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An Introduction to Economics
Lesson 1

 

What is Economics?

1. Humans are plagued with wants:

  • Materialistic wants - car, house, clothes, etc
  • Social recognition
  • Good grades

Goods are scarce because desire for goods are greater than availability in nature.

Blue Arrow Scarcity causes
  1. Economics
  2. Choose among available alternatives
  3. Limits material wants

Economics: Study of choice under conditions of scarcity

2. Scarcity is not poverty!

  • No poverty implies a basic level of need has been met
  • No scarcity implies all wants for goods are fully satisfied
Blue Arrow Poverty may be eliminated, but scarcity will always exists

3. Scarcity causes rationing. Who gets to consume the good?

  1. Socialist countries - first come, first serve. Who stands in line first gets the good.
  2. Market economy - prices ration goods and resources

4. Scarcity causes competition

  • Every country has competition
  • Changing the rationing method only changes the form of competition

The Economic Way of Thinking

1. Using scarce resources to produce a good always have a cost.

  • Opportunity cost - the highest valued alternative that must be sacrificed in choosing a good.
    • Ensures we use resources for the best uses
    • Are subjective, because a good's value is subjective; individual's preferences matter!
    • Includes the value of time.
    • The value of purchasing power spent.
    • "No free lunch"
  • Examples:
    1. Farm land outside of city limits is used to grow corn. The opportunity cost is the next best alternative use of this land, which could be a new subdivision of housing.
    2. You received free tickets to a concert. Your opportunity costs is travel costs and time
    3. Free education, free medical care, free housing, etc.
    4. College education - if opportunity cost of college rises (e.g. employers paying higher salaries), then one will be less likely to attend college.
  • Note - even though going to college is expensive, students expect to recoup these costs from higher lifetime incomes.
Example: The opportunity cost of college:
Opport. cost Tuition, books, room, & board $10,000 per year
Opport. cost Not working (forgone earnings) $20,000 per year
  Total $30,000

2. Individuals are rational.

  • Economizing behavior - gaining a specific benefit for the least possible cost.
  • Goods - person receives satisfaction to consume a good
    • Utility - satisfaction from consuming a good
  • Bads - person receives displeasure from consuming a good
    • Disutility - person receives a displeasure from a good
    • Some peple do not smoke cigarettes
    • Some people do not want to be sick
  • Example: Rational consumers will buy from Wal-mart if both choices take the same time and transportation costs.
  Wal-Mart Albertson's
2-liter of Pepsi $0.99 $1.09

3. Cost-Benefits Analysis

  • As the benefits increase for choosing a product, a person more likely chooses that product
  • As the costs increase for choosing a product, a person less likely chooses that product

        Example: "Law of Demand"
        As the price of computers Red Arrow, consumers buy Green Arrow

4. Decisions are based on marginal costs and marginal benefits

     marginal - "change in number of units,"  "additional units," or "extra units"
     Example:

Bank Account Balance Change / Marginal
Deposited $100 $100 + $100
Bought pizza for $10 $90 - $10
Cash gift of $50 $140 + $50
  • Example - you are thirsty for a Pepsi
    • You are willing to pay $3 for a Pepsi, Marginal Benefit (MB)
      • Pepsi costs $1, Marginal Cost (MC)
      • Since MB > MC, you buy the Pepsi
    • You are still thirsty and would pay $1 for a Pepsi
      • Pepsi costs $1
      • Since MB = MC, you pay for the Pepsi
    • You are not so thirsty so you value a third Pepsi for $0.5
      • Pepsi costs $1
      • Since MB < MC, you do not buy the Pepsi
  • When MB = MC, you maximize the benefits relative to costs

5. Information is scarce, therefore decisions are uncertain

  • Information has costs
  • Example: Buying a used car. How much time to spend calling, looking, and inspecting?

6. Economic events often cause secondary events to occur over time

Example: HSU constructs new apartment complexes

  • Direct effect: More students live on campus; more revenue for HSU.
  • Secondary effect: Off-campus apartment rents could decrease and quality could increase.(More competition for students). Traffic flows can change.

Theories, Principals, and Models

1. The world is too complex to describe. Thus, we simplify the world using the scientific method

  • Scientific method:
    1. Observe economic behavior (collect data)
      • Stock price, production level, etc.
    2. Formulate a reason why it acts the way it does
      • Called a hypothesis
    3. Compare hypothesis to reality
    4. Reject, accept, or modify hypothesis
    5. If hypothesis survives, then it becomes a law or principal

2. Economic theory - to systematically arrange, interpret, and generalize upon the facts

  • Economics generalizes and predicts behavior of individuals and institutions
    • “Laws”
    • “Principles”         All these words mean
    • “Theories”             the same thing.
    • “Models”

3. Ceteris paribus

  • Latin term
  • "other things constant"
    • Qd = f(PCoca-cola, PPepsi, Income, Tastes/preferences, etc.)
      • Qd: Quantity demanded of coca-cola.
      • PCoca-cola: Price of coca-cola.
      • PPepsi: Price of Pepsi.
  • How does the quantity of Coca-Cola change, if consumer income changes?
  • Other things must be held constant. Then exact relationship can be determined.
  • In reality all other factors do change, so it is difficult to determine exact relationships.
    • Economics is a social science!
    • Not like physics or chemistry, where one variable can be changed at a time in a laboratory.

4. Macro and microeconomics

  • Macroeconomics - study the whole economy of a country in broad sectors
    • Macro means “large” or “aggregates”
    • Aggregate - combine together many units
    • Four sectors: Government, households, businesses, and international
    • Examples:
      • Inflation
      • Unemployment
      • Government debt
      • Total consumer expenditures
      • Trade deficits
  • Microeconomics - study specific economic units
    • Micro means “small”
    • Examples:
      • An individual
      • A firm
      • A market
  • Macro and micro can overlap
    1. Labor market
      • Supply and demand for labor
    2. Housing market
      • Supply and demand for houses
      • Currently having a mortgage crisis
    3. International exchange rates
      • Trade / exchange currencies, products, and services

5. Positive versus normative economics

  1. Positive Economics - the scientific study of economic relationships
    • Either is true or false
    • Example:
      • Today is 950
      • Price of Pepsi increasesBlue Arrow quantity demanded decreases, (ceteris paribus)
  2. Normative Economics - judgments about "what ought to be" in economic matters
    • Neither true or false
    • Examples:
      • Today is hot!
      • Pepsi is expensive!
      • The unemployment rate is too high.
      • Trade deficit is too high.
      • Economists usually agree on the theories (positive), but disagree on policy prescriptions (normative).

Pitfalls in Economic Thinking

Economists have difficulties, when they study economic problems.
  1. Bias
    • Economists are people with emotions
    • Different views on:
      • Business profits
      • Government regulation
  2. Economics uses different definitions
    • Investment
      • Common definition - investment is buying stocks and bonds
      • Economists - investment in machiners, equipment, and buildings
  3. Fallacy of Composition - the erroneous view that what is true for the individual (or the part) will also be true for the group (or the whole)
    • Example:
      • Part - the government gives me $20,000. I will benefit.
      • Whole - the government gave everyone $20,000.
    • Nobody benefits! All prices in the economy increases and will on average cost $20,000 more for everyone. (Goods and services produced in the economy does not change)!
  4. Cause-and-effect relationships
    • Statistically related variables do not determine cause and effect
      • Linear regression
      • Correlation
    • Example: Positive relationship between grades and student salaries
      1. Do high grades cause high salaries? Maybe, if firms want the best students and pay more to get them.
      2. Do students' future salaries cause high grades? Maybe, if students know firms only hire the best, then they study more.
      3. A third factor - intelligence? Maybe, if smarter students get higher grades and higher paying jobs.

A Budget Line

  • Budget Line - shows how much a consumer can buy given his limited income
    • A microeconomics example
  • People have limited incomes, but are insatiable
    • Insatiable - a person always wants more and is never satisified
  • Example - The easy way
    • A person's income is $1,000
    • Price of pizza is $10
    • Price of soda is $1
  • Math:
    • If a consumer spends all his money on pizzas, then he can buy 100 pizzas
    • If a consumer spends all his money on sodas, then he can buy 1,000 sodas

A budget line

  • Draw a line connecting the two points
  • If on the line, the consumer is spending all of his income on pizzas and beer
    • Opportunity cost is consumer changes buying habits by moving along the line
    • He has to give up pizza in order to buy more sodas
  • If at Point A, the consumer is not spending all of his income
  • Point B is unattainable at current income
  • If a person's income increases, then budget line shifts outward evenly
  • Example - consumer now has $1,100 in income
  • Math:
    • If a consumer spends all his money on pizzas, then he can buy 110 pizzas
    • If a consumer spends all his money on sodas, then he can buy 1,100 sodas
  • Shown below in graph

A budget line shifts

Note - if a price changes, the slope of the line changes

Production Possibilities Curve (PPC)

  1. Production Possibilities Curve (PPC) - shows how much goods and services can be produced for society given its limited resources.
    • Macroeconomics example
    • Only two products are produced in this society
      • Bread and Milk
    • Resources are used efficiently
      • Resources - also called inputs or factors of production
        • Land - natural resources such as minerals, forests, water, and land
        • Capital is machines, equipment, buildings, tools
        • Labor - physical and mental abilities of workers
        • Entrepreneur - a person who seeks profits by introducing new products or lowering production costs.
          • Takes the risk of using resources to produce goods and services
          • Makes strategic decisions
          • Is an innovator
            • Samuel M. Walton - founded Wal-Mart
            • Ted Turner - WTBS, CNN, TNT, bought Atlanta Braves
            • William "Bill" Gates III - Microsoft
    • No technological progress.
PPC for U.S.
Milk
(in thousands)
A Production Possibilities Curve

Bread
(in thousands)
  • Point X - indicates society is not using resources efficiently, e.g. recession.
    • Unemployment - not all workers are working
    • Within the interior
    • Productive inefficiency
  • Point Y - beyond the resources for society to produce.
  • Point A - The U.S. produces 5 (thousand) milk and 0 Bread.
  • How to get to Point B from Point A? - The U.S. wants to produce more bread! The U.S. produces 1 (thousand) less bottles of milk and 4 (thousand) more loaves of bread.
    • Opportunity costs of moving from Pt A to Pt B.
      • Tangent point
    • Must switch resources from milk to bread production.
    • Law of Increasing Opportunity Cost - as more resources are switched into bread production, the cost of that industry rises
Blue Arrow

All points, A, B, and C are production efficient.

Which point people consume is a normative question.

Boundary reflect scarcity

  • PPC is straight line if all resources are perfect substitutes.
    • Example: Land is input to farms and houses.
    • Reality - land quality varies.
    • As we approach an extreme of all farms or all houses, then losses occur because of land quality.
      • Some land is better suited for farms while other land is more suitable for houses.
PPC for U.S.
Farms Convex vs. straight line PPC

Houses

 

Blue Arrow The shape of the PPC - some resources are better suited for the production of one good, while other resources are better suited for producing the other good.

2. Shifting the Production Possibilities Curve Outward

  • Economic growth - economy produces more goods and services over time
  • Economy's resource base increases
    • More labor
    • Investment:
      • More machines
      • More education (human capital)
  • Technology progress
    • Invention / Innovation - creation of a new product or process
    • Entrepreneur creates new products
  • "Improved legal structure"
    • Well-defined property rights
    • Patents - financial reward for new products
      • Exclusive right to produce for 17 years
    • Laws that allow corporations to form - allows mass production
  • Work harder and give up leisure time

3. Technology can influence one or both industries

Technology Impacts on Good Technology Impacts Both Goods
Bread Bread
Shifting PPC outward Shifting PPC outward
Cellphones Cellphones

4. Shifting the Production Possibilities Curve Inward.

  • War
  • Natural disaster
  • Poor legal structure
  • The opposite causes PPC to shift outward

5. Example: Investing in machines

  • In Year 2008, both China and U.S. have same PPC
  • China produces more machines at Point A while U.S. produces more bread at Point C
  • In Year 2009, both economies grow, because they have more machines (i.e. capital). PPC curves shift outward.
  • However, China produces more machines, therefore its PPC shifts more than the U.S.' s PPC.
China U.S.
Machines Machines
Shifting PPC outward Shifting PPC outward
Bread Bread

Why Study Economics?

  1. The modern world has been shaped by economists
    • Adam Smith - Father of Economics
    • David Ricardo - Comparative advantage and free trade
    • Karl Marx - Communism and influenced Soviet Union, China, Cuba, North Korea, and North Vietnam
    • John Maynard Keynes - use government spending and taxes to influence economy
  2. World leaders receive advice from economists
    • Taxation
    • Government spending
    • Poverty
    • Pollution
    • Discrimination, etc.
  3. Make well-informed decisions, when voting for politicians
    • For example
      • Increasing the legal minimum wage
      • What is the effect of this?
      • Could result in higher unemployment
  4. Could help businessmen make better decisions.
    • For example
      • If the central bank increases the money supply, what is the impact on the financial markets?
    • Note: Economics looks at a problem from a social viewpoint and not a personal one. Economics does not teach you how to make money, but this knowledge could help you run a business.

Terminology

  • economics
  • opportunity cost
  • economizing behavior
  • utility
  • marginal analysis
  • scientific method
  • laws / principles / theories / models
  • ceteris paribus
  • macroeconomics
  • aggregate
  • microeconomics
  • positive economics
  • normative economics
  • Fallacy of Composition
  • budget line
  • production possibilities curve (PPC)
  • resources
  • land
  • labor
  • capital
  • entrepreneur
  • investment
  • economic growth
 

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