• "the purpose of studying economics is not to acquire a set of ready-made answers to economic questions, but to learn how to avoid being deceived by economists."
• Joan Robinson

• “Economics is what economists do”
• Jacob Viner

• Study of the choices people make to attain their goals given their scarce resources.

1.
What do economists study?
• gasoline prices, inflation, housing markets, international trade, income inequality, sports, families, smoking, health care, happiness
• decision-making or choices
2.
How do they do it?
• by using theories and models
• theories are based on assumptions

What makes a good theory or a model?
• Models are not judged by their realism but by their usefulness
• What is the most useless map in the world?
To be useful a model has to be refutable

Why study theory?
•
“I don’t know how it is in theory but here is what I know from my 20 years of experience will happen “
• Laura, Executive MBA student
• Theory saves time!

Making the
Connection
Learning Objective 1.3
• When Economists Disagree:
A Debate over Outsourcing
Does outsourcing by U.S. firms raise or lower incomes in the United States?

• Study of the choices people make to attain their goals given their scarce resources.

Economics
Scarcity
When the price is zero there is not enough for everyone
Choices
People behave as if they are comparing the costs and benefits
Benefits Unlimite d wants
Limited availabilit y
Costs

Economics
Scarcity
Everything has alternative uses
Tradeoffs
Opportunity cost

Economics
Choices
People are rational when they behave as if they were comparing costs and benefits
People respond to incentives
Decisions are made on the margin

• Does a pool player need to know the laws of trigonometry and physics to win?
14

• “…getting out of bed in the morning and making breakfast involves more complex decisions than the average game of chess.
(Will that fries egg kill me in twenty-eight years?)”
• Charles Wheelan

• Study of the choices people make to attain their goals given their scarce resources.

Trade-offs force society to make choices, particularly when answering the following three fundamental questions:
1 What goods and services will be produced?
2 How will the goods and services be produced?
3 Who will receive the goods and services produced?

• Centrally Planned Economies versus Market
Economies
Centrally planned economy An economy in which the government decides how economic resources will be allocated.
Market economy An economy in which the decisions of households and firms interacting in markets allocate economic resources.

• The Modern “Mixed” Economy
Mixed economy An economy in which most economic decisions result from the interaction of buyers and sellers in markets but in which the government plays a significant role in the allocation of resources.

• Normative and Positive Analysis
Positive analysis Analysis concerned with what is.
Normative analysis Analysis concerned with what ought to be.
Don’t Let This Happen to YOU!
Don’t Confuse Positive Analysis with Normative Analysis

2
C H A P T E R

SCARCE RESOURCES
ECONOMIC RESOURCES
PROPERTY RESOURCES
1. LAND
2. CAPITAL
HUMAN RESOURCES
3. LABOR
4. ENTREPRENEURIAL ABILITY

Resource payments: correspond to resource categories
PROPERTY RESOURCES
LAND
RENTAL
INCOME
CAPITAL
HUMAN RESOURCES
INTEREST
INCOME
LABOR
ENTREPRENEUR
WAGES
PROFIT &
LOSS

• Definition: A particular set of institutional arrangements and a coordinating mechanism to respond to the economizing problem.
• Economic systems differ as to:
1) who owns the factors of production
2) the method used to motivate, coordinate, and direct economic activity.

• The government owns most property resources and economic decision making occur through a central economic plan.
• The central planning board determines production goals for each firm and resources to be allocated.

• There is private ownership of resources.
• Markets and prices coordinate and direct economic activity.
• Each participant acts in its own self-interest.
• In pure capitalism the government plays a very limited role.

• Private Property.
• Freedom of firms to choose.
• Self interest.
• Competition.
• Markets and prices.
• Technology and capital goods.
• Specialization.
• Use of money.
• Active, but limited government.

•
There are two groups of decision makers in the private economy: households (resource owners) and businesses (resource users)
•
The market system (resource markets and product markets) coordinates these decisions.

What happens in the resource markets? a. Households sell resources directly or indirectly
(through ownership of corporations) to businesses.
b. Businesses buy resources in order to produce goods and services.
c. Interaction of these sellers and buyers determines the price of each resource , which in turn provides income for the owner of that resource.
d. Flow of payments from businesses for the resources constitutes business costs and resource owners’ incomes .

What happens in the product markets?
a. Households are on the buying side of these markets, purchasing goods and services.
b. Businesses are on the selling side of these markets, offering products for sale.
c. Interaction of these buyers and sellers determines the price of each product.
d. Flow of consumer expenditures constitutes sales receipts for businesses.

CIRCULAR FLOW MODEL
RESOURCE
MARKET
BUSINESSES HOUSEHOLDS
PRODUCT
MARKET

CIRCULAR FLOW MODEL
RESOURCES
RESOURCE
MARKET
INPUTS
BUSINESSES HOUSEHOLDS
PRODUCT
MARKET

CIRCULAR FLOW MODEL
$ INCOMES $ COSTS
RESOURCES
RESOURCE
MARKET
INPUTS
BUSINESSES
GOODS &
SERVICES
PRODUCT
MARKET
GOODS &
SERVICES
HOUSEHOLDS

CIRCULAR FLOW MODEL
$ INCOMES $ COSTS
RESOURCES
RESOURCE
MARKET
INPUTS
BUSINESSES
GOODS &
SERVICES
PRODUCT
MARKET
GOODS &
SERVICES
HOUSEHOLDS

CIRCULAR FLOW MODEL
$ INCOMES $ COSTS
RESOURCES
RESOURCE
MARKET
INPUTS
BUSINESSES HOUSEHOLDS
GOODS &
SERVICES
$ REVENUE
PRODUCT
MARKET
GOODS &
SERVICES
$ CONSUMPTION

CIRCULAR FLOW MODEL
$ INCOMES $ COSTS
RESOURCES
RESOURCE
MARKET
INPUTS
BUSINESSES HOUSEHOLDS
GOODS &
SERVICES
$ REVENUE
PRODUCT
MARKET
GOODS &
SERVICES
$ CONSUMPTION

Limitations of the model:
1. Does not depict transactions between households and between businesses (interbusinesses).
2. Ignores government and the “rest of the world” in the decision-making process (we will take care of them later on).
3. Does not explain how prices of products and resources are actually determined.