1 WHAT IS ECONOMICS? Economics is….. 2 the social science that studies the production, distribution, and consumption of goods and services An economy consists of the economic system of a country or other area, the land, capital and land resources, and the economic agents that socially participate in the production, exchange, distribution, and consumption of goods and services of that area an economy delivers the goods The Economy of the United States: 3 US has a market economy production and consumption are the result of decentralized decisions by many firms and individuals opposite is a command economy – where there is a centralized authority making decisions about production and consumption (Soviet Union) Adam Smith, The Wealth of Nations 4 individuals, in pursuing their own interests, ended up serving the interests of society as a whole invisible hand – refers to the way a market economy manages to harness the power of selfinterest for the good of society Microeconomics: 5 Microeconomics individuals pursuing their own interests often do promote the interests of society as a whole Problems though --- Market Failure is when the individual pursuit of self-interest leads to bad results for society as a whole Fluctuations series of ups and downs which are a feature of modern economies the economy just does not always run smoothly recessions – economic downturns Macroeconomics: 6 concerned with the overall ups and downs of the economy economic growth is the “growing” ability of the economy to produce goods and services 7 THE ECONOMIC PERSPECTIVE The Economic Perspective: 8 Economic perspective is the economic way of thinking There are four economic principles that underlie the economics of a individual choice 1. Resources are scarce 9 A resource is anything that can be used to produce something else Countries resources: land, labor (the time of workers), capital (machinery, buildings, and other man-made productive assets), and human capital (the educational achievements and skills of workers) Scarce – there is not enough of the resource available to satisfy all the various ways a society wants to use it ex. natural resources, limited quantity of human resources, even clean air and water 2. The real cost of something is what you must give up to get it 10 opportunity cost – what you must give up in order to get it every choice you make means forgoing some other alternative 3. “How much?” is a decision at the margin 11 usually the question Is not “whether” but “how much” this is a question whose answer hinges on the costs and benefits of dong a bit more or bit less decision usually involves a trade-off – a comparison of the costs and benefits marginal decisions – decisions about whether to do a bit more or a bit less of an activity and the study of such decisions is known as marginal analysis 4. People usually exploit opportunities to make themselves better off 12 it is a good bet that people will exploit opportunities to make themselves better off incentives – anything that offers rewards to people who change their behavior 13 THE ECONOMIC WAY OF THINKING 1. Everything has a cost 14 “there is no such thing as a free lunch” Everything action costs someone time, effort or lost opportunities to do something else Opportunity costs 2. People choose for good reasons 15 Everyone faces choices and everyone should chose the alternative that gives them the most advantageous combination of costs and benefits Normative economics –economic analysis that makes predictions about the way the economy should work Positive economics – economic analysis that describes the way the economy actually works 3. Incentives matter 16 Economics is all about incentives Supply and demand analysis if about incentives Theory of the firm and factor markets are about incentives Government decision making is about incentives When incentives change, people’s behavior changes in predictable ways 4. People create economic systems to influence choices and incentives 17 Cooperation among people is governed by written and unwritten rules that are the core of an economic system As rules change, incentives and behavior change The success of market systems and the failures of communism are rooted in incentives 5. People gain from voluntary trade 18 Economics is about trade People trade when they believe the trade makes them better off, if there are no benefits, they won’t trade People, not countries, trade Market system is about trade Economics is about trade 6. Economic thinking is marginal thinking 19 Marginal choices involves the effects of additions and subtractions from current conditions 7. The value of a good or service is affected by people’s choices 20 Goods and services do not have intrinsic value – value is determined by the preferences of buyers and sellers Price of a good or service is set by supply and demand 8. Economic actions create secondary effects 21 Good economics involves analyzing secondary effects Example: Rent controls make apartments more affordable to some consumers Controls make it less profitable to build and maintain apartments Secondary effect is a shortage of apartments and houses for rent 9. The test of a theory is its ability to predict correctly 22 If the theory correctly predicts the consequences of actions it is a good theory Nothing is “good in theory but bad in practice” 23 WHAT IS ECONOMICS? Economics is….. 24 the social science that studies the production, distribution, and consumption of goods and services An economy consists of the economic system of a country or other area, the land, capital and land resources, and the economic agents that socially participate in the production, exchange, distribution, and consumption of goods and services of that area The Economy of the United States: 25 US has a market economy production and consumption are the result of decentralized decisions by many firms and individuals individual consumers make what they think will be most profitable each consumer buys what he or she chooses opposite is a command economy Adam Smith, The Wealth of Nations 26 individuals, in pursuing their own interests, ended up serving the interests of society as a whole invisible hand – Microeconomics: 27 Microeconomics individuals pursuing their own interests often do promote the interests of society as a whole Problems though --- Market Failure is when the individual pursuit of self-interest leads to bad results for society as a whole Fluctuations series of ups and downs which are a feature of modern economies the economy just does not always run smoothly Macroeconomics: 28 concerned with the overall ups and downs of the economy economic growth is the “growing” ability of the economy to produce goods and services 29 THE ECONOMIC PERSPECTIVE The Economic Perspective: 30 Economic perspective is the economic way of thinking 1. Resources are scarce 31 A resource is anything that can be used to produce something else Countries resources: land, labor (the time of workers), capital (machinery, buildings, and other man-made productive assets), and human capital (the educational achievements and skills of workers) Scarce – there is not enough of the resource available to satisfy all the various ways a society wants to use it 2. The real cost of something is what you must give up to get it 32 opportunity cost – 3. “How much?” is a decision at the margin 33 usually the question is not “whether” but “how much” decision usually involves a trade-off – a comparison of the costs and benefits marginal decisions – decisions about whether to do a bit more or a bit less of an activity and the study of such decisions is known as marginal analysis 4. People usually exploit opportunities to make themselves better off 34 incentives – anything that offers rewards to people who change their behavior 35 THE ECONOMIC WAY OF THINKING 1. Everything has a cost 36 “there is no such thing as a free lunch” Everything action costs someone time, effort or lost opportunities to do something else 2. People choose for good reasons 37 Normative economics –economic analysis that makes predictions about the way the economy should work Positive economics – economic analysis that describes the way the economy actually works 3. Incentives matter 38 Economics is all about incentives When incentives change, people’s behavior changes in predictable ways 4. People create economic systems to influence choices and incentives 39 Cooperation among people is governed by written and unwritten rules that are the core of an economic system As rules change, incentives and behavior change 5. People gain from voluntary trade 40 Economics is about trade People, not countries, trade 6. Economic thinking is marginal thinking 41 Marginal choices involves the effects of additions and subtractions from current conditions 7. The value of a good or service is affected by people’s choices 42 Goods and services do not have intrinsic value – value is determined by the preferences of buyers and sellers Price of a good or service is set by supply and demand 8. Economic actions create secondary effects 43 Good economics involves analyzing secondary effects Example: 9. The test of a theory is its ability to predict correctly 44 If the theory correctly predicts the consequences of actions it is a good theory Nothing is “good in theory but bad in practice”