Economics slides

CHAPTER 1

Economics : What is Economics?

Objectives

After studying this chapter, you will be able to: Define economics and distinguish between microeconomics and macroeconomics Explain the two big questions of economics Explain the key ideas that define the economic way of thinking Explain how economists go about their work as social scientists

Definition of Economics

All economic questions arise because we want more than we can get.

Our inability to satisfy all our wants is called scarcity.

Because we face scarcity, we must make choices.

The choices we make depend on the incentives we face.

An incentive is a reward that encourages an action or a penalty that discourages an action.

Definition of Economics

Economics is the social science that studies the choices that individuals, businesses, governments, and entire societies make as they cope with scarcity and the incentives that influence and reconcile those choices. Economics divides in to main parts: Microeconomics Macroeconomics

Two Big Economic Questions

Two big questions summarize the scope of economics: How do choices end up determining what, how, and for whom goods and services get produced? When do choices made in the pursuit of self-interest also promote the social interest?

Two big economic questions: What, How and For whom

What?What we produce changes over timeWhat determines the quantities and all the other millions of items that we produce? How?Goods and services are produced by using productive resources that economists call factors of production.

How? continues..

Factors of production are grouped into four categories: - Land - Labour - Capital -Entrepreneurship

How continues..

The “gifts of nature” that we use to produce goods and services are land.

The work time and work effort that people devote to producing goods and services is labour.

The quality of labour depends on human capital, which is the knowledge and skill that people obtain from education, on-the-job training, and work experience.

The tools, instruments, machines, buildings, and other constructions that businesses use to produce goods and services are capital.

The human resource that organises land, labour, and capital is entrepreneurship.

Two Big Economic Questions: For Whom?

Who gets the goods and services depends on the incomes that people earn. Land earns rent. Labour earns wages. Capital earns interest. Entrepreneurship earns profit.

Two Big Economic Questions: When is the Pursuit of Self-Interest in the Social Interest?

Every day, 49 million South Africans and 6.6 billion people in the rest of the world, make economic choices that result in What, How, and For Whom goods and services are produced.Do we produce the right things in the right quantities?Do we use our factors of production in the best way?Do the goods and services go to those who benefit most from them?

Two Big Economic Questions: When is the Pursuit of Self-Interest in the Social Interest? Continues..

You make choices that are in your self-interest—choices that you think are best for you.

Choices that are best for society as a whole are said to be in the social interest.

An outcome is in the social interest if it uses resources efficiently and distributes goods and services fairly.

Is it possible that when each one of us makes choices that are in our self-interest, it also turns out that these choices are also in the social interest?

Two Big Economic Questions: When is the Pursuit of Self-Interest in the Social Interest? Continues..

Five topics that generate discussion and that illustrate tension between self-interest and social interest arePrivatisationGlobalisation HIV/Aids Water storagesUnemployment

The Economic Way of Thinking: Choices and Trade-offs

Because of scarcity we must make choices, we select from the available alternatives.

You can think about every choice as a tradeoff—an exchange—giving up one thing to get something else.

The classic tradeoff is “guns versus butter.”“Guns” and “butter” stand for any pair of

goods.

The Economic Way of Thinking: What, How and For Whom Trade-offs

What Trade-offsWhat goods and services get produced depends on choices made by each one of us, when governments choose how to spend their tax revenues, and when businesses choose what to produce.How Trade-offsHow goods and services get produced depends on choices made by the businesses that produce them.

The Economic Way of Thinking: What, How and For Whom Trade-offs Continues..

For Whom Trade-offsFor whom goods and services are produced

depends on the distribution of buying power.Government redistribution of income from

the rich to the poor creates the big tradeoff - the tradeoff between equality and efficiency.

The Economic Way of Thinking: Choices Bring Change

The quantity and range of goods and services available today in the US are much greater than those in Africa.

The Economic condition of the world today is much better than it was a generation ago.

The quality of economic life depends on many of the choices made by each one of us and these choices involve trade-off.

The Economic Way of Thinking: Choices Bring Change Continues..

One choice is that of how much of our income to consume and how much to save. If we save more, we can buy more capital and increase our production.A second choice is how much effort to devote to education and training. If we take less leisure time, we can educate and train ourselves to become more productive.A third choice is how much effort to devote to research and development of new products and production methods. If businesses produce less and devote resources to research and developing new technologies, they can produce more in the future

The Economic Way of Thinking: Opportunity Cost

The opportunity cost of something is the highest-valued alternative that we give up to get it. In other words it is the value of the NEXT BEST opportunity that is sacrificed by the exercise of a choice

For instance if you have three items in front of you, namely: a chocolate, a toffee and jelly babies.

Arrange these items according to you preference (what you like most to what you like least).

Example chocolate, jelly babies and toffee. Chocolate is your first choice hence you will sacrifice the NEXT BEST opportunity which is ONLY jelly babies

The Economic Way of Thinking: Choosing at the Margin

You can allocate the next hour between studying and emailing your friends. You must decide how many minutes to allocate to each activity. you compare the benefits of a little bit more study time with its cost – you make your choice at the margin.

The benefit that arises from the increase in the activity is called marginal benefit.

The cost of an increase in an activity is called marginal cost.

The Economic Way of Thinking: Responding to Incentives

Our choices respond to incentives.For any activity, if marginal benefit exceeds

marginal cost, people have an incentive to do more of that activity.

If marginal cost exceeds marginal benefit, people have an incentive to do less of that activity.

Incentives are also the key to reconciling self-interest and the social interest.

The Economic Way of Thinking: Human Nature, Incentives and Institutions

Economists take human nature as given and view people as acting in their self-interest.

Self-interested actions are not necessarily selfish actions.

But if human nature is given and people pursue self-interest, how can the social interest be served?

Economists answer by emphasizing the role of institutions in creating incentives to behave in the social interest.

Private property protected by a system of laws and markets that enable voluntary exchange are the fundamental institutions.

Economics: A Social Science

Economists distinguish between two types of statement:

What is—positive statements What ought to be—normative statementsA positive statement can be tested by

checking it against facts.A normative statement cannot be tested.

Observation and Measurement

The first step toward understanding how the economic world works is to observe it.

Economists observe and measure data of all aspects of economic behaviour.

Model Building

The second step toward understanding how the economic world works is to build a model.

An economic model is a description of some aspect of the economic world that includes only those features that are needed for the purpose at hand.

Testing Models

The third step is testing models.A model’s predictions might correspond to

the facts or be in conflict with them.A model is tested by comparing its

predictions with the facts

Obstacles and Pitfalls

Unscrambling cause and effectCeteris Paribus is a Latin term that means

“other things being equal”.By changing one factor at a time and holding

all the other factors constant we isolate the factor of interest and are able to investigate its effects in the clearest possible way.