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Economics:
The Social Science which studies
social and individual choices in a
condition of scarcity with the objective
of maximizing the satisfaction of
human wants.
Resources and Wants
• We have limited resources.
• We have wants which exceed those
resources.
• This leads to scarcity
– Scarcity exists when there are
insufficient resources to satisfy
people’s wants.
Economic Resources
• Land - Natural Resources
• Labor - Skills of People
• Capital - Man made inputs to
production. (not money)
• Entrepreneurship - The organizing
resource of production; combines
the other resources and accepts risk.
Payment to the Resources
• Rent (for land)
• Wages (for labor)
• Interest (for
capital)
• Profit (for
entrepreneurial
ability)
Circular Flow of Economic Activity
Resource Prices
& Income
Resource
Market
Income $
Wages, Interest,
Rent, & Profit
Factors of Production
Households
Firms
Goods and
Services
Consumption $
Product
Market
Product Prices
Revenue $
The Questions of Economics
Scarcity requires us to make choices
involving:
• What to produce?
• How to produce it?
• For Whom? (how Income is distributed?)
Methods of Social Choice
Society makes choices through:
• Market Forces
• Governmental Forces
• Social Forces
(custom and tradition)
Economic Choice
In Capitalist economies the Market is
the major rationing device:
• Markets ration through the forces of
Supply and Demand.
• If Demand > Supply the Price
and rations the shortage.
Economic Choice
In Command Economies (centrally
planned), the Government make choices
which allocate resources and decide:
• What?
• How?
• For Whom?
Economic Choice
In Mixed Economies (both market and
government combined), the society makes
choices which allocate resources through
a combination of government intervention
and market forces.
Government Forces:
• Government Spending
• Regulation
• Taxes
• Subsidies
Opportunity Costs
Opportunity Cost - is the highest
valued alternative foregone when
choosing between alternatives.
• When an activity is chosen, the
opportunity cost is the benefit expected
from the next best alternative given up.
Economic Choice
• To choose, evaluate tradeoffs--the
opportunity cost of a choice is the value
of the best alternative you gave up
“Wow, I could have had a V8!”
BEER!
Rational Self-Interest
• Individuals
rationally select
alternatives they
perceive to be in
their best interests
Rational Choice
I will choose to make a choice if
MB > MC
Incentives change Benefit or Cost!
Incentives will cause:
MB > MC
Rational Choice
I will choose not to make a choice if
MB < MC
Incentives change Benefit or Cost!
Disincentives will cause:
MB < MC
Incentives
Economists believe that incentives work.
They believe that people respond to
incentives (that they weigh the costs and
benefits rationally).
• If the cost of choices increase, less of that
choice will be made.
• If the benefit of a choice is increased,
people will make that choice more.
How Do Economists Think:
Utility and Rationality
• Economists assume that people act
rationally Economists assume that
people act to maximize their own
happiness and minimize their costs.
• This happiness that economists assume
people maximize is called utility.
• This does not mean people are always
greedy - some people get happiness
from others happiness.
Types of Economics
• Microeconomics - Studies the behavior
of individual decision units (people and
firms).
• Macroeconomics - Studies the
behavior of entire economies as a
whole.
Types of Economics
• Positive Economics - The economics of what
is. This is descriptive of fact and theory
without opinion.
– A positive economic statement can be
proved or disproved by reference to facts.
• Normative Economics - The economics of what
should be. This is economics where policy
issues involve evaluation and the opinion of
the economist.
– A normative economic statement represents
an opinion, which cannot be proved or
disproved.
ECONOMIC GOALS
What are our
goals and
objectives?
ECONOMIC GOALS
ECONOMIC GROWTH
FULL EMPLOYMENT
ECONOMIC EFFICIENCY
PRICE LEVEL STABILITY
ECONOMIC FREEDOM
EQUITABLE DISTRIBUTION
ECONOMIC SECURITY
BALANCE OF TRADE
ECONOMIC GOALS
ECONOMIC GROWTH
FULL EMPLOYMENT
ECONOMIC EFFICIENCY
PRICE LEVEL STABILITY
ECONOMIC FREEDOM
EQUITABLE DISTRIBUTION
ECONOMIC SECURITY
BALANCE OF TRADE
Economic Models
• An economic model is a
simplification of reality
designed to capture the
important elements of the
relationship under
consideration
• A model is usually a
graph or a set of
mathematical equations
How are models created?
Inductive Reasoning:
• Reasoning from facts to generalizations.
- Gather, systematically arrange, and draw
conclusions from the analysis of facts and
data (empirical analysis). Test the theory
(hypothesis) against real-world situations.
• Deductive Reasoning:
- Starting with generalities of how the world
works, generate hypotheses and test those
predictions against real-world situations.
What is the
Scientific Method?
• Problem
identification
• Model
development
• Testing a theory
Either Can Lead to Policies
POLICIES
DEDUCTION
THEORETICAL
ECONOMICS
INDUCTION
THEORIES
FACTS
Scientific Reasoning Issues
In complicated, real-world systems, how
do you unscramble cause and effect?
• Hold other things equal (ceteris
paribus).
• Fallacy of composition
• Post hoc Fallacy If A happens before B,
did A cause B?
• Confusing correlation with causation
Scientific Reasoning Tool
Ceteris Paribus:
• It is Latin for “all else equal” and
• it means that we are assuming that
all other variables which might be
related are held constant.
Scientific Reasoning Fallacies:
• The Fallacy of Composition: What is
true for one individual is not always
true for the whole group.
• What is true at the Micro level is not
always true at the Macro level.
Example: If I stand up at a basketball
game, I can see better. If everybody
stands up, we can not see any better.
Scientific Reasoning Fallacies
• Post hoc, ergo propter hoc (after this,
therefore because of this).
• Just because one thing occurs before
another does not mean that it caused it.
Example: The sun comes up and people
drive to work. Did the sunlight cause this
activity? Don’t they drive to work on
cloudy days?
Scientific Reasoning Fallacies:
• Correlation vs. Causation :
Because two variables are systematically related,
(they may increase together or always seem to
move in opposite direction)
• this correlation is not proof of a cause-effect
relationship between them.
Example: Change in the Money Supply and
change in GDP, which causes which?
Graphs Used in
Economic Models
• Patterns to Watch For:
– variables that move in the same direction
– variables that move in opposite directions
– variables that are unrelated
A Line with Positive Slope
y
change in y >0
change in x
x
Two-Variable Diagram Representing a
Direct Relationship
Consumption ($)
C
360
F
300
E
240
D
180
C
120
60
0
B
The variables
income and
consumption are
directly related.
A
100 200 300 400 500
Income ($)
Income
C
A Line with Negative Slope
y
change in y < 0
change in x
x
Two-Variable Diagram Representing an
Inverse Relationship
The variables price
and quantity
demanded are
inversely related.
Price of CDs ($)
20
18
16
A
B
C
D
14
12
0
P
E
Demand for CDs
100 120 140 160 180
Quantity Demanded of CDs
Q
Two Diagrams Representing
Independence between Two Variables
Y
Variables X and Y are
independent (neither variable
is related to the other).
Variables X and Y
are independent.
Y
40
40
D
30
30
C
20
20
B
10
10
A
A
0
10
B
20
(a)
C
30
D
40
X
0
10
20
30
40
(b)
X
Calculating the Slope of a Line
Y
Y
Y
–10
=
Slope=
= –1
X
10
(negative slope)
A
40
Y +10
=
= +2
X
+5
(positive
Slope =
D
40
Y
B
30
30
X
C
C
B
20
20
D
10
10
0
10
20
30
(a)
40
X
0
A
X
10 15 20
(b)
Calculating Slopes
Y
Y
40
A
B
C
Y
0
=
Slope =
=0
X
10
(zero slope)
10
0
10
20
(c)
30
40
D
30
C
20
B
10
A
D
30
20
Y
+10
=
=`
X
0
(infinite slope)
Slope =
40
X
0
X
10
20
30
40
(d)
Calculating the Slope of a Curve at a
Particular Point
Graphing Relationships Among
More Than Two Variables
Price
Ice cream consumption
(cents per scoop)
(gallons per day)
30ºF
50ºF
70ºF
90ºF
15
12
18
25
50
30
10
12
18
37
45
7
10
13
27
60
5
7
10
20
75
3
5
7
14
90
2
3
5
10
105
1
2
3
6
Functional Relationships
DIC = f (P T)
• Ice Cream demand depends on
price and temperature.
• If temperature increases
• Demand Increases
A Change in Demand
Ceteris paribus, if
temperature rises,
people will buy
more Ice Cream at
each price
Price 6
5
4
3
New Demand for
Ice Cream
2
Demand for
Ice Cream
1
0
1
2
3
4
5
6
7
Quantity
Ice Cream
Price
A Movement Along a Curve vs.
A Shift in the Curve
A change in
quantity
demanded
P0
P2
D0
Q0
Q2
Quantity
Price
A Change in the Quantity Demanded
Versus a Change in Demand
A change in
quantity
demanded
P1
P0
D0
Q1 Q0
Quantity
Price
A Change in the Quantity Demanded
Versus a Change in Demand
A change in
demand
Decrease in
Increase in
demand
demand
D2
D0
Quantity
D1
Key Terms and Concepts
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Scarcity
Economics
Utility
Land
Labor
Capital
Entrepreneurship
Opportunity Cost
Marginal Analysis
Rational Behavior
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Induction
Deduction
Fallacy of Composition
Ceteris Paribus
Positive Economics
Normative Economics
Microeconomics
Macroeconomics
Inverse Relationship
Direct Relationship
Slope of a line