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ECONOMICS
Chapter 1
What is Economics?
contents
1.1
Basic Nature of Economics
1.2
Rational Choice
1.3
Economic Resources and Commodities
1.4
Basic Structure of National Economy
1.5
Market and Price
1.6
Microeconomics and Macroeconomics
1.7
Economic Ways of Thinking
1.1 Basic Nature of Economics
economics
• subjects of interest in economics
‐ various economic phenomena such as
unemployment, inflation, economic growth,
poverty, exchange rate, labor relations,
competition, environmental pollution
• Why should we learn economics?
‐ basic knowledge of economics is a prerequisite
for those who live in this modern world
1.1 Basic Nature of Economics
economics
– science of
choice
• economics : a field of study which explores the
ways to utilize economic resources efficiently to
meet material needs of human beings
• we can say that economics is a science of choice.
• anything that is related to choice can be the
subjects of exploration for economists
ex) economics of family, economics of crime and
punishment, economics of arts, economics of
sports etc.
1.2 Rational Choice
rationality
in
economics
‐ basic assumption of economics : all
economic agents are rational
‐ rationality in economics means rationality
in means, not in purpose
• How can we achieve a certain purpose
most efficiently?
‐ example of a rational choice: “Should I go
to college or not?” (benefits and costs of
going to college)
1.2 Rational Choice
Opportunity Cost and Sunk Cost
opportunity
cost
• accounting cost and opportunity cost
‐ the concept of accounting cost only includes
what is actually spent
‐ for a rational choice, however, something that
has the characteristic of cost must be counted
as cost even though it is not actually spent →
the concept of opportunity cost
‐ the opportunity cost of some decision is the
value of the next best alternative that must be
given up because of that decision
1.2 Rational Choice
Opportunity Cost and Sunk Cost
sunk cost
– a cost that has already been incurred and
cannot be recovered by any means is called
sunk cost
– since there is no way of recouping it, we should
not take this into consideration when we make
a decision
– an irrational choice could be made if we fail to
ignore this
– in actuality, however, many irrational choices
are made when sunk cost is involved
ex) Concorde fallacy
1.2 Rational Choice
Revenue and Cost of Running a Restaurant
• Mr. Park, Master Chef of the Shangri-La Hotel, decides to open his own restaurant
‐ presently, his annual salary is $90 thousand
‐ expected revenue and cost from his restaurant
<accounting cost>
<opportunity cost>
– If he quits his present position, he has to give up $90 thousand of annual
salary. Even though this is not actually spent, it should be counted as part of
cost
1.3 Economic Resources and Commodities
economic
resources
– broad sense : anything that we should use
economically
– narrow sense : factors of production
• labor, capital, land
• entrepreneurial efforts
1.3 Economic Resources and Commodities
commodities
‐ anything that is traded in the market is called a
commodity
‐ include goods that we can see and services
that we cannot see
‐ free goods vs. economic goods
1.4 Basic Structure of National Economy
3 Major Economic Agents
demand for
commodities and
supply of the
factors of
production
collect taxes and
provides various public
services
supply of commodities
and demand for the
factors of production
1.4 Basic Structure of National Economy
households
and firms
1.4 Basic Structure of National Economy
Three Major Tasks of National Economy
efficiency in
the process
of resource
allocation
• resource allocation → what, how, for whom?
(1) what to produce?
(2) how to produce?
(3) for whom to produce?
1.5 Market and Price
market and
gains from
exchange
– market
• any institution or social relation whereby
parties engage in trade can be called a
market
• some markets can be invisible
‐ gains from exchange
• even though there is no change in other
conditions, all the people engaged in
trade can enjoy higher material wellbeing thanks to the gains from exchange
1.5 Market and Price
Market Economy
market
economy
– economic system in which markets play
critical roles
• prices of all commodities are determined
in the markets
• establishment of property rights
• free competition
• free trade : division of labor and
specialization
1.5 Market and Price
Market Economy
command
economy
mixed economy
‐ economic system in which the
economy is controlled by
government mandates
– economic system in which both
government and markets play
important roles
1.5 Market and Price
Price Mechanism
price
mechanism
two main
roles price
plays
‐ price mechanism → efficiency of the market economy
‐ A. Smith ‘Invisible Hands’
(1) transmission of signals
• the level of price of a certain commodity
conveys information about how eagerly it is
wanted or how much it costs to produce it
(2) provision of incentives
• if the price of a certain commodity goes up,
producers get the incentive to produce more
1.6 Microeconomics and Macroeconomics
• two ways of observing a mountain
1) you stand at a long distance, and observe the outline of the
entire mountain
2) you walk into the mountain, and closely observe trees, plants
and soil in it
• likewise, there are also two ways of observing an economy
• we can focus on either the overall workings of national economy or
the particular movements of components of national economy
1.6 Microeconomics and Macroeconomics
(1) macroeconomics
• focus is on the overall workings of national economy
• main variables of interest : aggregate production, aggregate
employment, price level, balance of payments
(2) microeconomics
• focus is on the choices of individual economic agents and the
movements of individual markets
• main variables of interest : choices of consumers and firms, price of an
individual commodity and its amount of transaction
1.7 Economic Ways of Thinking
(1) There is no free lunch
– if a certain cost is invisible, people fail to recognize it as cost
– from the viewpoint of opportunity cost, nothing is costless
(2) All those who participate in exchange can get gains
‐ everyone who participate in exchange voluntarily can get gains
1.7 Economic Ways of Thinking
(3) It is difficult to repeal the laws of supply and demand
– paradox of water and diamond
– examples of price ceiling and price floor
(4) It is important to think at the margin
‐ marginal utility, marginal cost, marginal revenue
(5) People respond to incentives sensitively
‐ government policies try to utilize this characteristic
ex) energy tax, tax on tobacco
1.7 Economic Ways of Thinking
(6) Markets are efficient, but not perfect
– social costs of monopoly, environmental pollution
– inadequate supply of national defense or police services
(7) Government can be helpful,
but sometimes its intervention make things worse
‐ no guarantee that government intervention makes the situation better
‐ occurrence of government failure
1.7 Economic Ways of Thinking
(8) Trade-off between efficiency and equity
– a compromise is necessary between the two objectives
(9) Trade-off between inflation and unemployment
‐ fundamental dilemma of national economic policy
‐ which objective should get more attention?
ECONOMICS
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