EC1101E Lecture 1 Sem 1 2006

Lecture 1Economics?!?!!!

Economic perspectives, ideas and principles

Who gets paid more and why?

Who would rather pay $150 for a concert ticket?

Economics?!?!!!

Economics studies the choices that can be made when there is scarcity. . . The word economy comes from a Greek word for “one who manages a household.”

Scarcity is a situation in which resources are limited in quantity and can be used in different ways.

Because our resources are limited, we must sacrifice one thing for another.

Economists are always reminding us that there is scarcity—that there are tradeoffs in everything we do.

Economics?!?!!!

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?

Economics?!?!!! Positive versus Normative Analysis

• Positive economics predicts the consequences of alternative actions, answering the questions, “What is?” or “What will be?”

• Normative economics answers the question, What ought to be? Normative questions lie at the heart of policy debates.

Economics?!?!!! Choices choices, choices!

Economic decisions are made at every level in society.

The choices made by individuals, firms, and governments answer three questions:

• What products do we produce?• How do we produce the products?• Who consumes the products?

Economics?!?!!! …. And the real world

Economic analysis provides important insights into real-world problems.

Economists attempt to diagnose and provide solutions to problems such as traffic congestion, poverty in Africa, or the problems of an entire economy.

Economics?!?!!! … according to Keynes

The economic way of thinking is best summarized by British economist John Maynard Keynes (1883-1946) as follows:“The theory of economics does not furnish a body of settled conclusions immediately applicable to policy. It is a method rather than a doctrine, an apparatus of the mind, a technique of thinking which helps its possesor draw correct conclusions.”

Economics?!?!!! The way of economics!

• Three elements of the economic way of thinking:

1.Use assumptions to simplify

• Eliminate irrelevant details and focus on what really matters. Keep in mind that simplifying assumptions do not have to be realistic.


2. Isolate variables—Ceteris Paribus

• Economists are interested in exploring relationships between two variables. A variable is a measure of something that can take on different values.

• The expression ceteris paribus means that the effect of other tendencies is neglected for a time.


3. Think at the margin

• A small, one-unit change in value is called a marginal change.

• Economists use the answer to a marginal question as the first step in deciding whether to do more or less of something.


A key assumption of most economic analysis is that people act rationally, meaning that they act in their own self-interest.

Rational people respond to incentives.

Economics?!?!!! The way of economics!• Microeconomics is the study of the choices

made by households, firms, and government, and of how these choices affect the markets for goods or services.

• We can use microeconomic analysis to:

1. Understand how markets work and predict changes.

2. Make personal and managerial decisions.

3. Evaluate public policies.


• Macroeconomics is the study of the nation’s economy as a whole.

• We can use macroeconomic analysis to:

1. Understand why economies grow.

2. Understand economic fluctuations.

3. Make informed business decisions.

What kind of people qualify?




Economist’s toolkit: Principles of Microeconomics

Economics is the study of the choices made by people who are faced with scarcity.

ScarcityScarcity is a situation in which is a situation in which resources are limited and can be used resources are limited and can be used in different ways, so one good or in different ways, so one good or service must be sacrificed for another.service must be sacrificed for another.

The Principle of Opportunity Cost

PRINCIPLE of Opportunity CostThe opportunity cost of something is what you sacrifice to get it.

• Most decisions involve several alternatives. The principle of opportunity cost incorporates the notion of scarcity.

• There is no such thing as a free lunch.

Opportunity Cost and theProduction Possibilities Curve

The production possibilities curve illustrates the principle of opportunity cost for an entire economy.

The ability of an economy to produce goods and services is determined by its factors of production, including labor, land, and capital.


• The shaded area shows all the possible combinations of the two goods that can be produced.

• Only points on the curve show the combinations that fully employ the economy’s resources.


As we move downward along the curve, we must sacrifice more manufactured goods to get the same 10-ton increase in agricultural goods.

The curve is bowed outwards because resources are not perfectly adaptable for the production of both goods.


An increase in the amount of resources available, or a technological innovation, causes the production possibilities to shift outward, allowing us to produce more output with a given quantity of resources.

Using the Principle:The Cost of University Education

Total opportunity cost at a typical US universityOpportunity cost of money spent on tuition and books per year 5,855.70

Opportunity cost of college time (4 years ) 80,000

Economic cost or total opportunity cost $120,000


Total opportunity cost of education at FASS@NUS …… SGD

Opportunity cost of money spent on tuition and books per year

SG / SPR Foreign 5,855.70 6,405.70

Opportunity cost (4 years ) 23,422.80 25,622.80

Opportunity cost of time ???? ????

Economic cost or total opportunity cost


Programme Singapore Citizens / SPR

Foreign Students

Full Time Students

Part Time Students

Full Time Students

Part Time Students

Tution Fee (Per Academic Year)

S$5450 S$2730 S$6000 S$3000

Registration Fee (Payable Once, Non-Refundable)

S$52.50 S$52.50 S$52.50 S$52.50

Student Activity & Service Fee(Per Academic Year)

S$67.20 S$12.60 S$67.20 S$12.60

Academic Related Fees(Per Academic Year)

S$23.50 S$23.50 S$23.50 S$23.50

Examination Fee(Per Academic Year)

S$262.50 S$262.50 S$262.50 S$262.50

The Marginal Principle

Marginal PRINCIPLEIncrease the level of an activity if its marginal benefit exceeds its marginal cost; reduce the level of an activity if its marginal cost exceeds its marginal benefit. If possible, pick the level at which the activity’s marginal benefit equals its marginal cost.

The Marginal Principle When we say marginal, we’re looking

at the effect of only a small, incremental change.

The marginal benefit of some activity is the extra benefit resulting from a small increase in the activity.

The marginal cost is the additional cost resulting from a small increase in the activity.

Thinking at the margin enables us to fine-tune our decisions.

Example: Star Wars IV and V?

Number of Movies

Marginal Benefit

Marginal Cost

1 $300 million $125 million



• The marginal benefit exceeds the marginal cost for the first two movies, so it is sensible to produce two, but not three movies.

The Principle of Voluntary Exchange

PRINCIPLE of Voluntary ExchangeA voluntary exchange between two people makes both people better off.

• A market is an arrangement that allows people to exchange things.

• If participation in a market is voluntary, both the buyer and the seller must be better off as a result of a transaction.

The Principle of Diminishing Returns

PRINCIPLE of Diminishing ReturnsSuppose output is produced with two or more inputs and we increase one input while holding the other input or inputs fixed. Beyond some point—called the point of diminishing returns—output will increase at a decreasing rate.

The Real-Nominal Principle

Real-Nominal PRINCIPLE What matters to people is the real value of money or income—its purchasing power—not the “face” value of money or income.

• The nominal value of an amount of money is simply its face value.

• The real value of an amount of money is measured in terms of the quantity of goods the money can buy.

4 your reading pleasure! …. 1Mankiw's "Ten Principles of Economics"-.

How People Make Decisions People Face Tradeoffs. To get one thing, you have to give up something else. Making decisions requires

trading off one goal against another. The Cost of Something is What You Give Up to Get It. Decision-makers have to consider both the obvious

and implicit costs of their actions. Rational People Think at the Margin. A rational decision-maker takes action if and only if the marginal benefit

of the action exceeds the marginal cost. People Respond to Incentives. Behavior changes when costs or benefits change. How the Economy Works as A Whole Trade Can Make Everyone Better Off. Trade allows each person to specialize in the activities he or she does

best. By trading with others, people can buy a greater variety of goods or services. Markets Are Usually a Good Way to Organize Economic Activity. Households and firms that interact in

market economies act as if they are guided by an "invisible hand" that leads the market to allocate resources efficiently. The opposite of this is economic activity that is organized by a central planner within the government.

Governments Can Sometimes Improve Market Outcomes. When a market fails to allocate resources efficiently, the government can change the outcome through public policy. Examples are regulations against monopolies and pollution.

How People Interact A Country's Standard of Living Depends on Its Ability to Produce Goods and Services. Countries whose

workers produce a large quantity of goods and services per unit of time enjoy a high standard of living. Similarly, as a nation's productivity grows, so does its average income.

Prices Rise When the Government Prints Too Much Money. When a government creates large quantities of the nation's money, the value of the money falls. As a result, prices increase, requiring more of the same money to buy goods and services.

Society Faces a Short-Run Tradeoff Between Inflation and Unemployment. Reducing inflation often causes a temporary rise in unemployment. This tradeoff is crucial for understanding the short-run effects of changes in taxes, government spending and monetary policy.

4 your reading pleasure! ….. 2 Slembeck's "Ten Principles of Economics (as a Discipline)"…..

Scarcity: Economists study situations where needs or wants exceed means. Therefore, people have to make choices.

Rationality is assumed to guide people's choices or decisions. They systematically gauge all pros (benefit or "utility") and cons ("cost") of all alternatives or options they are facing when deciding.

Preferences: People are equipped with fixed and given preferences that allow them to assign utilities to all options, and to choose the option that maximizes (net) utility.

Restrictions: People face constrains that they cannot change themselves, and thus have to take as given (such as budgets, input cost etc.). Maximization is always constriaint by restrictions.

Combining the first four points makes up for the "rational choice approach" of Neoclassical economics. Opportunity Cost is induced by scarcity, and by the need to make choices. All choices always involve

opportunity cost because deciding in favor of one option always means deciding against some other option(s). There are two main aspects of opportunity cost: 1) Utility maximizing choices induce opportunity cost to be minimal (static aspect). 2) Choices may be revised when opportunity cost rises (dynamic aspect).

The Economic Principle is the application of rationality to situations of scarcity: Minimize cost with regard to a given goal (e.g., level of utility) OR maximize utility for a given level of cost or input. Hence the "economic principle" frames situations as a minimizing or a maximizing problem, and allows to assess efficiency. Do not mix the two formulations! Applying the principle avoids wasting valuable resources.

Efficiency of activities, rules, transactions or distributions is a basic theme in economic analysis. Efficiency is most often assessed either in terms of the economic principle (minimize cost or maximize utility) or the Pareto criterion (with regard to transactions and distributions).

Marginal Analysis is a typical way for economists to look at problems. They analyze decisions in terms of marginal benefits and marginal costs. Marginal thinking is rather uncommon among non-economists, however.

Equilibrium is a fundamental notion in economic analysis. Basic economic models deal with the comparison of two (or possibly more) equilibria (comparative statics). Economist think in terms of equilibria, which are situations where no one has an incentive to change his or her behavior. The Nash equilibrium is the most fundamental formulation of the concept of equilibrium as used in economics.

Game Theory is an approach to study situations of interdependence where people have incentives to think and behave strategically.

Have a nice day!

EC1101E Lecture 1 Sem 1 2006

Documents

way of economics

normative economics

economics studies

theory of economics

choices choices

economic way of thinking

economic decisions

economic perspectives