Chapter 1, 10 prin

A Lecture Presentation in PowerPoint to Accompany

A. Principles of Economicsby

Princess V. Lalwani

Ten Principles of Economics

Chapter 1

Economy. . .

. . . The word economy comes from a Greek word for “one who manages a household.”

A household and an economy face many decisions:

Who will work? What goods and how many of them

should be produced? What resources should be used in

production? At what price should the goods be

sold?

Society and Scarce Resources:

The management of society’s resources is important because resources are scarce.

Scarcity . . .

. . . means that society has limited resources and therefore cannot produce all the goods and services people wish to have.

Economics

Economics is the study of how society uses scarce resources to produce valuable commodities

and distribute them among different people.

Economists study. . .

How people make decisions.

How people interact with each other.

The forces and trends that affect the economy as a whole.

Ten Principles of Economics

1. People face tradeoffs.

2. The cost of something is what you give up to get it.

3. Rational people think at the margin.

4. People respond to incentives.

How People Make Decisions

Ten Principles of Economics

5. Trade can make everyone better off.

6. Markets are usually a good way to organize economic activity.

7. Governments can sometimes improve economic outcomes.

How People Interact

Ten Principles of Economics

8. The standard of living depends on a country’s production.

9. Prices rise when the government prints too much money.

10. Society faces a short-run tradeoff between inflation and unemployment.

How the Economy as a Whole Works

1. People face tradeoffs.

“There is no such thing as a free lunch!”

1. People face tradeoffs.

To get one thing, we usually have to give up another thing. Guns v. butter Food v. clothing Leisure time v. work Efficiency v. equity

Making decisions requires trading off one goal against another.

Environment v. Development

Efficiency relates to full utilization of the existing resources.

Equity fairness on the distribution of wellbeing to the members of society.

Efficiency v. Equity

2. The cost of something is what you give up to get it.

Decisions require comparing costs and benefits of alternatives.

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?

2. The cost of something is what you give up to get it.

The opportunity cost of an item is what you give up to

obtain that item.

3. Rational people think at the margin.

Marginal changes are small, incremental adjustments to an existing plan of action.

People make decisions by comparing costs and benefits at the margin.

4. People respond to incentives.

Marginal changes in costs or benefits motivate people to respond.

The decision to choose one alternative over another occurs when that alternative’s marginal benefits exceed its marginal costs!

LA Laker basketball star Kobe Bryant chose to skip college and go straight to the NBA from high school when offered a $10 million contract.

4. People respond to incentives.

5. Trade can make everyone better off.

People gain from their ability to trade with one another.

Competition results in gains from trading.

Trade allows people to specialize in what they do best.

6. Markets are usually a good way to organize economic

activity.

In a market economy, households decide what to buy and who to work for.

Firms decide who to hire and what to produce.

6. Markets are usually a good way to organize economic

activity.

Adam Smith made the observation that households

and firms interacting in markets act as if guided by an

“invisible hand.”

6. Markets are usually a good way to organize economic

activity.

Because households and firms look at prices when deciding what to buy and sell, they unknowingly take into account the social costs of their actions.

As a result, prices guide decision makers to reach outcomes that tend to maximize the welfare of society as a whole.

7. Governments can sometimes improve market outcomes.

When the market fails (breaks down) government can intervene to

promote efficiency and equity.

7. Governments can sometimes improve market outcomes.

Market failure occurs when the market fails to allocate

resources efficiently.

7. Governments can sometimes improve market outcomes.

Market failure may be caused by an externality, which is the impact of one person or firm’s actions on

the well-being of a bystander.

7. Governments can sometimes improve market outcomes.

Market failure may also be caused by market power, which is the ability of a single person or firm to unduly

influence market prices.

8. The standard of living depends on a country’s production.

Standard of living may be measured in different ways:

By comparing personal incomes. By comparing the total market value of a

nation’s production.

8. The standard of living depends on a country’s production.

Almost all variations in living standards are explained by

differences in countries’ productivities.

8. The standard of living depends on a country’s production.

Productivity is the amount of goods and services produced from each

hour of a worker’s time.

Higher productivity Higher standard of living

9. Prices rise when the government prints too much

money.

Inflation is an increase in the overall level of prices in the economy.

One cause of inflation is the growth in the quantity of money.

When the government creates large quantities of money, the value of the money falls.

10. Society faces a short-run tradeoff between inflation and

unemployment.

The Phillips Curve illustrates the tradeoff between inflation and unemployment:

Inflation Unemployment

It’s a short-run tradeoff!

Summary

When individuals make decisions, they face tradeoffs.

Rational people make decisions by comparing marginal costs and marginal benefits.

Summary

People can benefit by trading with each other.

Markets are usually a good way of coordinating trades.

Government can potentially improve market outcomes.

Summary

A country’s productivity determines its living standards.

Society faces a short-run tradeoff between inflation and unemployment.

B. Role and Methods

By

Laiza

WHY STUDY ECONOMICS?

More than half a century ago John Maynard Keynes (1883-1946), one of the most influential economists of the 1990s said:“The ideas of economists and political philosophers, both when they are right and when they are wrong., are more powerful than is commonly understood. Indeed the world is ruled by little else. Practical men, who believe themselves to be quite example from any intellectual influences, are usually the slaves of some defunct economist.”

Prominent economists:

Adam Smith David Ricardo John Stuart Mill Karl Marx John Maynard Keynes

Economic for Citizenship

A basic understanding of economics is essential for well-informed citizenship.

Important economic aspects: How aggressive should we be in pursuing the

war in terrorism at home and abroad? How can we ensure that corporate executives

act in the long-run interest of their share holders and not just themselves? What level of taxes should we have? How can we make the social security

retirement program financially secure?

How can we increase the rate of economic growth?

*How can we reduce poverty? As voters, we can influence the decisions of

our elected officials in responding to such questions. But intelligence at the polls requires a basic working knowledge of economics. And a sound grasp of economics is even more helpful to the politicians themselves.

Professional and Personal Applications

Economics lays great stress on precise, systematic analysis. Studying economics helps the students improved theater analytical skills which are in great demand in the workplace.

Economics is also vital to business. An understanding of the basics of economic decision making and the operation of the economic system enables business managers and executive to increase profit.

Economics helps consumers and workers make better buying and employment decisions.

Someone who understands the relationship between budget deficits or surplus and interest rates, between foreign exchange rates and exports, between interests rates and bind prices, is in a better position to successfully allocate personal savings.

Economics is mainly academic, not a vocational, subject. Economics ultimately examines problems and decisions from the social, rather than the personal, point of view.

ECONOMIC METHODOLOGY

Economic elements: The observation of facts Based on those facts the formulation of a

possible explanation of cause and effect. The testing of this explanation by comparing the

outcomes of specific events to the outcome predicted by the hypothesis.

the acceptance, rejection, or modification of the hypothesis, base on these comparisons

The continued testing of the hypothesis against the facts. As favorable results accumulate, the hypothesis evolves into a theory. A very well tested and widely accepted theory is referred to as a law or principle. Combinations of such laws or principles are incorporated into models-simplified representation of how something works, such as a market or segment of the economy.

Theoretical Economics

The process of deriving theories and principles is called theoretical economics.

The role of economic theorizing is to systematically arrange facts, interpret them, and generalize from them.

Economic theories and principles are statements about economic behavior or the

economy that enable prediction of the probable effects of certain aspects.

Theories, laws, and principles are highly useful in analyzing economic behavior and understanding how the e economy operates. They are the ingredients of analytical economics the ascertaining of cause and effect, of action and outcome, within the economic system.

Terminology

A hypothesis needs initial testing, a theory has been tested but needs more testing, a law or a principle is a theory that has provided strong predictive accuracy, over and over.

* Economic laws *principles *theory *model

Law of demand

is term used to describe the relationship between the price of the product and the amount of it purchased.

GENERALIZATIONS

Economic principles are expressed as the tendencies of typical or average consumers, workers, or business firms.

OTHER-THINGS EQUAL ASSUMPTION

Ceteris paribus or other-things-equal assumption to construct their generalizations.

-they assume that all other variables except those under immediate consideration are held constant for a particular analysis.

Abstractions –simplification that omits irrelevant facts and circumstances.

Policy Economics-recognizes the theories and data can be used to formulate policies-courses of action based on economic principles and intended to resolve a specific economic problem for further economic growth.

Economic policy

Basic steps in policy making: -state the goal -determine the policy options -implement and evaluate the policy that was

selected

Economic Goal Economic policies are designed to achieve certain economic goals,

then we need to recognize a number of goals that are widely accepted in the United States and may other countries. They include: Economic growth Full employment Economic efficiency Price-level stability Economic freedom Equitable distribution of income Economic security Balance of trade

Macroeconomics and Microeconomics

Macroeconomics-examines either the economy as a whole or its basic subdivisions or aggregates, such as the government, household, and business sectors.

Microeconomics-observes in details specific economic units

Positive and Normative Economics

Positive economics-focuses on facts and cause-effect relationships. concerns what is

Normative economics-incorporates value judgments about what the economy should be like or what particular policy actions should be recommended to achieve a desirability of certain aspects of the economy. embodies subjective feelings about what ought to be

Pitfalls to Objective Thinking

By

Arphax

Biases Most people bring a bundle of biases and

preconceptions to the field of economics. For example, some might think that lending money is always superior to borrowing money.

Biases cloud thinking  and interfere with objective analysis.

All of us must be willing to shed biases and preconceptions that are not supported by facts.

Loaded Terminology The economic terminology used in newspaper and broadcast

media in sometimes emotionally biases, or loaded. The writer or spokesperson may have cause to promote or ax to grind

and may slant comments accordingly. High profits may labelled "obscene" low wages may be called "exploitive" or self interested behaviour may be "greed". Government workers may be referred to as "mindless bureaucrats and those favouring stronger  government regulations may be called "socialists. To objectively analyze economic issues, you must be prepared to reject or discount such terminology.

Definitions Some of the terms used in economics have precise technical

definitions that are quite different from those implied by their common usage. This is generally not a problem if everyone understands these definitions and uses them consistently. For example, "investment" to the average citizen means the

purchase of stocks and bonds in security markets, as when someone "invests" in Microsoft stock or government bonds. But to the economist, "investment" means to purchase of newly created real capital assets such as machinery and equipment or the construction of a new factory building. It does not mean the purely financial transaction of swapping cash for securities.

Fallacy of Composition

Another pitfall economic thinking is the assumption that what is true for one individual or part of a whole is necessarily true for a group or individuals or the whole..This is a logical fallacy called the fallacy of composition; the assumption is not correct. A statement that is valid for an individual or part is not necessarily valid for the larger group or whole.

Example outside Economics Your are at a football game and the home team

makes an outstanding play. In the excitement, you leap to your feet to get a better view. A valid statement: "If you,an individual,stand,your view of the game is improved." But is this also true for the group for everyone watching the play? Not necessarily. If everyone stands to watch the play,probably nobody-including you will have a better view when all remain seated.

Example from economics An individual farmer who reaps a particularly large crop is

likely to realize a sharp gain in income. But this statement cannot be generalized to farmers as a group. The individual farmer's large or "bumper" crop will not noticeably influence (reduce) crop prices because each farmer produces a negligible fraction of the total farm output increases. Thus, if all farmers reap bumper crops,the total output of farm products will rise,depressing crop prices.If the price declines are relatively large,total farm income might actually fall/

Causation Fallacy Causation is sometimes difficult to identify in economics. Two

important fallacies often interfere with economic thinking. Post Hoc Fallacy You must think very carefully before concluding

that because event A preceded event B, A is the cause of B.This kind of faulty reasoning is known as the post hoc,ergo propter hoc, or "after this, therefore because of this, "fallacy“

Example: A professional football team hires a new coach and the team's record improves.Is the new coach the cause?Maybe.But perhaps the presence of more experienced and talented players or an easier schedule is the true cause.

Correlation vs Causation Do not confuse correlation,or connection, with

causation.Correlation between two events or two sets of data indicates only that they are associated in some systematic and dependable way.For example, we may find that when variable X increases,Y also increases.But this correlation does not necessarily mean that there is causation - that an increase in X is the cause of increase in Y.The relationship could be purely coincidental or dependent on some other factor,Z,not included in the analysis.

Economic example: Economist have found a positive correlation between education and income.In general,people with more education earn higher income than those with less education.Common sense suggest education is the cause and higher income is the effect,more education implies a more knowledgeable and productive worker,and such workers receive larger salaries.

But causation could also partly run the other way. People with higher incomes could buy more education, as they buy more furniture and steaks. Or is part of the relationship explainable in still other ways? Are education and income correlated because the characteristics required to succeed education-ability and motivation-are the same ones required to be a productive and highly paid worker? If so,then people with those traits will probably obtain more education and earn higher incomes. But greater education will not be the sole cause of higher income.

D. Graph and its Meaning

By

Alexes

Graph- is a visual representation of the relationship between two variables.

   Table 1.1A

The Relationship between Income and Consumption

-------------------------------------------------------------------

income per week      consumption per week    point

$ 0                                     $ 50                            a

  100                                    100                           b

  200                                    150                           c

  300                                    200                           d

  400                                    250                           e

--------------------------------------------------------------------

The dependent variables is the graph in consumption per week. the independent variables is the income per week. as the income increase P100 per week. the consumption also increase P50 per week. its relationship is ''Linear'

---------------graph  fig. 1.1A---------------

Direct Relationship( or positive relationship)

we mean that two variables- in this case, consumption and income- change in the same direction. the line in fig. 1.1A slopes upward to the right, so it depicts a direct relationship between income and consumption. an increase in consumption is associated with an an increase in income; a decrease in consumption accompanies a decrease in income.when two sets of data are positively or direct related, they always graph as an 'upward sloping' line

Inverse Relationship

TABLE 1.1B

The Relationship between Ticket Prices & Attendance

-----------------------------------------------

Ticket     Attendance          point           

Price      (thousands)

$ 50         $ 0                        a

   40            4                        b

   30            8                        c

   20           12                       d

   10           16                       e

    0            20                       f

-----------------------------------------------

 Inverse relationship(or negative relationship) because the two variables change in opposite direction

From Fig.1.1B when ticket prices decrease, attendance increase. when ticket prices increase, attendance decrease. an inverse relationship always graphs as a 'downward sloping' line.

Dependent and Independent Variables

The independent variable is the cause or source; it is the variable that changes first.(on the horizontal axis)

The dependent variable is the effect or outcome; it is the variable that changes because of the because of the change in the independent variable.(on the vertical axis)

price is always on the vertical axis ticket price is the dependent variable, amd the quantity

of the tickets purchased is the dependent variable.

SLOPE OF A LINE

a slope of a line is the ratio of the vertical change(the rise or drop) to the horizontal change(the run ) between any two points of the line.

Line can be describe in terms of their slopes.

Positive Slope

Positive slope between point b and point c in fig.1,1A the rise or vertical change(the change in consumption) is +$50 and the run or horizontal change(the change in income) is +$100.

  vertical change            +50          1

slope = ---------------------------    =    ------ =      --

               horizontal change       +100         2

slope is 1/2 or 5 positive because consumption and income change in the same direction; that is, consumption and income are directly or pocsitively related.

The slope of .5 tells us there will be a $1 increase in consumption of every $2 increase in income. Similarly, it indicates that for every $2 decrease in income there will be a decrease in consumption.

Negative Slope

Negative Slope between any two of the identified points in fig. 1.1B say, point c and point d, vertical change is -10 (the drop) and the horizontal change is +4 (the run). Therefore:

            vertical change          -10          1

slope = ------------------------        ----- =   2 ---  = -2.5

            horizontal change        4           2

This slope is negative because ticket price and attendance have an inverse relationship. Note that the horizontal axis attendance is stated in thousand of people. So the slope of -10/+4 or -2.5 means that lowering the price by $10 will increase attendance by 4000 people. This is the same as saying that a $2.50 price reduction will increase attendance by 1000 persons.

Slope and Measurement Analysis

Economics is largely concerned with the changes from the status qou. The concept  of the slope is important in economics because it reflect marginal changes- those involving 1 more (or 1 less) unit. example in fig. 1A - in this example people collectively will consume $0.50 of any $1 increase in their incomes and reduce their consumption by $0.50 for each $1 decline in income.

Infinite and Zero Slopes many variables are unrelated or independent of one

another. for example the quantity of wristwatches purchased is not related to the price of banana. in fig. 2a we represent the price of the bananas on the vertical axis and the quantity of watches demand on the horizontal axis. the graph of their relationship is the line parallel to the vertical axis, indicating that the same quantity of watches is purchased no matter what the price of bananas. the slope of such a line is 'infinite'.

In fig. 2B consumption is on the vertical axis and the divorce rate on the horizontal axis. the parallel to the horizontal axis represents this lack of

relatedness. This line has a slope of 'zero'.

Price of Bananas                                 Consumption

        |         |                                                      |

        |         |                                                      |

        |         |  Slope = Infinite                              -------------------

        |         |                                                      |  Slope = Zero

        |         |                                                      |

        ----------------------------                             ---------------------

    Purchases of Watches                                   Divorce Rate

             Fig. 2A                                                       Fig. 2B

Vertical Intercept

of a line is the point where the line meets the vertical axis. in fig. 1A the intercept is $50. This intercept means that if current income were zero, consumers would still spend $50. Similarly, the $50 vertical intercept  in fig. 1B shows that at a $50 ticket price, would be playing in an empty arena.

Equation of a Linear Relationship              equation of a straight line is:                      y= a+bx     where y= dependent variable                                                   a= vertical intercept                                                   b= slope of line                                                   x= independent variable For our income-consumption exmple, if C represents consumption (the

dependent variable) and Y represent income (the independent variable), we can write C = a + bY.

By substituting the known values of the independent and the slope, we get C = 50 + 5Y

  This equation also allows us to determine the amount of consumption C at any specific level of income.

Slope of a Nonlinear Curve This slope of a straight line is the same at all its points. the slope of a line

representing a nonlinear relationship changes from one point to another. Such lines are referred to as curves. (it is permissible to refer to a straight line as a "curve".)

      Downsloping curve in fig. 1.3. its slope is negative throughout, but the curve as we move down along it. Thus, its slope constantly changes; the curve has a different slope at each point.

      To measure the slope at a specific point, we draw a straight line tangent to the curve at that point. A line is tangent at a point if it touches, but does not intersect, the curve at that pint. Thus line aa is tangent to the curve in fig. 1.3 at point A. The slope of the curve at that point is equal to the slope of the tangent line. Specifically, the total vertical change (drop) in the tangent line aais -20 and the total horizontal change (run) is +5. Because the slope of the tangent line aa is -20/+5, or -4, the slope of the curveat point A is also -4.

Line bb in fig. 1.3 is tangent to the curve at point B. following the same procedure, we find the slope at point B to be -5/+15, or -1/3.Thus, in this

flatter part of the curve, the slope is less negative.

  Price

                      20|

                          |

                      15|

                          |

                      10|

                          |

                        5|

                          |

                          |

                        0-------------------------------  Quantity

                                5       10      15      20    

                               Figure 1.3

             Determining the slopes of curves

THE END