ECONOMICS
What does it mean to me?
Part I:
•Eleven Powerful Ideas of Economics
READ Krugman Section 1, Module 1
Mankiw Ch 1, 2
DO Morton Unit 1
What you will learn
in this Module:
•
What a business cycle is and why policy makers
seek to diminish the severity of business cycles
•
How employment and unemployment are
measured and how they change over the
business cycle
•
The definition of aggregate output and how it
changes over the business cycle
•
The meaning of inflation and deflation and why
price stability is preferred
•
How economic growth determines a country's
standard of living
•
Why models - simplified representations of
reality- play a crucial role in economics
ECONOMICS:
The study of the allocation of our
scarce resources to satisfy our
unlimited wants for goods and
services.
Economics is:
*A social science concerned with how resources
are used to satisfy wants.
*A study of how people and countries use their
resources to produce, distribute, and consume
goods and services.
*An examination of behavior related to how
goods and services are acquired.
*A study of how people decide who will get the
goods and services.
BASIC ECONOMIC QUESTIONS
WHAT TO PRODUCE?
HOW TO PRODUCE?
FOR WHOM TO
PRODUCE?
ECONOMICS is concerned with
PRODUCTION
DISTRIBUTION
CONSUMPTION
of GOODS and SERVICES
The FACTORS OF PRODUCTION include:
LAND (natural resources)
LABOR (human resources)
CAPITAL (capital resources)
ENTREPRENEURSHIP
RESOURCES: materials from which
goods and services are produced.
Those things such as people, tools,
machinery, and factories.
NATURAL RESOURCES:
Water, oil, gems, land, and trees.
Human Resources: People at
work--manual, clerical,
technical, professional,
managerial.
Capital Resources:
includes any good used to
create a final good or
service.
CAPITAL RESOURCES are further divided
into:
CAPITAL GOODS
Goods used in the
production process
that can be reused
for another product.
(computers, trucks,
machines, et.al.)
INTERMEDIATE
GOODS
Goods that are
used up in the
production process.
(paper, oil, ink,
et.al.)
ENTREPRENEURSHIP:
*a particular
type of human
resource
*business
innovator
*sees
opportunity to
make a profit
*uses
unexploited raw
materials
*takes RISK
with new
product or
process
*brings together land, labor, capital
FINANCIAL CAPITAL:
*NOT a real
resource
*ENABLES
ENTREPRENEURS
AND MANAGERS TO
PURCHASE THE
FACTORS OF
PRODUCTION
*Money to acquire capital goods and
employ land and labor resources
How do we pay for resources?
RESOURCE PAYMENTS
LAND
Rent
LABOR
Wages & Salaries
CAPITAL
Interest
ENTREPRENEUR
Profit
There are 11 powerful ideas that
serve as the foundation of
economics.
If you develop a good
understanding of them and
master the problem-solving skills
inherent in them, they will serve
you for the rest of your life.
NUMBER 1:
WANTS AND DESIRES
How do we satisfy our
unlimited wants and desires in
a world of limited resources?
“Goods” and “services” are those
things that we value or desire.
GOODS tend to be TANGIBLE things-objects that can be seen, held, tasted,
heard, or smelled.
INTANGIBLE GOODS are things
we cannot reach out and touch, such as
friendship, knowledge, and fairness.
SERVICES are intangible.
In contrast to goods, BADS are
items that people do not desire
or want---garbage, pollution,
weeds, and crime.
The elimination of a bad
becomes a good.
In economics, we assume that more
goods lead to greater satisfaction, or
UTILITY, and that bads lead to
dissatisfaction or DISUTILITY.
Normal good
Inferior good
http://www.yadayadayadaecon.com/clip/3/
http://www.yadayadayadaecon.com/clip/75/
NUMBER 2:
SCARCITY
We all face scarcity because it is not
possible for an individual to have all the
goods and services that he or she desires.
However, because we all have differing
wants and desires, scarcity affects
individuals differently.
The essential question in
Economics is:
Scarcity
Insufficient supply of something where
“insufficient” is interpreted relative to
the desires of a group of people.
For instance, antiques are valued for their
scarcity. . .
When our wants exceed
our needs we have
SCARCITY.
Scarcity forces us to
make choices on how
to best use our limited
resources.
Scarcity is NOT:
the same as poverty.
(eg. Goods can be
scarce in United States AND Somalia. However, scarcity
isn’t going away; poverty might.)
the same as shortage.
(eg. Whether you
have a shortage or not depends upon how you handle the
rationing problem made necessary by scarcity)
Oh, Scarcity (Tune: Oh, Christmas Tree)
Oh, scarcity! Oh, scarcity
We can't have all the things we want. Oh,
scarcity! Oh, scarcity!
We cannot have it all.
We really want a lot of stuff.
But sometimes there's just not
enough. Oh, scarcity! Oh, scarcity!
We cannot have it all.
Scarcity
http://www.yadayadayadaecon.com/clip/47/
NUMBER 3:
CHOICES
We may all want a home, two cars,
gourmet food, all with a pristine
environment with no pollution. If we had
unlimited resources to produce all of the
goods and services everyone wanted, we
would not have to choose among these
decisions.
If we did not have to make meaningful
economic choices, the study of economics
would not be necessary.
But a woman who waits ‘til the third time around…..She’s the
girl he’s found……The girl who’s hard to get….. (taken from
Meredith Wilson’s The Music Man)
MARKETS AND MARRIAGE
As in markets for goods and services in which rare stuffed animals
and exclusive doctors are prized, judgments about whom to pursue
may rest on signals of quality, such as how hard people are to
attract. That is the crux of the social price theory, which considers
marriage through an economic (but human) lens.
Economics isn’t only about money. Economics is also about
scarcity, choice and utility maximization. Ninety-five percent of
Americans marry, so most of us become buyers and sellers in the
marriage market at some point……and the marriage market is alive
and well in residence halls, nightclubs, churches and workplaces
across the country.
Taken from “Economics by Example” by David Anderson
This concept also translates into the ROLE OF PRICE.
Searching for a marriage partner involves making a decision
about whether to pursue a relationship on the basis of an
initially meager number of signals. Just as you choose a
doctor, a college, or a bottle of wine, consumers seek
indicators of the relative value of the available alternatives.
Suppose your boss asks you to buy an outstanding bottle of
wine to impress a new client. To pick a winner, you might
look at the bottles, survey the knowledge and opinions of
friends, look into the various reputations of various vineyards,
and sample a few vintages. You would probably also use
price as a guide.
Taken from “Economics by Example” by David Anderson
What does it take to win someone’s heart?
For some people the answer may involve money, but for
many, it has more to do with kindness, intellect, humor,
romantic gestures, appearance and ability to contribute.
People must decide what they value most. This standard has
been called social price. As extremes, someone with high
standards has a high social price; someone with low
standards has a low social price.
Sometimes parents know an individual’s prospects better
than the individual. They may set a price floor (a minimum
price). If a daughter announces her interest in an “inferior”
male, the parents may forbid her to see him because the
“social price” is too low.
Taken from “Economics by Example” by David Anderson
Scarcity (such as the one you
love) forces us to choose
and choices are costly
because we always give
up other opportunities.
Economists call this
OPPORTUNITY COST.
Opportunity Cost:
The next best
alternative given up
to get something.
Everyone must give up
something to get more
of other things, called
trade-offs.
Opportunity Cost
Trade-offs
http://www.yadayadayadaecon.com/clip/10/
http://www.yadayadayadaecon.com/clip/9/
Some economists argue that we are
worse off because of the FDA (Food
and Drug Administration).
What are the “costs” of having a government
administrative agency control the food and
drugs a society can consume?
TINSTAAFL
(There is no such thing as a free lunch)
This statement clarifies the relationship between
scarcity and opportunity cost. If the cafeteria is
offering “free” lunches, is it really free from society’s
perspective?
Could the
resources used to
create the free
lunch have been
used to create
something else of
value?
Technically, this is
called a “subsidized”
lunch.
Prices and Costs are NOT the same
thing.
PRICES reflects the monetary value of a good or
service, which is an objective fact.
COSTS are personal and subjective.
For example, would a $60,000 Lexus cost more to
a poorer person than a richer one?
They both give up the same amount of money,
however, the costs are different for each person.
In market settings, goods
have positive prices
y
Economists
generally
use
quadrant 1
to graph
their
equations.
Quadrant II
Quadrant I
x
Quadrant III
Quadrant IV
Too often the long-term consequences of
a choice is ignored.
“….must trace not
merely the immediate
results but the results
in the long run, not
merely the primary
consequences but the
secondary
consequences, and not
merely the effects on
some special group but
the effects on
everyone.”
--Henry Hazlitt
Especially in politics there is a
tendency to stress the short term
benefits while completely
ignoring the longer-term
consequences. . . . we hear an
endless pleading for proposals to
help specific industries, regions,
or groups without consideration
given to their impact on the
broader community, including
taxpayers and consumers.
--Common Sense Economics
Consider the rent controls imposed on apartments. Cities
like Berkeley and Santa Monica, California, as well as New
York City have adopted such controls, usually in response to
claims that rent controls will keep rents from rising and make
housing more affordable for the poor.
True, in the short run…..but what about the long-run
consequences:
1) Market for apartments will stagnate.
*existing apartments will not go to those who need them
*expensive for someone to give up a rent controlled apartment
*hard to find place closer to work because others are holding onto
theirs
2) Reduce investment in new housing
*no incentive to build new apartments for the future.
NUMBER 4:
THINKING
MARGINALLY
Choices are not all or nothing.
Most choices are of the “little
more” or “little less” variety.
Most of us do not dine in the nude so we can afford food.
--Common Sense Economics
Economists call this “marginal thinking”
because the focus is on the additional, or
marginal, choices.
People will alter their behaviors if they
expect the marginal benefits from doing so
will outweigh the expected marginal costs
they will bear.
This is called the
RULE OF RATIONAL CHOICE.
Thinking at the margin
http://www.yadayadayadaecon.com/clip/7/
http://www.yadayadayadaecon.com/clip/54/
http://www.yadayadayadaecon.com/clip/88/
http://www.yadayadayadaecon.com/clip/95/
NUMBER
5: INCENTIVES CREATE
RATIONAL BEHAVIOR
Much of human behavior can be explained
and predicted as a response to incentives.
Rational behavior exists as people respond to
incentives--both positive and negative--in
the relative cost-benefit structure.
An integral part of the “Late Show with David Letterman” is
stage manager Biff Henderson wandering around New York
City timing things. How long would it take a shop owner to
stop Biff from drawing faces on watermelons? OR how long
would a restaurant cashier let him eat free mints out of the
bowl at the counter?” In most cases, Biff was stopped after a
short period of time. However, in this case, the cashier never
stopped him and, just before he left, Biff emptied the bowl into
his pocket and walked out.
Why did the cashier let Biff Henderson eat all the
free mints?
Taken from “Economics by Example” by David Anderson
Why did the cashier let Biff Henderson eat all the
free mints?
The answer: INCENTIVES MATTER.
With each watermelon Biff defaced, the shop owner risked
financial loss. The shop owner had an incentive to protect
his property.
If the cashier had a financial stake in the restaurant, perhaps
he would have said something. However, while the cashier’s
duty was to maximize her employer’s profits, her “incentive”
was to avoid hassles and collect a fixed wage.
Taken from “Economics by Example” by David Anderson
INCENTIVES are important in communist societies
as well.
In the former Soviet Union, employees in a glass
plant were rewarded by the number of tons of sheet
glass they produced.
This led to factories producing sheet glass so thick,
one could barely see through it.
So they changed the strategy and employees were
rewarded by the number of square meters they could
produce.
This led to production of glass so thin that it broke
easily.
**Taken from “Common Sense Economics” 2005
Incentives can be either positive or
negative.
POSITIVE incentives will either increase benefits
or reduce costs.
NEGATIVE incentives will either decrease
benefits or increase costs.
Would a tax on cigarettes be a
negative or positive incentive?
Would a subsidy to electric cars be a
positive or negative incentive?
Incentives
http://www.spike.com/video-clips/duaf9s/shower-with-a-gorilla-program
Seinfeld
http://www.yadayadayadaecon.com/clip/29/
http://www.yadayadayadaecon.com/clip/52/
NUMBER 6:
SPECIALIZATION AND
TRADE
People tend to dedicate their resources to one lifetime
activity, whether it be teaching school, child-rearing, or
cooking food. Why is this?
The answer is simple: OPPORTUNITY COST.
By concentrating their energies into a single,
best- suited activity, individuals incur lower
opportunity costs. In this way, they make better
use of their limited resources.
If a country, region, firm, or person
can produce a good or service for a
lower cost, economists would say
they have a COMPARATIVE
ADVANTAGE.
The advantages of specialization include
greater skill, lower costs, greater
efficiency, higher production, and
increased wealth.
NUMBER 7:
MARKETS AND THE PRICE SYSTEM
How do we
determine
who gets
what?
The market
system allows communication
between consumers and producers regarding the
allocation of scarce resources. This is done
through PRICES.
Every individual is continually
exerting himself to find out the
most advantageous
employment for whatever
capital he can command. It is
his own advantage, indeed,
and not that of the society
which he has in view. But the
study of his own advantage
naturally, or rather necessarily,
leads him to prefer that
employment which is most
advantageous to society….He
intends only his own gain, and
he is in this, as in many other
cases, let by an invisible hand
to promote an end which was
not part of his intention.
--Adam Smith
The remarkable thing about
an economy based on private
property is that self-interest
will further the general
prosperity of a community or
nation. The individual
“intends only his own gain”
but he is directed by the
“invisible hand” of market
prices to promote the goals of
others…….
--Common Sense Economics
Government policy sometimes
interferes with the market system.
Consider how minimum-wage legislation
censors effective communication from
teenagers to employers.
While it is true that minimum wage protects
teenagers from being paid extremely low
wages for unskilled labor, the increase in
minimum wage has two effects on
teenage employment:
1) the higher minimum wage
increases the number of teenagers
who want jobs, sometimes even
causing them to drop out of
school,
2) the higher minimum wage for
low-skilled workers discourages
hiring.
NUMBER 8:
GOVERNMENT POLICIES
Governments are
institutions devised
by humans to serve
the collective group
or will.
There are seven
reasons to justify
government
involvement into the
economic decisionmaking process:
•government provides legal framework
•some goods and services are inherently
“public”
•lack of competition has led markets to operate
inefficiently
•government can help participants in market
activity make better decisions
•the existence of externalities--like pollution-can cause inappropriate market signals
•income distribution as determined by the
market may be considered unfair or
inappropriate
•overall level of output may be viewed as
inappropriate in the market.
NUMBER 9:
ECONOMIC GROWTH
Economic growth enhances the potential amount
of individual consumption---the greater the
economic growth, the more goods we and our
descendants will have to consume in the future.
Americans produce and earn approximately 30
times as much per person today as in 1750.
Why are Americans so much more productive than 250
years ago?
1) Scientific knowledge and technological abilities
2) Complex machines and factories, better roads,
extensive systems of communication
3) Families in 1750 directly produced most of the items
they consumed; today we purchase them from others
--Common Sense Economics
Other sources of economic growth:
1) Investments in people (skills) and machines
(assets)
2) Improvements in technology (brain power, less
cost)
3) Improvements in Economic Organization
*human activities
*entrepreneurship
*open markets promote free exchange of
ideas
*competition
NUMBER 10:
PRICE
STABILITY
When
overall prices
increase in an economy, it
is called INFLATION.
When overall prices
decrease, it is called
DEFLATION.
When either of these
conditions exist, the
PURCHASING POWER of
money is changing.
Inflation will cause the purchasing power of
money to decrease.
It can raise one nation’s prices relative to
prices in other countries , which will lead to
difficulties in financing foreign goods.
In extreme situations, it
can erode the faith the
people have in the
currency resulting in the
refusal to accept paper
money as a form of
payment.
In a deflationary period, the
purchasing power of an individual
will rise, however, businesses may
be forced to lay off workers in an
effort to reduce costs to offset the
lower prices of the product.
NUMBER 11:
Ceteris Paribus: all other
things equal
The Use of Models in Economics
•Models
•Other things equal
assumption
•Ceteris Paribus
POSITIVE vs
NORMATIVE
Positive Versus Normative
Economics
• Positive economics:
questions that have definite right and
wrong answers.
• Normative economics:
economics analysis saying how the
world should work.
• Examples: facts vs. predictions
• Economic model
ECONOMIC way of thinking
…….making use of a common set of tools
for economic analysis.
Statistics
Factual Tools
Theoretical Tools
Models
Concepts
Institutions
History
WHY IS ECONOMICS A
SOCIAL SCIENCE??
Economics is very similar to the other social
sciences--psychology, history, sociology,
anthropology, and political science--in that
it is concerned with reaching conclusions
based on human behavior.
Social scientists may study the same issue
but have a different perspective on the
subject.
The two main
branches of
Economics are:
Macroeconomics-looks at problems in the
economy which affect
society as a whole.
Microeconomics--
Despite the fact that the two
areas stress different topics,
they both still strive to
understand people’s behavior.
looks at the smaller areas
in the economy trying to
understand how firms and
businesses make their
decisions.
The study of economics can
help you to understand
education, pollution
concerns, global warming,
welfare reform, health care,
in that we all must make
choices between our
unlimited wants/desires and
our basic needs.
The disciplined mind
developed by the study of
economics will give one the
problem-solving tools
which will be valuable to
anyone regardless of career
choice.
Is it rational for people to strive for a better
situation in their own lives?
Economists believe that
self-interest = rational behavior
They also believe
that rational
behavior includes
the idea that
individuals will
attempt to
anticipate the
future
consequences of
their acts.
Rationality
http://www.yadayadayadaecon.com/clip/19/
What tradeoffs occur when
a driver with a suspended
license drives a car
illegally?
What are the
consequences of smoking
cigarettes?
What are the tradeoffs of
not finishing high school?
What are the
consequences of not going
to college?
Not all humans react in
similar ways, however, by
looking at large groups of
people, economists can
make many reliable
predictions about human
behavior.
The
End
Compiled by Virginia Meachum, Economics
Teacher
Exploring Economics, Pathways to Problem
Solving, by Robert L. Sexton (Dryden Press, 1999)
Principles of Economics, by N. Gregory Mankiw,
2nd & 3rd edition (Thompson, Southwest Publishing, 2004)
Economics For AP, by Paul Krugman, Robin Wells,
David Anderson, Margaret Ray