Transcript Title

Chapter 1
What Is
Economics?
Nariman Behravesh
Edwin Mansfield
What do economists study?
MONEY!
What is
Money?
What is Money?
Money has no value other than what we give
it—it is a socially acceptable:
• Measure of Value
•Means of Transaction
•Store of Value
Numismatics
is the study of
money
So what is
Economics?
The
Fundamental
Economic
Problem
Unlimited
Wants
Scarce
Resources
People Face Tradeoffs.
“There is no such thing as a free lunch!”
tinstaafl
What do economists study?
How people
make
choices.
The Basic Principles of
Economics
The 6 Basic Principles of Economics
1. Because of Scarcity, people have to make Choices
2. Choices have Costs
3. Profit Matters.
4. People are Rational
5. People make decisions at the Margin
6. Trade is Good.
Principle #:1 SCARCITY
Because time is limited, people face trade-offs
To get something, we usually have to give up
something else:
– Guns v. Butter
– Food v. Clothing
– Party v. Study
Making CHOICES requires trading
off one goal against another.
Principle #2: OPPORTUNITY COST
• All decisions have consequences.
– Whether to go to college or to work?
– Whether to study or go out on a date?
– Whether to go to class or sleep in?
The opportunity cost of an item is what
you gave up, it is the NEXT BEST
ALTERNATIVE.
Principle #3: PROFIT MATTERS
• People seek to maximize Profit
• Profit is not simply measured in monetary
terms; it is where benefit is greater than cost
• Imperfect Information
Changes in costs or benefits
motivate people to respond to
maximize their benefit and
minimize their costs.
Principle #4: RATIONAL BEHAVIOR
• Rational Thinking involves making decisions
based on long-term cost-benefit analysis rather
than short-term gain.
• Giving up something NOW in expectation of
greater gain in the future is called an
INVESTMENT
People make decisions by thinking of
the future costs and benefits.
Principle #5: MARGINAL THINKING
• Rational People Think at the Margin.
• Decisions are NOT all or nothing actions
• Marginal changes are incremental adjustments
to an existing plan of action based on longterm analysis.
People make decisions by comparing
costs and benefits at the margin.
Principle #6: TRADE IS GOOD
• People gain from their ability to trade with
one another.
• Both sides in a trade gain—it is not a zero
sum.
• Trade allows people to specialize in what
they do best.
Trade Can Make Everyone Better Off.
The Basic Principles of Economics
1. Scarcity
-Choices: “There is no such thing as a free lunch.”
2. Opportunity cost
-What you give up to get something.
1. People try to maximize their Profit.
-All decisions have Risks.
2. People are Rational
-They make Long-term investments based on Cost/Benefit
Analysis
3. People make decisions at the Margin
-Don’t look back, always look forward
5. Trade is a Win/Win situation.
How do we make the
most Efficient Use of
The
Fundamental
our Scarce Resources to
Maximize the
Economic
Satisfaction of our
Problem
Unlimited Wants?
MSUW=EUSR
MOST=LEAST
ECONOMICS
IS A
SOCIAL
SCIENCE
ECONOMICS
IS A SCIENCE
POSITIVE ECONOMICS
Scientific Method
Hypothesis Testing
Theory
Induction
Deduction
ECONOMIC METHODOLOGY
Theoretical Economics
Theories
Facts
PITFALLS TO
OBJECTIVE THINKING
Bias
Definition
Fallacy of Composition
Post Hoc (Causation)
SOCIAL SCIENCE
MACROECONOMICS...
MACROECONOMICS...
MICROECONOMICS...
NORMATIVE ECONOMICS
Policy Economics
Theoretical Economics
Theories
Facts
Positive and Normative
Economics
• Barak Obama is President of
the United States
• Not everyone in the United
States can afford health
insurance.
• Positive Statements:
• Barak Obama is the best/worst
President of the United States
ever.
• The government ought to
provide affordable health care
for everyone
• Normative Statements:
– Capable of being verified or
refuted by resorting to fact
or further investigation
– Contains a value judgement
which cannot be verified by
resort to investigation or
research
POSITIVE and NORMATIVE
NORMATIVE
Policy
POSITIVE
Facts
Basic questions of production
1.
2.
3.
4.
What to produce?
How to produce?
Who gets it?
How do we get MORE?
Resources
(Factors of Production)
• Resources used to make goods and services
which provide satisfaction:
– LAND
• “Gifts”: All natural resources
– LABOR
• “Sweat”: Human effort that is compensated
– CAPITAL
• “Tools”: Human and Physical
ECONOMIC MODELS
SIMPLIFY OUR ALTERNATIVES
CLARIFY OUR CHOICES
Production Possibility Frontiers
• Show the different combinations of goods and services that
can be produced with a given amount of resources
• No ‘ideal’ point on the curve
• Any point inside the curve – suggests resources are not
being utilized efficiently
• Any point outside the curve – not attainable with the
current level of resources
• The curve can shift through changes in resources,
technology, and trade
• Useful to show opportunity cost and economic growth
John’s Possibilities
Given: $20 cash
Pizzas
$2 pizza
Burritos
$1 burrito
0
20
1
18
2
16
3
14
4
12
5
10
6
8
7
6
8
4
9
2
10
0
John’s Production Possibilities
Pizzas
10
9
8
7
6
5
4
3
2
1
Burritos
In this case, we have a straight line because opportunity
costs are constant; his resource is perfectly interchangeable
2
4
6
8
10
12
14
16
18
20
Time Constraints
• Your choices in a
typical 24 hour
weekday:
–
–
–
–
8 hours Sleeping
8 hours Staring
8 hours Studying
8 hours Partying
• Your Opportunity
Cost is ALWAYS the
next best alternative
YOUR POSSIBILITIES
Production Possibility Frontier
STUDY
Production possibilities frontier represents an
economy working at Full Employment. Any
point on the curve is Efficient.
Any point inside the line
indicates an Underutilization
or Unemployment of resources
and is Inefficient.
PARTY
The Law of Increasing Cost
Resources are not
perfectly
interchangeable
Production Possibility Frontier
STUDY
When an economy grows,
the production possibilities
curve shifts to the right.
The curve shifts due to
changes in resources,
technology, or trade.
PARTY
When a country’s production
capacity decreases, the
curve shifts to the left.
STUDY
PARTY
Production Possibility Frontiers
Capital Goods
Ym
Yo
A
it devotes all
Assume
a country
IfIf
the
country
is
resources
to its
capital
If it reallocates
can
produce
at
point
A ontwo
the
resources
round
goods
it (moving
could
types
of
the
PPF
A to B) it can
PPF
Itfrom
can
produce
agoods
maximum
produce
more
consumer
with
resources
of Ym.its
produce
the
goods
but only
at the
– capital
goods
combination
of
expense
of fewer
If it devotes
allcapital
its Yo
and
consumer
goods.
Thegoods
opportunity
resources
to
capital
and
goods
cost
of
producing
anitextra
consumer goods
Xo– consumer
Xo
X1 consumer goods
could
produce a
is
Yo
–
Y1
capital goods.
goods
maximum of Xm
B
Y1
Xo
X1 Xm Consumer Goods
Production Possibility
Frontiers
An Economy
Capital Goods
can grow
through:
C
Y1
Yo
.
A
•Increased
Resources
•Technology
•Trade
B
Xo X1
Consumer Goods
The Law of Increasing Cost