Ec102 - April 13

INTRODUCTIONINTRODUCTIONTEN PRINCIPLES OF ECONOMICSTEN PRINCIPLES OF ECONOMICSNORMATIVE VS POSITIVENORMATIVE VS POSITIVECIRCULAR FLOW DIAGRAMCIRCULAR FLOW DIAGRAMPRODUCTION POSSIBILITIES FRONTIER`PRODUCTION POSSIBILITIES FRONTIER`

April 13, 2011Ec102 D

OverviewOverview

Economics Defined Ten Principles of Economics Process in Economics Theories and Models Circular Flow Diagram Production Possibilities Frontier (PPF)

Group Quiz #1Group Quiz #1

1. Economists use _______ to simplify the complex world and make it easier to understand.

2. Economists assume that all human beings are ________.

3. The “automatic adjustments” was called _________ by Adam Smith.

4. It means “all else equal”.5. Accdg to Keynes, “In the long run, we are all

____.”6. BONUS: Room number

ECONOMICSECONOMICS

A social science of allocation of scarce resources among alternative uses to attain desired ends. How people make choices Add it all up -- how society makes choices

1. PEOPLE FACE TRADE-1. PEOPLE FACE TRADE-OFFSOFFS No free lunch To get one thing, you have to

give up another Example:

Choice of attending class or sleeping

2. COST OF SOMETHING IS 2. COST OF SOMETHING IS WHAT YOU GIVE UP TO GET ITWHAT YOU GIVE UP TO GET IT

Opportunity cost – the next best alternative foregone If you did not choose do “this”, then

the opportunity cost is what you would have done instead

Example: Opportunity cost of going to class –

SLEEP Study or be a rock star?

3. RATIONAL PEOPLE THINK AT 3. RATIONAL PEOPLE THINK AT THE MARGINTHE MARGIN Rationality Principle Decisions are not always between

extremes More often, in smaller increments

Marginal Changes – Incremental changes Around the edges Additional

4. PEOPLE RESPOND TO 4. PEOPLE RESPOND TO INCENTIVESINCENTIVES

What induces you to act Maybe be a punishment or

reward What do I get for it?

5. TRADE CAN MAKE 5. TRADE CAN MAKE EVERYONE BETTER OFFEVERYONE BETTER OFF

6. MARKETS ARE A GOOD WAY 6. MARKETS ARE A GOOD WAY TO ORGANIZE THE ECONOMYTO ORGANIZE THE ECONOMY

Market – a group of buyers and sellers

Economy – group of people dealing with one another as they go about their lives

Market Economy vs Centrally Planned Economy

Invisible Hand

7. Governments can 7. Governments can sometimes improve market sometimes improve market outcomesoutcomes Maintain rules and institutions Step in when there are market

failures Choice between efficiency or

equality

8. A country’s standard of living 8. A country’s standard of living depends on its ability to produce depends on its ability to produce goods and servicesgoods and services Differences in productivity

differences in average income

9. Prices rise when 9. Prices rise when governments print too much governments print too much moneymoney Long Run Inflation Example

Produce 1000 units, M = P10, 000Price = P10,000/1000 = P10

Produce 1000 units, M = P15, 000Price = P15,000/P1000 = P15

Demand Pull Inflation

10. Society faces a short-run 10. Society faces a short-run trade-off between inflation and trade-off between inflation and unemploymentunemploymentShort run Increase M increased income increased demand higher prices (INFLATION) hire more workers lessen unemployment

Phillips Curve

METHODOLOGY OF METHODOLOGY OF ECONOMICSECONOMICS

Positive Economics - attempts to understand behavior and operation of economic systems without making judgmentsDescribes what exists and how it worksFacts, cause and effectsDescriptive -- WHAT ISExample: Minimum wage laws cause unemployment.

METHODOLOGY OF METHODOLOGY OF ECONOMICSECONOMICS

Normative Economics - Looks at outcomes of economic behavior and asks whether they are good or badMay prescribe courses of actionPolicy economicsPrescriptive -- WHAT OUGHT TO BEExample: The government should raise the minimum wage.

METHODOLOGY OF METHODOLOGY OF ECONOMICSECONOMICSEconomists cannot simply do experiments

Role of Assumptions Example: Trade between two countries producing only two goods

POSITIVE ECONOMICSPOSITIVE ECONOMICS

Descriptive economics - compilation of data that describe phenomena and facts

NSO Publications


Economic Theory - statement or set of related statements about cause and effect, action and reaction

Model - formal statement of a theory, usually a mathematical statement of a presumed relationship between two variables

Variables - measure that can change from time to time


Example:Theory: Law of DemandModel: Graph (equation)Variables: Price and Quantity

Models are abstractions.

CETERIS PARIBUSCETERIS PARIBUS

“All else equal” Assume that all other factors do

not change Isolate effects Focus on the relationship

CIRCULAR FLOW DIAGRAMCIRCULAR FLOW DIAGRAM


Visual model of how money flows through markets among households and firms

How economy is organized and how participants interact


Firms – produce goods and services using inputs (labor, land, capital, entrepreneurial activity) Factors of production

Households – own factors of production and consume goods and services (g/s)


Two kinds of markets Market for g/s:

Firms – sellers HH – buyers

Market for factors of prod’n Firms – buyers HH – sellers


Two loops: Inside – movement of inputs and

output HH sell use of factors of prod’n to firms in mkt for factors of prod’n. Firms use this to produce g/s in the mkt for g/s.

Outer – movement of money HH spend money to buy g/s from firms in

mkt for g/s. Firms use revenue to pay for factors of prod’n




Wallet (HH) Buy food at the caf (firm) Firm use resource to buy inputs

(example: wages) Wages wallets (HH)

Ec102 - April 13

Technology

circular flow

opportunity

trade

inputs

services

markets

firm

good