ECON 2313: Fall , 2011
Welcome!
Economics is the studyof how individuals and
societies allocatescarce resources among(competing) alternative
uses.
Available resources are insufficient to satisfy wants.
We cannot produce enough goods and services to satisfy
everyone—we don’t have the resources!
Congress made supplemental
appropriations for the Iraq effort of $110 billion June
2003 and March 2004. We should ask the question: what could we have for
$110 billion?
• 628 Boeing 7E7 Aircraft
• Construct three (3) 700 mile bullet trains (includes the cost of inner-city land acquisition).
• 4,075 “high quality” educational facilities to accommodate 1,000 students.
• Write a $379 check to every U.S. citizen.
• Fund 1,000 universities the size of Arkansas State for one year.
Economics Webster’s Ninth New Collegiate Dictionary. eco• nom • ic 1. archaic: of or relating to a household or its management. eco = oikos, meaning “house” or “household” nom = nemein, meaning “to manage” ic = ic, mean “of” or “relating to”
The geneology of economics
Finley. The World of Odysseus.
LO1
The Economic Perspective
• Thinking like an economist
• Key features:
• Scarcity and choice
• Purposeful behavior
• Marginal analysis
1-7
Economics: The Big Questions
• How do choices end up determining what, how, and for whom goods and services are produced?
• When do choices made in the pursuit of self-interest also promote the social interest?
Economic Resources
• Land• Labor • Capital• Entrepreneurship
Things that give us the physical means to produce and distribute goods and services.
Land or natural resources
Labor or “human resources”
Capital or “manmade instruments of production”
Human Capital
Human capital is the knowledge and skill people
obtain from education, on-
the-job training, and work
experience.
Entrepreneurship Entrepreneurship is the willingness and ability to combine land, labor and capital into productive enterprises.
• Entrepreneurs identify profitable business opportunities and mobilize and coordinate resources to take advantage.
• Entrepreneurs have a key role in the commercialization of new knowledge
• Sam Walton, Michael Dell, Martha Stewart, and Bill Gates are examples of highly successful entrepreneurs.
What, How, For Whom?
Because resources are scarce, growing more corn means growing less wheat, building more SUV’s means
building fewer military vehicles, and building more prisons means we have to sacrifice something else—
like new schools.
How to produce?
• In France, basket-carrying workers pick the grape crop by hand. Grape picking in California is often mechanized.
• GM uses workers to weld body parts together in some plants and uses robots in others.
Occupation Mean Annual Income ($)Chief Executives $139,810Airline Pilots and Co-Pilots 135,040Dentists 133,680Marketing Managers 101,190Actuaries 90,760Speech Pathologists 58,000Registered Nurses 56,880Funeral Directors 56,540Food Service Managers 44,930
Source: Bureau of Labor Statistics 2005 Occupational Survey
For whom are goods produced?
The personal distribution of income describes the
distribution of income among households or individuals
1967 1990 20080
2
4
6
8
10
12
Household Income Ratios of Selected Percentiles, the United States
90th/10th80th/50th
Year
Ratio
Source: Bureau of the Census
1967 1990 20080
10
20
30
40
50
60
Shares of Household Income Quintiles,the United States
LowestSecondMiddleFourthHighest
Year
Shar
e (P
erce
nt)
Source: Bureau of the Census
When is the Pursuit of Self-Interest in the Social Interest?
• Subprime mortgage brokers and underwriters behaved in their own interests—but contributed to the housing prices bust.
• BP scrimped on deep water drilling safety measures—with catastrophic results.
• Farmers on the high plains draw from the Ogallala Aquifer—but the water is rapidly running out.
MicroeconomicsThe study of the choices that individuals and
businesses make and the way these choices respond to incentives, interact, and are influenced by government
Examples of microeconomic questions?
• What determines the price of gasoline?
• Why is housing so much more expensive in San Francisco compared to Dallas?
• Will more students enroll in nursing schools in response to rising incomes of nurses?
• Will the “free” availability of Linux affect sales of Windows?
Macroeconomics
The study of the aggregate (or total) effects on the national economy and the global economy of the choices that individuals, businesses, and governments make.
Macroeconomic Questions
• The standard of living
• The cost of living
• Economic fluctuations—recessions and expansions
The Standard of Living
The standard of living is (imperfectly) measured by the average quantity of goods and services per person (or per capita).
Issues:
• How to explain changes over time in the standard of living?
• How to explain cross-national differences in the standard of living?
The Cost of Living
The cost of living refers to the prices of goods and services that are typically purchased by households.
Issues:
• How to explain changes over time in the cost of living?
• How to explain cross-national differences in the cost of living?
The Business Cycle
The term business cycle is used to describe observed fluctuations in key macroeconomic measures such as real GDP, personal income, profits, or employment.
A full cycle consists of an expansion and a contraction (or recession).
Business cycles are recurring phenomena; however, they are irregularly recurring.
Time
Real G
DP
Tot
al P
rod
uct
ion
Year
Business Cycle Phases and Turning Points
Expansion
ExpansionPeak
Peak
Recession
Recession
Trough
2 4 8
USA Employment is down 7.7 million since December 2007
Recessions shaded pink
LO1
Purposeful Behavior
• Rational self-interest
• Individuals and utility
• Firms and profit
• Desired outcomes
1-31
Economists assume that economic
decision-makers are rational and engage
in purposeful, “maximizing”
behavior
Rationality means:• The ability to make comparisons and
form preferences.• Choice consistency
Economics deals with questions of “what is”
and “what ought to be.” The former set of
questions belong to positive economics; the
latter to normative economics
Positive and normative economics
A B
1. I prefer A to B2. I prefer B to A3. I am indifferent between A
and B4. I prefer B to C5. Therefore, I prefer A to C
C
Gift Baskets
“All swans are white.”
“Pink swans are prettier than white swans.”
Positive economics attempts set forth scientific statements--that is, statements subject to verification or falsification
For instance:
• “ If they raise tuition again at ASU, enrollment will decline.”
• The recent fall in interest rates is likely to stimulate housing construction.
• Total employment in the U.S. fell in the year 2002.
It’s unfair to ask a person
to live on $7.25 an hour.
I shouldn’t have the government telling me how much I should pay for fast
food cooks or any other type of labor service.
Who is right? It is a normative issue.
An economic model is a simplified substitute
for economic reality.
What is an Economic Model?
This map of Arkansas is a good example of a “model”
Ceteris Paribus “All other things being equal” or “All other factors held constant.”
Simplification in model building is achieved by the ceteris paribus assumption. It allows us to reason about
the relationship between two variables without the
intrusion of other variables.
Economic reasoning:Some pitfalls
• Post hoc fallacy
• Association-is-causation fallacy
• Fallacy of composition
• Ignoring secondary effects
Post hoc fallacy
I washed my car today, and that is why it
rained.
Correlation versus Causation
Correlation is the tendency for the values of two variables to move in a
predictable and related way. For example, beer consumption tends to
rise when unemployment rises—that is, these variables are correlated. Does it follow that beer consumption causes
unemployment?
Sleeping with one's shoes on is strongly correlated with waking up with a headache.
Therefore, sleeping with one's shoes on causes headache.
• Researchers at the Aabo Akademi found that Finns who speak the language of their Nordic neighbors were up to 25 percent less likely to fall ill than those who do not.
• My rooster died—the sun won’t come up tomorrow.
• Crimes rates tend to be higher in cities with more police per capita.
Association-is-causationfallacy: More examples
To commit the fallacy of composition is to suppose that what is true in the individual case also holds true for the group.
• Example: “The best way to leave a burning theater is to run for the exit.”
Fallacy of composition
LO4
Individual’s Economizing Problem
• Limited income
• Unlimited wants
• A budget line
• Attainable and unattainable options
• Tradeoffs and opportunity costs
• Make the best choice possible
• Change in income
1-49
LO4
Individual’s Economizing Problem
6543210
02468
1012
DVDs$20
Books$10
$120 Budget 12
10
8
6
4
2
02 4 6 8 10 12 14
Quantity of Paperback Books
Qu
an
tity
of
DV
Ds Income = $120
Pdvd = $20= 6
Income = $120
Pb = $10= 12
Attainable
Unattainable
1-50
LO4
Global Perspective
1-51
LO5
Production Possibilities Model
• Illustrates production choices
• Assumptions:
• Full employment
• Fixed resources
• Fixed technology
• Two goods1-52
Technology
Technology is the application of scientific or other types of know-how to practical tasks.• “A sharp axe is better than a dull axe.”
• Improved technology enables us to produce more with the same resources.
• “Specialization is the inevitable counterpart of technology.”
John K. Galbraith. The New Industrial State (1967).
Model T : 1903
Ford Mustang: 1964
Important technical innovations
• Internal combustion engine• Cotton harvester• Transistor• Internet browser software• Air conditioning• Satellite communication• Antibiotics• Genetically modified seeds
LO5
Production Possibilities Table
Type of Product
Pizzas (in hundred thousands)
Industrial Robots (in thousands)
Production Alternatives
A B C D E
10 9 7 4 0
0 1 2 3 4
Plot the Points to Create the Graph…
1-56
LO5
Production Possibilities Curve
Pizzas
Ind
ustr
ial R
ob
ots
Attainable
0 1 2 3 4 5 6 7 8 9
1413121110 9 8 7 6 5 4 3 2 1
Unattainable
AB
C
D
E
U
The law of increasing opportunity costs makes the PPC concave.
1-57
Optimal Allocation
LO5
a
b
c
d
e
MB = MC
MC
MB
15
10
5
0
1 2 3Quantity of Pizza
Marg
inal B
en
efi
t &
Marg
inal
Cost
1-58
LO6
A Growing Economy
• Economic Growth
• More resources
• Improved resource quality
• Technological advances
1-59
Type of Product
Pizzas (in hundred thousands)
Industrial Robots (in thousands)
Production Alternatives
A' B' C' D' E'
14 12 9 5 0
0 2 4 6 8
A Growing Economy
LO6 1-60
LO6
A Growing Economy
Pizzas
Ind
ustr
ial R
ob
ots
Attainable
0 1 2 3 4 5 6 7 8 9
1413121110 9 8 7 6 5 4 3 2 1
Unattainable
AB
C
D
E
EconomicGrowth
Now Attainable
A’
B’
C’
D’
E’
1-61