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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: ◦ ◦ ◦ ◦ ◦ 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 1 23.09.2010 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 2 23.09.2010 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. 3