WHAT IS ECONOMICS? 1CHAPTER

WHY DO WE STUDY ECONOMICS??

WHY DO WE STUDY ECONOMICS??

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WHY STUDY ECONOMICS Among TOP TEN REASONS …..

Economists can supply it on demand.

You can talk about money without ever having to make any.

When you are in the unemployment line, at least you will know why you are there.

So that you know more than the most world leaders about what is actually going on.

CHAPTER 1: CHAPTER 1: WHAT IS WHAT IS ECONOMICSECONOMICS

CHAPTER 1: CHAPTER 1: WHAT IS WHAT IS ECONOMICSECONOMICS

Definition of Economics

-scarcity and choices

-economics

-Microeconomics

-Macroeconomics

Big Microeconomics Questions

-What, How, For Whom

-Factors of Production

Land, Labor, Capital and Entrepreneur

Economics: A Social Science

-positive statement

-normative statement

-Economic theory

-economic model

-ceteris paribus

Economic Way of Thinking

-Choice

-Tradeoff

-opportunity cost

-Marginal benefit and Marginal Cost

Slide #1

Definition of Economics

All economic questions arise because we want more than we can get.

Our inability to satisfy all our wants is called scarcity.

Because we face scarcity, we must make choices.

The choices we make depend on the incentives we face.

An incentive is a reward that encourages or a penalty that discourages an action.

Economics

We want more than what we get

leads SCARCITY

CHOICES

INCENTIVES

depends

Definition of Economics

Economics is the social science that studies the choices that individuals, businesses, governments, and societies make as they cope with scarcity and the incentives that influence and reconcile those choices.

Economics

Microeconomics Macroeconomics

Definition of Economics

MicroeconomicsMicroeconomics is the study of choices

made by individuals and businesses, and the influence of government on those choices.

MacroeconomicsMacroeconomics is the study of the effects

on the national and global economy of the choices that individuals, businesses, and governments make.

TWO BIG ECONOMIC QUESTIONS

CHOICES

1. FIRST BIG ECON QUESTION

What to produce How to Produce For whom to produce

2. SECOND BIG ECON QUESTION

Self Interest or Social Interest

Two Big Economic Questions

Two big questions summarize the scope of economics:

How do choices end up determining what, how, and for whom goods and services get produced?

When do choices made in the pursuit of self-interest also promote the social interest?

Two Big Economic Questions

What, How, and For Whom?Goods and services are the objects

that people value and produce to satisfy wants.

What?Given the resources or factors of

production available to us, we have to decide on what to produce

Two Big Economic Questions

How?Goods and services are produced by using

productive resources that economists call factors of production.

Factors of production are grouped into four categories:

Land Labor Capital Entrepreneurship

Factors of Production

The “gifts of nature” that we use to produce goods and services are land.

The work time and effort that people devote to producing goods and services is labor.

The quality of labor depends on human capital, which is the knowledge and skill that people obtain from education, on-the-job training, and work experience.

Two Big Economic Questions

The tools, instruments, machines, buildings, and other constructions that are used to produce goods and services are capital.

The human resource that organizes land, labor, and capital is entrepreneurship.

Two Big Economic Questions

For Whom?Who gets the goods and services depends

on the incomes that people earn. Land earns rent. Labor earns wages. Capital earns interest. Entrepreneurship earns profit.

Two Big Economic Questions

When is the Pursuit of Self-Interest in the Social Interest?Every day, 6.3 billion people make economic choices that result in “What,” “How,” and “For Whom” goods and services get produced.

Do we produce the right things in the right quantities? Do we use our factors of production in the best way? Do the goods and services go the those who benefit

most from them?

Two Big Economic Questions

You make choices that are in your self-interest—choices that you think are best for you.

Choices that are best for society as a whole are said to be in the social interest.

Is it possible that when each one of us makes choices that are in our self-interest, it also turns out that these choices are also in the social interest?

B. The second big question is “When is the pursuit of self-interest also in the social interest?”

1. People make choices in their own self-interest—they make choices they think are best for their own well-being.

a) The incentives surrounding an individual’s choice amongst available alternatives influence the tradeoffs involved in making that choice.

b) The choice made by one individual changes the incentives surrounding the tradeoffs facing other individuals, which influences their choices.

c) In this way, many self-interested individuals making choices in society will bring about change to the incentive surrounding all decisions to be made by individuals in the economy.

2. When people make self-interested choices that are the best for society, they make choices that are considered in the social interest.

a) In 1776 Adam Smith published The Wealth of Nations describing how a market based system can theoretically motivate self-interested individuals to make choices that promote the social interest.

b) Economists try to identify those characteristics of a market system that successfully promote self-interested individuals to make choices that coincide with the social interest

3. We can examine a number of current events to determine whether self- interested individuals made choices in the social interest:

a) Privatization: The fall of socialism and the rise of capitalism in Europe

b) Globalization: The local impact of growing international trade c) The “New” Economy: Workers adjusting to changing

technologies d) The post 9-11 economy: Terror changes vacation habits e) Corporate scandals: Preventing stealing by corporate officials

through lying f) HIV/AIDs: Poorest countries hit hardest but lack medicines g) Disappearing tropical rainforests: Lack of property rights

creates waste h) Water shortages: Consumers fail to pay the opportunity cost

of consumption i) Unemployment: Persistence in minority teenage

unemployment j) Deficits and Debt: Having future generations pay for today’s

servi

The Economic Way of Thinking

Choices and TradeoffsThe economic way of thinking places scarcity and

its implication, choice, at center stage.You can think about every choice as a tradeoff—

an exchange—giving up one thing to get something else.

The classic tradeoff is “guns versus butter.”“Guns” and “butter” stand for any two objects of

value.

(give up the highest value alternative)

SCARCITYSCARCITY

CHOICESCHOICES

TRADEOFFTRADEOFF

OPPORTUNITY COSTOPPORTUNITY COST

The Economic Way of Thinking

Opportunity CostThinking about a choice as a tradeoff

emphasizes cost as an opportunity forgone.

The highest-valued alternative that we give up to get something is the opportunity cost of the activity chosen.

The Economic Way of Thinking

Choosing at the MarginPeople make choices at the margin, which

means that they evaluate the consequences of making incremental changes in the use of their resources.

The benefit from pursuing an incremental increase in an activity is its marginal benefit.

The opportunity cost of pursuing an incremental increase in an activity is its marginal cost.

Marginal Benefit vs Marginal Cost

Marginal Benefit: the benefit arises from an increase in activity

i.e- Study three nights in a week GPA is 3.0 Study 4 nights in a week GPA is 3.5 Marginal Benefit = 3.5- 3.0 =0.5 Marginal cost: The cost of an increase in activity Marginal cost: cost of additional night not watching

TV DECISION: MB> MC STUDY MB< MC DON’T STUDY

Marginal Benefits vs. Marginal Costs

MB >MC Incentive to continue activity

MB < MC Incentive to discontinue activity

Economics: A Social Science

Social scienceEconomics is a social science.Economists distinguish between two types of

statement: What is—positive statements What ought to be—normative statements

A positive statement can be tested by checking it against facts

A normative statement cannot be tested.

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3. ECONOMIC METHODOLOGY

Relying on scientific method to view at things. Consisting of the following elements:- Observation of facts- Hypothesis formulation- Testing- Acceptance/rejection: Modification- Continued testing against facts

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3. ECONOMIC METHODOLOGY

Continued testing against facts

Accumulation of favorable results =THEORY

Accepted theory = LAW/PRINCIPLESCombination of law & principles = MODELS (Simplified version of relationships)

All these enable us to understand, explain & predict economic outcomes

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3. ECONOMIC METHODOLOGY

Theoretical economics- Develop models of behavior of economic agents- Relevant and useful information- Establishing cause-effect

testing discovering theories & principles use in analytical economics

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3. ECONOMIC METHODOLOGY

Terminology

- Hypothesis – Needs initial testing

- Theories – Tested, need more testing

- Law/principle – accepted theory, provided

strong predictive accuracy

- Model – Combines principles into simplified

representation of reality

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3. ECONOMIC METHODOLOGY

Generalizations

- Theories, laws & principles are

generalizations to economic behavior

- Imprecise due to economic diversity

- Economic principles are expressed as the

tendencies of average economic agents

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3. ECONOMIC METHODOLOGY

Other-things-equal assumption

- Ceteris paribus

- Enable generalizations

- All variables, except the one under analysis, are held constant

Obstacles and Pitfalls in Economics There are several obstacles that can

affect economic analysis. • Confusion can result when too many

things change and so it might not be possible to understand what caused

what. So in their models economists change one factor at a time to isolate its effects using the ceteris paribus

assumption. Ceteris paribus is a Latin phrase that means “other things being equal.”

Economists cannot easily do experiments and most economic behavior has many simultaneous causes.

To isolate the effect of interest, economists use the logical device called ceteris Paribus or “other things being equal.

Economists try to isolate cause-and-effect relationship by changing only one variable at a time, holding all other relevant factors unchanged.

• The fallacy of composition is the (false) statement that what is true for the parts is also true for the whole, or what

is true for the whole is also true for the parts. For example, one person can walk through the door into the class,

so the entire 30-person class can simultaneously walk through the door.

• The post hoc fallacy (from the Latin phrase, post hoc, ergo propter hoc, which means “after this, therefore because of

this”) is the error of reasoning that a first event causes a second event because the first event occurred before the

second. For instance, claiming that you are delivering an economics lecture because the room first filled with

students is a post hoc fallacy.

Agreement and Disagreement Among Economists Economists tend to agree on positive statements,

though they might disagree on normative statements.

Economists are often accused of contradicting each other.

In contrast to the popular image, economists find much common ground on a wide range of issues.

(Page X lists twelve different economic propositions that at least 70 percent of all economists polled will agree upon.)

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