Download ch01 Modern Economics

23.09.2010
Economics studies how individuals, firms, the
government, and other organizations make choices and
how those choices determine society's use of its
resources.
There are five core concepts:
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All choices involve trade-offs:
◦ What should you spend your weekly budget on—pizza, CDs, movies,
books, and so on?
Incentives are the rewards and costs that stem from
making choices.
◦ Prices reflect incentives: rewards and costs.
◦ All decision makers, consumers, businesses, and
governments respond to incentives.
More of one of these means you can spend less on another.
There is no such thing as a free lunch.
trade-offs
incentives
exchange
information
distribution
Trade-offs stem from scarcity.
◦ You have limited money and time.
◦ Society has limited resources.
Exchange is the trade of goods and services.
Voluntary exchange in markets is how modern economies like
Turkey determine which goods and services to produce to satisfy
the vast number of consumers.
Voluntary exchange means both parties get something they want;
a worker wants income and a firm wants a certain job done, for
example.
A market is any situation in which an exchange takes place.
◦ A market need not be a physical location.
◦ With competition, consumers have a choice of alternatives.
◦ Turkish economy is a mixed economy where most exchanges take place in
a market but the government plays a critical role in other aspects of the
economy.
Making informed choices requires information.
Information is like any other good or service.
◦ There are firms and institutions that specialize in the purchase and
sale of information.
◦ The seller of a car lets you test drive it, but a seller of information
cannot let you see the information.
In some markets information is so crucial it shapes the whole
market:
◦ Market for used cars
◦ Stock market and other security markets
◦ Insurance
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Markets determine who gets which goods according to the
demand and supply of goods, labor, and capital.
Some view the uneven distribution of wealth with unease.
Government programs attempt to even out the distribution.
◦ However, efforts to soften the distributional impact of markets often
blunt economic incentives.
◦ That is, there is a trade-off between equity and efficiency.
Trade-offs: resources are scarce, so trade-offs are a basic fact of
life
Incentives: in making choices, decision makers respond to
incentives
Exchange: people benefit from voluntary exchange, and in market
economies, market exchanges lead to the efficient use of
resources
Information: the structure that markets take and how well they
can function depend critically on the information available to
decision makers
Dıstribution: markets determine how the goods and services
produced by the economy are allocated to members of the society
The product market: where final goods and services are
exchanged
The labor market: where workers sell labor and firms hire
workers
The capital market: where households, firms, and
government save and raise funds
Microeconomics, the study of the small:
Macroeconomics, the study of the large:
◦ Specific goods and services, industries, individuals, and firms
Revenue
Goods and
Services Sold
Consumption
Product Market
Goods and
Services Bought
◦ How the overall economy behaves
Firms
Households
Inputs for
Production
Labor, Capital
and Land
Factor Markets
Wages, Rent
and Profit
Income
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Economics is a social science.
◦ Economic theory is composed of:
Assumptions or hypotheses and the conclusions derived from
them.
Theories are logical exercises that lead from assumptions to
conclusions.
Economists seek to understand the relationships
among economic variables that can be measured and
may change.
Economists use models to test theories.
Models are abstractions.
◦ They are oversimplified to stress the essentials of a complex
social reality.
◦ Economists use the theory of perfect competition even where it
only holds approximately.
Correlation – when one variable changes another
tends to change.
Causation – when changing one variable “causes”
another variable to change then changing the first
necessarily changes the second.
◦ In the 1970s imports of cars from Japan rose while U.S. auto
production fell
These variables are correlated, but was there causation?
No; both events were related to a third event:
Higher oil prices pushed U.S. consumers away from “gasguzzling” U.S. cars toward more fuel efficient Japanese cars.
Economists often disagree about public policy.
Their differences usually fall into one of two categories.
◦ Positive Economics: differences about how the economy
operates
These differences stem from differences over which model to use.
◦ Normative Economics: differences about how to evaluate the
consequences of policies
These differences stem from different assessments of the quantitative
magnitudes of the analysis.
◦ Economists have different values which may lead them to disagree
about policies.
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