INTRODUCTION OF ECONOMICS
Lecturer: Jack Wu
Economics 101
WHAT IS ECONOMY (經濟，經濟體)?
The word economy originally comes from a Greek
word for “one who manages a household.”
 Broader definition: household, society, and
country.

FUNDAMENTAL PROBLEM FACED
BY ECONOMY
 Fundamental
economic problem: scarce resources.
-- Scarcity. . . means that economy has limited
resources and therefore cannot produce all the
goods and services people wish to have.
-- Resources : physical resource, financial resource,
human resource, natural resource
WHAT IS ECONOMICS (經濟學)?
Economics is the study of how society or economy
manages its scarce resources.
 It comprises of Microeconomics and
Macroeconomics.

MICROECONOMICS 個體經濟學(台
灣)，微觀經濟學(大陸)
Microeconomics: the study of how households and
firms make decisions and how they interact in
markets (Econ 101: introductory Microeconomics,
Econ 201: intermediate Microeconomics)
 Examples: mobile phone consumption choice
decision, mobile phone production decision, and
mobile phone market

MACROECONOMICS 總體經濟學
(台灣)，宏觀經濟學(大陸)
Macroeconomics: the study of economy-wide
phenomena including inflation, unemployment,
and economic growth (Econ 102: Introductory
Macroeconomics, Econ 202: Intermediate
Macroeconomics)
 Examples: Quantitative Easing (QE) Policy, Euro
Zone Crisis, Abenomics, China Economy Soft
Landing, Sluggish Income Growth of Taiwan

EVERYBODY SHOULD LEARN
ECONOMICS

<Reason>. Economics is a subject that we must
confront in our everyday lives. As a matter of
fact, we already spend a great deal of our time
thinking about economic issues: prices(inflation),
incomes (economic growth), consumption
decisions, use of our time, job opportunity
(unemployment), and so on.
TEN PRINCIPLES OF ECONOMICS
PRINCIPLE #1: PEOPLE FACE
TRADEOFFS.
There is no such thing as a free lunch.
 To get one thing, we usually have to give up
another thing.
 Making decisions requires trading
off one goal against another.

SPECIAL EXAMPLE OF TRADEOFF
 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.
Example: Tax paid by wealthy Taiwanese and then
distributed to those less fortunate.
Outcome: Increased equity and reduced efficiency
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?
The opportunity cost of an item is what you give
up to obtain that item.
Opportunity cost comprises of both explicit cost
and implicit cost.
PRINCIPLE #3: RATIONAL PEOPLE
THINK AT THE MARGIN
Many decisions in life involve incremental
decisions: should I take another course this
semester?
 Marginal changes are small, incremental
adjustments to an existing plan of action.
 People make decisions by comparing costs and
benefits at the margin.

PRINCIPLE #4: PEOPLE RESPONDS TO
INCENTIVES
Because people make decisions by weighing costs
and benefits, their decisions may change in
response to changes in costs and benefits.
 Example: Seat Belt Laws increase use of seat
belts and lower the incentives of individuals to
drive safely.

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.


Examples: Most families do not build their own
homes, make their own clothes, or grow their own
food.
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.
 Adam Smith made the observation that
households and firms interacting in markets act
as if guided by an “invisible hand”—Market
Prices.

PRINCIPLE #7: GOVERNMENT CAN
SOMETIMES IMPROVE MARKET
OUTCOMES
Market failure occurs when the market fails to
allocate resources efficiently.
 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.


When the market fails (breaks down) government
can intervene to promote efficiency and equity.
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 (GDP, Gross Domestic Product).

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.

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.

PRINCIPLE #10: SOCIETY FACES A
SHORT-RUN TRADEOFF BETWEEN
INFLATION AND UNEMPLOYMENT

The Phillips Curve illustrates the tradeoff
between inflation and unemployment:
Inflation is lower  Unemployment is higher
It’s a short-run tradeoff!
THINKING LIKE AN ECONOMIST
ECONOMIC MODELS
Economists use models to simplify reality in
order to improve our understanding of the world
 Economists make assumptions in order to make
the world easier to understand.
 Economists use different assumptions to answer
different questions.

BASIC ECONOMIC MODELS
Two of the most basic economic models include:
The Circular Flow Diagram
 The Production Possibilities Frontier

CIRCULAR-FLOW DIAGRAM
The circular-flow diagram is a visual model of
the economy that shows how dollars flow through
markets among households and firms.
 Decision makers



Firms & Households
Markets
For goods and services
 For factors of production

THE CIRCULAR FLOW DIAGRAM
MARKETS
FOR
GOODS AND SERVICES
•Firms sell
Goods
•Households buy
and services
sold
Revenue
Wages, rent,
and profit
Goods and
services
bought
HOUSEHOLDS
•Buy and consume
goods and services
•Own and sell factors
of production
FIRMS
•Produce and sell
goods and services
•Hire and use factors
of production
Factors of
production
Spending
MARKETS
FOR
FACTORS OF PRODUCTION
•Households sell
•Firms buy
Labor, land,
and capital
Income
= Flow of inputs
and outputs
= Flow of dollars
PRODUCTION POSSIBILITIES FRONTIER

The production possibilities frontier is a graph
that shows the combinations of output that the
economy can possibly produce given the available
factors of production and the available production
technology.
Quantity of
Computers
Produced
3,000
D
C
2,200
2,000
A
Production
possibilities
frontier
B
1,000
0
300
600 700
1,000
Quantity of
Cars Produced
EFFICIENT OR INEFFICIENT?

Efficient levels of production
Economy’s getting all it can from the scarce resources
available
 Points on the production possibilities frontier
 Trade-off:

The only way to get more of one good is to get less of the
other good
 Positive opportunity cost


Inefficient levels of production
Points inside production possibilities frontier.
 Zero opportunity cost.

SHAPE OF PRODUCTION
POSSIBILITIES FRONTIER
Concave curve (bowed outward):
The opportunity cost of producing one good
increases as the production of this good rises.
REASON:
Some resources are better suited to the production
of this good than another good (and vice versa).
 Straight line:
The opportunity cost of producing one good is
constant as the production of this good rises.

A SHIFT IN PRODUCTION
POSSIBILITIES FRONTIER
Resource Availability Changes
(natural resources, human resources, physical
resources)
 Technology Changes

A SHIFT IN THE PRODUCTION POSSIBILITIES FRONTIER DUE
TO A TECHNOLOGICAL ADVANCE IN COMPUTER INDUSTRY
Quantity of
Computers
Produced
4,000
3,000
G
2,300
2,200
A
0
600 650
1,000 Quantity of
Cars Produced
30
TECHNOLOGICAL ADVANCE

A technological advance in the computer industry
enables the economy to produce more computers
for any given number of cars. As a result, the
production possibilities frontier shifts outward. If
the economy moves from point A to point G, then
the production of both cars and computers
increases.
IMPORTANT CONCEPTS

Concepts illustrated by the Production
Possibilities Frontier
Efficiency
 Tradeoffs
 Opportunity Cost
 Economic Growth

POSITIVE AND NORMATIVE ANALYSIS

Positive statements are statements that attempt
to describe the world as it is.


Called descriptive analysis
Normative statements are statements about how
the world should be.

Called prescriptive analysis
GAINS FROM TRADE
AUTARKY (自給自足)OR TRADE?

How do we satisfy our wants and needs in a
global economy?
We can be economically self-sufficient (Autarky).
 We can specialize and trade
with others, leading to
economic interdependence.

CASE 1: THE SIMPLEST ECONOMY
only two goods: potatoes and meat
 only two people: a potato farmer and a cattle
rancher
 Each only works 8 hours/day

What should each produce?
 Why should they trade?

CASE 1 (CONTINUED)
Minutes needed to make 1 ounce of
___________________________________
Meat
Potatoes
___________________________________
Farmer
60min/oz
15min/oz
Rancher
20min/oz
10min/oz

CASE 1 (CONTINUED)
Amounts produced in 8 hours
___________________________________
Meat
Potatoes
___________________________________
Farmer
8 oz
32 oz
Rancher
24 oz
48 oz

THE FARMER’S PRODUCTION POSSIBILITIES FRONTIER
(a) The Farmer ’s Production Possibilities Frontier
Meat (ounces)
8
0
32
Potatoes (ounces)
THE RANCHER’S PRODUCTION POSSIBILITIES FRONTIER
(b) The Rancher ’s Production Possibilities Frontier
Meat (ounces)
24
0
48
Potatoes (ounces)
OPPORTUNITY COST

Definition
Whatever must be given up to obtain some item
 Measures the trade-off between the two goods that
each producer faces

CASE 1(CONTINUED): OPPORTUNITY COSTS
1oz of meat
1oz of potatoes
Farmer
4 oz of potatoes
¼ oz of meat
Rancher
2 oz of potatoes
½ oz of meat
ABSOLUTE ADVANTAGE

The comparison among producers of a good
according to their productivity—absolute
advantage
Describes the productivity of one person, firm, or
nation compared to that of another.
 The producer that requires a smaller quantity of
inputs to produce a good is said to have an absolute
advantage in producing that good.

COMPARATIVE ADVANTAGE

Compares producers of a good according to their
opportunity cost.


Whatever must be given up to obtain some item
The producer who has the smaller opportunity
cost of producing a good is said to have a
comparative advantage in producing that good.
SPECIALIZATION AND TRADE

Comparative advantage and differences in
opportunity costs are the basis for specialized
production and trade.
BENEFITS OF TRADE
Whenever potential trading parties have
differences in opportunity costs, they can each
benefit from trade.
 Benefits of Trade


Trade can benefit everyone in a society because it
allows people to specialize in activities in which they
have a comparative advantage.
SELF-SUFFICIENCY (AUTARKY)

By ignoring each other:
Each consumes what they each produce.
 The production possibilities frontier is also the
consumption possibilities frontier.
 Without trade, economic gains are diminished.

SELF-SUFFICIENCY (AUTARKY) IN CASE 1

Assume: Farmer spends 4 hours on meat and 4
hours on potatoes. Rancher spends 4 hours on
meat and 4 hours on potatoes.
CASE 1 (CONTINUED): WITHOUT TRADE


Production: Farmer produces 4 oz of meat and 16
oz of potatoes. Rancher produces 12 oz of meat
and 24 oz of potatoes.
Consumption: Farmer consumes 4 oz of meat and
16 oz of potatoes. Rancher consumes 12 oz of
meat and 24 oz of potatoes.
THE FARMER’S PRODUCTION AND CONSUMPTION WITHOUT
TRADE
(a) The Farmer’s Production and Consumption
Meat (ounces)
Farmer's
production and
consumption
without trade
8
4
A
0
32
Potatoes (ounces)
16
Copyright©2003 Southwestern/Thomson Learning
THE RANCHER’S PRODUCTION AND CONSUMPTION WITHOUT
TRADE
(b) The Rancher’s Production and Consumption
Meat (ounces)
24
B
12
0
24
Rancher's
production and
consumption
without trade
48
Potatoes (ounces)
Copyright © 2004 South-Western
ONE PROPOSAL FOR SPECIALIZATION
Farmer devotes all his time to growing potatoes.
 Rancher spends 6 hours a day raising cattle and
2 hours growing potatoes.

PRODUCTION UNDER THIS PROPOSAL
Farmer’s production with Specialization: 0 oz of
meat and 32 oz of potatoes
 Rancher’s production with Specialization: 18 oz of
meat and 12 oz of potatoes.

PROPOSAL FOR TRADE

The price of trade


Must lie between the two opportunity costs
Trade deal: Farmer gives rancher 15 oz of
potatoes, and rancher gives farmer 5 oz of meat
in return.
Note: Trade Price of Meat: 2~4 oz of potatoes
 Note: Trade Price of Potatoes: 1/4 oz ~1/2 oz of
meat

CONSUMPTION WITH TRADE
Farmer’s consumption with trade: 5 oz of meat
and 17 oz of potatoes
 Rancher’s consumption with trade: 13 oz of meat
and 27 oz of potatoes.

HOW TRADE EXPANDS THE FARMER’S SET OF CONSUMPTION
OPPORTUNITIES
(a) The Farmer’s Production and Consumption
Meat (ounces)
8
Farmer's
consumption
with trade
A*
5
4
Farmer's
production and
consumption
without trade
A
Farmer's
production
with trade
0
32
16
17
Potatoes (ounces)
HOW TRADE EXPANDS THE RANCHER’S SET OF
CONSUMPTION OPPORTUNITIES
(b) The Rancher’s Production and Consumption
Meat (ounces)
Rancher's
production
with trade
24
Rancher's
consumption
with trade
18
13
B*
B
12
0
12
24 27
Rancher's
production and
consumption
without trade
48
Potatoes (ounces)
INTERNATIONAL TRADE

Each country has many citizens with different
interests. International trade can make some
individuals worse off, even as it makes the
country as a whole better off.

Imports—goods produced abroad and sold
domestically

Exports—goods produced domestically and sold
abroad