CHAPTER 1

WHAT IS ECONOMICS?

Why is the economy us?

What kind of economy do we have

Why do we have this economy?

Definition of Economics?

Definition of EconomicsThe study of how people, both individually and in groups, deal with the

problem of scarcity.

Why is economics considered a social science?

Scarcity forces human beings to make choices

Why has there always been an economic problem?

man’s wants are virtually unlimited

scarcity of resources

*Have to prioritize

All resources regardless where they are located are scarce.

The scarcity causes most to have a cost because the demand does not go away…. Supply is limited

The scarcity of resources causes most things to have a cost.

 

Remember****

Society has virtually unlimited wants BUT limited resources

This means prioritization!The three questions are ever-present:

WhatHow

For Whom?

Resources to produce GoodsThese are referred to as FACTORS

Of production.

LandLaborCapital

Entrepreneurship…….

When we use resources….

If we use corn for ethanol then we can’t use it for another product.

Opportunity Cost.

(the thing you give up.)

When we are successful…. IS THAT GREED? Should we share with those who do not produce?

Did you ever wonder????? How did man advance from clans and tribes? How could a small feisty group of people put together

a country that would become the leader of the free world?

How did we finally get electricity, running water, clean water, good nutrition, good health standards, good education, and all these bounties of nature?

Why aren’t we still struggling like other countries today? Some of the world refers to the U.S. as the “greedy Americans.”

Is that true or are they just envious of our freedom to better ourselves?

U.S. as an independent nation

Weak economy- heavy in resources Transportation spotty and unreliable In-fighting among the states Trade was high priority Infant mortality was very high- life expectancy

(men and women between 38 and 48 years.) Disease and sanitary conditions poor Majority depended on growing own food. Living as a pioneer was a challenge daily.

Let’s go back to the 1900’s

Average worker made $12.98/week for 59 hours  Life expectancy: 47.3 female, 46.3 male - 33.0

blacks  Life was brutal. Books like The Jungle, Woman’s

Suffrage, Wizzard of Oz were published. Industrial age was here – mass production brought

prices down. Social issues included urban poor and disease and

filth and monopoly power – disparity of incomes and standard of living.

U.S. in the 1930’s

Population: 123,188,000 in 48 states Life Expectancy: Male, 58.1; Female, 61.6  Average salary: $1,368  Depression in U.S. Unemployment rises to 25%  The economy was the linchpin to survival……..poverty

spread like wildfire Democracy still strong- Germany and Italy fell to dictators,

but the U.S. Constitution prevailed

 

1950’s

Economic growth- homes construction, post war boom

Manufacturing jobs available Many families had 2 cars. Salaries going up each year – average

approx salary was $600/month Late 1950’s minimum wage increased to

$1.25. Life expectancy approximately 60 years.

Jump to 2000

Life expectancy ( men and women – 77.1) 100 deaths per 1,000 births in 1900 to 6.89 in

2000  Per capita income $46,999 Productivity (output per hour) still leading the

world, but slower than 1990. Minimum wage $7.25 is federal law- see

below http://www.dol.gov/whd/minwage/america.htm

Improved standard of living- why?

Greeks had it figured out- lots of inventions, etc, but it never got off the ground.

Not until 18th century England with Industrial Revolution did the economic growth take off.

What caused that success and then the spread of ideas to other countries (America included.)

Certain institution were in place that opened up the world economic growth and higher standard of living.

Classic video on Greed

Scarcity forces individuals and groups to do what?

What IS Greed? What is self-interest?

Is there a difference.

Key institutions

Democracy (nobles were taken out of power, common man merchant and manufacturer had a say in direction.)

Limited Liability Corporation (corporate growth was accelerated as no one could lose more than initial investment.)

Patent rights to protect inventors (individuals could keep the spoils from their innovation.)

Literacy and education ( key to economic growth and individual success.)

Challenge today! Need to get more out of world’s limited resources. How is the best way to achieve that so that all

mankind can prosper and profit? Still have diseases to conquer, infant mortality is too

high, poverty and malnutrition exist everywhere, illiteracy, unemployment.

Need to raise standards of living without massive pollution.

What is your choice???? What type of government? What about education? Don’t mean a piece of paper,

but real knowledge. Let’s dig in and see what we can learn.

The Five Foundations of Economics

1. Incentives matter

2. Life is about trade-offs

3. Opportunity costs

4. Marginal thinking

5. Trade creates value

1. Incentives Matter

Incentives Factors that motivate you to act or

exert effort People respond to incentives! Incentives are everywhere, and

financial gain often plays a prominent role

Positive incentives Tax refund, pay raise, employee of the month

award, sticker and a smiley face, extra credit

Negative incentives Taxes, jail, fees, fines, spankings, getting

grounded, getting fired, failing class

Incentives Work……

What is a Trade-off

Giving up one thing to get something else.

Thing you give up is called “opportunity cost.”

So if resources are limited and wants are unlimited…. Makes for an interesting “trade-off.”

Reality of Trade-offs- Crude Oil optionsJust a few of the products getting a start from a

barrel of oil:Aspirin furniture not to mention gasolineCandles hair dryers carpetsCD players lipstick paintsClothing luggage fertilizerCompact discs perfumes oils of all kindsComputers photographsCredit cards piano keysDeodorant roller bladesDiapers shampooDinnerware soft contact lensesDVDs toothpasteEyeglass frames vitamin capsules

2. Life is About Trade-offs

With scarcity, decisions incur costs Individual examples

Go to theater: do I watch the action movie or the romantic comedy?

Go to food court: do I eat Nick’s Barbeque or Sushi Bar?

After high school: do I attend Harvard or University of Texas?

Which president do I vote for?

4. Marginal Thinking

Economic thinking Systematically evaluating a course of

action Requires a purposeful evaluation of

available opportunities to make the best decision

Marginal thinking Evaluate whether the benefit of one

more unit of something is greater than the cost

Margin examples: one more unit (slice of pizza), one more hour of activity (studying, sleeping)

5. Trade Creates Value

Markets Bring buyers and sellers together to

voluntarily exchange goods and services

Trade The voluntary exchange of goods and

services between two or more parties Key word = voluntary You don’t engage in trade if it makes you

worse off; therefore, trade only occurs if both parties feel they gain from the trade!

Economics is a Social Science

What does that mean?

What is the Invisible Hand?

In 350 BC – Aristotle declared property should be private.

In 1776 – Adam Smith _ Wealth of Nations

All of this evolves around self-interest – Why?

How? How could there be an invisible hand???

How scary!!!

Rational Self-Interest

Individuals act as if motivated – self interest Idea first brought forth- Adam Smith- Wealth

of Nations. Father of Market Economics. Did you arise this a.m. and say>>>> I want to

make terrible decisions all day that are NOT in my self-interest???

Is Self-interest translated as greed? Did Smith really mean you think of you always above others?

The Mechanisms of Choice

Our personal choice is altered by the freedoms we have to make it… should market allow us to make our selection or should government have a major say.

There are three basic ways to make the necessary choices: The market mechanism. Government directive. A mixture of both.

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The Market

• Adam Smith called it “the invisible hand.”– It is as if we are “guided” to the correct point on the PPC.

(to be discussed later.)– In fact, we get there by the interaction of millions of

decisions made by buyers, sellers, and producers in their own self-interest (i.e., to make themselves better off).

• We call this the market mechanism:• Price directs resources.– The use of market prices and sales signal desired outputs

and resource allocations.– Will the market direct us to purchases a Prius?

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The Market

• Here is how the market answers the three basic questions:– WHAT to produce? Produce goods and services

that customers want.– HOW to produce? Profitably; produce an

acceptable good or service while keeping production costs low.

– FOR WHOM to produce? Produce for those who are both willing and able to pay for it.

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The Government

• At its extreme, government could dictate answers to all three questions.– Such decisions would be made by political leaders

and bureaucrats.– In many or most instances these decisions would not

mirror the individual desires of the people.– The FOR WHOM decision would lean heavily toward

their political base: goods for those the government favors and nothing for those not in favor.

– Remember this is by degree depending on type of government.

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A Mixture of Both

• The market is highly efficient in production of wanted goods and services.

• The government acts as a maintainer of balance in the economy.– Makes sure the market does not go to excesses

either in underproduction or overproduction.– Regulates production to ensure that goods and

services are safe.– Acts to redress excessive inequalities.

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What Mix Is Best?

• Few governments have relied exclusively on either pure market or pure government to manage the economy.

• Public opinion around the world indicates that the free-market economic system is best.

• The Index of Economic Freedom ranks nations according to economic freedom.– Market-dominated economies rank high;

government-run economies rank low.

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Market Failure and Government Failure

• If the market does not produce the mix of goods that society desires, market failure is said to occur.

• This provides an opening for government to step in.– If government can move us closer to the mix

society desires, the intervention is successful.• However, government can do the opposite, or

impose such high costs that the market simply ceases to produce. This is government failure.

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What Economics Is All About

Society and its leaders set the nation’s economic goals. Economics focuses on the means of achieving those goals.

Macroeconomics will focus on “big picture” economics while microeconomics will focus on economic interactions of consumers and producers.

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Invisible Hand- apolitical

Individuals rather than government should answer the 3 basic questions. What to produce How to produce For Whom to produce

But not just carte’ blanche Smith distinguished between self-interest and

greed! It is in our self-interest to have Rule of Law in

place – (property rights, patents, copyright, protection of workers, regulations, etc.)

Two things that allow economies to progress

This is an Adam Smith concept:

Division of labor

Specialization of labor

Economic Wants These wants vary from culture to culture. One culture’s ideas may not be the goals of another

cultures’. Ones we satisfy in the economic system. Ones that money will buy.

Economics Wants a concept underlying for all mankind. things we feel we need to have so we can

live the style of life we want to enjoy.

Economics depends on models

Models are used to predict behavior.

Models are simplified replica of real world

Empirical Evidence and data- material gathered by observation or experience. Usually a working hypothesis that is testable.

Enter Ceteris Paribus

Economic models do not relate to how people think, but how they behave.

What is Standard of Living?How can you calculate it?

How well off people are!

How well off are you?

Divide total production by population…GDP/population

If production is high and population is low…. “get more stuff.”

3rd world countries… high population/low production

http://www.photius.com/rankings/economy/gdp_per_capita_2013_0.html

Terms to KnowPositive economics = deals with facts “what is”

Normative economics = involves someone’s judgment “what ought to be”

Fallacy of Composition = it is not correct.. (the validity of a particular generalization for an individual or part does not necessarily ensure its accuracy for the group or the whole) I stand up… everyone stands up…

Post Hoc Fallacy = Be careful concluding that because event A precedes event B that A is the cause of B. Wear purple shirt to ballgame…win.. Need to wear purple shirt again to win. Rooster crows before dawn… rooster responsible for sunrise.

Rational Behavior = based on rational self-interest. People make different choices because their circumstances and available information differs.

Marginalism = extra or less (one more unit, one less unit)

Marginal Cost = additional cost over sunk cost paid for choosing an action

Marginal Benefit = benefit received from choosing an action

Talk today is about the federal debt and deficit

What is a deficit?

What is a debt?

In what area do you think government spends the greatest amount of revenue?

Why is it significant to address the debt ceiling?

Latest release on federal budget

Office of Management and Budget, Budget of the U.S. Government, FY2008,

2014 Budget Outlook

http://www.usfederalbudget.us/federal_budget_detail_fy13

Conventional wisdom accepts economic goals

Economic growthFull EmploymentEconomic EfficiencyPrice-level stabilityEconomic FreedomEquitable Distribution of Income –believed by

someEconomic SecurityBalance of trade

Any Questions?

Are you learning to think in Economic Terms?????

When you drive by a strip mall –

What do you see? What do you think? Does the economy

come to mind?