Some definitions of economics

Some definitions of economics

• “Economics is a study of mankind in the

ordinary business of life”

•Alfred Marshall

• "the purpose of studying economics is not to acquire a set

of ready-made answers to economic questions, but to learn how to avoid being deceived by

economists."

• Joan Robinson

• “Economics is what economists do”

• Jacob Viner

Economics (1)

• Study of the choices people make to attain their goals given their scarce resources.

Economics: Foundations and Models1. What do economists study?

• gasoline prices, inflation, housing markets, international trade, income inequality, sports, families, smoking, health care, happiness

• decision-making or choices

2. How do they do it?

• by using theories and models

• theories are based on assumptions

What makes a good theory or a model?

• Models are not judged by their realism but by their usefulness

• What is the most useless map in the world?To be useful a model has to be refutable

Why study theory?

• “I don’t know how it is in theory but here is what I know from my 20 years of experience will happen “

• Laura, Executive MBA student

• Theory saves time!

•When Economists Disagree: A Debate over Outsourcing

Makingthe

Connection

Learning Objective 1.3

Does outsourcing by U.S. firms raise or lower incomes in

the United States?

Economics (2)

• Study of the choices people make to attain their goals given their scarce resources.

Economics

When the price is zero there is not enough for

everyone

People behave as if they are comparing

the costs and benefits

Scarcity Choices

Benefits

Costs

Unlimited wants

Limited availabilit

y

Economics

Everything has alternative uses

Scarcity

Tradeoffs

Opportunity cost

Economics

People are rational when they behave as if they were comparing

costs and benefits

Choices

People respond to incentives

Decisions are made on the margin

14

as if• Does a pool player need to know the

laws of trigonometry and physics to win?

as if• “…getting out of bed in the

morning and making breakfast involves more complex decisions than the average game of chess. (Will that fries egg kill me in twenty-eight years?)”

• Charles Wheelan

Economics (3)

• Study of the choices people make to attain their goals given their scarce resources.

Trade-offs force society to make choices, particularly when answering the following three fundamental questions:

1 What goods and services will be produced?

2 How will the goods and services be produced?

3 Who will receive the goods and services produced?

The Economic Problem That Every Society Must Solve

Centrally planned economy An economy in which the government

decides how economic resources will be allocated.

The Economic Problem That Every Society Must Solve

Market economy An economy in which the decisions of households and firms

interacting in markets allocate economic resources.

• Centrally Planned Economies versus Market Economies

Mixed economy An economy in which most economic decisions result from

the interaction of buyers and sellers in markets but in which the government

plays a significant role in the allocation of resources.

The Economic Problem That Every Society Must Solve

• The Modern “Mixed” Economy

Positive analysis Analysis concerned with what is.

Economic Models• Normative and Positive Analysis

Normative analysis Analysis concerned with what ought to

be.

Don’t Let This Happen to YOU!Don’t Confuse Positive Analysis with Normative Analysis

The Market The Market System and System and the Circular the Circular

FlowFlow2C H A P T E R

PROPERTY RESOURCESPROPERTY RESOURCES1. LAND1. LAND

2. CAPITAL2. CAPITAL

HUMAN RESOURCESHUMAN RESOURCES3. LABOR3. LABOR4. ENTREPRENEURIAL ABILITY4. ENTREPRENEURIAL ABILITY

SCARCE RESOURCESSCARCE RESOURCESECONOMIC RESOURCESECONOMIC RESOURCES

Resource payments: correspond to resource Resource payments: correspond to resource categoriescategories

RENTALRENTALINCOMEINCOME

INTERESTINTERESTINCOMEINCOME

WAGESWAGESPROFIT &PROFIT &

LOSSLOSS

PROPERTY RESOURCESPROPERTY RESOURCES

LANDLAND

CAPITALCAPITALHUMAN RESOURCESHUMAN RESOURCES

LABORLABOR

ENTREPRENEURENTREPRENEUR

Macroeconomics Starts Here

Economic Systems

• Definition: A particular set of institutional arrangements and a coordinating mechanism to respond to the economizing problem.

• Economic systems differ as to: 1) who owns the factors of production 2) the method used to motivate, coordinate, and

direct economic activity.

The Command System

• The government owns most property resources and economic decision making occur through a central economic plan.

• The central planning board determines production goals for each firm and resources to be allocated.

The Market System

• There is private ownership of resources.• Markets and prices coordinate and direct

economic activity.• Each participant acts in its own self-interest.• In pure capitalism the government plays a very

limited role.

Characteristics of the Market System

• Private Property.• Freedom of firms to choose.• Self interest.• Competition.• Markets and prices.• Technology and capital goods.• Specialization.• Use of money.• Active, but limited government.

The Circular Flow Model

• There are two groups of decision makers in There are two groups of decision makers in the private economy: households the private economy: households (resource (resource owners)owners) and businesses and businesses (resource users)(resource users)

• The market system The market system (resource markets and (resource markets and product markets)product markets) coordinates these decisions. coordinates these decisions.

What happens in the resource markets? What happens in the resource markets? a.a. Households Households sellsell resources directly or resources directly or

indirectly (through ownership of corporations) to indirectly (through ownership of corporations) to businesses.businesses.

b. Businesses b. Businesses buybuy resources in order to produce resources in order to produce goods and services.goods and services.

c.c. Interaction of these sellers and buyers Interaction of these sellers and buyers determines the determines the price of each resourceprice of each resource, which in , which in turn provides turn provides incomeincome for the owner of that for the owner of that resource.resource.

d.d. Flow of payments from businesses for the Flow of payments from businesses for the resources constitutes business resources constitutes business costscosts and resource and resource owners’ owners’ incomesincomes..

What happens in the product markets?What happens in the product markets?a. Households are on the a. Households are on the buyingbuying side of these side of these

markets, purchasing goods and services.markets, purchasing goods and services.

b.b. Businesses are on the Businesses are on the sellingselling side of these side of these markets, offering products for sale.markets, offering products for sale.

c.c. Interaction of these buyers and sellers determines Interaction of these buyers and sellers determines the price of each product.the price of each product.

d.d. Flow of consumer expenditures constitutes Flow of consumer expenditures constitutes sales receiptssales receipts for businesses. for businesses.

CIRCULAR FLOW MODEL

BUSINESSES HOUSEHOLDS

RESOURCEMARKET

PRODUCTMARKET

BUSINESSES HOUSEHOLDS

RESOURCEMARKET

RESOURCES INPUTS

PRODUCTMARKET

CIRCULAR FLOW MODEL

BUSINESSES HOUSEHOLDS

RESOURCEMARKET

RESOURCES INPUTS

$ COSTS $ INCOMES

GOODS &GOODS &SERVICESSERVICES

GOODS &GOODS &SERVICESSERVICES

PRODUCTMARKET

CIRCULAR FLOW MODEL

BUSINESSES HOUSEHOLDS

RESOURCEMARKET

RESOURCES INPUTS

$ COSTS $ INCOMES

PRODUCTMARKET

GOODS &SERVICES

GOODS &SERVICES

CIRCULAR FLOW MODEL

BUSINESSES HOUSEHOLDS

RESOURCEMARKET

RESOURCES INPUTS

$ COSTS $ INCOMES

PRODUCTMARKET

GOODS &SERVICES

GOODS &SERVICES

$ CONSUMPTION$ REVENUE

CIRCULAR FLOW MODEL

CIRCULAR FLOW MODEL

BUSINESSES HOUSEHOLDS

RESOURCEMARKET

RESOURCES INPUTS

$ COSTS $ INCOMES

PRODUCTMARKET

GOODS &SERVICES

GOODS &SERVICES

$ CONSUMPTION$ REVENUE

More Realistic Circular Flow

Macroeconomic Policies

Limitations of the model:

1. Does not depict transactions between households and between businesses (inter-businesses).

2. Ignores government and the “rest of the world” in the decision-making process (we will take care of them later on).

3. Does not explain how prices of products and resources are actually determined.