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© The McGraw-Hill Companies, 2008 Economics is the study of how society manages its scarce resources.
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©The McGraw-Hill Companies, 2008
Chapter 1Economics and the Economy
David Begg, Stanley Fischer and Rudiger Dornbusch, Economics, 9th Edition, McGraw-Hill Education, 2008
PowerPoint presentation by Alex Tackie and Damian Ward
©The McGraw-Hill Companies, 2008
Society and Scarce Resources: – The management of society’s resources
is important because resources are scarce.
– Scarcity. . . means that society has limited resources and therefore cannot produce all the goods and services people wish to have.
©The McGraw-Hill Companies, 2008
Economics is the study of how society manages its scarce resources.
©The McGraw-Hill Companies, 2008
What is Economics?• ECONOMICS ...• is the study of how society decides:
– What– For whom– How
to produce...
©The McGraw-Hill Companies, 2008
The price of oil
0
20
40
60
80
100
120
1965 1970 1975 1980 1985 1990 1995 2000
US$
per
bar
rel
Tripled in 1973-74, and doubled again in 1979-80 … and affected people all over the world.
©The McGraw-Hill Companies, 2008
An increase in the price of oil affects:
• What to produce– less oil-intensive products
• How to produce– less oil-intensive techniques
• For whom to produce– oil producers have more buying power;
importers have less
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The distribution of world population and GNP, 2007
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
Population GNP
LIC MIC HIC
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Income Distribution and Three Questions
• Poor Countries which has 40% of the population has 3% of the total income
• Rich Countries has 15% of the population and get 80% of the total income
• What to produce– Whatever consumers in developed countries
prefer. • How to produce
– Cheaper techniques (labor or capital intensive)• For whom to produce:
– Consumers in developed countries
©The McGraw-Hill Companies, 2008
Scarcity forces choices to be made
• Opportunity cost • a crucial concept in economic analysis• the quantity of other goods that must be
sacrificed to obtain another unit of a good
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The production possibility frontier (1)
• For each level of the output of one good, the production possibility frontier shows the maximum amount of the other good that can be produced.
©The McGraw-Hill Companies, 2008
The production possibility frontier (2)
Film output (G)
Food
out
put (
F)
Production possibility frontier
G = 8
F= 4
A
B10
14
6 14
F/G = opportunity cost (=1/2)Unattainable points
Production possibilities set.
©The McGraw-Hill Companies, 2008
The production possibility frontier (3)
• The points on the curve are efficient points because these represents the maximum production given the limited resources.
• The points below the curve (in the set) are inefficient points.
• The points above the curve are unattainable points
• If the economy grows and have more capital, labor, land or technology, the PPF shift out and the previously unattainable points would be a possibility.
©The McGraw-Hill Companies, 2008
The production possibility frontier (5)
• Diminishing Marginal Returns• The PPF is a curve (not a line !) because the
opportunity cost of producing a product increases as we produce more of that product.
• As we produce more of a good, we have to use less productive inputs in production of that good. This increases the opportunity cost.
©The McGraw-Hill Companies, 2008
The operation of markets
• Market• a shorthand expression for the process by
which … – households’ decisions about consumption of
alternative goods– firms’ decisions about what and how to
produce– and workers’ decisions about how much and
for whom to work• … are all reconciled by adjustment of prices
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Resource allocation (1)
• Resource allocation is crucial for a society and is handled in different ways in different societies, e.g.:– Command economy– Mixed economy– Free market
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Resource allocation (2)
• In market economies, the prices are determined by supply and demand.
• The price is an important factor for resource allocation.
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Efficiency or Equity ?
• In market economies, efficiency is more of a concern whereas the planned economies gives more emphasis on equity.
• Since the prices are not free in the planned economies a central office decides the prices and the production. A heavy bureaucracy is required for this process. Lack of competition decreases the productivity and quality in planned economies.
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Market orientation
Commandeconomy
Freemarketeconomy
Cuba
China
Hungary
Sweden
UK
USA
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Normative and Positive Economics
• Positive economics deals with objective explanation– e.g. if a tax is imposed on a good its price will
tend to rise
• Normative economics offers prescriptions based on value judgements– e.g. a tax should be imposed on tobacco to
discourage smoking
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Micro and Macro (1)• Microeconomics
– offers a detailed treatment of individual economic decisions concerning particular commodities
– Footballers’ wages and the price of oil, for example, are both microeconomic issues
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Micro and Macro (2)• Macroeconomics
– emphasises the interactions in the economy as a whole
– Gross domestic product, the aggregate price level and unemployment, for example, are all macroeconomic issues
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Models and data• If we investigate the relationship between
unemployment and minimum wage, we should start with a model.
• Model– a framework based on simplifying assumptions– helps to organize our economic thinking
• Data– the economist’s link with the real world– time series– cross section
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Real and nominal
• Many economic variables are measured in money terms
• Nominal values– measured in current prices– not good for time series analysis.
• Real values– adjusted for price changes compared with a
base year– measured in constant prices– Good for time series analysis.
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