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What is Economics ?
(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
Individual choice: The core of Economics
• 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 individuals,
groups, and countries make choices in
attempting to satisfy their unlimited wants.
Why make choices?
• You can never get everything you desire because of
limited resources (i.e. income, wealth, time, etc.). This
means that one must choose among many different
possible alternatives
• This means that we could have done something else
with our time or with our income.
– In other words we must always give up some other
alternative to get something else.
• This is called: Opportunity cost, (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.
– It could be the amount of money you give up to get a good
or service but opportunity cost can be in terms of time or
other measure.
– It is also, for the most part, subjective. That is it is
measured by the person making the choice.
– “ There is no such thing as a free lunch”
Decision Making: Marginal Analysis
How can individuals, business firms, and nations use our
resources and capabilities to make us as well off as
possible?
Fact: People & Businesses usually exploit
opportunities to make themselves better off.
Economists use the concept of opportunity cost as a
way to visualize these decisions:
1. There is an opportunity cost to everything we do
2. Therefore, a benefit (the opposite of cost) to
everything we do must exist and this is measured by
what we are willing to give up.
Since decisions are rarely all or nothing, this comparison
of benefits and costs determine how much of
something we choose to have.
This is referred to as a trade-off.
Decision Making: Marginal Analysis
• 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 (called 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, small
change.
– In fact you will choose an action or alternative until the
marginal benefit = marginal cost (this will fully exploit the
opportunity presented to you).
• 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.
Decision Making: Marginal Analysis
• Example: How many classes do you plan to take in the
Fall?
– The marginal cost of a class is tuition, books, time.
– The marginal benefit for each class is more knowledge
gained and closer to graduation.
• You are probably taking more than 1 class but less than 6.
• At some point the marginal benefit of taking another class
diminishes while the marginal cost is constant.
• Eventually, taking that 3rd, 4th, 5th, or 6th class is “no
longer worth it” compared to the cost.
• At the point where marginal benefit = marginal cost for you
what determines the amount of classes you will take.
• Much of the material covered in Microeconomics is based
on comparing marginal benefits & marginal costs
Microeconomics takes a close look at
how individuals and firms make choices
• It shows how the market-capitalist system answers the
following three fundamental questions: (which every
economy faces these because of Scarcity)
What to Produce?
How to Produce?
For Whom to Produce?
Interaction: How Economies work
• Interaction of choices: My choices affect your choices
and vice versa. Results are often different from
intentions.
5 Principles underlying interaction of individual
choice
1. There are gains from trade
2. Markets move toward equilibrium
3. Resources should be used as efficiently as possible to
achieve individual, group, or a countries goals
4. Markets usually lead to efficiency
5. If markets don’t achieve efficiency, government
intervention may improve the well being of participants
in the economy (called the welfare of society)
Interaction: How Economies work
• There are gains from trade
All Rights Reserved.
Ed Frascino from cartoonbank.com.
© The New Yorker Collection 1991
– by providing goods to others and receiving goods from
others, all can be made better off.
– This occurs because specialization improves
productivity (each person does what he is best at) and
we exchange our surplus
“I hunt and she gathers – otherwise we couldn’t make ends meet.”
• Markets move toward equilibrium
− equilibrium means at rest or no tendency to change
− people & businesses will exploit opportunities until they
can’t be made any better off. This will be an equilibrium.
Interaction: How Economies work
• Resources should be used as efficiently as possible to
achieve individual, group, or a countries goals.
– they are used to fully exploit all opportunities to make
everyone better off.
– this means that if we are operating efficiently it will be
impossible to make one better off unless we make
someone worse off.
– Other measurement of well being – equity. This is very
difficult to measure, but to gain equity we usually must
sacrifice some efficiency.
• Markets usually lead to efficiency
– voluntary trade is done for mutual gain, as long as gains
exist people will exploit them
• If markets don’t achieve efficiency, government
intervention may improve the well being of participants
in the economy (called the welfare of society)
Macroeconomics
• The study of how choices of households, businesses, and
governments affect the aggregate (total) economy.
• Three large issues of Macroeconomics:
1. Standard of Living - level of consumption of goods and
services people enjoy. (Issue of: Full Employment)
Relationship between: 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, called the business cycle
Recessions and Expansions affecting Unemployment &
Inflation:
Economy wide Interactions
Principles that underlie Economy wide transactions
1. One person’s spending is another person’s income
When spending on a particular good or type of good
increases, the income of resources producing that good
increases.
2. Overall spending sometimes gets out of line with the
economy’s productive capacity
Fluctuations in spending in the economy leads to the
business cycle with periodic recessions (a lack of
spending compared to the ability to produce goods &
services) and inflations (too much spending compared
to the ability to produced goods & services)
3. Government policies can change spending
Actions of the President, Congress, and the Federal
Reserve can influence spending.
Macroeconomic policymaking
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
Gasoline used
Driven
(gallons)
200
10
400
20
600
30
800
40
800
600
400
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
...and then moving vertically
The graph is read by
until you hit the relationship
moving to the right
on the horizontal axis..... 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
30
Gasoline used
(gallons)
10
20
30
40
40
Gallons of gasoline used
This relationship line is constructed “all things equal”
• 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?
Miles
Driven
Use more gas more same amount of 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
600
400
entire curve to shift.
200
0
10
20
Miles
Driven
200
400
600
800
30
40
Gallons of gasoline used
Gasoline used
(gallons)
10
20
30
40
Gasoline used
(gallons)
12
24
36
48
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
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 1976-2009
Summary
1. All economic analysis is based on a list of basic principles.
These principles apply to three levels of economic
understanding. First, we must understand how individuals
make choices; second, we must understand how these
choices interact; and third, we must understand how the
economy functions overall.
2. Everyone has to make choices about what to do and what not
to do. Individual choice is the basis of economics.
3. The reason choices must be made is that resources—
anything that can be used to produce something else—are
scarce.
4. Because you must choose among limited alternatives, the true
cost of anything is what you must give up to get it— all costs
are opportunity costs.
Summary
5. Many economic decisions involve questions not of “whether”
but of “how much. Such decisions must be taken by
performing a trade-off at the margin—by comparing the costs
and benefits of doing a bit more or a bit less. Decisions of this
type are called marginal decisions, and the study of them,
marginal analysis, plays a central role in economics.
6. The study of how people should make decisions is also a
good way to understand actual behavior. Individuals usually
exploit opportunities to make themselves better off. If
opportunities change, so does behavior: people respond to
incentives.
7. Interaction—that my choices depend on your choices, and
vice versa, adds another level to economic understanding.
Summary
8. The reason for interaction is that there are gains from trade:
by engaging in the trade of goods and services with one
another, the members of an economy can all be made better
off. Underlying gains from trade are the advantages of
specialization, of having individuals specialize in the tasks
they are good at.
9. Economies normally move toward equilibrium—a situation in
which no individual can make himself or herself better off by
taking a different action.
10. An economy is efficient if all opportunities to make some
people better off without making other people worse off are
taken. Efficiency is not the sole way to evaluate an economy:
equity, or fairness, is also desirable. There is often a trade-off
between equity and efficiency.
Summary
11. Markets usually lead to efficiency, with some well-defined
exceptions.
12. When markets fail and do not achieve efficiency government
intervention can improve society’s welfare.
13. One person’s spending is another person’s income.
14. Overall spending in the economy can get out of line with the
economy’s productive capacity, leading to recession or
inflation.
15. Governments have the ability to strongly affect overall
spending, an ability they use in an effort to steer the economy
between recession and inflation.