Econ ppt1

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Introduction to Economics

  What is Economics?   Two important terms: 1.  Choice 2.  Scarcity   Study of choice under conditions of scarcity

  Scarcity   Situation in which the amount of something

available is insufficient to satisfy the desire for it

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Scarcity and Individual Choice

  There are an unlimited variety of scarcities, however they are all based on two basic limitations  Scarce time  Scarce spending power

  Limitations force each of us to make choices  Economists study

 choices we make as individuals, and consequences of those choices

 more subtle and indirect effects of individual choice on our society

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Scarcity and Social Choice   Resources in our society —land, labor, and capital—are limited   Scarcity of Labor

  Time human beings spend producing goods and services   Scarcity of Capital

 Something produced that is long-lasting, and used to make other things that we value

 Human capital  Capital stock

  Scarcity of land/natural resources  Physical space on which production occurs, and the natural

resources that come with it   Scarcity of entrepreneurship

 Ability and willingness to combine the other resources into a productive enterprise

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Agents and Scarcity in Economics  Who are involved in resource allocation?

 Households allocate limited income / time among goods and services

 Business firms choices of what to produce and how much are limited by costs of production

 Government agencies work with limited budgets and must carefully choose which goals to pursue

 Economists study these decisions to  Explain how our economic system works  Forecast the future of our economy  Suggest ways to make that future even better

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Microeconomics vs Macroeconomics

 Micro  Micro comes from Greek word mikros,

meaning “small”  Microeconomics

 Study of behavior of individual households, firms, and governments  Choices they make   Interaction in specific markets

 Focuses on individual parts of an economy, rather than the whole

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Microeconomics vs Macroeconomics

 Macro  Macro comes from Greek word, makros,

meaning “large”  Macroeconomics

 Study of the economy as a whole  Focuses on big picture and ignores fine

details

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Microeconomics

 Scarcity, opportunity cost  Price determination -- theory of Supply and

Demand  Elasticities  Consumer Choice  Production and cost, Producer Choice  Perfect competition and imperfect competition   Labor market and Economic Inequality  Capital and investment  Economic Efficiency �

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Positive Economics v.s. Normative Economics

 Positive economics  Study of how economy works  Accessing the expected, objective

outcomes  No matter whether they are true or not  Accuracy of positive statements can be

tested by looking at the facts—and just the facts

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Positive Economics v.s. Normative Economics

 Normative Economics  Study of what should be

 Used to make value judgments, identify problems, and prescribe solutions

 Statements that suggest what we should do about economic facts, are normative statements  Based on values

 Normative statements cannot be proved or disproved by the facts alone

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Why Study Economics

  To understand the world better  You’ll begin to understand the cause of many of the things that

affect your life   To gain self-confidence

 You’ll lose that feeling that mysterious, inexplicable forces are shaping your life for you

  To achieve social change   understand origins of social problems and design more effective

solutions   To help prepare for other careers

 You’ll discover that a wide range of careers deal with economic issues on many levels

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The Methods of Economics

 Modeling  Model: Abstract representation of reality  Economic theories must have a well-

constructed model  While most models are physical constructs

 Economists use words, diagrams, and mathematical statements

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Assumptions

 Assumptions are very important for modeling   Types of assumptions in an economic model

 Simplifying assumptions   Way of making a model simpler without affecting any of its

important conclusions

 Critical assumptions   Affect conclusions of a model in important ways   If critical assumptions are wrong model will be wrong

 All economic models have one or more critical assumptions

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Questions 1.  What are the opportunity costs of the choices you

make? 2.  How does a production possibility frontier (PPF)

illustrate opportunity cost, specialization of resources, inefficiency, and economic growth?

3.  What are the differences between command economies, free market economies, and mixed economies in terms of the ways they address the 3 basic economic questions?

4.  Why do we observe specialization in production and trade? �

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Opportunity Cost - Concept   Remember that scarcity in time and money

results in choice making in real world   Definition: Opportunity cost of any choice

 What we forego when we make that choice   Most accurate and complete concept of cost we

should use when making decisions   An Example:

 in one hour, George can fix 4 flat tires or type 200 words. What is his opportunity cost of fixing a flat tire? What is his opportunity cost of typing 100 words?

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Opportunity Cost - Components �

  Direct money cost of a choice may only be a part of opportunity cost of that choice

  Opportunity cost of a choice = explicit costs + implicit costs

 Explicit cost—money actually paid out for a choice  Accounting cost

 Implicit cost—value of something sacrificed when no direct payment is made

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Opportunity Cost - Examples

  Opportunity cost of investing on education  Explicit cost: tuition and fees  Implicit cost: time or forgone income �

  Opportunity cost of a typical firm �Explicit cost � Implicit cost �

Rent paid out � Owner’s rent forgone Manager’s salaries � Owner’s return from investment

Worker’s wages � Owner’s labor income forgone Cost of raw material �

Interest on loans

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Opportunity Cost and Society

 Resources in whole society are limited.  All production carries an opportunity cost

 To produce more of one thing  Must shift resources away from producing

something else  There is no such thing as a free lunch!

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Increasing Opportunity Cost

 According to law of increasing opportunity cost  The more of something we produce

 The greater the opportunity cost of producing even more of it

 This principle applies to all of society’s production choices

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Production Possibilities Frontiers �

 Production Possibilities Frontiers (PPF) shows the combinations of two goods that can be produced with resources and technology available �

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Figure 1: (PPF)

grains

cars

100,000 200,000 300,000 400,000 500,000

1,000,000 950,000 850,000

700,000

500,000 400,000

B A

C

D

E

F

W

At point A, all resources are used for ”biofuels."

Moving from point A to point B requires shifting resources out of biofuels and into grains/ food.

At point F. all resources are used for grains/food

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Characteristics of PPF

 The points on the curve show the maximum number of goods capable to be produced

 Unit in the horizontal and vertical axis is quantity (not price) of the two different goods

 The points inside the curve show the possible other combinations of goods possible to be produced

  Inefficient production  The shape of the curve is concave toward the origin

in most cases  The law of increasing opportunity cost

 The points outside the curve show the impossible combinations of goods

Society’s choices are limited to points on or inside the PPF�

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Productive Inefficiency

 Productive Inefficiency  More of at least one good can be produced

 Without pulling resources from the production of any other good

 Reasons  Waste of sources  Recession (economic slump)

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Recessions  A slowdown in overall economic activity

when resources are idle  Widespread unemployment   Factories shut down

 Land and capital are not being used  An end to the recession would move the

economy from a point inside its PPF to a point on its PPF   Using idle resources to produce more goods and

services without sacrificing anything   Can help us understand an otherwise confusing episode in

economic history

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The Case of Production and Unemployment in the US

A

B

Civilian Goods per Period

Military Goods per Period

2. then moved to the PPF during the war. Both military and civilian production increased.

1. Before WWII the United States operated inside its PPF . . .

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Economic Growth   If economy is already operating on its PPF

 Cannot exploit opportunity to have more of everything by moving to it   But what if the PPF itself were to change? Couldn’t we then

produce more of everything?   This happens when an economy’s productive capacity grows

  Many factors contribute to economic growth, but they can be divided into two categories  Quantities of available resources—especially capital—can increase

  An increase in physical capital enables economy to produce more of everything that uses these tools

 More factories, office buildings, tractors, or high-tech medical equipment   Same is true for an increase in human capital

 Skills of doctors, engineers, construction workers, software writers, etc.   Technological change enables us to produce more from a given

quantity of resources  Capital and technological change usually go hand in hand

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Economic Growth

  Increases in capital and technological change often go hand in hand

  For instance, PET body scanners will enable us to save even more lives than our current set of resources  Moving horizontal intercept of PPF rightward, from F to F‘   Impact of PET scanners stretches PPF outward along horizontal

axis   How can a technological change in lifesaving enable us

to produce more goods in other areas of the economy?  Society can choose to use some of increased lifesaving potential

to shift other resources out of medical care and into production of other things

  Because of technological advance and new capital, we can shift resources without sacrificing lives

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Figure 3: The Effect of a New Medical Technology

Number of Lives Saved per Period

Quantity of All Other Goods

per Period

300,000 500,000 600,000

1,000,000

700,000

A

J

D

H

F

1. A technological advance in saving lives increases this PPF's horizontal intercept . . .

4. or more lives saved and greater production of other goods.

3. The economy can end up with more lives saved and un-changed production of other goods . . .

2. But not its vertical intercept.

F'

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Economic Growth

  If we can produce more of the things that we value, without having to produce less of anything else, have we escaped from paying an opportunity cost?  Yes . . . and no   Figure 3 tells only part of story

  Leaves out steps needed to create this shift in the PPF   For example, technological innovation doesn’t just “happen”—

resources must be used to create it  Mostly by research and development (R&D) departments of large

corporations

  In order to produce more goods and services in the future, we must shift resources toward R&D and capital production  Away from production of things we’d enjoy right now

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Specialization and Exchange   self sufficiency   Specialization

 Method of production in which each person concentrates on a limited number of activities

  Example: Adam Smith observed that   10 men produce 200 pins a day working separately   10 men produce 48,000 pins a day through specialization!

  Exchange - Practice of trading with others to obtain what we want   Allows for

 Greater production  Higher living standards than otherwise possible

  All economics exhibit high degrees of specialization and exchange

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Resource Allocation  Problem of resource allocation

  Which goods and services should be produced with society’s resources?  Where on the PPF should economy operate?

  How should they be produced?   Labor or Capital intensive

 No capital at all  Small amount of capital  More capital

  Who should get them?  How do we distribute these products among the

different groups and individuals in our society?

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The Three Methods of Resources Allocation

 Traditional Economy  Resources are allocated according to long-

lived practices from the past  Command Economy (Centrally-Planned)

 Resources are allocated according to explicit instructions from a central authority

 Market Economy  Resources are allocated through individual

decision making  Dominant method

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The Nature of Markets  A market is a group of buyers and

sellers with the potential to trade with each other  Global markets

 Buyers and sellers spread across the globe  Local markets

 Buyers and sellers within a narrowly defined area

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The Importance of Prices  A price is the amount of money that must

be paid to a seller to obtain a good or service

 When people pay for resources allocated by the market  They must consider opportunity cost to

society of their individual actions  Markets can create a sensible allocation of

resources

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Resource Allocation

 Various levels of government collect about one-third of our incomes as taxes  Enables government to allocate resources by

command  Government uses regulations of various types to

impose constraints on our individual choice   The market is the dominant method of resource

allocation  However, it is not a pure market

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Resource Ownership  Communism

 Most resources are owned in common  Socialism

 Most resources are owned by state  Capitalism

 Most resources are owned privately

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Types of Economic Systems

 An economic system is composed of two features  Mechanism for allocating resources

 Market  Command

 Mode of resource ownership  Private  State

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Figure 4: Types of Economic Systems Resource Allocation

Market Command

Private

State

Resource Ownership

Market Capitalism

Centrally Planned

Capitalism

Centrally Planned

Socialism

Market Socialism

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Summaries

 Opportunity cost  vs accounting cost  PPF

  Recession/inefficiency   Economic growth /

Technological Change   Law of increasing

opportunity cost   Other Characteristics

 Specialization and Exchange

 Economic system  4 types