient to satisfy the desire for it
Scarcity and Individual Choice There are an unlimited variety of scarcities, however they are all based on two basic limitations Scarce time Scarce spending power Limitations force each of us to make choices Economists study choices we make as individuals, and consequences of those choices more subtle and indirect effects of individual choice on our society
Scarcity and Social Choice Resources in our society —land, labor, and capital—are limited Scarcity of Labor Time human beings spend producing goods and services Scarcity of Capital Something produced that is long-lasting, and used to make other things that we value Human capital Capital stock Scarcity of land/natural resources Physical space on which production occurs, and the natural resources that come with it Scarcity of entrepreneurship Ability and willingness to combine the other resources into a productive enterprise
Agents and Scarcity in Economics Who are involved in resource allocation? Households allocate limited income / time among goods and services Business firms choices of what to produce and how much are limited by costs of production Government agencies work with limited budgets and must carefully choose which goals to pursue Economists study these decisions to Explainhow our economic system works Forecast the future of our economy Suggest ways to make that future even better
Microeconomics vs Macroeconomics Micro Microcomes from Greek word mikros, meaning “small” Microeconomics Study of behavior of individual households, firms, and governments Choices they make Interaction in specific markets Focuses on individual parts of an economy, rather than the whole
Microeconomics vs Macroeconomics Macro Macro comes from Greek word, makros, meaning “large” Macroeconomics Study of the economy as a whole Focuses on big picture and ignores fine details
Microeconomics Scarcity, opportunity cost Price determination -- theory of Supply and Demand Elasticities Consumer Choice Production and cost, Producer Choice Perfect competition and imperfect competition Labor market and Economic Inequality Capital and investment Economic Efficiency
Positive Economics v.s. Normative Economics Positive economics tudy S of how economy works ccessing the expected, objective A outcomes o matter whether they are true or not N ccuracy of positive statements can be A tested by looking at the facts—and just the facts
Positive Economics v.s. Normative Economics Normative Economics Study of what should be Used to make value judgments, identify problems, and prescribe solutions Statements that suggest what we should do about economic facts, are normative statements Based on values Normative statements cannot be proved or disproved by the facts alone
Why Study Economics To understand the world better You’llbegin to understand the cause of many of the things that affect your life To gain self-confidence You’ll lose that feeling that mysterious, inexplicable forces are shaping your life for you To achieve social change understand origins of social problems and design more effective solutions To help prepare for other careers You’ll discover that a wide range of careers deal with economic issues on many levels
The Methods of Economics Modeling Model: Abstractrepresentation of reality Economic theories must have a well- constructed model While most models are physical constructs Economists use words, diagrams, and mathematical statements
Assumptions Assumptions are very important for modeling Types of assumptions in an economic model Simplifying assumptions Way of making a model simpler without affecting any of its important conclusions Critical assumptions Affect conclusions of a model in important ways If critical assumptions are wrong model will be wrong All economic models have one or more critical assumptions
Questions1. What are the opportunity costs of the choices you make?2. How does a production possibility frontier (PPF) illustrate opportunity cost, specialization of resources, inefficiency, and economic growth?3. What are the differences between command economies, free market economies, and mixed economies in terms of the ways they address the 3 basic economic questions?4. Why do we observe specialization in production and trade?
Opportunity Cost - Concept Remember that scarcity in time and money results in choice making in real world Definition: Opportunity cost of any choice What we forego when we make that choice Most accurate and complete concept of cost we should use when making decisions An Example: in one hour, George can fix 4 flat tires or type 200 words. What is his opportunity cost of fixing a flat tire? What is his opportunity cost of typing 100 words?
Opportunity Cost - Components Direct money cost of a choice may only be a part of opportunity cost of that choice Opportunity cost of a choice = explicit costs + implicit costs Explicit cost—money actually paid out for a choice Accounting cost Implicit cost—value of something sacrificed when no direct payment is made
Opportunity Cost - Examples Opportunity cost of investing on education Explicit cost: tuition and fees Implicit cost: time or forgone income Opportunity cost of a typical firm Explicit cost Implicit cost Rent paid out Owner’s rent forgone Manager’s salaries Owner’s return from investment Worker’s wages Owner’s labor income forgone Cost of raw material Interest on loans
Opportunity Cost and Society Resources in whole society are limited. All production carries an opportunity cost o produce more of one thing T Must shift resources away from producing something else There is no such thing as a free lunch!
Increasing Opportunity Cost According to law of increasing opportunity cost he T more of something we produce The greater the opportunity cost of producing even more of it This principle applies to all of society’s production choices
Production Possibilities Frontiers ProductionPossibilities Frontiers (PPF) shows the combinations of two goods that can be produced with resources and technology available
Figure 1: (PPF) cars At point A, all resources are used for ”biofuels." A Moving from point A to point B 1,000,000 B 950,000 requires shifting resources out of 850,000 C biofuels and into grains/ food. D 700,000 500,000 At point F. all W E resources are used 400,000 for grains/food F 100,000 200,000 300,000 400,000 500,000 grains
Characteristics of PPF The points on the curve show the maximum number of goods capable to be produced Unit in the horizontal and vertical axis is quantity (not price) of the two different goods The points inside the curve show the possible other combinations of goods possible to be produced Inefficient production The shape of the curve is concave toward the origin in most cases The law of increasing opportunity cost The points outside the curve show the impossible combinations of goods Society’s choices are limited to points on or inside the PPF
Productive Inefficiency Productive Inefficiency More of at least one good can be produced Without pulling resources from the production of any other good Reasons Wasteof sources Recession (economic slump)
Recessions A slowdownin overall economic activity when resources are idle Widespread unemployment Factories shut down Land and capital are not being used An end to the recession would move the economy from a point inside its PPF to a point on its PPF Using idle resources to produce more goods and services without sacrificing anything Can help us understand an otherwise confusing episode in economic history
The Case of Production andUnemployment in the US 1. Before WWII the United StatesMilitary Goods operated inside its PPF . . . per Period 2. then moved to the PPF B during the war. Both military and civilian production increased. A Civilian Goods per Period
Economic Growth If economy is already operating on its PPF Cannot exploit opportunity to have more of everything by moving to it But what if the PPF itself were to change? Couldn’t we then produce more of everything? This happens when an economy’s productive capacity grows Many factors contribute to economic growth, but they can be divided into two categories Quantities of available resources—especially capital—can increase An increase in physical capital enables economy to produce more of everything that uses these tools More factories, office buildings, tractors, or high-tech medical equipment Same is true for an increase in human capital Skills of doctors, engineers, construction workers, software writers, etc. Technological change enables us to produce more from a given quantity of resources Capital and technological change usually go hand in hand
Economic Growth Increases in capital and technological change often go hand in hand For instance, PET body scanners will enable us to save even more lives than our current set of resources Moving horizontal intercept of PPF rightward, from F to F‘ Impact of PET scanners stretches PPF outward along horizontal axis How can a technological change in lifesaving enable us to produce more goods in other areas of the economy? Society can choose to use some of increased lifesaving potential to shift other resources out of medical care and into production of other things Because of technological advance and new capital, we can shift resources without sacrificing lives
Figure 3: The Effect of a New MedicalTechnologyQuantity of All 2. But not its vertical Other Goods 4. or more lives saved and greater intercept. per Period production of other goods. A 1,000,000 3. The economy can end J up with more lives H saved and un-changed 700,000 production of other D goods . . . 1. A technological advance in saving lives increases this PPFs horizontal intercept . . . F F 300,000 500,000 600,000 Number of Lives Saved per Period
Economic Growth If we can produce more of the things that we value, without having to produce less of anything else, have we escaped from paying an opportunity cost? Yes . . . and no Figure 3 tells only part of story Leaves out steps needed to create this shift in the PPF For example, technological innovation doesn’t just “happen”— resources must be used to create it Mostlyby research and development (R&D) departments of large corporations In order to produce more goods and services in the future, we must shift resources toward R&D and capital production Away from production of things we’d enjoy right now
Specialization and Exchange self sufficiency Specialization Method of production in which each person concentrates on a limited number of activities Example: Adam Smith observed that 10 men produce 200 pins a day working separately 10 men produce 48,000 pins a day through specialization! Exchange - Practice of trading with others to obtain what we want Allows for Greater production Higher living standards than otherwise possible All economics exhibit high degrees of specialization and exchange
Resource Allocation Problem of resource allocation Which goods and services should be produced with society’s resources? Where on the PPF should economy operate? How should they be produced? Labor or Capital intensive No capital at all Small amount of capital More capital Who should get them? How do we distribute these products among the different groups and individuals in our society?
The Three Methods of ResourcesAllocation Traditional Economy Resources are allocated according to long- lived practices from the past Command Economy (Centrally-Planned) Resources are allocated according to explicit instructions from a central authority Market Economy Resources are allocated through individual decision making Dominant method
The Nature of Markets A market is a group of buyers and sellers with the potential to trade with each other lobal G markets Buyers and sellers spread across the globe ocal L markets Buyersand sellers within a narrowly defined area
The Importance of Prices A price is the amount of money that must be paid to a seller to obtain a good or service When people pay for resources allocated by the market They must consider opportunity cost to society of their individual actions Marketscan create a sensible allocation of resources
Resource Allocation Various levels of government collect about one- third of our incomes as taxes Enables government to allocate resources by command Government uses regulations of various types to impose constraints on our individual choice The market is the dominant method of resource allocation However, it is not a pure market
Resource Ownership Communism Most resources are owned in common Socialism Most resources are owned by state Capitalism Most resources are owned privately
Types of Economic Systems Aneconomic system is composed of two features echanism M for allocating resources Market Command ode M of resource ownership Private State
Figure 4: Types of Economic Systems Resource Allocation Market Command Centrally Market Private Planned Capitalism Capitalism Resource Ownership Centrally Market State Planned Socialism Socialism
Summaries Opportunity cost Specialization and vsaccounting cost Exchange PPF Recession/inefficiency Economic system Economic growth / Technological Change 4 types Law of increasing opportunity cost Other Characteristics
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