Download CHAPTER 1 THE ECONOMY IS US!

CHAPTER 1
WHAT IS ECONOMICS?
Why is the economy us?
What kind of economy do we have
Why do we have this economy?
Definition of Economics
The study of how people, both individually and in groups, deal with the
problem of scarcity.
Why is economics considered a social science?
Scarcity forces human beings to make choices
Why has there always been an economic problem?
man’s wants are virtually unlimited
scarcity of resources
*Have to prioritize
Do all countries regardless of type of economy
deal with scarcity?
Scarcity of what?
Even the U.S. has a problem with this?
The scarcity of resources causes most things to
have a cost.
Remember****
Society has virtually unlimited wants BUT limited resources
This means prioritization!
When did you last have to prioritize?
Companies? Are you seeing them prioritize? Where
What about government?
Scarcity forces individuals and groups to do what?
All economies evolve around a basic conflict.. Want more
than we can have.
Choices- Trade-offs (giving up one thing to get another)
Example: Barrel of crude oil?
What is thing given up called?
Reality of Trade-offs
Just a few of the products getting a start from a
barrel of oil:
Aspirin
Candles
CD players
Clothing
Compact discs
Computers
Credit cards
Deodorant
Diapers
Dinnerware
DVDs
Eyeglass frames
furniture
not to mention gasoline
hair dryers
carpets
lipstick
paints
luggage
fertilizer
perfumes
oils of all kinds
photographs
piano keys
roller blades
shampoo
soft contact lenses
toothpaste
vitamin capsules
Economics is a Social Science
What does that mean?
What is the Invisible Hand?
In 350 BC – Aristotle declared property should
be private.
In 1776 – Adam Smith _ Wealth of Nations
All of this evolves around self-interest – Why?
How?
Rational Self-Interest
 Individuals act as if motivated – self interest
 Idea first brought forth- Adam Smith- Wealth
of Nations. Father of Market Economics.
 Did you arise this a.m. and say>>>> I want to
make terrible decisions all day that are NOT
in my self-interest???
 Is Self-interest translated as greed? Did
Smith really mean you always above others?
Rational Decisions involve all
aspects of society!
 Governments – (guns v butter)
 Individuals – (buy or rent house)
 Businesses – (expand or lay off)
 Non-profits – (providing for greater good)
The Mechanisms of Choice
 There are three basic ways to make the
necessary choices:



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The market mechanism.
Government directive.
A mixture of both.
The Market
• Adam Smith called it “the invisible hand.”
– It is as if we are “guided” to the correct point on the
PPC.
– In fact, we get there by the interaction of millions of
decisions made by buyers, sellers, and producers in
their own self-interest (i.e., to make themselves better
off).
• We call this the market mechanism:
• Price directs resources.
– The use of market prices and sales signal desired
outputs and resource allocations.
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The Market
• Here is how the market answers the three basic
questions:
–
–
–
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WHAT to produce? Produce goods and services
that customers want.
HOW to produce? Profitably; produce an
acceptable good or service while keeping
production costs low.
FOR WHOM to produce? Produce for those who
are both willing and able to pay for it.
The Government
• At its extreme, government could dictate answers to
all three questions.
–
–
–
–
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Such decisions would be made by political leaders
and bureaucrats.
In many or most istances these decisions would not
mirror the individual desires of the people.
The FOR WHOM decision would lean heavily toward
their political base: goods for those the government
favors and nothing for those not in favor.
Remember this is by degree depending on type of
government.
A Mixture of Both
• The market is highly efficient in production of
wanted goods and services.
• The government acts as a maintainer of balance
in the economy.
–
–
–
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Makes sure the market does not go to excesses
either in underproduction or overproduction.
Regulates production to ensure that goods and
services are safe.
Acts to redress excessive inequalities.
What Mix Is Best?
• Few governments have relied exclusively on
either pure market or pure government to
manage the economy.
• Public opinion around the world indicates that
the free-market economic system is best.
• The Index of Economic Freedom ranks nations
according to economic freedom.
–
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Market-dominated economies rank high;
government-run economies rank low.
Market Failure and
Government Failure
• If the market does not produce the mix of goods
that society desires, market failure is said to
occur.
• This provides an opening for government to step
in.
–
If government can move us closer to the mix
society desires, the intervention is successful.
• However, government can do the opposite, or
impose such high costs that the market simply
ceases to produce. This is government failure.
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What Economics Is All About
 Society and its leaders set the nation’s economic
goals. Economics focuses on the means of
achieving those goals.
 Macroeconomics will focus on “big picture”
economics while microeconomics will focus on
economic interactions of consumers and
producers.
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Invisible Hand- apolitical
 Individuals rather than government should
answer the 3 basic questions.
What to produce
 How to produce
 For Whom to produce
But not just carte’ blanche
 Smith distinguished between self-interest and
greed!
 It is in our self-interest to have Rule of Law in
place – (property rights, patents, copyright,
protection of workers, regulations, etc.)

Economic Wants
 These wants vary from culture to culture.
 One culture’s ideas may not be the goals of another
cultures’.
 Ones we satisfy in the economic system.
 Ones that money will buy.
Economic wants vs non-economic wants
Economics Wants

a concept underlying for all mankind.

things we feel we need to have so we can
live the style of life we want to enjoy.
What are some non-economic wants?
 Friendship
 Health
 Self Esteem
 Love
Two things that allow economies to
progress
This is an Adam Smith concept:
Division of labor
Specialization of labor
Economics depends on models
Models are used to predict behavior.
Models are simplified replica of real world
Empirical Evidence and data- material gathered
by observation or experience. Usually a
working hypothesis that is testable.
Enter Ceteris Paribus
Economicsts models do not relate to how
people think, but how they behave.
What is Standard of Living?
How can you calculate it?
How well off people are!
How well off are you?
Divide total production by population…
If production is high and population is low…. “get
more stuff.”
3rd world countries… high population/low production
Per capital income China = $8,500
Per capita income U.S.= $41,663
Terms to Know
Positive economics = deals with facts “what is”
Normative economics = involves someone’s judgment “what ought
to be”
Fallacy of Composition = it is not correct.. (the validity of a particular
generalization for an individual or part does not necessarily ensure its
accuracy for the group or the whole) I stand up… everyone stands up…
Post Hoc Fallacy = Be careful concluding that because event A precedes
event B that A is the cause of B. Wear purple shirt to ballgame…win.. Need
to wear purple shirt again to win. Rooster crows before dawn… rooster
responsible for sunrise.
Rational Behavior = based on rational self-interest. People make different
choices because their circumstances and available information differs.
Marginalism = extra or less (one more unit, one less unit)
Marginal Cost = additional cost over sunk cost paid for choosing an action
Marginal Benefit = benefit received from choosing an action
SO…..Are You Rational?
What is rational?
Are you pursuing opportunities to increase your
utility?
Are you allocating your time, energy and money
to maximize your well-being?
Do you weigh your decisions looking at costs vs
benefits? If you do you are rational.
If you do not… you may be random or
haphazard with your decisions.
Talk today is about the federal debt
and deficit
What is a deficit?
What is a debt?
In what area do you think government spends
the greatest amount of revenue?
What happens if we experience a fiscal cliff in
December? – what does that mean?
Latest release on federal budget
Office of Management and Budget,
Budget of the U.S. Government,
FY2008,
Conventional wisdom accepts economic goals
Economic growth
Full Employment
Economic Efficiency
Price-level stability
Economic Freedom
Equitable Distribution of Income –believed by
some
Economic Security
Balance of trade
Any Questions?