CHAPTER 1
INTRODUCTION TO ECONOMIC ANALYSIS
2nd Semester, S.Y 2013 – 2014
Pangasinan State University
Social Science Department – PSU Lingayen
BACHELOR OF ARTS IN ECONOMICS
Econ 111 – ECONOMIC ANALYSIS
What is Economics?
 The study of how individuals and societies
choose to allocate and use scarce resources to
satisfy unlimited wants.
 Economics is about economizing; that is, about
choice among alternative uses of scarce
resources. Choices are made by millions of
individuals, businesses, and government units.
Economics examines how these choices add up
to an economic system, and how this system
operates. (L.G. Reynolds).
Pangasinan State University
Social Science Department – PSU Lingayen
BACHELOR OF ARTS IN ECONOMICS
Econ 111 – ECONOMIC ANALYSIS
Concept of Scarcity
 Scarcity exists because individuals want
more than can be produced
• Scarcity means the goods available are too few
to satisfy individuals’ desires
 The degree of scarcity is constantly changing
 The quantity of goods, services and usable resources
depends on technology and human action
Pangasinan State University
Social Science Department – PSU Lingayen
BACHELOR OF ARTS IN ECONOMICS
Econ 111 – ECONOMIC ANALYSIS
Microeconomics vs. Macroeconomics
 Microeconomics focuses on the individual
parts of the economy.
– How households and firms make decisions and
how they interact in specific markets
 Macroeconomics looks at the economy as a
whole.
– Economy-wide phenomena, including inflation,
unemployment, and economic growth
Pangasinan State University
Social Science Department – PSU Lingayen
BACHELOR OF ARTS IN ECONOMICS
Econ 111 – ECONOMIC ANALYSIS
Scope of Microeconomics
Microeconomics studies
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Buying decisions of the individual
Consumers’ satisfaction
Buying and selling decisions of the firm
The determination of prices and in markets
The quantity, quality and variety of products
Profits
Pangasinan State University
Social Science Department – PSU Lingayen
BACHELOR OF ARTS IN ECONOMICS
Econ 111 – ECONOMIC ANALYSIS
Scope of Macroeconomics
Macroeconomics studies
 Economic growth
 Unemployment and inflation
 Aggregate demand and aggregate supply
 Economic policies – fiscal and monetary
 International trade – exports and imports
 Money supply
Pangasinan State University
Social Science Department – PSU Lingayen
BACHELOR OF ARTS IN ECONOMICS
Econ 111 – ECONOMIC ANALYSIS
Microeconomics vs. Macroeconomic
Questions
Should I go to business school or take a job right now?
How many people are employed in the economy as a whole this year?
What determines the salary offered by San Miguel Corporation to Juan Dela Cruz,
a new MBA?
What determines the overall salary levels paid to workers in a given year?
What determines the cost to a university or college of offering a new course?
What determines the overall level of prices in the economy as a whole?
What government policies should be adopted to make it easier for low-income
students to attend college?
What government policies should be adopted to promote employment and
growth in the economy as a whole?
What determines whether BPI opens a new Branch in Shanghai?
What determines the overall trade in goods, services, and financial assets
between the Philippines and the rest of the world
Pangasinan State University
Social Science Department – PSU Lingayen
BACHELOR OF ARTS IN ECONOMICS
Econ 111 – ECONOMIC ANALYSIS
Let’s Check Your Understanding!
Which of the following questions involve microeconomics, and which
involve macroeconomics? In each case, explain your answer.
A. Why did consumers switch to smaller cars in 2012?
B. Why did overall consumer spending slow down in 2012?
C. Why did the standard of living rise more rapidly in the current
administration compared to previous administration?
D. Why have starting salaries for students with geology degrees
risen sharply of late?
E. What determines the choice between rail and road
transportation?
F. Why has salmon got cheaper over the past 20 years?
G. Why did inflation fall in the 1990s?
Pangasinan State University
Social Science Department – PSU Lingayen
BACHELOR OF ARTS IN ECONOMICS
Econ 111 – ECONOMIC ANALYSIS
Ten Principles of Economics
• A household and an economy
face many decisions:
– Who will work?
– What goods and how many of them should be
produced?
– What resources should be used in
production?
– At what price should the goods be sold?
Pangasinan State University
Social Science Department – PSU Lingayen
BACHELOR OF ARTS IN ECONOMICS
Econ 111 – ECONOMIC ANALYSIS
Ten Principles of Economics
Society and Scarce Resources:
– The management of society’s resources is
important because resources are scarce.
– Scarcity. . . means that society has limited
resources and therefore cannot produce all the
goods and services people wish to have.
Pangasinan State University
Social Science Department – PSU Lingayen
BACHELOR OF ARTS IN ECONOMICS
Econ 111 – ECONOMIC ANALYSIS
Ten Principles of Economics
 How people make decisions.
– People face tradeoffs.
– The cost of something is what you give up to
get it.
– Rational people think at the margin.
– People respond to incentives.
Pangasinan State University
Social Science Department – PSU Lingayen
BACHELOR OF ARTS IN ECONOMICS
Econ 111 – ECONOMIC ANALYSIS
Ten Principles of Economics
• How people interact with each other.
– Trade can make everyone better off.
– Markets are usually a good way to organize
economic activity.
– Governments can sometimes improve
economic outcomes.
Pangasinan State University
Social Science Department – PSU Lingayen
BACHELOR OF ARTS IN ECONOMICS
Econ 111 – ECONOMIC ANALYSIS
Ten Principles of Economics
 The forces and trends that affect how the
economy as a whole works.
– The standard of living depends on a country’s
production.
– Prices rise when the government prints too
much money.
– Society faces a short-run tradeoff between
inflation and unemployment.
Pangasinan State University
Social Science Department – PSU Lingayen
BACHELOR OF ARTS IN ECONOMICS
Econ 111 – ECONOMIC ANALYSIS
Principle #1: People Face Tradeoffs
“There is no such thing as a free lunch!”
Pangasinan State University
Social Science Department – PSU Lingayen
BACHELOR OF ARTS IN ECONOMICS
Econ 111 – ECONOMIC ANALYSIS
Principle #1: People Face Tradeoffs
 To get one thing, we usually have to give
up another thing.
– Guns v. butter
– Food v. clothing
– Leisure time v. work
– Efficiency v. equity
Making decisions requires trading
off one goal against another.
Pangasinan State University
Social Science Department – PSU Lingayen
BACHELOR OF ARTS IN ECONOMICS
Econ 111 – ECONOMIC ANALYSIS
Principle #1: People Face Tradeoffs
 Efficiency v. Equity
– Efficiency means society gets the most that it
can from its scarce resources.
– Equity means the benefits of those resources
are distributed fairly among the members of
society.
Pangasinan State University
Social Science Department – PSU Lingayen
BACHELOR OF ARTS IN ECONOMICS
Econ 111 – ECONOMIC ANALYSIS
Principle #2: The Cost of Something
Is What You Give Up to Get It.
 Decisions require comparing costs and
benefits of alternatives.
– 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
give up to obtain that item.
Pangasinan State University
Social Science Department – PSU Lingayen
BACHELOR OF ARTS IN ECONOMICS
Econ 111 – ECONOMIC ANALYSIS
Opportunity Cost
 Opportunity cost is the benefit forgone of the
next-best alternative to the activity you have
chosen
 Opportunity cost should always be less than the
benefit of what you have chosen
 Opportunity cost is the basis of cost/benefit economic
reasoning
Pangasinan State University
Social Science Department – PSU Lingayen
BACHELOR OF ARTS IN ECONOMICS
Econ 111 – ECONOMIC ANALYSIS
Marginal Costs and Marginal Benefits
 Using economic reasoning, decisions are often made by
comparing marginal costs and marginal benefits
 Marginal cost is the additional cost or sacrifice
one makes of participating in an activity or
purchasing a product.
 Marginal benefit is the additional satisfaction
or value one obtains from an activity or product.
Pangasinan State University
Social Science Department – PSU Lingayen
BACHELOR OF ARTS IN ECONOMICS
Econ 111 – ECONOMIC ANALYSIS
Marginal Costs and Marginal benefits
The economic decision rule:
 If the marginal benefits of doing something exceed the
marginal costs, do it.
MB > MC  Do it!
 If the marginal costs of doing something exceed the
marginal benefits, don’t do it.
MC > MB  Don’t do it!
Pangasinan State University
Social Science Department – PSU Lingayen
BACHELOR OF ARTS IN ECONOMICS
Econ 111 – ECONOMIC ANALYSIS
Opportunity Cost
Examples of opportunity cost:
1. Individual decisions
• The opportunity cost of college includes:
• Items you could have purchased with the
money spent for tuition and books
• Loss of the income from a full-time job
2. Government decisions
• The opportunity cost of money spent on the war
on terrorism is less spending on health care or
education
Pangasinan State University
Social Science Department – PSU Lingayen
BACHELOR OF ARTS IN ECONOMICS
Econ 111 – ECONOMIC ANALYSIS
Principle #2: The Cost of Something
Is What You Give Up to Get It.
LA Laker basketball
star
Kobe
Bryant
chose to skip college
and go straight from
high school to the pros
where he has earned
millions of dollars.
Pangasinan State University
Social Science Department – PSU Lingayen
BACHELOR OF ARTS IN ECONOMICS
Econ 111 – ECONOMIC ANALYSIS
Principle #3: Rational People Think
at the Margin.
• Marginal changes are small, incremental
adjustments to an existing plan of action.
People make decisions by comparing
costs and benefits at the margin.
Pangasinan State University
Social Science Department – PSU Lingayen
BACHELOR OF ARTS IN ECONOMICS
Econ 111 – ECONOMIC ANALYSIS
Principle #4: People Respond to
Incentives.
• Marginal changes in costs or benefits
motivate people to respond.
• The decision to choose one alternative
over another occurs when that
alternative’s marginal benefits exceed its
marginal costs!
Pangasinan State University
Social Science Department – PSU Lingayen
BACHELOR OF ARTS IN ECONOMICS
Econ 111 – ECONOMIC ANALYSIS
Principle #5: Trade Can Make
Everyone Better Off.
• People gain from their ability to trade with
one another.
• Competition results in gains from trading.
• Trade allows people to specialize in what
they do best.
Pangasinan State University
Social Science Department – PSU Lingayen
BACHELOR OF ARTS IN ECONOMICS
Econ 111 – ECONOMIC ANALYSIS
Principle #6: Markets Are Usually a Good
Way to Organize Economic Activity
 A market economy is an economy that
allocates resources through the
decentralized decisions of many firms and
households as they interact in markets for
goods and services.
– Households decide what to buy and who to
work for.
– Firms decide who to hire and what to
produce.
Pangasinan State University
Social Science Department – PSU Lingayen
BACHELOR OF ARTS IN ECONOMICS
Econ 111 – ECONOMIC ANALYSIS
Principle #6: Markets Are Usually a Good
Way to Organize Economic Activity
• Adam Smith made the observation that
households and firms interacting in markets
act as if guided by an “invisible hand.”
– Because households and firms look at prices
when deciding what to buy and sell, they
unknowingly take into account the social costs
of their actions.
– As a result, prices guide decision makers to
reach outcomes that tend to maximize the
welfare of society as a whole.
Pangasinan State University
Social Science Department – PSU Lingayen
BACHELOR OF ARTS IN ECONOMICS
Econ 111 – ECONOMIC ANALYSIS
Principle #7: Governments Can
Sometimes Improve Market Outcomes
• Market failure occurs when the market fails
to allocate resources efficiently.
• When the market fails (breaks down)
government can intervene to promote
efficiency and equity.
Pangasinan State University
Social Science Department – PSU Lingayen
BACHELOR OF ARTS IN ECONOMICS
Econ 111 – ECONOMIC ANALYSIS
Principle #7: Governments Can
Sometimes Improve Market Outcomes
• Market failure may be caused by
– an externality, which is the impact of one
person or firm’s actions on the well-being of a
bystander.
– market power, which is the ability of a single
person or firm to unduly influence market
prices.
Pangasinan State University
Social Science Department – PSU Lingayen
BACHELOR OF ARTS IN ECONOMICS
Econ 111 – ECONOMIC ANALYSIS
Principle #8: The Standard of Living
Depends on a Country’s Production
 Standard of living may be measured in
different ways:
– By comparing personal incomes.
– By comparing the total market value of a
nation’s production.
Pangasinan State University
Social Science Department – PSU Lingayen
BACHELOR OF ARTS IN ECONOMICS
Econ 111 – ECONOMIC ANALYSIS
Principle #8: The Standard of Living
Depends on a Country’s Production
• Almost all variations in living standards are
explained by differences in countries’
productivities.
• Productivity is the amount of goods and
services produced from each hour of a
worker’s time.
Pangasinan State University
Social Science Department – PSU Lingayen
BACHELOR OF ARTS IN ECONOMICS
Econ 111 – ECONOMIC ANALYSIS
Principle #8: The Standard of Living
Depends on a Country’s Production
• Standard of living may be measured in
different ways:
– By comparing personal incomes.
– By comparing the total market value of a
nation’s production.
Pangasinan State University
Social Science Department – PSU Lingayen
BACHELOR OF ARTS IN ECONOMICS
Econ 111 – ECONOMIC ANALYSIS
Principle #9: Prices Rise When the
Government Prints Too Much Money
 Inflation is an increase in the overall level
of prices in the economy.
 One cause of inflation is the growth in the
quantity of money.
 When the government creates large
quantities of money, the value of the
money falls.
Pangasinan State University
Social Science Department – PSU Lingayen
BACHELOR OF ARTS IN ECONOMICS
Econ 111 – ECONOMIC ANALYSIS
Principle #10: Society Faces a Short-run
Tradeoff Bet. Inflation and Unemployment
• The Phillips Curve illustrates the tradeoff
between inflation and unemployment:
Inflation  Unemployment
It’s a short-run tradeoff!
Pangasinan State University
Social Science Department – PSU Lingayen
BACHELOR OF ARTS IN ECONOMICS
Econ 111 – ECONOMIC ANALYSIS
Thinking Like an Economist
• Economics trains you to. . . .
– Think in terms of alternatives.
– Evaluate the cost of individual and social
choices.
– Examine and understand how certain events
and issues are related.
Pangasinan State University
Social Science Department – PSU Lingayen
BACHELOR OF ARTS IN ECONOMICS
Econ 111 – ECONOMIC ANALYSIS
The Economist As a Scientist
• The economic way of thinking . . .
– Involves thinking analytically and objectively.
– Makes use of the scientific method.
Pangasinan State University
Social Science Department – PSU Lingayen
BACHELOR OF ARTS IN ECONOMICS
Econ 111 – ECONOMIC ANALYSIS
Economic Model
 This is a simple analytic frame which shows the
relationship between the main factors, and
explains the behavior of an economic theory or
phenomenon.
 Economists use economic models to simplify
reality and to facilitate the understanding of the
actual world economic inconveniences.
Pangasinan State University
Social Science Department – PSU Lingayen
BACHELOR OF ARTS IN ECONOMICS
Econ 111 – ECONOMIC ANALYSIS
Types of Economic Model
 Descriptive
– Like the Circular Flow
 Analytical
– Assumptions
– Mathematical model ( functions and
equations)
– Graphical analysis
Pangasinan State University
Social Science Department – PSU Lingayen
BACHELOR OF ARTS IN ECONOMICS
Econ 111 – ECONOMIC ANALYSIS
First Model: The Circular-Flow Diagram
• The circular-flow diagram is a visual model of
the economy that shows how income flows
through markets among households and
firms.
Pangasinan State University
Social Science Department – PSU Lingayen
BACHELOR OF ARTS IN ECONOMICS
Econ 111 – ECONOMIC ANALYSIS
First Model: The Circular-Flow Diagram
Wages, rent,
and profit
Factors of
production
MARKETS
FOR
FACTORS OF PRODUCTION
•Households sell
•Firms buy
HOUSEHOLDS
•Buy and consume
goods and services
•Own and sell factors
of production
Goods
and services
bought
Spending
Income
Labor, land,
and capital
FIRMS
•Produce and sell
goods and services
•Hire and use factors
of production
MARKETS
FOR
GOODS AND SERVICES
•Firms sell
•Households buy
Goods and
services
sold
Income
= Flow of inputs
and outputs
= Flow of Money
Pangasinan State University
Social Science Department – PSU Lingayen
BACHELOR OF ARTS IN ECONOMICS
Econ 111 – ECONOMIC ANALYSIS
General Features of Economic Model
 All economic models incorporate three common
elements:
1. The ceteris paribus (other things the same)
assumption;
2. The supposition that economic decision
makers seek to optimize something;
3. A careful distinction between “positive” and
“normative” questions.
Pangasinan State University
Social Science Department – PSU Lingayen
BACHELOR OF ARTS IN ECONOMICS
Econ 111 – ECONOMIC ANALYSIS
Ceteris Paribus Assumption
 The ceteris paribus (other things the same)
assumption – which allows analysis of the
effect of a change in one factor by holding all
other relevant factors unchanged.
Pangasinan State University
Social Science Department – PSU Lingayen
BACHELOR OF ARTS IN ECONOMICS
Econ 111 – ECONOMIC ANALYSIS
Optimization Assumption
2. The supposition that economic decision makers
seek to optimize something;
 Many economic models start from the assumption that the
economic actors being studied are rationally pursuing some
goal.
Pangasinan State University
Social Science Department – PSU Lingayen
BACHELOR OF ARTS IN ECONOMICS
Econ 111 – ECONOMIC ANALYSIS
Positive versus Normative Analysis
 Positive economics are statements that
attempt to describe how the economy
functions and the the world as it is.
– Called descriptive analysis
 Normative economics are statements about
how the economy or world should be which
relies on value judgments to evaluate or
recommend alternative policies.
– Called prescriptive analysis
Pangasinan State University
Social Science Department – PSU Lingayen
BACHELOR OF ARTS IN ECONOMICS
Econ 111 – ECONOMIC ANALYSIS
Positive versus Normative Analysis
Positive or Normative Statements?
 If the minimum wage increases, then firms’ cost
of production rises.
POSITIVE
 Higher budget deficits will cause interest rates to
increase.
POSITIVE
Pangasinan State University
Social Science Department – PSU Lingayen
BACHELOR OF ARTS IN ECONOMICS
Econ 111 – ECONOMIC ANALYSIS
Positive versus Normative Analysis
 Positive or Normative Statements?
 The minimum wage in Metro Manila should
increase to P600.
NORMATIVE
 The government should be allowed to collect
from tobacco companies the costs of treating
smoking-related illnesses among the poor.
NORMATIVE
Pangasinan State University
Social Science Department – PSU Lingayen
BACHELOR OF ARTS IN ECONOMICS
Econ 111 – ECONOMIC ANALYSIS
Let’s Check You Understanding!
Which of the following statements is a positive
statement? Which is a normative statement?
A. Society should take measures to prevent
people from engaging in dangerous personal
behavior.
B. People who engage in dangerous personal
behavior impose higher costs on society
through higher medical costs.
Pangasinan State University
Social Science Department – PSU Lingayen
BACHELOR OF ARTS IN ECONOMICS
Econ 111 – ECONOMIC ANALYSIS