Introduction to Economics
Professor Hedrick
SS 424
Instructional Method
• Primarily Lecture format with discussion,
simulations, and video presentations
• Constructive discussion is welcomed
• Grading is based on five mini-exams and Aplia
Homeworks. – NO MAKEUPS GIVEN
• Professor available during office hours and by
appointment
• Suggestions for the study of economics
What is Economics?
• Scarcity – a basic human dilemma
– Limited resources vs. unlimited wants
– The human condition requires making choices
• Definitions of Economics
– Mankiw’s definition
• …is the study of how society manages its scarce resources
– Hedrick’s definition
• …is how society chooses to allocate its scarce resources among
competing demands to improve human welfare
– Alternative definitions
• … what economists do.
• … is the study of choice.
• Fundamental Questions of Economics - Scarcity
requires all societies to answer the following
questions:
– What is to be produced?
– How is to be produced?
– For whom will it be produced
WHFM Questions
How Do Economists Study Human
Behavior?
• Economics as a Science
– The scientific method
• Observation→Theory→Data→Testing
– Rational Behavior
• Weighing benefits and costs and maximizing total net benefits
• Marginal vs. Total Thinking
– Economic Theory and Models
• Simplification by assumption
• Ceteris Paribus – Holding other factors constant
• Prediction vs. realism
– Microeconomic versus Macroeconomics
– Bias towards use of natural rather than controlled
experiments
– The specialized language of economics (e.g. “He has
lots of money.”)
• Money – medium of exchange
• Wealth – accumulated financial and non-financial assets
• Income – the purchasing power earned during a given period
Why do Economists Study Human
Behavior?
• Scientists versus policy makers
• Positive Economics
– Descriptive - what the world is like.
– Objective- value judgments need not be made
– Positive statements can theoretically be tested by
appealing to the facts
• Normative Economics
– Prescriptive - what the world ought to be like
– Subjective – value judgments must be made
– Normative statements cannot be tested appealing to
facts.
Categories of Basic Principles of
Economics
• How do people make decisions?
• How do people interact?
• How does the economy work overall?
How Do People Make Decisions?
• Principle #1 - People face tradeoffs
– Time allocation – an example of tradeoffs
– Efficiency versus equity
– Production Possibilities Frontier
• Principle #2 - The cost of something is what
you have to give up to get it
– Opportunity costs come from Von Weiser, a
German economist late 1800s
– Opportunity costs are independent of monetary
units
– TINSTAAFL
– The real costs of going to college
• Principle #3 - Rational people think at the
margin
– Rational or irrational decision-making
– Marginal benefits and costs versus total benefits
and costs
– Weighing marginal costs and benefits leads to
maximizing net benefits (total welfare)
– The boxes example
.
• Principle #4 –People respond to incentives
– Reactions to changes in marginal benefits and costs
– Increases (decreases) in marginal benefits mean more
(less) of an activity
– Increases (decreases) in marginal costs mean less
(more) of an activity
– Example of seat belts leading to increased speeds
– Example of SUV (with child car seat) in Issaquah
How Do People Interact?
• Principle #5 - Trade can make everybody
better off
– Adam Smith author of the “An Inquiry into the
Causes and Consequences of the Wealth of
Nations” 1776
– Gains from the division of labor and
specialization
– Mercantilists perspectives
– Example of why Ellensburg
• Principle #6 - Markets are usually a good way of
organizing economic activity
– feudal times where feudal states were self-supporting,
also haciendas in the new world
– the benefits of trade are so powerful that people began
to trade
– markets for economists are more abstract than the
notion of a middle eastern bazaar or a flea market and
simply determine the prices and quantities traded of
different goods and services
– the “failure” of centrally planned economies and the
movement towards markets for the WHFM questions
Markets
– Principles 1-5 combine with markets to turn the pursuit
of self-interest into promoting the interests of society
– Adam Smith and the “invisible hand”
– creativity and productivity are stimulated by the pursuit
of self-interest into improving resource allocations
– “set it and forget it” becomes “compete or be obsolete”
– in some cases markets fail to allocate resources
effectively so,
• Principle #7 Governments can sometimes improve
interaction that occurs in markets
– there are circumstances when market signals fail to
allocate resources efficiently or equitably
– Public Goods, Externalities and Income Distribution
– Some goods or services that people desire will not be
produced by markets (e.g. lighthouses).
– Some goods or services will either be underproduced
(vaccines) or overproduced (pollution) because markets
fails to register certain benefits or costs.
– markets may also fail to provide an equitable or fair
distribution of resources
– government intervention with its ability to coerce (the
opposite of voluntary) can regulate, tax and subsidize to
change market outcomes
– efficiency and equity: the pie analogy
– if government intervention always the proper solution?
How Does the Economy Work as
a Whole?
• Principle # 8 – A country’s standard of living
depends upon its ability to produce goods and
services
– Adam Smith’s “An Inquiry into the Nature and the
Consequences of the Wealth of Nations”
– Materialism – more toys mean more welfare
– wealth: a necessary or sufficient condition for
happiness (are rich people happier, children with lots of
toys)
– leisure time and productivity
– the factors of production: land or natural
resources, labor, capital, entrepreneurship
– technology and productivity
– the rule of 72 for growth rates
• Principle #9 – The general level of prices rises
when the government prints and distributes too
much money
– definition of money, the concept of snow to Inuits, and
economic language
– inflation is an increase in the general or average level of
prices in an economy
– “not worth a continental” and recent example in
Argentina
– the establish of the Federal Reserve and the
introduction of sustained inflation in the US
• Principle #10 – Society faces a short-run tradeoff
between inflation and unemployment
– Short-run and the long-run
– demand and supply shocks
– short-run increases (decreases) in output above (below)
long-run potential output lead to adjustments
– countercyclical stabilization versus pro-cyclical
destabilization
– political business cycles