Download Econ101.Ch.1.A

WHAT IS ECONOMICS?
1
CHAPTER
WHY DO WE STUDY
ECONOMICS??
BAHRAIN STOCK MARKET
Swine Flu & Economics
UNSOLD CARS & ECONOMICS
WHY STUDY ECONOMICS
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Among TOP TEN REASONS …..
Economists can supply it on demand.
You can talk about money without ever having to make
any.
When you are in the unemployment line, at least you will
know why you are there.
So that you know more than the most world leaders
about what is actually going on.
Slide #1
Definition of
Economics
-scarcity and choices
-economics
-Microeconomics
-Macroeconomics
Economics: A
Social Science
-positive
statement
CHAPTER 1:
WHAT IS
ECONOMICS
Big Microeconomics
Questions
-normative
statement
-What, How, For Whom
-Factors of Production
-Economic theory
-economic model
Economic Way of Thinking
-ceteris paribus
-Choice
-Tradeoff
-opportunity cost
-Marginal benefit and Marginal
Cost
Land, Labor, Capital
and Entrepreneur
Definition of Economics
All economic questions arise because we want
more than we can get.
Our inability to satisfy all our wants is called
scarcity.
Because we face scarcity, we must make
choices.
The choices we make depend on the incentives
we face.
An incentive is a reward that encourages or a
penalty that discourages an action.
Economics
We want more than what we get
leads
SCARCITY
CHOICES
INCENTIVES
depends
Definition of Economics
Economics is the social science that studies
the choices that individuals, businesses,
governments, and societies make as they
cope with scarcity and the incentives that
influence and reconcile those choices.
Economics
Microeconomics
Macroeconomics
Definition of Economics
Microeconomics
Microeconomics is the study of choices made
by individuals and businesses, and the
influence of government on those choices.
Macroeconomics
Macroeconomics is the study of the effects
on the national and global economy of the
choices that individuals, businesses, and
governments make.
TWO BIG ECONOMIC
QUESTIONS
CHOICES
1. FIRST BIG ECON
QUESTION
 What to produce
 How to Produce
 For whom to produce
2. SECOND BIG ECON
QUESTION
 Self Interest or Social
Interest
Two Big Economic Questions
Two big questions summarize the scope of
economics:
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How do choices end up determining what,
how, and for whom goods and services get
produced?
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When do choices made in the pursuit of
self-interest also promote the social
interest?
Two Big Economic Questions
What, How, and For Whom?
Goods and services are the objects that
people value and produce to satisfy wants.
What?
Given the resources or factors of production
available to us, we have to decide on what
to produce
Two Big Economic Questions
How?
Goods and services are produced by using
productive resources that economists call
factors of production.
Factors of production are grouped into four
categories:
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Land
Labor
Capital
Entrepreneurship
Factors of Production
The “gifts of nature” that we use to produce goods and
services are land.
The work time and effort that people devote to producing
goods and services is labor.
The quality of labor depends on human capital, which is
the knowledge and skill that people obtain from
education, on-the-job training, and work experience.
Two Big Economic Questions
The tools, instruments, machines, buildings, and
other constructions that are used to produce
goods and services are capital.
The human resource that organizes land, labor, and
capital is entrepreneurship.
Two Big Economic Questions
For Whom?
Who gets the goods and services depends on
the incomes that people earn.
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Land earns rent.
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Labor earns wages.
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Capital earns interest.
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Entrepreneurship earns profit.
Two Big Economic Questions
When is the Pursuit of Self-Interest in the Social Interest?
Every day, 6.3 billion people make economic choices that
result in “What,” “How,” and “For Whom” goods and
services get produced.
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Do we produce the right things in the right quantities?
Do we use our factors of production in the best way?
Do the goods and services go the those who benefit most
from them?
Two Big Economic Questions
You make choices that are in your selfinterest—choices that you think are best
for you.
Choices that are best for society as a whole are
said to be in the social interest.
Is it possible that when each one of us makes
choices that are in our self-interest, it also
turns out that these choices are also in the
social interest?
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B. The second big question is “When is the pursuit of selfinterest also in the social interest?”
1. People make choices in their own self-interest—they
make choices they think are best for their own well-being.
a) The incentives surrounding an individual’s choice amongst
available alternatives influence the tradeoffs involved in making
that choice.
b) The choice made by one individual changes the incentives
surrounding the tradeoffs facing other individuals, which
influences their choices.
c) In this way, many self-interested individuals making
choices in society will bring about change to the incentive
surrounding all decisions to be made by individuals in the
economy.
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2. When people make self-interested
choices that are the best for society,
they make choices that are considered
in the social interest.
a) In 1776 Adam Smith published The
Wealth of Nations describing how a
market based system can theoretically
motivate self-interested individuals to
make choices that promote the social
interest.
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3.
We can examine a number of current events to determine whether selfinterested individuals made choices in the social interest:
a)
Privatization: The fall of socialism and the rise of capitalism in Europe
b)
Globalization: The local impact of growing international trade
c)
The “New” Economy: Workers adjusting to changing technologies
d)
The post 9-11 economy: Terror changes vacation habits
e)
Corporate scandals: Preventing stealing by corporate officials through
lying
f)
HIV/AIDs: Poorest countries hit hardest but lack medicines
g)
Disappearing tropical rainforests: Lack of property rights creates waste
h)
Water shortages: Consumers fail to pay the opportunity cost of
consumption
i)
Unemployment: Persistence in minority teenage unemployment
j)
Deficits and Debt: Having future generations pay for today’s servi
The Economic Way of
Thinking
Choices and Tradeoffs
The economic way of thinking places scarcity
and its implication, choice, at center stage.
You can think about every choice as a
tradeoff—an exchange—giving up one
thing to get something else.
The classic tradeoff is “guns versus butter.”
“Guns” and “butter” stand for any two objects
of value.
SCARCITY
CHOICES
TRADEOFF
OPPORTUNITY COST
(give up the highest value alternative)
The Economic Way of
Thinking
Opportunity Cost
Thinking about a choice as a tradeoff emphasizes
cost as an opportunity forgone.
The highest-valued alternative that we give up to
get something is the opportunity cost of the
activity chosen.
The Economic Way of
Thinking
Choosing at the Margin
People make choices at the margin, which
means that they evaluate the consequences
of making incremental changes in the use of
their resources.
The benefit from pursuing an incremental
increase in an activity is its marginal
benefit.
The opportunity cost of pursuing an incremental
increase in an activity is its marginal cost.
Marginal Benefit vs Marginal
Cost
Marginal Benefit: the benefit arises from an increase in
activity
i.e- Study three nights in a week GPA is 3.0
Study 4 nights in a week
GPA is 3.5
Marginal Benefit = 3.5- 3.0 =0.5
 Marginal cost: The cost of an increase in activity
Marginal cost: cost of additional night not watching TV
DECISION: MB> MC
STUDY
MB< MC
DON’T STUDY
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Marginal Benefits vs. Marginal
Costs
MB >MC
MB < MC
Incentive to
continue activity
Incentive to
discontinue activity
Economics: A Social Science
Social science
Economics is a social science.
Economists distinguish between two types of statement:

What is—positive statements
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What ought to be—normative statements
A positive statement can be tested by checking it against
facts
A normative statement cannot be tested.
3. ECONOMIC METHODOLOGY
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Relying on scientific method to view at
things. Consisting of the following
elements:
- Observation of facts
- Hypothesis formulation
- Testing
- Acceptance/rejection: Modification
- Continued testing against facts
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3. ECONOMIC METHODOLOGY
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Continued testing against facts
Accumulation of favorable results =THEORY
Accepted theory = LAW/PRINCIPLES
Combination of law & principles = MODELS
(Simplified version of relationships)
All these enable us to understand, explain &
predict economic outcomes
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3. ECONOMIC METHODOLOGY
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Theoretical economics
- Develop models of behavior of economic agents
- Relevant and useful information
- Establishing cause-effect
 testing
 discovering theories & principles
 use in analytical economics
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3. ECONOMIC METHODOLOGY
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Terminology
- Hypothesis – Needs initial testing
- Theories – Tested, need more testing
- Law/principle – accepted theory, provided strong
predictive accuracy
- Model – Combines principles into simplified
representation of reality
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3. ECONOMIC METHODOLOGY
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Generalizations
- Theories, laws & principles are generalizations to
economic behavior
- Imprecise due to economic diversity
- Economic principles are expressed as the
tendencies of average economic agents
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3. ECONOMIC METHODOLOGY
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Other-things-equal assumption
- Ceteris paribus
- Enable generalizations
- All variables, except the one under analysis,
are held constant
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Obstacles and Pitfalls in Economics
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There are several obstacles that can affect
economic analysis.
• Confusion can result when too many things
change and so it might not be possible to
understand what caused
what. So in their models economists change
one factor at a time to isolate its effects using
the ceteris paribus
assumption. Ceteris paribus is a Latin phrase
that means “other things being equal.”
Economists cannot easily do
experiments and most economic
behavior has many simultaneous
causes.
To isolate the effect of interest,
economists use the logical device
called ceteris Paribus or “other things
being equal.
Economists try to isolate cause-andeffect relationship by changing only
one variable at a time, holding all
other relevant factors unchanged.
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• The fallacy of composition is the (false) statement that what
is true for the parts is also true for the whole, or what
is true for the whole is also true for the parts. For example, one
person can walk through the door into the class,
so the entire 30-person class can simultaneously walk through
the door.
• The post hoc fallacy (from the Latin phrase, post hoc, ergo
propter hoc, which means “after this, therefore because of
this”) is the error of reasoning that a first event causes a second
event because the first event occurred before the
second. For instance, claiming that you are delivering an
economics lecture because the room first filled with
students is a post hoc fallacy.
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Agreement and Disagreement Among
Economists
Economists tend to agree on positive
statements, though they might disagree
on normative statements.
Economists are often accused of
contradicting each other.
In contrast to the popular image,
economists find much common ground
on a wide range of issues.
(Page X lists twelve different economic
THE END