UNIT I – Basic Economic Concepts

1. UNIT I – Basic Economic Concepts Chapters – Introduction, 1, and 2

2. Definition(?) Other TEXT Examples Social science concerned with using scarce resources to obtain the maximum satisfaction of the unlimited material wants of society. The science that explains the choices we make and how those choices change as we cope with scarcity. The study of people producing and exchanging to get the goods and services they want.

3. Definition(?) Our working definition -- SOCIAL SCIENCE CONCERNED WITH THE WAY SOCIETY CHOOSES TO EMPLOY ITS LIMITED RESOURCES WHICH HAVE ALTERNATIVE USES TO PRODUCE GOODS AND SERVICES FOR PRESENT AND FUTURE CONSUMPTION.

4. Definition(?) “The study of mankind in the ordinary business of life.” -- Alfred Marshall Oikos / Nomos-- comes from these two Greek words for “one who managesa household.” The science which makes common sense difficult.

5. Economics – Social Science analyze human behavior, not physical science (no atoms, electrons, moles, quantum theory)

6. Economic Analysis Many decisions -- economic underpinnings Framework of analysis -- economic way of thinking

7. Economic Analysis • Why study economics??? • Learning its tenents will help you understand the world

8. Economic Analysis Why study economics??? • Some questions to think about ... • Why are apartments so hard to find in New York City? • Why do airlines charge less for a round-trip ticket if the traveler stays over a Saturday night? • Why is (put famous actor/actress here) paid so much to star in TV/Film? • Why are living standards so meager in many African countries? • Why do some countries have high rates of inflation while others have stable prices? • Why are jobs easy to find in some years and hard to find in others?

9. Economic Analysis Why study economics??? • You will be an astute participant in the economy • Many “life” decisions have economic underpinnings • Job, spending, investing, decisions w/in your career

10. Economic Analysis Why study economics??? • You will understand potential limits of governmental economic policy • As a voter, you help choose the policies that guide the allocation of society’s resources. • Examples: • What are the burdens associated with alternative forms of taxation? • What are the effects of free trade with other countries? • What is the best way to protect the environment? • How does the budget deficit effect the economy?

11. The Economic Problem: Making Choices • “The difficulty in life is the choice.” George Moore, The Bending of the Bough, Act IV • Basic Terms • Resources-- Things used to produce other things to satisfy people’s wants • Wants -- What people would buy if their incomes were unlimited

12. The Economic Problem: Making Choices Scarcity Problem -- Not all wants can be realized • Why? • Resources are limited • Wants are unlimited • Central economic idea:

13. The Economic Problem: Making Choices • Due to scarcity, people are forced into making choicesbased on their limited resources • Framework = economic way of thinking • Remember-- To be scarce, the item: • Must be limited • Desirable • Have a price • Example: • Scarcity not always about money

14. Economic Disciplines • Two types: • Microeconomics • Decisions undertaken by individuals (or households) / by firms • Microscope -- focus on small elements of economy • New taxes on a specific industry or product • Wages (up) by an effective union strike

15. Economic Disciplines • Two types: • Macroeconomics • Behavior of the economy as a whole • Rate of inflation • Economy wide unemployment • Yearly growth in output of goods / services in U.S.

16. People Behave Rationally • Assumption: • Individuals act as if motivated by self-interest, respond predictably to gain • “... it is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own interest.” -- Adam Smith An Inquiry into the Nature and Causes of the Wealth of Nations

17. People Behave Rationally • Assumption: • People will look out for their self-interest in a rational manner • Example: • Explain the anomaly concerning the makeup of U.S. population.

18. People Behave Rationally • Assumption: • People do not intentionally make decisions that leave them worse off • Economics: • Does not involve itself in thought processes • Looks at what people actually do in life with their limited resources • Example: • Why can’t you sometimes teach an old dog new tricks?

19. People Behave Rationally • Incentives • Rewards for engaging in a particular activity • One will react to incentives after making rational choices involving balancing costs and benefits

20. People Behave Rationally • Self-interest • Not always measured in the goal of attaining more dollars and cents • Self-interest goals may relate to: • prestigelove • helping othersfriendship • powercreating works of art • Example: • How valuable is your gift giving? • Charitable acts -- self-interest?

21. Unique Terms / Ideas • Models, or Theories • Simplified representations of the real world • Used as basis for predictions or explanations • Important: • -- no economic model complete -- • -- can not capture every detail -- • Example: • I35W, I35, I80, I15, I99, I55, I73, Southwest on Jamboree, Lt. on San Joaquin Hills Rd., Lt. Big Canyon Rd., Rt. Burning Tree Rd. • Focus on relevance to problem / omit what is not

22. Unique Terms / Ideas • Ceteris Paribus Assumption • Assumption: • Nothing changes except factor or factors being studied • “other things being equal” • Example: • Lower prices cause people to buy more. Other factors beyond price influence buying decisions • IncomeReligious beliefs • SeasonTastes • Custom, etc.

23. Unique Terms / Ideas • Positive Economics • Analysis limited to making either purely descriptive statements or scientific predictions. • No subjective or moral judgments. • A statement of “what is” • “If A, then B.”

24. Unique Terms / Ideas • Normative Economics • Analysis involving value judgments about economic policies • Relates to whether things are good or bad • Statement of “what ought to be”

25. Unique Terms / Ideas • Positive and Normative Economics • Example: • Positive economic statement: • “If the price of gas rises, people will buy less.” • Normativeeconomic statement: • “So, we should not allowthe price to go up.” • We have expressed a value judgment

26. Tools of Production • Production • Conversion of resources to products -- used in consumption

27. Tools of Production Five Factors of Production 1. Land (natural resource) encompasses non human gifts of nature Example: timber, water, mineral deposits, climate

28. Tools of Production Five Factors of Production 2. Labor Productive contributions of humans Involves both mental and physical activities Example: steelworkers, teachers, computer programmers

29. Tools of Production Bloomington, Indiana Five Factors of Production 3.Physical capital Manufactured resources Includes: buildings, machines, equipment, improvements to land used for production Example: Pizza oven, irrigation ditches, Best Buy Campus

30. Tools of Production Five Factors of Production 4. Human capital Accumulated training / education Whenever skills increase, human capital improves

31. Tools of Production Five Factors of Production 5.Entrepreneurship Human resources -- perform functions of raising capital, organizing, managing, assembling other factors of production Risk taker

32. Tools of Production • Goods • Physical objects that are produced • Example: • Bike, GI Joe with the Kung Fu Grip, surfboard • Capital goods • Nonconsumerablegoods used to make other goods

33. Tools of Production • Service • Mental / physical labor purchased by consumers • Example: • Sales, laundry, ski waxing, psychological counseling

34. Big Economic Questions • Resource allocation • By answering economic questions, scarce resources allocated • What? • How? • For Whom?

35. Big Economic Questions • What??? • A society must determine how much of each of the many possible goods and services it will make, and when they will be produced. Will we produce frozen pizzas or shirts today? A few high-quality shirts or many cheap shirts? Will we use scarce resources to produce many consumption goods (like frozen pizzas)? Or will we produce fewer consumption goods and more capital goods (like pizza-making machines), which will boost production and consumption tomorrow.

36. Big Economic Questions • How??? • A society must determine who will do the production with what resources, and what production techniques they will use. Who farms and who teaches? Is electricity generated from oil, from coal, or from nuclear power? With much air pollution or with little?

37. Big Economic Questions • For Whom??? • One key task for any society is to decide who gets to eat the fruit of the economy’s efforts. Or, to put it formally, how is the national product divided among different households? Are many people poor or a few rich? Do high incomes go to managers or workers or landlords? Do the sick or elderly eat well, or are they left to fend for themselves?

38. Cost In economics, cost is always a forgone opportunity. Opportunity cost best alternative given up in order to satisfy wants Remember: opportunity cost is the next-highest- ranked alternative, not all alternatives

39. Cost of Something is What You Give up to Get It Examples: The opportunity cost of … … growing carrots for the gardener, is the alternative crop that might have been grown instead (potatoes, tomatoes, pumpkins, etc.). … seeing the latest Lincoln film is not just the price of the ticket, but the value of the time you spend in the AMC Rosedale theater. Question: “The best things in life are free.” True?

40. Cost Explicit Cost • Costs that must be paid • Fixed costs • Example: Rent, taxes, tuition

41. Cost Implicit Cost Not paid out of pocket so not explicitly calculated Opportunity cost of a decision

42. Marginal (cost vs. benefit) Analysis Marginal analysis Extra or additional benefits of a decision Cost / Benefit analysis Decision making comes down to benefits vs. costs If I do a little more of “this” what is the cost of “that.” Remember: People will only choose actions which will bring the greater benefits over costs.

43. Marginal (cost vs. benefit) Analysis

44. Rational People THINK at the Margin A person is rational if she systematically and purposefully does the best she can to achieve her objectives. Many decisions are not “all or nothing,”but involve marginal changes– incremental adjustments to an existing plan. Evaluating the costs and benefits of marginal changes is an important part of decision making

45. Rational People THINK at the Margin Examples: A student considers whether to go to college for an additional year, comparing the fees & foregone wages to the extra income he could earn with an extra year of education. A firm considers whether to increase output, comparing the cost of the needed labor and materials to the extra revenue.

46. People Respond to Incentives • incentive: something that induces a person to act, i.e. the prospect of a reward or punishment. • Rational people respond to incentives because they make decisions by comparing costs and benefits. Examples: • In response to higher gas prices, sales of “hybrid” cars (e.g., Toyota Prius) rise. • In response to higher cigarette taxes, teen smoking falls.

47. A C T I V E L E A R N I N G 1: Exercise You are selling your 1996 Mustang. You have already spent $1000 on repairs. At the last minute, the transmission dies. You can pay $600 to have it repaired, or sell the car “as is.” In each of the following scenarios, should you have the transmission repaired? A.Blue book value is $6500 if transmission works, $5700 if it doesn’t B.Blue book value is $6000 if transmission works, $5500 if it doesn’t

48. A C T I V E L E A R N I N G 1: Answers Cost of fixing transmission = $600 A.Blue book value is $6500 if transmission works, $5700 if it doesn’t Benefit of fixing the transmission = $800 ($6500 – 5700). It’s worthwhile to have the transmission fixed. B.Blue book value is $6000 if transmission works, $5500 if it doesn’t Benefit of fixing the transmission is only $500. Paying $600 to fix transmission is not worthwhile.

49. A C T I V E L E A R N I N G 1: Answers Observations: • The $1000 you previously spent on repairs is irrelevant. What matters is the cost and benefit of the marginal repair (the transmission). • The change in incentives from scenario A to scenario B caused your decision to change.

50. People Face Tradeoffs All decisions involve tradeoffs. Examples: Going to a basketball game the night before your economics exam leaves less time for studying. Having more money to buy stuff requires working longer hours, which leaves less time for leisure. Protecting the environment requires resources that might otherwise be used to produce consumer goods.