Unit 1 Introduction to Economics University
- 2. Ten Principles of Economics • Resources are scarce • Scarcity: the limited nature of society’s resources – Society has limited resources • Cannot produce all the goods and services people wish to have • Economics – The study of how society manages its scarce resources 2
- 3. Scarcity By the end of 2023, how many percentages of the world’s nations are facing scarcity? a. 20% b. 45% c. 69% d. 100%
- 4. Scarcity The most fundamental economic problem is how to best use a. Unlimited resources to satisfy unlimited wants. b. Limited resources to satisfy unlimited wants. c. Unlimited resources to satisfy limited wants. d. Limited resources to satisfy limited wants.
- 5. Ten Principles of Economics • Economists study: – How people decide what to buy, how much to work, save, and spend – How firms decide how much to produce, how many workers to hire – How society decides how to divide its resources between national defense, consumer goods, protecting the environment, and other needs 5
- 6. How People Make Decisions Principle 1: People face trade-offs Principle 2: The cost of something is what you give up to get it Principle 3: Rational people think at the margin Principle 4: People respond to incentives 6
- 7. Principle 1: People Face Trade-offs • To get something that we like, we have to give up something else that we also like – Going to a party the night before an exam • Less time for studying – Having more money to buy stuff • Working longer hours, less time for leisure – Protecting the environment • Resources could be used to produce consumer goods 7
- 8. Principle 1: People Face Trade-offs • Society faces trade-offs: – The more it spends on national defense (guns) to protect its shores • The less it can spend on consumer goods (butter) to raise the standard of living at home – Pollution regulations: cleaner environment and improved health • But at the cost of reducing the incomes of the firms’ owners, workers, and customers 8
- 9. Principle 2: The Cost of Something Is What You Give Up to Get It • Making decisions: – Compare costs with benefits of alternatives – Need to include opportunity costs • Opportunity cost – Whatever must be given up to obtain some item 9
- 10. • The opportunity cost of: – Going to college for a year • Tuition, books, and fees • PLUS foregone wages – Going to the movies • The price of the movie ticket • PLUS the value of the time you spend in the theater 10 Principle 2: The Cost of Something Is What You Give Up to Get It
- 11. Opportunity Cost You consider attending a course on Economics this summer. If you choose to study, you can not go to your summer job, which has an income of 6000 USD. The tuition is 2000 USD, the textbook is 200 USD, the living cost is 1400 USD (which stay the same whether you study or work). Ignore all non-monetary costs. Calculate your opportunity cost of attending the summer course.
- 12. Principle 3: Rational People Think at the Margin • Rational people – Systematically and purposefully do the best they can to achieve their objectives – Given the available opportunities – Make decisions by evaluating costs and benefits of marginal changes • Small incremental adjustments to a plan of action 12
- 13. Maginal Analysis A student plans to spend 5 hours studying for 2 exams this evening. Example Hours on studying Economics Economics Grade 5 100 4 96 3 90 2 82 1 60 0 0 Hours on studying History History Grade 0 0 1 40 2 60 3 72 4 77 5 80
- 14. • Examples: – Cell phone users with unlimited minutes (the minutes are free at the margin) • Are often prone to making long/frivolous calls • Marginal benefit of the call > 0 – A manager considers whether to increase output • Compares the cost of the needed labor and materials to the extra revenue 14 Principle 3: Rational People Think at the Margin
- 15. • Incentive – Something that induces a person to act • Examples: – When gas prices rise, consumers buy more hybrid cars and fewer gas guzzling SUVs – When cigarette taxes increase, teen smoking falls 15 Principle 4: People Respond to Incentives
- 16. Electrification caused an increase in fertility rate in remote regions. Akpandjar, G., Puozaa, C., & Quartey, P. (2018). Explaining Fertility Variation in Rural Communities: The Role of Electricity in Ghana. Economies, 6(3), 40. https://doi.org/10.3390/economies6030040 Principle 4: People Respond to Incentives
- 17. Active Learning Applying the principles You are selling your 2007 Mustang. You have already spent $1,000 on repairs. At the last minute, the transmission dies. You can pay $900 to have it repaired, or sell the car “as is.” In each of the following scenarios, should you have the transmission repaired? Explain. A. Blue book value (what you could get for the car) is $7,500 if transmission works, $6,200 if it doesn’t. B. Blue book value is $6,300 if transmission works, $5,500 if it doesn’t. 17
- 18. Active Learning Answers Cost of fixing the transmission = $900 A. Blue book value is $7,500 if transmission works, $6,200 if it doesn’t – Benefit of fixing transmission = $1,300 (= 7500 – 6200) – Get the transmission fixed B. Blue book value is $6,300 if transmission works, $5,500 if it doesn’t – Benefit of fixing the transmission = $800 (= 6300 – 5500) – Do not pay $900 to fix it 18
- 19. How People Interact Principle 5: Trade can make everyone better off Principle 6: Markets are usually a good way to organize economic activity Principle 7: Governments can sometimes improve market outcomes 19
- 20. • People benefit from trade: – People can buy a greater variety of goods and services at lower cost • Countries benefit from trade and specialization – Get a better price abroad for goods they produce – Buy other goods more cheaply from abroad than could be produced at home 20 Principle 5: Trade Can Make Everyone Better Off
- 21. • Market – A group of buyers and sellers (need not be in a single location) • “Organize economic activity” means determining – What goods and services to produce – How much of each to produce – Who produced and consumed these 21 Principle 6: Markets Are Usually a Good Way to Organize Economic Activity
- 22. • A market economy allocates resources – Decentralized decisions of many firms and households – as they interact in markets • Famous insight by Adam Smith in The Wealth of Nations (1776): – Each of these households and firms acts as if “led by an invisible hand” to promote general economic well-being 22 Principle 6: Markets Are Usually a Good Way to Organize Economic Activity
- 23. • Prices: – Determined: interaction of buyers and sellers – Reflect the good’s value to buyers – Reflect the cost of producing the good • Invisible hand: – Prices guide self-interested households and firms to make decisions that maximize society’s economic well-being 23 Principle 6: Markets Are Usually a Good Way to Organize Economic Activity
- 24. • Government - enforce property rights – Enforce rules and maintain institutions that are key to a market economy • People are less inclined to work, produce, invest, or purchase if large risk of their property being stolen 24 Principle 7: Governments Can Sometimes Improve Market Outcomes
- 25. • Government - promote efficiency – Avoid market failures: market left on its own fails to allocate resources efficiently – Externality – source of market failure • Production or consumption of a good affects bystanders (e.g. pollution) – Market power – source of market failure • A single buyer or seller has substantial influence on market price (e.g. monopoly) 25 Principle 7: Governments Can Sometimes Improve Market Outcomes
- 26. • Government - promote equality – Avoid disparities in economic wellbeing – Use tax or welfare policies to change how the economic “pie” is divided 26 Principle 7: Governments Can Sometimes Improve Market Outcomes
- 27. Active Learning 2 Discussion Question In each of the following situations, what is the government’s role? Does the government’s intervention improve the outcome? a. Public schools for K-12 b. Workplace safety regulations c. Public highways d. Patent laws, which allow drug companies to charge high prices for life-saving drugs 27
- 28. How the economy as a whole works Principle 8: A country’s standard of living depends on its ability to produce goods and services Principle 9: Prices rise when the government prints too much money Principle 10: Society faces a short-run trade-off between inflation and unemployment 28
- 29. • Huge variation in living standards – Across countries and over time – Average income in rich countries • Is more than ten times average income in poor countries – The U.S. standard of living today • Is about eight times larger than 100 years ago 29 Principle 8: Country’s Standard of Living Depends on Its Ability to Produce Goods and Services
- 30. • Productivity: most important determinant of living standards – Quantity of goods and services produced from each unit of labor input – Depends on the equipment, skills, and technology available to workers • Other factors (e.g., labor unions, competition from abroad) have far less impact on living standards 30 Principle 8: Country’s Standard of Living Depends on Its Ability to Produce Goods and Services
- 31. • Inflation – An increase in the overall level of prices in the economy • In the long run – Inflation is almost always caused by excessive growth in the quantity of money, which causes the value of money to fall – The faster the government creates money, the greater the inflation rate 31 Principle 9: Prices Rise When the Government Prints Too Much Money
- 32. • Short-run trade-off between unemployment and inflation – Over a period of a year or two, many economic policies push inflation and unemployment in opposite directions – Other factors can make this tradeoff more or less favorable, but the tradeoff is always present 32 Principle 10: Society Faces a Short-run Trade-off between Inflation and Unemployment
- 33. • Economists play two roles: 1. Scientists: try to explain the world 2. Policy advisors: try to improve it 33 Thinking Like an Economist
- 34. The Economist as a Scientist • As scientists, economists employ the scientific method – Dispassionate development and testing of theories about how the world works 34
- 35. The Economist as a Scientist • Assumptions – Simplify the complex world and make it easier to understand – Example: to study international trade, assume two countries and two goods • Economists use models to study economic issues – Highly simplified representation of a more complicated reality 35
- 36. The Economist as a Scientist • Circular-flow diagram – Visual model of the economy – Shows how dollars flow through markets among households and firms • Two decision makers – Firms and Households • Interacting in two markets – Market for goods and services – Market for factors of production (inputs) 36
- 37. Figure 1 The circular flow 37 Households: Own the factors of production, sell/rent them to firms for income Buy and consume goods & services Household s Firms Firms: Buy/hire factors of production, use them to produce goods and services Sell goods & services
- 38. Figure 1 The circular flow 38 Markets for Factors of Production Household s Firms Income Wages, rent, profit Factors of production Labor, land, capital Spending G & S bought G & S sold Revenue Markets for Goods & Services
- 39. Microeconomics and macroeconomics • Microeconomics – The study of how households and firms make decisions and how they interact in markets • Macroeconomics – The study of economy-wide phenomena, including inflation, unemployment, and economic growth 39
- 40. Microeconomics and Macroeconomics Classify each of the following topics as relating to microeconomics or macroeconomics. 1. a family’s decision about how much income to save 2. the effect of government regulations on auto emissions 3. the impact of higher national saving on economic growth 4. a firm’s decision about how many workers to hire 5. the relationship between the inflation rate and changes in the quantity of money
- 41. The Economist as Policy Adviser • Positive statements: descriptive – Attempt to describe the world as it is – Confirm or refute by examining evidence: “Minimum-wage laws cause unemployment” • Normative statements: prescriptive – Attempt to prescribe how the world should be: “The government should raise the minimum wage” 41
- 42. Active Learning Positive vs. Normative Which of these statements are “positive” and which are “normative”? How can you tell the difference? a. Prices rise when the government increases the quantity of money. b. The government should print less money. c. A tax cut is needed to stimulate the economy. d. An increase in the price of burritos will cause an increase in consumer demand for music downloads. 42
- 43. Why Economists Disagree • Economists often give conflicting policy advice – Can disagree about the validity of alternative positive theories about the world – May have different values and, therefore, different normative views about what policy should try to accomplish • Yet, there are many propositions about which most economists agree 43
Editor's Notes
- #29: “Rich countries” refers to countries like the U.S. and Germany. “Poor countries” refers to countries like India, Indonesia, and Nigeria.
- #37: This and the following slide build the Circular-Flow Diagram piece by piece.
- #38: In this diagram, the green arrows represent flows of income/payments. The red arrows represent flows of goods and services (including services of the factors of production in the lower half of the diagram). To keep the graph simple, we have omitted the government, financial system, and foreign sector, as discussed on the next slide. You may wish to change the order in which the elements appear. To do so, look for “Custom Animation” in your version of PowerPoint.
- #39: These two branches of economics are closely intertwined, yet distinct—they address different questions.