Download What is Economics?

Welcome to Econ 202
Principles of Microeconomics
Dr. David Sobiechowski, Instructor
www-personal.umd.umich.edu/~davidski
www-personal.umd.umich.edu/~davidski
What is Economics ?
(or why does economics exist)
Problem 1. Human Beings have unlimited wants
for goods and services.
Problem 2. Resources
(which are used to produce goods and services)
are Limited
Example: You have a limited income (your
resources), but could always want more goods &
services than you do now.
The Economic problem is Scarcity
• Scarcity is the imbalance between:
the unlimited wants of humans and
the limited means to satisfy those wants
• An Economy is: a mechanism through which the use
of land, labor, and capital are organized...
...in an attempt to satisfy the unlimited wants of it's
members.
• Economics is...
...1. the study of how individuals, groups, and countries
use their limited resources in an attempt to satisfy
their unlimited wants.
2. Economics is the study of how people make choices in
attempting to satisfy their unlimited wants.
Why make choices?
• You can’t ever get everything you desire
because of limited resources...
...(i.e. income, wealth, time, etc.) this implies
that one must choose among many different
possible alternatives.
…which means that we could have done
something else with our time or with our
income…
…in other words we must give up some other
alternative to get something else.
This is called: Opportunity cost...
... is the cost of making a choice...
…it is measured as the sacrifice of the next best
alternative given up by a person, group, or
nation.
Opportunity cost is, for the most part, subjective
(by the person making the choice).
But it always exists regardless of person or nation.
This leads to the saying: There is no such thing as
a free lunch.
Decision Making
The question that is fundamental to economics is:
How should we use our resources and capabilities?
This applies to an individual, a business firm, and a
nation as a whole…
…because all face the universal problem of scarcity
• Economists use the concept of opportunity cost as
a way to make decisions:
1. There is an opportunity cost to everything we do
2. There must also be a benefit (the opposite of cost)
to everything we do…
…it is measured by what we are willing to give up.
Marginal Analysis
• Economists assume that people have objectives they
want to reach, such as getting as much profit as possible
from producing goods or services.
• How can a firm or a person make sure they do this?
• By comparing the benefits and costs of an action!...
…moreover, you will only be concerned with the additional
benefits and additional costs from your current
situation…
…because there is nothing you can do about past costs and
benefits(Sunk Costs)…
…the decision rule is simple: pursue an action where the
additional benefits are greater or equal to the additional
costs of an action.
It is called marginal analysis because this is the name
economists give to the words: additional, next, extra.
Example: The choice of going to college.
• All of you decided the marginal benefit of going to
college was higher than the marginal cost of going to
college.
• I assume you are a rational self-interested person
• Rational means you have an objective and will choose
that action that will give you the greatest satisfaction
• Choosing the alternative where the
marginal benefit >= marginal cost will do this.
• In fact you will choose the amount of that alternative
until the marginal benefit = marginal cost
(get the most satisfaction from your action).
How do we study Economics?
A look at a Theories (Models)
To explain economic behavior
• Looks closely at how individuals, business
firms, and societies make choices.
• It attempts to show how the market-capitalist
system answers the following three
fundamental questions
(every economy faces these because of Scarcity) :
The study of how the choices individuals, businesses and
governments affect the aggregate or total economy.
Three large issues of Macroeconomics:
1. Standard of Living - level of consumption of goods and
services people enjoy.
Economic growth and Unemployment.
Productivity - Total Production / Number employed
2. The cost of Living - number of dollars it takes to buy
goods and services for a given standard of living.
Inflation and Price Stability : Quantity of Money
3. Economic Fluctuations - the periodic rise and fall of total
production in the economy, the business cycle
Recessions and Expansions affecting
Unemployment & Inflation : Fluctuations in total spending
Begins with observing the economy
• All Scientific inquiry starts with observations about
what is happening in the world.
• Economists gather information and describe the
economy by organizing the data.
• This data can be shown with tables of numbers
which we can translate into a picture(graph).
• A discussion of how to read and interpret these
observations will be done later in the lecture.
• However, this is only the start: Descriptions are not
explanations…
…this is why economic models or theories are needed:
To explain the data that is collected
Two types of Scientific inquiry
• Positive Economics...making objective statements about
economic phenomena that can be tested and proved
right or wrong.
a. Explaining why events occur
b. Predicting under what circumstances economic events
will occur in the future
Example: An increase in income taxes will cause
consumer spending to go down
• Normative Economics...a way of determining the
desirability of outcomes based on some value judgments
(opinions)
a. Recommending appropriate courses of actions to take.
Example: Taxes should be lowered in order to increase
consumer spending.
b. Criteria: 1. Efficiency
2. Equity
Theories or Models
• Used to explain how something works.
• An Economic model is a simplified way of
expressing how the economy or parts of that
economy function.
• It’s main purpose is to explain how the
economy (or parts of it) work and to make
predictions about what could happen when
something changes in the economy.
Theories or models include four steps
1. Identify what you want to study (variables)
Example: You may want to study how a congressperson
will vote on bill.
Some variables that may be relevant to that vote are:
Party affiliation
Congressional district (Constituents)
Conscience
Money received for political campaigns
2. Make assumptions on variable behavior
Example: What is the objective of the Congressperson?
1. Reflect constituent views, 2.Vote with Party,
3. Get Re-elected
Theories or models include four steps
3. Make hypothesis or Predictions
(In the form of IF... THEN..)
• Example: If a Congressman receives money from the
UAW he will vote Yes on raising the minimum wage...
....Ceteris Paribus: All other things held constant.
(This is an implicit assumption made with all predictions)
It means that we only use two variables at a time when
making predictions (in order to isolate how one
variable affect one other variable)...
...Everything else is assumed not to change.
4. Test your predictions
• If wrong you may have to adjust theory
Problems in theory building:
1. Fallacy of Composition...what is true for the
individual is true of the group
2. Post hoc, ergo Propter Hoc (Post Hoc fallacy)
Association does not imply causation
1. The Fallacy of Composition: The often
mistaken belief that what is true for a part
is necessarily true for the whole.

When I stand up at a ballgame, I can see
better. Therefore, if everyone stands up,
everyone will be able to see better?

If Farmer Jones produces more corn, her
revenues will rise. If all farmers produce
more corn, their revenues will all rise?
2. Post Hoc Fallacy: If event A happens
before event B, it is not necessarily true that
event A caused event B.
Many, many examples exist...
 I went to the beach and it began to rain. It
must have rained because I went to the
beach?

We increased our advertising budget and
people stopped buying our product. Our
advertising must be discouraging
consumers?
Correlation vs. Causation
• Two variables are correlated if
one variable changes when the
other variable changes.
• This does NOT mean that
changes in one variable
CAUSE changes in the other.
APPLICATION: Correlation vs.
Causation

Cities with high crime rates also have
many automobiles. Does this mean that
automobiles cause crime?

President Bush took office in 2001 and
soon after the economy began to get
worse. Does this mean that the Bush
inauguration caused the worsening
economy?
An Introduction in reading
and using Graphs
Graphs
• Graphs are pictures that show the relationship
between two variables
• A variable is something that can take on more
than one value.
• There are two ways that variables can be
related:
1) Positive relationship: variables move in the
same direction
2) Negative relationship: variables move in the
opposite direction
Example: Positive or Direct
relationship
Miles driven in a car and the
total amount of gasoline used
As you drive more you will use up more gasoline.
Miles Driven
Gasoline used (gallons)
200
400
600
800
10
20
30
40
A graph always starts with labeling the vertical
and horizontal axis with the variables
(numbering is usually optional)
Next, we plot the points from our table...
Miles
Driven
Miles
Driven
200
400
600
800
800
600
400
Gasoline used
(gallons)
10
20
30
40
200
0
10
20
30
40
Gallons of gasoline used
Then we connect the dots to represent other possible
observations and to describe the relationship
The graph is read by
...and then moving vertically
moving to the right
on the horizontal axis..... until you hit the relationship line.
If we want more detailed information
about this relationship we can calculate
the slope of the line
Miles
Driven
Slope = Change in vertical distance
Change in horizontal distance
800
600
200 miles
10 gallons
400
= 20 miles
gallon
200
0
Miles
Driven
200
400
600
800
= Rise
Run
= 200 miles
10 gallons
10
20
Gasoline used
(gallons)
10
20
30
40
30
40
Gallons of gasoline used
This relationship line is constructed ceteris paribus
• Are there other variables could affect the amount of
gasoline a car would use for the same amount of miles
driven?
Tire inflation
Weather conditions
a well tuned engine
amount of weight in car or towing
• If a car is driven is cold weather it will use more gas for
same miles driven
• How will this affect the relationship line we have
drawn?
Use more gas more same amount of miles driven...
Miles
Driven
Adding the variable driving in cold weather
has caused the curve to Shift Position!
800
When a third(or more)
variable is included in a
model it causes the entire
600
400
curve to shift.
200
0
10
20 30 40
Gallons of gasoline used
Miles Gasoline used Gasoline used
Driven
(gallons)
(gallons)
200
10
20
400
20
30
600
30
40
800
40
50
Cost of
Next car
Any time a line gets steeper,
the slope is getting larger
Dealing with curves
Interpretation:
As production gets
larger the same
increase in production
leads to greater
increases in costs than
before.
Production of Cars
This curve also shows a positive relationship, except it is a not
a straight line...
...The slope of a curved line changes at every point on that
curve...
...you should be able to tell how the slope of the line changes as
we move away from the origin.......
Production of Autos
Dealing with curves
Interpretation:
As more workers are
added the same
increase in workers
leads to smaller
increases in
production.
Amount of Workers
Here is a positive relationship where Y increases
but at a smaller rate as X increases.
The Difference Between a Line
and a Curve
Equal increments in
X lead to constant
increases in Y.
Equal increments in
X lead to diminished
increases in Y.
Negative or Inverse relationship
• Two Variables move in the opposite direction
• Example: Birthrate and Family income
• As Family income increases the Birthrate tends
to decline
Birthrate
(average
per family)
c
A negative relationship shows a downward
sloping line (moving to the southeast)
A
B
d
0
e
f Family Income (average per family)
When we move to the right on the horizontal axis, the
relationship line tells us we must move down the vertical
axis.
Y
Dealing with curves
Interpretation:
As X gets larger the same
increase in X leads to
Y decreasing in
greater amounts than when
X was smaller
X
Here is a case of a negative relationship
that is not a straight line
Y
A Graph that shows no relationship
between the two variables...
20
X
…as X increases, Y does not change
This means that Y is independent of X and vice versa.
A straight horizontal or vertical line indicate no
relationship between the two variables.
This is a time series graph.
It shows how a variable performs over time.
This graph shows Mortgage rates 1978-2008