Economics: Intro
Economics
 Economics is derived from the Greek word,
oikonomos.


Oikos – “house”
Nomos – “management”
 What is required when people, firms, and
government manage their resources?

Decisions.
 Economics – The study of how economic agents
allocate their limited resources to satisfy their
unlimited wants.
Economics
 "Economics is a social science that studies human
behaviour as a relationship between ends and scarce
means which have alternative uses. That is,
economics is the study of the trade-offs involved
when choosing between alternate sets of decisions.“

Lionel Robbins, 1935.
 Textbook definition - economics is study of how
economic agents allocate their limited resources to
satisfy their unlimited wants.
Why do we have to make decisions?
 Scarcity – when unlimited wants exceed limited
resources.


Wants – Unfulfilled desires that motivate human behavior to
use resources to quench biological and psychological desires
that when satisfied improve human well-being.
Resources – the inputs to produce outputs to meet human
wants. They are also known as the factors of production.
Resources
 Resources are also known as inputs or factors of
production.



(L) – Land – this includes physical land and natural resources
(oil, fish stocks, nickel)
(N) – Labor
(K) – Capital
Physical capital – machinery, buildings, equipment, new housing.
 Human capital – The skill set embodied in labor


(E) – Entrepreneurship
 F.o.P = (L, N, K, E); These are the inputs required to
make the goods and services that people value.
Is a Car a Capital Good?
 A car can be both a final good (consumer good) or an
input (capital good).
 When you drive around for personal use, a car is
considered a consumer good.
 Suppose you use your car to deliver pizza, now your
car is a piece of capital that is used in the production
of home delivery for pizza.
Three Key Economic Ideas
 1. People are rational.
 People make choices because it is in their own self-interest.
They do not make choices that leave them worse off.
 Economic agents weigh the benefits and costs of each action
and choose an action only if the benefits outweigh the costs—
even if it is not always the “best” decision.

The economic definition of rationality does not necessarily mean
“sane” or “level headed”.
Three Key Economic Ideas
 2. People respond to incentives.
 Why did you come to class or enroll at DMACC?
 Why didn’t banks take the FBI’s advice to install bulletresistant plastic windows for tellers and hire well trained
armed guards to deter bank robberies?
 Why are there large underground economies in countries with
corrupt governments?
 Why do M&M’s lead to better bladder control in young
children?

http://www.youtube.com/watch?v=W2hhIWbz0Ns
Three Key Economic Ideas
 3. Optimal decisions are made at the margin.

While some decisions are all or nothing, many decisions are
marginal.
 Marginal choices facing a consumer:


What is the best use of the next hour of my time?
How should I spend the $20 in my pocket?
 Marginal choices facing a firm:


Should profits be used to hire another worker or upgrade capital?
Should the firm stay open an hour later?
 Marginal choices facing a government:

Should we add another freeway exit ramp?
Optimal Decisions
 Optimal decisions – continue any activity up to the
point where the MB = MC


MB – marginal benefits
MC – marginal costs
 Marginal analysis – comparing MB and MC.
 When you hear the word ‘marginal’, think additional,
incremental, extra, or small change in.
Three Basic Questions: What, How, and For
Whom?
 Due to the problem of scarcity, every economy must
answer the three basic questions:



1. What goods and services will be produced?
2. How will goods and services be produced?
3. Who will receive the goods and services produced?
 To answer these questions, society will organize
themselves in two main ways; command and control
economies and free markets.
Command and Control / Centrally Planned
Economics
 In Command and Control economies, government
decrees economic activity and how resources will be
allocated.
 Some problems inherent in centrally planned
economies:


Coordination – without market prices, central planners
establish what gets produced. These economies often suffer
shortages and surpluses.
Incentives – There is often a lack of entrepreneurship in these
economies due to a lack of profit incentive.
Free Markets
 Free markets – decisions of resource allocation is
made by the interaction of households and firms
participating in markets, coordinated by a price
system.




No/Little government involvement.
Complete individual control.
Strong and well-defined property rights.
Regulated by the invisible hand.

Self-interest and competition promote efficiency and the best
interest of society with no government involvement.
Free Markets
 1. What?
 Dictated by consumer sovereignty.
 2. How?
 Determined by the least cost production technique achieved
through competition.
 3. For Whom?
 Goods and services will be distributed to consumers on the
basis of their willingness and ability to pay.
The “Virtues” of Free Markets
 Efficiency – Markets promote efficiency by allocating
resources towards their highest valued use and
promotes the least cost production technique.
 Incentives – Built in financial incentives for hard
work, skill acquisition, and innovation.
 Freedom – Decision on how to allocate resources is
based on voluntary consent rather than by decree of
government.
The Tale of Two Koreas
 After WW II, the Korean Peninsula was divided into
North and South.

North Korea
South Korea
GDP
$40 billion
$1.3 trillion
GDP/capita
$1,800
$27,700
Exports
$2 billion
$355 billion
Imports
$3.5 billion
$313 billion
Agriculture: % of
GDP
23%
3%
*2010 data
Mixed Economy
 All economies are mixed economies, but vary in their
degree of free markets and central planning.
 While markets are good at promoting efficiency,
incentives, and freedom, equity matters to people
and market failures occur.


Markets may seem unfair when presenting opportunities to
others since not everyone can provide “economic” value
(elderly, disabled, young).
Markets can fail in regards to monopolies, externalities, and
provision of public goods.
Positive vs. Normative Economics
 Positive Statements – Value free descriptions of and
predictions about economic relationships.

Positive statements do not have to be true, but can be checked
for veracity with verifiable evidence.

The unemployment rate is 25% is a positive statement, but not
true.
 Address with “what is”.
Positive vs. Normative Economics
 Normative Statements – Value-induced descriptions.
These statements are not settled by evidence, but by
persuasive rhetoric.
 Address “what ought to be”.
 Positive vs. Normative


The government should increase the minimum wage to reduce
poverty.
Increasing the minimum wage by 10% will reduce the poverty
rate by 3%.
Economic Modeling
 An economic model is a simplified version of reality
to help analyze real-word economics situations.
 The purpose of economic modeling is to understand,
explain, and predict economic events.
 General steps to develop a model.





1. Decide on assumptions
2. Formulate testable hypothesis
3. Use data to test the hypothesis
4. Revise the model if it fails
5. Retain the model for future use
Micro and Macroeconomics
 Microeconomics – the study of how households and
firms makes choices, how they interact in markets,
and how the government attempts to influence their
choices.
 Macroeconomics – the study of the economy as a
whole, including topics such as inflation,
unemployment, and economic growth.
Trade-Offs, Opportunity Cost, and PPF
 Due to the economic problem of scarcity, every
decision requires a sacrifice or trade-off.
 What are the trade-offs households, firms, and
governments are faced with rising health care costs?
 Opportunity Cost – The highest-valued alternative
that must be given up to engage in any activity.

Explains why TINSTAAFL.
Trade-Offs, Opportunity Cost, and PPF
 Production Possibility Frontier (PPF) – a curve
showing the maximum attainable combinations of
two or more products that can be produced with
given resources and technology during a given time
period.