ECON 2313:Spring, 2013
Economics is the study
of how individuals and
societies allocate
scarce resources among
(competing) alternative
uses.
Available resources are insufficient
to satisfy wants.
We cannot produce
enough goods and
services to satisfy
everyone—we don’t have
the resources!
Congress made
supplemental
appropriations for the Iraq
effort of $110 billion June
2003 and March 2004. We
should ask the question:
What could we have for
$110 billion?
•628 Boeing 7E7 Aircraft
• Construct three (3) 700 mile bullet trains (includes
the cost of inner-city land acquisition).
•4,075 “high quality” educational facilities to
accommodate 1,000 students.
•Fund 1,000 universities the size of Arkansas State
for one year.
The geneology of economics
Economics
Webster’s Ninth New Collegiate Dictionary.
eco• nom • ic 1. archaic: of or relating to a household
or its management.
eco = oikos, meaning “house” or “household”
nom = nemein, meaning “to manage”
ic = ic, mean “of” or “relating to”
Finley. The World of Odysseus.
The Economic Perspective
• Thinking like an economist
• Key features:
• Scarcity and choice
• Purposeful behavior
• Marginal analysis
LO1
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Economics: The
Big Questions
•How do choices end up determining
what, how, and for whom goods and
services are produced?
•When do choices made in the pursuit
of self-interest also promote the social
interest?
Do “public virtues spring from private vices”?
Economic Resources
Things that give us the physical means to
produce and distribute goods and services.
•
•
•
•
Land
Labor
Capital
Entrepreneurship
Land or natural resources
Labor or “human resources”
Capital or “manmade instruments of
production”
Human Capital
Human capital is
the knowledge
and skill people
obtain from
education, onthe-job training,
and work
experience.
Entrepreneurship
Entrepreneurship is the
willingness and ability to combine
land, labor and capital into
productive enterprises.
•Entrepreneurs identify profitable business opportunities and
mobilize and coordinate resources to take advantage.
•Entrepreneurs have a key role in the commercialization of new
knowledge
•Sam Walton, Michael Dell, Martha Stewart, and Bill Gates are
examples of highly successful entrepreneurs.
What, How, For Whom?
Because resources are
scarce, growing more corn
means growing less wheat,
building more SUV’s means
building fewer military
vehicles, and building more
prisons means we have to
sacrifice something else—
like new schools.
How to produce?
•In France, basket-carrying
workers pick the grape crop by
hand. Grape picking in
California is often mechanized.
•GM uses workers to weld
body parts together in some
plants and uses robots in
others.
For whom are goods produced?
Occupation
Chief Executives
Airline Pilots and Co-Pilots
Dentists
Marketing Managers
Actuaries
Speech Pathologists
Registered Nurses
Funeral Directors
Food Service Managers
Mean Annual Income ($)
$139,810
135,040
133,680
101,190
90,760
58,000
56,880
56,540
44,930
Source: Bureau of Labor Statistics 2005 Occupational Survey
The personal distribution of
income describes the
distribution of income among
households or individuals
Household Income Ratios of Selected Percentiles,
the United States
12
10
Ratio
8
6
90th/10th
80th/50th
4
2
0
1967
1990
Year
2008
Source: Bureau of the Census
Shares of Household Income Quintiles,
the United States
60
Share (Percent)
50
40
Lowest
Second
30
Middle
20
Fourth
Highest
10
0
1967
1990
Year
2008
Source: Bureau of the Census
When is the Pursuit of Self-Interest in
the Social Interest?
• Subprime mortgage brokers and
underwriters behaved in their own
interests—but contributed to the
housing prices bust.
• BP scrimped on deep water drilling
safety measures—with catastrophic
results.
• Farmers on the high plains draw
from the Ogallala Aquifer—but the
water is rapidly running out.
Microeconomics
The study of the choices that individuals and
businesses make and the way these choices
respond to incentives, interact, and are influenced
by government
Examples of microeconomic questions?
•What determines the price of gasoline?
•Why is housing so much more expensive in San Francisco
compared to Dallas?
•Will more students enroll in nursing schools in response to
rising incomes of nurses?
•Will the “free” availability of Linux affect sales of
Windows?
Macroeconomics
The study of the aggregate (or total)
effects on the national economy and
the global economy of the choices that
individuals, businesses, and
governments make.
Macroeconomic Questions
•The standard of living
•The cost of living
•Economic fluctuations—recessions and
expansions
The Standard of Living
The standard of living is
(imperfectly) measured by the
average quantity of goods and
services per person (or per
capita).
Issues:
•How to explain changes over time in the standard of
living?
•How to explain cross-national differences in the
standard of living?
The Cost of Living
The cost of living refers to the
prices of goods and services that
are typically purchased by
households.
Issues:
•How to explain changes over time in the
cost of living?
•How to explain cross-national differences
in the cost of living?
The Business Cycle
Time
The term business cycle is used to describe
observed fluctuations in key macroeconomic
measures such as real GDP, personal income,
profits, or employment.
A full cycle consists of an expansion and a
contraction (or recession).
Business cycles are recurring phenomena;
however, they are irregularly recurring.
Total Production
Business Cycle Phases and Turning Points
Peak
Expansion
Peak
Expansion
Recession
Recession
2
Trough
4
8
Year
Nonfarm employment decreased by 8.8 million between January
2008 and February 2010, an average of 351,000 jobs lost per
month.
Purposeful Behavior
• Rational self-interest
• Individuals and utility
• Firms and profit
• Desired outcomes
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Economists assume
that economic
decision-makers are
rational and engage
in purposeful,
“maximizing”
behavior
Rationality means:
• The ability to make comparisons and
form preferences.
• Choice consistency
Gift Baskets
A
C
1. I prefer A to B
2. I prefer B to A
3. I am indifferent between A
and B
4. I prefer B to C
5. Therefore, I prefer A to C
B
Economics deals with
questions of “what is”
and “what ought to be.”
The former set of
questions belong to
positive economics; the
latter to normative
economics
“All swans are white.”
“Pink swans are prettier
than white swans.”
Positive economics attempts
set forth scientific statements
--that is, statements subject to verification or
falsification
For instance:
• If they raise tuition again at ASU, enrollment will
decline.
•Quantitative easing (QE) by the Federal Reserve
system will be inflationary.
• Total employment in the U.S. fell in the year 2009.
It’s unfair to
ask a person
to live on
$7.25 an hour.
I shouldn’t have the
government telling me how
much I should pay for fast
food cooks or any other type
of labor service.
Who is right?
It is a normative issue.
What is an Economic Model?
An economic model is
a simplified substitute
for economic reality.
This map of Arkansas is a good example of a “model”
Ceteris Paribus
“All other things being equal” or
“All other factors held constant.”
Simplification in model
building is achieved by the
ceteris paribus assumption.
It allows us to reason about
the relationship between
two variables without the
intrusion of other variables.
Application of Ceteris Paribus:
Sales of Pizza
SP/Week =f(PP, PT, PH, Income, . . . )
Where,
SP/Weeks is pizzas sold per week
PP is the price of pizza
PT is the price of tacos
PH is the price of hamburgers
To isolate on the responsiveness of pizza sales to a
change in pizza prices, hold all other factors
constant.
•Post hoc fallacy
•Association-is-causation fallacy
•Fallacy of composition
I washed my car today,
and that is why it
rained.
Correlation versus Causation
Correlation is the tendency for the
values of two variables to move in a
predictable and related way. For
example, beer consumption tends to rise
when unemployment rises—that is,
these variables are correlated. Does it
follow that beer consumption causes
unemployment?
Sleeping with one's shoes on
is strongly correlated with
waking up with a headache.
Therefore, sleeping with
one's shoes on causes
headache.
• Researchers at the Aabo Akademi found that
Finns who speak the language of their Nordic
neighbors were up to 25 percent less likely to fall
ill than those who do not.
• My rooster died—the sun won’t come up
tomorrow.
• Crimes rates tend to be higher in cities with more
police per capita.
To commit the fallacy of composition is to
suppose that what is true in the individual case
also holds true for the group.
•Example: “The best way to leave a burning
theater is to run for the exit.”
Individual’s Economizing Problem
•
•
•
Limited income
Unlimited wants
A budget line
•
•
•
•
LO4
Attainable and unattainable options
Tradeoffs and opportunity costs
Make the best choice possible
Change in income
1-52
Individual’s Economizing Problem
12
DVDs Books
$20 $10
10
6
0
5
2
4
4
3
6
2
8
1 10
0 12
Quantity of DVDs
$120 Budget
Income = $120
=6
Pdvd = $20
8
Unattainable
6
Income = $120
= 12
Pb = $10
4
2
0
Attainable
2
4
6
8
10
12
Quantity of Paperback Books
LO4
14
1-53
Global Perspective
LO4
1-54
Production Possibilities Model
• Illustrates production
choices
• Assumptions:
• Full employment
• Fixed resources
• Fixed technology
• Two goods
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Technology
Technology is the application of scientific or
other types of know-how to practical tasks.
•“A sharp axe is better than a dull axe.”
•Improved technology enables us to
produce more with the same resources.
•“Specialization is the inevitable counterpart
of technology.”
John K. Galbraith. The New
Industrial State (1967).
Model T : 1903
Ford Mustang: 1964
Important technical innovations
•
•
•
•
•
•
•
•
•
•
Internal combustion engine
Cotton harvester
Transistor
Internet browser software
Air conditioning
Satellite communication
Antibiotics
Hypertext markup language
Genetically modified seeds
Multi-modal freight containers
Production Possibilities Table
Production Alternatives
A
B
C
D
E
Pizzas
0
1
2
3
4
Industrial Robots
10
9
7
4
0
Type of Product
(in hundred thousands)
(in thousands)
Plot the Points to Create the Graph
LO5
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Industrial Robots
Production Possibilities Curve
14
13
12
11
10
9
8
7
6
5
4
3
2
1
The law of
increasing
opportunity
costs
makes
the PPC
concave.
X
A
B
C
Unattainable
D
U
Attainable
E
0
1
2
3
4
5
6
7
8
9
Pizzas
LO5
1-60
Marginal Benefit & Marginal
Cost
Optimal Allocation
1
5
MC
a
c
MB = MC
e
1
0
5
LO5
b
d
MB
1
2
Quantity of
Pizza
3
1-61
Marginal Benefit (MB): The addition to society’s
total benefits attributable to the last unit
produced.
MC: The addition to society’s total cost
attributable to the last unit produced.
G.I. Bill
Robert Solow
Henry Ford,
Thomas Edison—
Pioneers in
“process
innovation.”
Depletion of
nonrenewable
resources
Australian
rabbit
menace
A Growing Economy
• Economic Growth
• More resources
• Improved resource
quality
• Technological advances
LO6
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A Growing Economy
Production Alternatives
A'
B'
C'
D'
E'
Pizzas
0
2
4
6
8
Industrial Robots
14
12 9
5
0
Type of Product
(in hundred thousands)
(in thousands)
LO6
1-64
Industrial Robots
A Growing Economy
14
13
12
11
10
9
8
7
6
5
4
3
2
1
A’
B’
Unattainable
A
B
C’
C
Economic
Growth
D’
D
Now Attainable
Attainable
E’
E
0
1
2
3
4
5
6
7
8
9
Pizzas
LO6
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