Transcript Slide 1

Economics for the 21st Century
An Introduction (Part 1)
Henry B. Stobbs, MFA
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Three Insights
• The mutual determination insight:
Everything depends on everything else.
Three Insights
• The mutual determination insight
• The subjective insight: There are no
objective costs.
– Things cannot have costs – only actions can
have costs.
– Costs accrue to the actor.
Three Insights
• The mutual determination insight
• The subjective insight.
• The marginal insight:
– The “edge” is where we make decisions.
– The only relevant value is the marginal value,
the additional value we expect to gain from
making a certain decision.
Three Insights
• The mutual determination insight
• The subjective insight.
• The marginal insight.
• The word economics derives from the
Greek oikonomikos, related to the
management of a household, but the study
and application of economics as we
understand it is, historically speaking,
quite recent.
The Study of Economics
begins with a simple problem.
It’s referred to by economists as
the economizing problem.
• We live in a world of unlimited wants &
needs;
• We live in a world of limited resources;
• When unlimited needs and wants are
combined with limited resources, scarcity
is created;
• In a world of scarcity, we must decide
something…
Economists refer to
the satisfaction we
gain from satisfying
our needs and
wants as UTILITY.
What we must
decide
The mechanism we employ to
organize the gathering of resources,
production, and distribution of the
goods and services we need and
desire is referred to as an economic
system.
Economics is concerned with
observing and figuring how best to
adjust the economic system in order
to efficiently manage limited
productive resources, so that we
can maximize our utility.
Therefore, we can say that…
Economics is the study of how
humans behave in producing,
distributing, and consuming
material goods and services in a
world of scarce resources.
Economists do Economics
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Some famous economists whose names
you will come to know include…
Adam Smith
David Ricardo
Henry Hazlitt
F. A. Hayek
John Maynard Keynes…
… and many others…
John Maynard Keynes said…
“The ideas of economists and political
philosophers, both when they are right
and when they are wrong, are more
powerful than is commonly
understood. Indeed the world is ruled
by little else. Practical men, who
believe themselves to be quite exempt
from any intellectual influences, are
usually the slaves of some defunct
economist.”
We can be slaves, or…
We can gain a basic understanding of
economics in order to…
– Make more informed decisions as citizens
– Gain insight about making wiser personal
decisions
What are some economic decisions we make in
our daily lives?
A Matter of Methodology
How exactly do economists do
their work?
• Economists formulate economic
principles…
• The principles are used to
establish economic policies…
• Economic policies are designed
to solve economic problems.
Economists use Inductive
reasoning to distill or create
principles from facts.
They also use deductive
reasoning, called the
hypothetical method, to form
a tentative, untested
principle, or hypothesis.
Economics is…
a descriptive science
• It is empirical, meaning that it is
based on facts (the observable and
verifiable behavior of data or subject
matter)
• It is a social science, meaning that it
is concerned with human behavior
The goal of economics is to…
Systematically arrange, interpret, and
generalize upon facts in order to
derive general principles, theories,
and models.
General =
• Imprecise…
• Approximate…
• Close enough for government work…
• In the general vicinity…
• More, or less…
Economists like to use a Latin phrase
a lot: ceteris paribus… other things
being equal… in other words, we
assume that all the variables of a
problem except those under our
immediate consideration are fixed,
constant, unchanging.
Therefore, economic theories are
abstractions that do not necessarily
accurately reflect reality.
Two Levels of Analysis
1. Macroeconomics
– Deals with the economy as a
whole, or…
– With the basic subdivisions or
aggregates that make up the
economy…
– In other words, macroeconomics
looks at forests, not trees…
Two Levels of Analysis
2. Microeconomics
– Deals with specific economic units
and…
– A detailed consideration of these
units..
– In other words, microeconomics
looks at each tree, not at the
whole forest…
Review
• Economics is concerned with the efficient
management of scarce resources
• Induction is observing regularities in
factual data and drawing from them
generalizations
• Deduction uses logic to create hypotheses
which are then tested with factual data
Review
• Economic theories (laws, principles,
models) are generalizations, based on
facts, concerning the economic behavior
of individuals and institutions
• Macroeconomics deals with the economy
as a whole or with the basic subdivisions
(aggregates) of the economy
• Microeconomics focuses on detailed
aspects of the specific units which
comprise the economy
Time for A Mind-Probe
• What is the economizing problem?
• What is utility?
• What is the difference between
macroeconomics and microeconomics?
• What does empirical mean?
• What must we decide in order to solve the
economizing problem?
• What is meant by the phrase ceteris paribus?
• What is the goal of economic policy?
COMING NEXT
Mankiw’s
Ten Principles of Economics
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Set 1:
How People Make Decisions
Ten Principles of Economics
• Principle # 1: People face trade-offs.
– Making decisions requires trading off one goal
against another
– To get one thing, you have to give up
something else
– Efficiency v. Equity:
• Efficiency means that society gets the most that it
can from scarce resources
• Equity means that the benefits of resources are
distributed fairly among members of society
Ten Principles of Economics
• Principle # 2: The cost of something is
what you give up to get it
– Decision-makers must consider both the
obvious and implicit costs of their actions
– Basketball stars who quit school early to turn
pro understand all about opportunity costs
and incentives
Ten Principles of Economics
• Principle # 3: Rational people think at the
margin.
– Marginal changes are small, incremental
adjustments to an existing plan of action
– People make decisions by comparing costs
and benefits at the margin.
Ten Principles of Economics
• Principle # 4: People respond to incentives
(in predictable ways!)
– Marginal changes in costs or benefits
motivate people to behave in certain ways
– The decision to choose one alternative over
another occurs when that alternative’s
marginal benefits exceed its marginal costs
– Behavior changes when costs or benefits
change
Set 2:
How the Economy Works As a Whole
Ten Principles of Economics
• Principle # 5: Trade can make everyone
better off
– People gain from their ability to trade with
one another
– Competition results in gains from trading
– Trade allows people to specialize in what
they do best
Ten Principles of Economics
• Principle # 6: Markets are usually a good
way to organize economic activity.
– Adam Smith observed that households and
firms interact in markets as if guided by an
“invisible hand.”
• Because households and firms look at prices when
deciding what to by and sell, they unknowingly
take into account the social costs of their actions.
• Thus, prices guide decision makers toward
outcomes that tend to maximize the welfare of
society as a whole.
Market Economies
• A market economy is one that allocates
resources through the decentralized
decisions of individuals, operating within
households and firms, and interacting in
markets for goods and services
– Households decide what to buy and who
to work for
– Firms decide who to hire and what to
produce
Market Failure
• Market failure may be caused by:
– Externalities. An externality is the
impact of a person’s or a firm’s actions
on the well-being of a bystander.
– Market power. Market power is the
ability of a single person or firm to
unduly influence market prices.
Ten Principles of Economics
• Principle # 7: Governments can
sometimes improve market outcomes.
– Market failure occurs when the market fails to
allocate resources efficiently
– When the market fails, government can
intervene to promote efficiency and equity
(But knowing when, if, how and how much to
interfere is a bug of a different sort…)
Ten Principles of Economics
• Principle # 8: A country’s standard of living
depends on its ability to produce goods
and services
– Standards of living may be measured by:
• Comparing personal incomes
• Comparing the total market value of a nation’s
production: Wealth increases as productivity
increases
• Variation in living standards between countries can
be explained in terms of their productivities
• Productivity is the amount of goods and services
produced from each hour of a worker’s time
Set 3: How People Interact
Ten Principles of Economics
• Principle # 9: Prices rise when
governments print too much money
– Inflation is an increase in the overall level of
prices in the economy
– One cause of inflation is the growth in the
supply of money
– When the government creates a large supply
of money, the value of the money falls
Ten Principles of Economics
• Principle # 10: Society faces a short-run
trade-off between inflation and
unemployment