Transcript chapter 1

CHAPTER
1
What is
Economics?
a
“Aside from Religion, economics is perhaps the most
pervasive yet least understood force in American life.”
Jon Meacham – Editor, Newsweek Magazine
September 24, 2007
After studying this chapter, you will
be able to:
 Define economics and distinguish between
microeconomics and macroeconomics
 Explain the two big questions of economics
 What are the consequences of choices (what, how, and
for whom)?
 Does self-interest unintentionally promote social
interest?
 Explain the key ideas that define the economic
way of thinking
 Explain how economists go about their work as
social scientists and policy advisers
Economics and Choice
 Economics is the study of the
choices people make to cope with
scarcity.
 Economics is sometimes called the
science of choice — the science that
explains the choices that people
make and predicts how choices
change as circumstances change.
How Economists Think
 Economists, as professionals, try to
stand clear of emotion and to
approach their work with the
detachment, rigor, and objectivity of
scientists.
 The first step in this process is to
identify the fundamental economic
problem: scarcity.
Scarcity
 When wants exceed the resources
available to satisfy them, there is
scarcity.
 People have unlimited wants.
 Resources to satisfy those wants are
limited.
Scarcity and Poverty
 Scarcity is not poverty.
 The poor and the rich alike face
scarcity.
 Faced with scarcity, people must
make choices.
Choice and Opportunity
Cost
 Choosing more of one thing means
having less of something else.
 The opportunity cost of any action is
the best foregone alternative.
 There is no such thing as a free
lunch. Every choice involves an
opportunity cost.
Opportunity Cost
 Opportunity cost is the single best
alternative foregone (it varies over
people).
 For example, the opportunity cost of
attending ECO 211 class is either
 sleeping
 working
 studying
 going to the beach
 taking another class
Marginal Analysis
 Economic analysis uses marginal
analysis to study choices made by
people, businesses and
governments.
 Choices are made in small steps —
at the margin.
Marginal Cost and
Marginal Benefit
 The cost of a small increase in an
activity is called marginal cost.
 The benefit that arises from a small
increase in an activity is called
marginal benefit.
What Economists Do
 Economic questions can be divided
into two big groups:
microeconomics and
macroeconomics.
Microeconomics
 Microeconomics is the study of the
decisions of people and businesses
and the interaction of those
decisions in markets.
 Goal: to explain the prices and
quantities of individual goods and
services.
Macroeconomics
 Macroeconomics is the study of the
national economy and the global
economy and the way that economic
aggregates grow and fluctuate.
 Goal: to explain average prices and
total employment, income, and
production.
Economic Science and
Economic Policy
 Economic science is the attempt to
understand the economic world.
Science makes predictions.
 Economic policy is the attempt to
improve the economic world. Policy
makes prescriptions.
 Policies made without science
usually will not be very good.
Economic Science
 Economists distinguish between
what is and what ought to be.
 Statements about what is are called
positive statements.
 Statements about what ought to be
are called normative statements.
Positive Versus Normative
 A positive statement can be tested
by checking it against facts.
 A normative statement depends on
values and cannot be scientifically
tested.
Economic Theories
 Economists create theories by
building and testing models.
 We learn as much from theories that
fail as is learned from theories that
are confirmed.
 When a theory fails, it prompts us to
revise other models.
Economic Science is Young
 Economics as a science is just over
200 years old.
 Adam Smith’s The Wealth of Nations
(1776) marks the beginning of our
subject.
 Compared to physics and chemistry,
however, we’re newcomers.
Economic Policy
 Economic policy is the attempt to
devise government actions and to
design institutions that might
improve economic performance.
Objectives of
Economic Policy
 Efficiency
 Equity
 Growth
 Stability
Efficiency
 When economic efficiency has been
achieved, production costs are as
low as possible and consumers are
as satisfied as possible with the
combination of goods and services
that are being produced.
 When economic efficiency is
achieved, noone can be made better
off without someone else being made
worse off.
Conditions That Produce
Economic Efficiency
 Efficient production (called
production efficiency)
 Efficient consumption (called
allocative efficiency)
 Efficient exchange (called trade
efficiency)
Equity
 Equity is economic justice or fairness.
 An efficient economy is not necessarily an
equitable economy.
 The definition of equity (or fairness)
remains a matter about which reasonable
people disagree.
 Hence, of the four economic policy
objectives, equity is the most difficult to
define.
Growth
 Economic growth is the increase in
income and output per person.
 Growth results from the ongoing
advance of technology, accumulation
of capital, and improved education.
 Government policies can encourage
or discourage growth.
Stability
 Economic stability is the absence of
wide fluctuations in the economic
growth rate, the level of employment,
and average prices.
 Macroeconomics is devoted to the
study of these problems.
Why Economists Disagree
 Some disagreements are about what
is possible — positive economics.
These disagreements are often
settled by gathering more evidence.
 Other disagreements are about what
is desirable — normative economics.
These arise from differences in
values or priorities.
The Economy: An Overview
 What goods and services will be
produced and in what quantities?
 How will they be produced?
 When will they be produced?
 Where will they be produced?
 Who will consume them?
Production
 Goods and services are the objects that
people value and produce to satisfy human
wants.
 Agriculture accounts for less than 1 percent
of total U.S. production, manufactured
goods for 22 percent, and services for 77
percent.
 In China, agriculture accounts for 11 percent
of total production, manufactured goods for
47 percent, and services for 43 percent.
Production Breakdown in
Three Countries
 The breakdown
of production
into agricultural,
manufacturing,
and services
depends on the
level of
economic
development
Decision Makers
 Households are groups of people
that live together.
 Firms are organizations that use
resources to produce goods and
services.
 Government is an organization that
sets laws and rules, taxes, spends,
and provides public services.
Markets
 A market is any arrangement that
enables buyers and sellers to get
information and to do business with
each other.
 Goods markets are markets for
goods and services.
 Factor markets are markets for
factors of production.
Factors of Production
 Factors of production are the
economy’s productive resources,
including:
§ Labor
§ Land
§ Capital
§ Entrepreneurial ability
Labor
 Labor is the time and effort people
devote to producing goods and
services.
 The price of labor is the wage rate.
Land
 Land is natural resources used to
produce goods and services.
 The price of land is called rent.
Capital
 Capital (sometimes called physical capital)
is all the equipment, buildings, tools and
other manufactured goods used to
produce other goods and services.
 The price of physical capital is the interest
rate.
 Physical capital is to be distinguished
from human capital, which is the
productivity inherent in people.
Entrepreneurial Ability
 Entrepreneurial ability is a special
type of human resource that
organizes the other three factors of
production, makes business
decisions, innovates, and bears
business risk.
 Entrepreneurship is rewarded with
profit.
Coordinating Decisions
 In free market societies, conflicting
choices by households, firms, and
governments are resolved by
markets.
 Markets coordinate individual
decisions through adjustments in
market prices
 Prices are the primary rationing
mechanism in a market economy
Alternative Coordinating
Mechanisms
 In other societies, a command mechanism
is used. A command mechanism is a
method of determining what, how, when,
and where goods and services are
produced and who consumes them, using
a hierarchical organization structure in
which people carry out the instructions
given to them.
 In a command economy, prices are not the
primary mechanism that rations goods
and services
Alternative Coordinating
Mechanisms



Market Economies (Hong Kong)
Command Economies (Cuba, North
Korea)
Mixed Economies (U.S.)
Ranking of Free Markets
 The link below is an excellent site to
examine the extent of several types of
freedom in most countries throughout the
world.
 http://www.heritage.org/index/ranking