©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

©The McGraw-Hill Companies, 2008

The distribution of world population and GNP, 2007

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Population GNP

LIC MIC HIC

©The McGraw-Hill Companies, 2008

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

©The McGraw-Hill Companies, 2008

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

©The McGraw-Hill Companies, 2008

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

©The McGraw-Hill Companies, 2008

Resource allocation (2)

• In market economies, the prices are determined by supply and demand.

• The price is an important factor for resource allocation.

©The McGraw-Hill Companies, 2008

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.

©The McGraw-Hill Companies, 2008

Market orientation

Commandeconomy

Freemarketeconomy

Cuba

China

Hungary

Sweden

UK

USA

©The McGraw-Hill Companies, 2008

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

©The McGraw-Hill Companies, 2008

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

©The McGraw-Hill Companies, 2008

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

©The McGraw-Hill Companies, 2008

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

©The McGraw-Hill Companies, 2008

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.