Economics for the 21 st Century An Introduction (Part 1) Henry B. Stobbs, MFA.

Economics for the 21Economics for the 21stst Century CenturyAn Introduction (Part 1)

Henry B. Stobbs, MFA

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Three Insights

• The mutual determination insight: Everything depends on everything else.

Three Insights

• The mutual determination insight

• The subjective insight: There are no objective costs. – Things cannot have costs – only actions can

have costs.– Costs accrue to the actor.

Three Insights

• The mutual determination insight

• The subjective insight.

• The marginal insight: – The “edge” is where we make decisions. – The only relevant value is the marginal value,

the additional value we expect to gain from making a certain decision.

Three Insights

• The mutual determination insight

• The subjective insight.

• The marginal insight.

• The word economics derives from the Greek oikonomikos, related to the management of a household, but the study and application of economics as we understand it is, historically speaking, quite recent.

The Study of EconomicsThe Study of Economics

begins with a simple problem.begins with a simple problem.

It’s referred to by economists as the economizing problem.

• We live in a world of unlimited wants & needs;

• We live in a world of limited resources;

• When unlimited needs and wants are combined with limited resources, scarcity is created;

• In a world of scarcity, we must decide something…

What we must decide

Economists refer to the satisfaction we gain from satisfying our needs and wants as UTILITY.UTILITY.

The mechanism we employ to organize the gathering of resources, production, and distribution of the goods and services we need and desire is referred to as an economic system.

EconomicsEconomics is concerned with observing and figuring how best to adjust the economic system in order to efficiently manage limited efficiently manage limited productive resourcesproductive resources, so that we can maximize our utilitymaximize our utility.

Therefore, we can say that…

EconomicsEconomics is the study of how humans behave in producing, distributing, and consuming material goods and services in a world of scarce resources.

EconomistsEconomists do Economics

Some famous economists whose names you will come to know include…

• Adam SmithAdam Smith• David RicardoDavid Ricardo• Henry HazlittHenry Hazlitt• F. A. HayekF. A. Hayek• John Maynard Keynes…John Maynard Keynes…

… … and many others…and many others…

John Maynard Keynes said…John Maynard Keynes 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 exempt from any intellectual influences, are usually the slaves of some defunct economist.”

We can be slaves, or…

We can gain a basic understanding of economics in order to…– Make more informed decisions as citizensMake more informed decisions as citizens– Gain insight about making wiser personal Gain insight about making wiser personal

decisionsdecisions

What are some economic decisions we make in our daily lives?

A Matter of Methodology

How exactly do economists do their work?

• Economists formulate economic formulate economic principles…principles…

• The principles are used to to establish economic policiesestablish economic policies…

• Economic policies are designed to solve economic problemsto solve economic problems.

Economists use Inductive reasoning to distill or create principles from facts.

They also use deductive reasoning, called the hypothetical method, to form a tentative, untested principle, or hypothesis.

Economics is…Economics is…a descriptive sciencea descriptive science

• It is empirical, meaning that it is based on facts (the observable and verifiable behavior of data or subject matter)

• It is a social science, meaning that it is concerned with human behavior

The goal of economics is to…

Systematically arrange, interpret, and generalize upon facts in order to derive general principles, theories, and models.

General =

• Imprecise…

• Approximate…

• Close enough for government work…

• In the general vicinity…

• More, or less…

Economists like to use a Latin phrase a lot: ceteris paribus… other things being equal… in other words, we assume that all the variables of a problem except those under our immediate consideration are fixed, constant, unchanging.

Therefore, economic theories are abstractions that do not necessarily accurately reflect reality.

Two Levels of Analysis1.1. MacroeconomicsMacroeconomics

– Deals with the economy as a whole, or…

– With the basic subdivisions or aggregates that make up the economy…

– In other words, macroeconomics looks at forests, not trees…

Two Levels of Analysis

2.2. MicroeconomicsMicroeconomics

– Deals with specific economic units and…

– A detailed consideration of these units..

– In other words, microeconomics looks at each tree, not at the whole forest…

ReviewReview

• Economics is concerned with the efficient management of scarce resources

• Induction is observing regularities in factual data and drawing from them generalizations

• Deduction uses logic to create hypotheses which are then tested with factual data

ReviewReview• Economic theories (laws, principles,

models) are generalizations, based on facts, concerning the economic behavior of individuals and institutions

• Macroeconomics deals with the economy as a whole or with the basic subdivisions (aggregates) of the economy

• Microeconomics focuses on detailed aspects of the specific units which comprise the economy

Time for A Mind-ProbeTime for A Mind-Probe• What is the economizing problem?• What is utility?• What is the difference between

macroeconomics and microeconomics?• What does empirical mean?• What must we decide in order to solve the

economizing problem?• What is meant by the phrase ceteris paribus?• What is the goal of economic policy?

COMING NEXTCOMING NEXT

Mankiw’s

Ten Principles of Economics

1010101010

Set 1: How People Make Decisions

Ten Principles of EconomicsTen Principles of Economics

• Principle # 1: People face trade-offs.– Making decisions requires trading off one goal

against another– To get one thing, you have to give up

something else– Efficiency v. Equity:

• Efficiency means that society gets the most that it can from scarce resources

• Equity means that the benefits of resources are distributed fairly among members of society

Ten Principles of EconomicsTen Principles of Economics

• Principle # 2: The cost of something is what you give up to get it– Decision-makers must consider both the

obvious and implicit costs of their actions– Basketball stars who quit school early to turn

pro understand all about opportunity costs opportunity costs and incentivesncentives

Ten Principles of EconomicsTen Principles of Economics

• Principle # 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.

Ten Principles of EconomicsTen Principles of Economics

• Principle # 4: People respond to incentives (in predictable ways!)– Marginal changes in costs or benefits

motivate people to behave in certain ways– The decision to choose one alternative over

another occurs when that alternative’s marginal benefits exceed its marginal costs

– Behavior changes when costs or benefits change

Set 2:How the Economy Works As a Whole

Ten Principles of EconomicsTen Principles of Economics

• Principle # 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

Ten Principles of EconomicsTen Principles of Economics

• Principle # 6: Markets are usually a good way to organize economic activity.– Adam Smith observed that households and

firms interact in markets as if guided by an “invisible hand.”

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

• Thus, prices guide decision makers toward outcomes that tend to maximize the welfare of society as a whole.

Market EconomiesMarket Economies

• A market economy is one that allocates resources through the decentralized decisions of individuals, operating within households and firms, and interacting in markets for goods and services– Households decide what to buy and who to

work for– Firms decide who to hire and what to

produce

Market FailureMarket Failure

• Market failure may be caused by:

– Externalities. An externality is the impact of a person’s or a firm’s actions on the well-being of a bystander.

– Market power. Market power is the ability of a single person or firm to unduly influence market prices.

Ten Principles of EconomicsTen Principles of Economics• Principle # 7: Governments can

sometimes improve market outcomes.– Market failure occurs when the market fails to

allocate resources efficiently– When the market fails, government can

intervene to promote efficiency and equity (But knowing when, if, how and how much to interfere is a bug of a different sort…)

Ten Principles of EconomicsTen Principles of Economics• Principle # 8: A country’s standard of living

depends on its ability to produce goods and services– Standards of living may be measured by:

• Comparing personal incomes• Comparing the total market value of a nation’s

production: Wealth increases as productivity increases

• Variation in living standards between countries can be explained in terms of their productivities

• Productivity is the amount of goods and services produced from each hour of a worker’s time

Set 3: How People Interact

Ten Principles of EconomicsTen Principles of Economics• Principle # 9: Prices rise when

governments print 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

supply of money– When the government creates a large supply

of money, the value of the money falls

Ten Principles of EconomicsTen Principles of Economics• Principle # 10: Society faces a short-run

trade-off between inflation and unemployment