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1 economics intro


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1 economics intro

  1. 1. Economics An introduction
  2. 2. Economic activity
  3. 8. Why study economics <ul><li>Why the world is what it is….. </li></ul><ul><li>Soviet Union collapsed …. setting countries throughout Eastern Europe and Asia free </li></ul><ul><li>The nations of Latin America are struggling with progress and development </li></ul><ul><li>General Motors loses $4 billion and millions of workers worry that their jobs and pension plans </li></ul><ul><li>Housing bubble burst in USA and thousands in India lose their jobs </li></ul>
  4. 9. A true story <ul><li>Spring 1996 – 19yr college sophomore, who had just finished taking introductory economics, was faced with a choice – to continue college education or to devote time to a job. </li></ul><ul><li>The job – become a professional golfer on the Pro Tour </li></ul><ul><li>Choice had to be made – time was scarce </li></ul><ul><li>Completing college had a great cost – </li></ul><ul><ul><li>Two years of college expenses </li></ul></ul><ul><ul><li>Forgone tournament winnings </li></ul></ul><ul><ul><li>Advertising endorsements </li></ul></ul><ul><li>The golfer made a choice – he became a pro. </li></ul>
  5. 10. <ul><li>Fall of 1996 – selected Sprotsman of the Year by Sports Illustrated </li></ul><ul><li>1997 – record setting win of Masters Tournament </li></ul><ul><li>First player to hold all four major professional championships at the same time </li></ul><ul><li>2005 – earned over $50 million in prizes worldwide + advertising & endorsements </li></ul>
  6. 11. The central idea <ul><li>People make purposeful choices with scarce resources and interact with other people when they make these choices. </li></ul><ul><li>Economics is the study of how people deal with scarcity . </li></ul><ul><li>It is the study of how scarce resources are allocated among unlimited wants. </li></ul>
  7. 12. <ul><li>Scarcity </li></ul><ul><li>The shortage that exists when less of something is available than is wanted at a zero price. </li></ul><ul><li>Choice </li></ul><ul><li>A selection among alternative goods, services or actions. </li></ul>
  8. 13. Lord Lionel Robbins <ul><li>1898 – 1984 </li></ul><ul><li>“ An Essay on the Nature and Significance of Economic Science ” (1932) </li></ul>
  9. 14. <ul><li>Economics is a Science which studies human behaviour as a relationship between ends and scarce means, which have alternative uses. </li></ul><ul><ul><ul><ul><ul><li>Lord Robbins </li></ul></ul></ul></ul></ul>
  10. 15. <ul><li>“ Economics is a social science which deals with human behaviour pertaining to production, exchange and consumption of goods and services (wealth)” </li></ul>Classical view
  11. 16. Adam Smith <ul><li>Scottish Economist and Philosopher </li></ul><ul><li>1723 - 1790 </li></ul><ul><li>“ Virtue is more to be feared than vice, because its excesses are not subject to the regulation of conscience.” </li></ul><ul><li>He became famous for his influential book &quot; The Wealth of Nations &quot; written in 1776 and launched the economic doctrine of free enterprise. </li></ul>
  12. 17. <ul><li>Economics is the study of the nature and causes of national wealth. </li></ul><ul><li>Adam Smith </li></ul>
  13. 18. Alfred Marshall <ul><li>1842 – 1924 </li></ul><ul><li>Professor of Political Economy at the University of Cambridge from 1884-1908 </li></ul><ul><li>Founder of the Cambridge School of Economics </li></ul><ul><li>A.C. Pigou and J.M. Keynes were among his pupils. </li></ul><ul><li>Principles of Economics was his magnum opus and the most influential treatise of its era. </li></ul>
  14. 19. <ul><li>Economics is a study of man’s actions in the ordinary business of life; it enquires how he gets his income and how he uses it. Thus, it on the one side a study of wealth and on the other, and more important side, a part of the study of man. </li></ul><ul><li>Alfred Marshall </li></ul>
  15. 20. <ul><li>E conomics is a social science that seeks to understand how different societies allocate scarce resources to meet the unlimited wants and needs of its members </li></ul>Neoclassical
  16. 21. Rational self-interest <ul><li>People make choices that give them the greatest satisfaction given the information at that time </li></ul><ul><li>Measure and compare the costs and benefits of a decision </li></ul><ul><li>Individual’s perception of his/her best interest </li></ul>
  17. 22. Some Recent Definitions <ul><li>The study of how in a civilized society one obtains the share of what other people have produced and of how the total product of a society changes and is determined. </li></ul><ul><li>Henry Smith </li></ul>
  18. 23. <ul><li>Economics is what economists do. </li></ul><ul><li>Jacob Viner </li></ul>
  19. 24. Cateris paribus <ul><li>“ with other things (being) the same” or </li></ul><ul><li>“ all other things being equal” </li></ul><ul><li>Assumption applied to all economic analysis where causal relationship between two variables can be studied </li></ul>
  20. 25. The economic approach <ul><li>Positive and Normative Analysis </li></ul><ul><li>Positive – analysis of what is – analysis that does not impose the value judgments of one individual on the decision of others </li></ul><ul><li>Normative – analysis of what ought to be </li></ul>
  21. 26. Central Problems of an Economy <ul><li>What to produce </li></ul><ul><li>How to produce </li></ul><ul><li>For Whom to produce </li></ul><ul><li>What provision (if any) be made for economic growth. </li></ul>
  22. 27. Micro & Macro <ul><li>In the 1930s Ragnar Frisch classified economics into two branches. </li></ul><ul><li>The terms are derived from the Greek terms micros and macros , meaning small and large respectively. </li></ul>
  23. 28. Microeconomics <ul><li>Micro means a millionth part. </li></ul><ul><li>It deals with a small part or a small component of the national economy. </li></ul><ul><li>Studies economic actions of individual units and small groups like particular households , individual prices, wages , income , individual industry, particular commodities . </li></ul>
  24. 29. Macroeconomics <ul><li>Studies the economy as a whole and its large aggregates, such as total national output and income, total employment, total consumption, aggregate investment . </li></ul>
  25. 30. John Maynard Keynes <ul><li>1883 – 1946 </li></ul><ul><li>He revolutionized economics with his classic book, The General Theory of Employment, Interest and Money (1936).  </li></ul><ul><li>Probably the most influential social science treatise of the 20th Century. </li></ul><ul><li>It quickly and permanently changed the way the world looked at the economy and the role of government in society. </li></ul>
  26. 31. Theory of Aggregation <ul><li>Macro is the sum of micro </li></ul>
  27. 32. <ul><li>If an individual salary goes up, he is happy; if salaries of all go up proportionately, no one is happy. </li></ul>Fallacy of Composition
  28. 33. <ul><li>Increased savings by everyone may lead to decrease in total savings </li></ul><ul><li> Paradox of Thrift </li></ul>
  29. 34. Kenneth E. Boulding <ul><li>1910 – 1993 </li></ul><ul><li>1944 – produced a paper on liquidity preference </li></ul><ul><li>1950 – “ Reconstruction of Economics ” on stock-flow distinction. </li></ul>
  30. 35. <ul><li>Forest, though an aggregation of trees, exhibits characteristics and behaviour patters different from individual trees: </li></ul><ul><li>An individual tree germinates, grows and decays, but forests go on forever. </li></ul><ul><li>A tree may not burn easily, but forests often catch fire. </li></ul><ul><li>An individual tree cannot affect the climate of the vicinity in which it grows, but forests can and do affect the climate. </li></ul>
  31. 36. Short-run and Long-run <ul><li>Introduction of time periods in market analysis – Marshall’s contribution </li></ul><ul><li>Short-run : a time period not enough for consumers and producers to adjust completely to any new situation </li></ul><ul><li>Long-run : is the ‘planning horizon’ – consumers and producers can adjust to any new situation </li></ul>
  32. 37. Opportunity Cost <ul><li>The problem of choice makes it necessary to sacrifice some of the alternatives against the one selected. </li></ul><ul><li>Opportunity cost is the benefit foregone from the alternative that is not selected. </li></ul>
  33. 38. Production Possibility Curve <ul><li>Also called Transformation Curve </li></ul><ul><li>A graph that shows different combinations of the quantities of the two goods that can be produced (or consumed) in an economy, subject to limited resources. </li></ul><ul><li>It represents the Opportunity cost concept – if we want to have more of one good, we must have less of another good </li></ul><ul><li>Also measures the OC – slope of the curve </li></ul><ul><li>Applicable to an individual (microeconomics) – shows options of production or consumption </li></ul><ul><li>Used in macroeconomics – shows the production possibilities of a nation or economy as a whole. </li></ul>
  34. 39. PPC for individual <ul><li>Different combinations of 2 goods given </li></ul><ul><ul><li>Resources (income) </li></ul></ul><ul><ul><li>Prices </li></ul></ul><ul><li>AB – PPC of individual </li></ul><ul><li>F- food, C – clothing </li></ul><ul><li>Pt. P => Fp of food and Cp of clothing </li></ul><ul><li>More of clothing with same income => move to pt. Q </li></ul><ul><li>Any pt. to the right of AB, e.g. M is unattainable => income constraint </li></ul><ul><li>Any pt. below AB, e.g. N is undesirable => violation of rationality </li></ul>A B F p F q O C p C q P Q N M
  35. 40. PPC for society <ul><li>Assumptions: </li></ul><ul><ul><li>Economy is operating at full employment </li></ul></ul><ul><ul><li>Factors of production are fixed in supply; they can however be reallocated among different uses </li></ul></ul><ul><ul><li>Technology remains the same </li></ul></ul><ul><li>Economy must sacrifice some units of one product to obtain more units of another => trade-off </li></ul><ul><li>“ Substitution is the law of life in a full-employment economy. The PPC or frontier depicts the society’s menu of choices ” - Samuelson </li></ul>
  36. 41. <ul><li>Slopes downward – shows maximum feasible amount that can be produced given the factors of production and technology </li></ul><ul><li>It is concave to the origin – OC increases as more of one good is produced instead of another – shift specialised factors from food to clothing – cost will increase </li></ul>Food Clothing F p F q O C p C q Infeasible area Productively inefficient area P Q
  37. 42. Types of Macroeconomics <ul><li>Macrostatics </li></ul><ul><li>Comparative Macrostatics </li></ul><ul><li>Macrodynamics </li></ul>
  38. 43. Macrostatics <ul><li>Method to explain certain aggregative relations in a stationary state. </li></ul><ul><li>Does not explain the process by which the national economy reaches the final equilibrium. Deals with the final equilibrium at a particular point of time. </li></ul><ul><li>Provides a series of ‘still pictures’ at a point of time. </li></ul>
  39. 44. Example <ul><li>Y = C + I </li></ul><ul><li>(Y = total income, C = total consumption, </li></ul><ul><li>I = total investment) </li></ul><ul><li>Equation merely explains that Income is equal to aggregate Consumption and Investment </li></ul><ul><li>Does not throw light on the process by which the equality is reached. </li></ul>
  40. 45. Comparative Macrostatics <ul><li>Macro variables change with time </li></ul><ul><li>Economy reaches new level of equilibriums. </li></ul><ul><li>This method involves a comparative study of different equilibrium achieved </li></ul><ul><li>Does not detail the process by which economy moves from one equilibrium to another. </li></ul>
  41. 46. Macrodynamics <ul><li>Developed by Frisch, Hicks, Kalecki, Tinbergen and Samuelson. </li></ul><ul><li>Studies how the equilibrium is reached consequent upon changes in macro variables and aggregates. </li></ul><ul><li>Presents a full picture of all the developments taking place in the transitional period. </li></ul>
  42. 47. Indian Economy <ul><li>Per Capita Income (2004): Ranges from a low of US $ 90 for Burundi to a high of US $ 52,030 for Norway. India US $ 620; USA $ 41,400. </li></ul><ul><li>Ranges from Rs. 3557 in Bihar to Rs.33,047 for Chandigarh. India: Rs.11,799 (2003-04 at 93-94 prices) </li></ul><ul><li>Growth rate of real income: 1990-2001 </li></ul><ul><li>– 3.7% Russian Federation, 10% China, India 5.9% (2005-06) (World average of 2.7%) </li></ul><ul><li>People Below poverty line: 2% Republic of Korea, 43% in Nigeria; India 28.6% </li></ul><ul><li>External Debt/GDP ratio: Sri Lanka 50%; India 20% </li></ul>