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HCS 112 Fundamentals of Economics Lecture 1
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Fundamentals of Economics
Introduction
Economics is defined as the study of how people, businesses manage scarce resources.
Microeconomics is the study of the decisions of individuals, households, and businesses in
specific markets, whereas macroeconomics is the study of the overall functioning of an economy
such as basic economic growth, unemployment, or inflation. Scarcity in microeconomics is not
the same as poverty. It arises from the assumption of very large (or infinite) wants or desires, and
the fact that resources to obtain goods and services are limited.
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wants exceed resources necessary to obtain them
therefore we must make choices
every choice leads to a cost
Principles of Economics:
1. People face trade-offs.
Every decision involves choices, and more of one good means less of another good. Income and
wealth are not limitless, since there is only so much time available. Trade-offs apply to
individuals, families, corporations and societies.
2. Cost of something is what you give up to get it.
When we make a decision we implicitly compare the costs and benefits of our choices.
Opportunity cost is whatever must be given up to obtain something. Some costs are obvious –
out-of-pocket expenses; other costs are less obvious but must be included in total opportunity
cost.
3. Rational people think at the margin.
Basic economics assumes that people act rationally and try to act so as to gain the most benefit
for themselves compared to the associated costs. Microeconomics focuses on small or marginal)
changes and it is often rational to consider the marginal rather than the average effects of
decisions.
4. People respond to incentives.
If rational people compare costs and benefits, then changes in either one may change decisions.
An example of an incentive that people respond to, are changes in prices. In general, people are
more likely to buy something if it is cheaper. If an action becomes more costly, then there is an
incentive to switch to other choices. Note that all actions have substitutes.
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Sometimes people will encounter emergencies with costs that are beyond the cash they have
available. In these situations, they may consider getting a cash advance to ease the pressure of
liquidity in the present.
Explicit costs vs. implicit costs
The cost of something, say a business, includes both the explicitly cost (usually the price) and the
implicit costs. One major implicit cost is the opportunity cost. Opportunity costs include the next
best opportunity given up. Only actions have costs; if there are no choices, then there are no
costs. Be aware that cost is subjective. For example, compare the psychological benefit of a new
computer. Decide whether you would rather have the vacation to Europe, or a brand new
computer.
Disagreement in Economics
Business economics is both a science and a study of policy – united by a common “way of
thinking”. As a science, economists develop models and deliberately simplify accounts of how
cause and effect work in some part of the economy. Based on assumptions of what is important,
models are created and used to make suggestions about policy and improve basic economic
outcomes. Policy involves decisions about scientific theories, personal values and particular
circumstances.
Positive statements are claims about what the world is like, although they may be false. For
example, "Minimum wage laws cause unemployment". Normative statements are claims about
how the world ought to be, and are based on values as well as positive knowledge. For example,
"The government should raise minimum wage". Economists may disagree over either positive or
normative statements or both, but the great majority tends to agree over basic positive
propositions. As such, most disagreements are over normative/policy issues.
Public Goods
Public goods include things such as fireworks displays, and basic research. According to basic
economics, a free market is unlikely to provide enough public goods, due to the “free rider”
problem. A free-rider is a person who consumes a good without paying for it. Public goods
create a free-rider problem because the quantity consumed is not directly related to the amount
paid. As a result:
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there may not be enough incentive to pay for public goods through individual action;
you cannot be prevented from consuming the good even if you do not pay for it and;
It creates an external benefit on those not involved.
Business economics state that we can decide how much of a public good to produce, by
considering a cost-benefit analysis of public goods. The total benefit is equal to the total dollar
value that an individual places on a given level of production of a public good. Total Cost is
what we must give up to get more of the public good. These are often difficult to calculate -
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especially the benefits. For example, what is the benefit of saving a human life, and what is the
benefit of more flowers in the downtown?
Once we decide on the benefits, then we want to provide enough of the public good to maximize
net benefits. That is, total benefits - total costs. The private market will usually not produce
enough of a public good. However, it is often done by government because it can compel
everyone to contribute through taxes.
The problem is not that people like Marc Accetta are selfish, per se, but the free-rider problem. If
some people do not voluntarily contribute, others who do contribute will feel that it is unfair and
may stop contributing as well.
Common Property Resources
These resources include clean air, oil pools, congested roads, fish, whales and other wild life.
The problem here is that it is hard to exclude people, but one person’s use reduces that of others'.
Over-use of these resources is sometimes dramatically referred to as, "Tragedy of the
Commons". This tragedy refers to the common grazing rights in medieval England, in which:
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all families could graze sheep on the common land which was collectively owned and;
As population and number of sheep increased, common land became over-grazed.
People did not reduce their use, because social and private incentives differed. Each individual’s
best move is to get as much of the resource as possible before it is gone. The social optimum is
to restrict use. The problem is that each individual creates a negative externality by reducing
amount available to others. A few possible solutions were:
1) Custom or regulations could put a maximum on how much each family could use the
resource;
2) They could have internalized the externality by auctioning off rights to graze and;
3) They could have created private property rights.
Property Rights
Economists realize that property rights are very important for efficient use of resources. When an
individual owns and controls the resource, they have an incentive to increase its value. When
everyone owns a resource, or rather, no one owns the resource, there is no one to charge for use,
or who can attach a price. An example of such is air that we breathe.
For some goods we can establish property rights, like the pollution permit. For other goods, like
national defence or clean air, the government can improve the outcome by regulating or
providing the product.
While the economy is becoming more global, some factions in developing countries are against
the merging of markets. This has lead to violence in some parts of the world. Ambassadors and
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other officials traveling to foreign nations are normally supplied with body armor and a convoy
for protection against hostile groups.