Section 1

Thinking like an economist

Scarcity: limited nature of society’s resources

Economics: the study of how society manages its scarce resources

An economic model is a simplified version of reality used to analyze real world economic situations.

Why is economics important?

Economy: one who manages household

Economics and Individual Decision

People (buyers and sellers) interact in markets. When studying their interactions we apply 3

important ideas:

1) People are rational Individuals and firms use all available information

as they act to achieve their goals. We act if the benefits of our actions outweigh the

costs.

Economics and Individual Decision

People (buyers and sellers) interact in markets. When studying their interactions we apply 3

important ideas:

2) People respond to incentives Moral incentives Social incentives Economic incentives

Economics and Individual Decision

People (buyers and sellers) interact in markets. When studying their interactions we apply 3

important ideas:

3) Optimal decisions are made at the margin Marginal decision vs. all or nothing decisions Optimal decision is to continue any activity up to

the point where the marginal benefit equals the marginal cost.

Economics is the study of how human beings coordinate their wants and desires.

1) What and how much to produce?– Butter or guns?

2) How to produce?– Locally or offshore?

3) Who should consume what is produced?– Income distribution

Planned vs. Market Economics

The fundamental problem

Efficiency and Equity

Productive efficiency– When production takes place at the lowest

possible cost

Allocative efficiency– When production reflects consumer preferences

Equity– The fair distribution of economic benefits

Is it a science? Economics uses scientific methods

– Using assumptions we develop economic models

– we collect data– using the data we test hypotheses– we then revise our models if necessary.

ECONOMICS

Microeconomics vs Macroeconomics– Microeconomics: the study of how households and firms

make decisions– Macroeconomics: The study of economy-wide phenomena

(inflation, unemployment…)

Positive statement vs Normative statement– Positive: Claims that attempt to describe the world as it is.– Normative: Claims that attempt to prescribe how the world

should be.

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Positive or Normative Statements?

An increase in the minimum wage will cause a decrease in employment among the least-skilled.

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Positive or Normative Statements?

Higher federal budget deficits will cause interest rates to increase.

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Positive or Normative Statements?

The income gains from a higher minimum wage are worth more than any slight reductions in employment.

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??Positive or Normative Statements?

State governments should be allowed to collect from tobacco companies the costs of treating smoking-related illnesses among the poor.

Why economists disagree?

Different values different normative views they may disagree on theories about how the world works

Problems

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