ECON 2313: Fall Semester, 2008
Economics is the study
of how individuals and
societies allocate
scarce resources among
competing alternative
ends
Available resources are insufficient
to satisfy wants.
We cannot produce
enough goods and
services to satisfy
everyone—we don’t have
the resources!
What to produce?
Because resources are
scarce, growing more corn
means growing less wheat,
building more SUV’s means
building fewer military
vehicles, and building more
prisons means we have to
sacrifice something else—
like new schools.
Congress made
supplemental
appropriations for the Iraq
effort of $110 billion June
2003 and March 2004. We
should ask the question:
what could we have for
$110 billion?
•628 Boeing 7E7 Aircraft
• Construct three (3) 700 mile bullet trains (includes
the cost of inner-city land acquisition).
•4,075 “high quality” educational facilities to
accommodate 1,000 students.
•Write a $379 check to every U.S. citizen.
•Fund 1,000 universities the size of Arkansas State
for one year.
The geneology of economics
Economics
Webster’s Ninth New Collegiate Dictionary.
eco• nom • ic 1. archaic: of or relating to a household
or its management.
eco = oikos, meaning “house” or “household”
nom = nemein, meaning “to manage”
ic = ic, mean “of” or “relating to”
The production of
goods and services
is impossible
without economic
resources or factors
of production
Land or natural resources
Labor or “human resources”
Capital or “manmade instruments of
production”
Human Capital
Human capital is the
knowledge and skill
people obtain from
education, on-thejob training, and
work experience.
Entrepreneurship
Entrepreneurship is the
willingness and ability to combine
land, labor and capital into
productive enterprises.
•Entrepreneurs identify profitable business
opportunities and mobilize and coordinate
resources to take advantage.
•Sam Walton, Michael Dell, Martha Stewart,
and Bill Gates are examples of highly successful
entrepreneurs.
Income received by owners
of economic resources
•Rent: Income paid for the use of land.
•Wages (and salaries): income paid for
the services of labor.
•Interest: income paid for the use of
capital.
•Profit (or loss): Income earned by an
entrepreneur for running a business.
Goods and Services
• Good: see, feel, touch
• Service: intangible
• Scarce good/service
– The amount people desire exceeds the amount
available at a zero price
• Choice
– Give up some goods and services
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Goods and Bads
• Bads
– We want none of them; not even at a zero price
• Free goods and services
• “There is no such thing as a free lunch”
– Involve a cost to someone
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Economic Decision Makers
• Households
– Consumers
• Demand goods and services
– Resource owners
• Supply resources
• Firms, Governments, Rest of the World
– Demand resources
– Produce goods and services
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Markets
• Bring together buyers and sellers
• Determine price and quantity
• Product markets
– Goods and services
• Resource markets
– Resources
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A Simple Circular-Flow Model
• Flow of
– Resources
– Products
– Income
– Revenue
• Among economic decision makers
• Interaction
– Households
– Firms
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The simple circular-flow model for households and
firms
Exhibit 1
Households
- Supply resources
to resource market;
earn income
- Demand goods
and services from
product market; spend
income
Firms
- Demand resources
to produce goods and
services; payment for
resources
- Supply goods and
services to product
market; earn revenue
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Economists assume
that economic
decision-makers are
rational and engage
in “maximizing”
behavior
Choice Requires Time and Information
• Time and information – scarce; valuable
• Rational decision makers
– Willing to pay for information
• Improve choices
– Acquire information:
• Additional benefit expected exceeds the additional cost
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Economic Analysis Is Marginal Analysis
• Expected marginal benefit
• Expected marginal cost
• Marginal
– Incremental, additional, extra
• Rational decision maker:
– Change the status quo if expected marginal
benefit exceeds expected marginal cost
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Microeconomics and Macroeconomics
• Microeconomics
– Individual economic choices
– Markets coordinate the choices of economic
decision makers
– Individual pieces of the puzzle
• Macroeconomics
– Performance of the economy as a whole
– Big picture
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Economics deals with
questions of “what is”
and “what ought to be.”
The former set of
questions belong to
positive economics; the
latter to normative
economics
Positive economics attempts
set forth scientific statements
--that is, statements subject to verification or
falsification
For instance:
•“ If they raise tuition again at ASU, enrollment will
decline.”
•The recent rise in interest rates is likely to depress
housing construction.
•Total employment in the U.S. fell in the year 2002.
It’s unfair to
ask a person
to live on
$6.55 an hour.
I shouldn’t have the
government telling me how
much I should pay for fast
food cooks or any other type
of labor service.
Who is right?
It is a normative issue.
The Scientific Method: Step by Step
1. Identify the Question and Define Relevant
Variables
2. Specify Assumptions
Modify
Approach
3. Formulate a hypothesis
4. Test the hypothesis
or
Reject the
hypothesis
Use the hypothesis until a
better one shows up
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What is an Economic Model?
An economic model is
a simplified substitute
for economic reality.
This map of Arkansas is a good example of a “model”
Ceteris Paribus
“All other things being equal” or
“All other factors held constant.”
Simplification in model
building is achieved by the
ceteris paribus assumption.
It allows us to reason about
the relationship between
two variables without the
intrusion of other variables.
•Association-is-causation fallacy
•Fallacy of composition
•Ignoring secondary effects
Correlation versus Causation
Correlation is the tendency for the
values of two variable to move in a
predictable and related way. For
example, beer consumption tends to rise
when unemployment rises—that is,
these variables are correlated. Does it
follow that beer consumption causes
unemployment?
• Researchers at the Aabo Akademi found that
Finns who speak the language of their Nordic
neighbors were up to 25 percent less likely to fall
ill than those who do not.
• My rooster died—the sun won’t come up
tomorrow.
• Crimes rates tend to be higher in cities with more
police per capita.
To commit the fallacy of composition is to
suppose that what is true in the individual case
also holds true for the group.
•Example: “The best way to leave a burning
theater is to run for the exit.”
The imposition of a
luxury tax in 1990 (for
items priced $100,000 or
more was blamed for
destroying jobs in the
yacht-building industry.