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?
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
All resources regardless where they are located
are scarce.
The scarcity causes most to have a cost because
the demand does not go away…. Supply is
limited
The scarcity of resources causes most things to
have a cost.
Remember****
Society has virtually unlimited wants BUT limited resources
This means prioritization!
The three questions are ever-present:
What
How
For Whom?
Resources to produce Goods
These are referred to as FACTORS
Of production.
Land
Labor
Capital
Entrepreneurship…….
When we use resources….
If we use corn for ethanol then we can’t use it
for another product.
Opportunity Cost.
(the thing you give up.)
When we are successful…. IS THAT GREED?
Should we share with those who do not produce?
Did you ever wonder?????
 How did man advance from clans and tribes?
 How could a small feisty group of people put together
a country that would become the leader of the free
world?
 How did we finally get electricity, running water, clean
water, good nutrition, good health standards, good
education, and all these bounties of nature?
 Why aren’t we still struggling like other countries
today? Some of the world refers to the U.S. as the
“greedy Americans.”
 Is that true or are they just envious of our freedom to
better ourselves?
U.S. as an independent nation
 Weak economy- heavy in resources
 Transportation spotty and unreliable
 In-fighting among the states
 Trade was high priority
 Infant mortality was very high- life expectancy
(men and women between 38 and 48 years.)
 Disease and sanitary conditions poor
 Majority depended on growing own food.
 Living as a pioneer was a challenge daily.
Let’s go back to the 1900’s
 Average worker made $12.98/week for 59 hours
 Life expectancy: 47.3 female, 46.3 male - 33.0
blacks
 Life was brutal. Books like The Jungle, Woman’s
Suffrage, Wizzard of Oz were published.
 Industrial age was here – mass production brought
prices down.
 Social issues included urban poor and disease and
filth and monopoly power – disparity of incomes
and standard of living.
U.S. in the 1930’s
 Population: 123,188,000 in 48 states
 Life Expectancy: Male, 58.1; Female, 61.6
 Average salary: $1,368
 Depression in U.S.
 Unemployment rises to 25%
 The economy was the linchpin to
survival……..poverty spread like wildfire
 Democracy still strong- Germany and Italy fell to
dictators, but the U.S. Constitution prevailed
1950’s
 Economic growth- homes construction, post
war boom
 Manufacturing jobs available
 Many families had 2 cars.
 Salaries going up each year – average
approx salary was $600/month
 Late 1950’s minimum wage increased to
$1.25.
 Life expectancy approximately 60 years.
Jump to 2000
 Life expectancy ( men and women – 77.1)
 100 deaths per 1,000 births in 1900 to 6.89 in
2000
 Per capita income $46,999
 Productivity (output per hour) still leading the
world, but slower than 1990.
 Minimum wage $7.25 is federal law- see
below
 http://www.dol.gov/whd/minwage/america.htm
Improved standard of living- why?
 Greeks had it figured out- lots of inventions, etc, but it
never got off the ground.
 Not until 18th century England with Industrial
Revolution did the economic growth take off.
 What caused that success and then the spread of
ideas to other countries (America included.)
 Certain institution were in place that opened up the
world economic growth and higher standard of living.
Key institutions
 Democracy (nobles were taken out of power,
common man merchant and manufacturer had a say
in direction.)
 Limited Liability Corporation (corporate growth was
accelerated as no one could lose more than initial
investment.)
 Patent rights to protect inventors (individuals could
keep the spoils from their innovation.)
 Literacy and education ( key to economic growth and
individual success.)
Challenge today!
 Need to get more out of world’s limited resources.
 How is the best way to achieve that so that all
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mankind can prosper and profit?
Still have diseases to conquer, infant mortality is too
high, poverty and malnutrition exist everywhere,
illiteracy, unemployment.
Need to raise standards of living without massive
pollution.
What is your choice???? What type of government?
What about education? Don’t mean a piece of paper,
but real knowledge. Let’s dig in and see what we can
learn.
The Five Foundations of
Economics
1. Incentives matter
2. Life is about trade-offs
3. Opportunity costs
4. Marginal thinking
5. Trade creates value
1. Incentives Matter
 Incentives
 Factors that motivate you to act or
exert effort
 People respond to incentives!
 Incentives are everywhere, and
financial gain often plays a prominent role
 Positive incentives
 Tax refund, pay raise, employee of the month
award, sticker and a smiley face, extra credit
 Negative incentives
 Taxes, jail, fees, fines, spankings, getting
grounded, getting fired, failing class
Incentives Work……
What is a Trade-off
 Giving up one thing to get something else.
 Thing you give up is called “opportunity cost.”
 So if resources are limited and wants are
unlimited…. Makes for an interesting “tradeoff.”
Reality of Trade-offs- Crude Oil options
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
2. Life is About Trade-offs
 With scarcity, decisions incur costs
 Individual examples
 Go to theater: do I watch the action movie or
the romantic comedy?
 Go to food court: do I eat Nick’s Barbeque or
Sushi Bar?
 After high school: do I attend Harvard or
University of Texas?
 Which president do I vote for?
4. Marginal Thinking
 Economic thinking
 Systematically evaluating a course of
action
 Requires a purposeful evaluation of
available opportunities to make the
best decision
 Marginal thinking
 Evaluate whether the benefit of one
more unit of something is greater than
the cost
 Margin examples: one more unit (slice
of pizza), one more hour of activity
(studying, sleeping)
5. Trade Creates Value
 Markets
 Bring buyers and sellers together to
voluntarily exchange goods and services
 Trade
 The voluntary exchange of goods and
services between two or more parties
 Key word = voluntary
 You don’t engage in trade if it makes you
worse off; therefore, trade only occurs if both
parties feel they gain from the trade!
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? How could there be an invisible hand???
How scary!!!
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 think of you always
above others?
The Mechanisms of Choice
 Our personal choice is altered by the freedoms
we have to make it… should market allow us to
make our selection or should government have
a major say.
 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.
(to be discussed later.)
– 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.
– Will the market direct us to purchases a Prius?
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The Market
• Here is how the market answers the three basic
questions:
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–
–
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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 instances 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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–
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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.)

Two things that allow economies to
progress
This is an Adam Smith concept:
Division of labor
Specialization of labor
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.
Economics Wants

a concept underlying for all mankind.
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things we feel we need to have so we can
live the style of life we want to enjoy.
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
Economic 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…
GDP/population
If production is high and population is low…. “get
more stuff.”
3rd world countries… high population/low production
http://www.photius.com/rankings/economy/gdp_per_c
apita_2013_0.html
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
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?
Why is it significant to address the debt ceiling?
Latest release on federal budget
Office of Management and Budget,
Budget of the U.S. Government,
FY2008,
2014 Budget Outlook
 http://www.usfederalbudget.us/federal_budge
t_detail_fy13
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?
Are you learning to think in
Economic Terms?????
When you drive by a strip
mall –
 What do you see?
 What do you think?
 Does the economy
come to mind?