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WHAT IS
ECONOMICS?
1
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1
Course Assessment
2 assignments: 15%
Midterm Exam: 25% (19:00 -- 21:00 Oct. 17th,
2014)1 quiz: 20%
Final exam: 35%
Attendance: 5%
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Chapter One: What Is Economics?
After studying this chapter, you should be ableto:
Define economicsand distinguish between
microeconomics and macroeconomics
Explain the two big questions of economics
Explain the key ideas that define the economicway of thinking
Explain how economistsgo about their work as
social scientists and policy advisers
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What is Economics?
Scarcity(
)Our inability to satisfy all our wants
Resources are scarce
means that society has limited resourcesandtherefore cannot produce all the goods and
services people wish to have
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What is Economics?
Choice
Because we face scarcity, we must make choices
Choice, the act of selecting among alternatives, isthe logical consequence of scarcity
Scarcityforces us to choose among availablealternatives.
Incentive
An incentiveis a reward that encourages an actionor a penalty that discourages an action.
Economics is about the study of choicesand theirconsequences.
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What is Economics?
Economics
is the social science
studies the choicesthat individuals,
businesses, governments, and entiresocieties makeas they cope with scarcity
studies the incentivesthat influence and
reconcile those choices.
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What is Economics?
Economics divides in two main parts:
Microeconomics
Macroeconomics
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What is Economics?
Microeconomicsis the study of choicesthat individuals and businesses make, the
waythose choices interactin markets, and
the influenceof governments.
An example of a microeconomic question
is: Why are people buying more e-books and fewer
hard copy books?
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What is Economics?
Macroeconomicsis the study of theperformanceof the national and
global economies.An example of a macroeconomic
question is:
Why is the unemployment rate in theUnited States so high?
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Two Big Economic Questions
About production Goods and services
They are the objects that people valueand produce to satisfy human wants.
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Two Big Economic Questions
1. How do choices end up determiningwhat, how, andfor whomgoods and
services get produced?2. When do choices made in the pursuit
of self-interestalso promote the social
interest?
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Two Big Economic Questions:
Question 1
What are produced?
How to be produced?
For whom produced?
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What are produced?
U.S. production Agriculture (Primary
industry ): Less than
1% of total U.S.
production;
Manufactured goods
(secondary industry):
for 22%; Services(tertiary
industry): 77%.
China production
Agriculture: 11% of
total China production;
Manufactured goods:
47%;
Services: 43%.
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How to be produced?
Goods and services are produced by usingproductive resources that economists callfactors of production.
Factors of production are grouped into four
categories:
Land
Labor
Capital Entrepreneurship
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How to be produced?
Land: The gifts of nature that we use to
produce goods and services. Labor: The work time and work effort that
people devote to producing goods andservices.
Capital: The tools, instruments, machines,buildings, and other constructions thatbusinesses use to produce goods andservices (financial capital is not a factor of
production). Entrepreneurship: The human resource that
organizes land, labor, and capital.
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How to be produced?
The qualityoflabordepends onhuman capital,which is the
knowledge andskill that peopleobtain fromeducation, on-
the-job training,and workexperience.
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For Whom Produced?
Who gets the goods and services dependson the incomesthat people earn.
People earn their income by selling the
service of the factors of production theyown
Land earns rent.
Labor earns wages. Capital earns interest.
Entrepreneurship earns profit.
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For Whom Produced?
Which factor of production earns the most
income?
Labor!
In the U.S., in 2011, wages were 68%of total
income
The income from land, capital and
entrepreneurship was 32%
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Two Big Economic Questions:
Question 2
Does the Pursuit of Self-InterestUnintentionally
Promote the Social Interest?
Every day, people make economic choices that
result in What, How, and For Whomgoods and
services are produced.
These choices are made by people who are
pursuing their self-interest.
Are they promoting the social interest?
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Two Big Economic Questions:
Question 2
Does the Pursuit of Self-InterestUnintentionally Promote the Social Interest?
Self-Interest
You make choices that are in your self-interest choices that you think are best for you.
Social Interest
Choices that are best for society as a whole.
Social interest has two dimensions:
Efficiency
Equity
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Two Big Economic Questions:
Question 2
Efficiency and Social Interest
Resource use is efficientif it is notpossible tomake someone better off without makingsomeone else worse off.
Equityis fairness, but economists have avariety of views about what is fair.
Fair Shares and Social Interest
The idea that the social interest requires fairshares is a deeply held one.
But what isfair?
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Two Big Economic Questions:
Question 2
Four topics that generate discussion and
that illustrate tension betweenself-interest
and social interest are:
Globalization
The information-age monopolies
Climate change
Economic instability
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Two Big Economic Questions:
Question 2
Globalization Globalizationmeans the expansion of
international trade, borrowing and lending,and investment.
Globalization is in the self-interest ofconsumerswho buy low-cost importedgoods and services.
Globalization is also in the self-interest of themultinational firms that produce in low-costregions and sell in high-price regions.
Is globalization in the social interest?
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Two Big Economic Questions:
Question 2
The Information-Age Monopolies The technological change of the past forty years has
been called the Information Revolution.
The information revolution has clearly served your self-
interest: It has provided your cell-phone, laptop, loads
of handy applications, and the Internet.
It has also served the self-interest of Bill Gates of
Microsoft and Gordon Moore of Intel, both of whom
have seen their wealth soar.
But did the information revolution serve the social
interest?
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Two Big Economic Questions:
Question 2
Every day, when you make self-interested choices touse electricity and gasoline, you contribute to carbonemissions.
You leave your carbon footprint.
You can lessen your carbon footprint bywalking, riding abike, taking a cold shower, or planting a tree.
But can each one of us be relied upon to make decisionsthat affect the Earths carbon-dioxide concentration in
the social interest?
Can governments change the incentives we face sothat our self-interested choices are also in the socialinterest?
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Two Big Economic Questions:
Question 2
Economic Instability
Between 1993 and 2007, the U.S. and global economies
expandedstrongly. Incomesin the United States
increased by 30 percent and incomesin China tripled. But in August 2007, a period of financial stress began
that soon gripped the entire global financial system.
The choices of banks to borrow and lend and the
choices of people and businesses to lend to and borrowfrom banks are made in self-interest.
Does this lending and borrowing serve the social
interest?
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The Economic Way of Thinking
Six key ideas define the economic way of
thinking: A choice is a tradeoff.
People make rational choicesby comparing
benefits and costs. Benefitis what you gainfrom something.
Cost is what you must give up to get something.
Most choices are how-much choices made atthe margin.
Choices respond to incentives.
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The Economic Way of Thinking
A Choice Is a Tradeoff
Theeconomic way of thinkingplaces scarcityand its implication, choice, at center stage.
You can think about every choice as a tradeoff:
an exchangegiving up one thing to getsomething else.
On Saturday night, will you study or have fun?
You cant study and have fun at the same time,so you must make a choice.
Whatever you choose, you could have chosensomething else. Your choice is a tradeoff.
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People face tradeoffs.
There is no such thing as a free lunch!
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People face tradeoffs.
To get one thing, we usually have to give upanother thing
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People face tradeoffs.
To get one thing, we usually have to give upanother thing
Guns v. butter
Food v. clothing
Efficiency v. equity
Making decisions requires trading offone goal against another
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People face tradeoffs
Efficiencymeans society getsthe mostthat it can
from its scarceresources.
Equitymeans the benefitsof those resources aredistributedfairly among the members of society.
Efficiency v.Equity
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People face tradeoffs
After graduate from UM, you will face the trade-off betweengoing to work and taking a further
study
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People face tradeoffs
The basic ideas of scarcityand choice, along
with the trade-offswe must face as decision
makers, are the basic ingredients of
economic analysis
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Questions
Which of the following involves a trade-off?
A. buying a new car
B. going to college
C. watching a football game on Saturday afternoon
D. taking a snap in class
E. all of the above
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The Economic Way of Thinking
Making a Rational Choice A rational choiceis one that compares costs
and benefitsand achieves the greatest benefit
over cost for the person making the choice. The idea of rational choice provides an answer
to the first question: What goods and services
will be produced and in what quantities?
The answer is: Those that people rationally
choose to buy!
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The Economic Way of Thinking
Howdo people choose rationally?
The answers turn on benefits and costs.
Benefit: What you Gain
The benefit of something is the gain or
pleasure that it brings and is determined by
preferences
Preferences are what a person likes and
dislikes and the intensity of those feelings.
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Questions
Which of the following involves a trade-off?
A. buying a new car
B. going to college
C. watching a football game on Saturday afternoon
D. taking a snap in class
E. all of the above
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The Economic Way of Thinking
The cost of something is what you give
up to get it.
Decisions require comparing costsand
benefits
)of alternatives.
Whether to go to college or to work?
Whether to go to class or sleep in?
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Opportunity Cost
The use of scarce resourcesto produce a good isalways costly.
Someone must give upsomething if we are tohave more of a scarce good.
The highest valued alternativethat must besacrificed is the opportunity costof the choice.
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Opportunity Cost
Individuals choose purposefully;therefore they will economize.
Economizing:
gaining a specific benefit at the least
possiblecost.
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Opportunity Cost
Th C t f S thi I Wh t Y
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The Cost of Something Is What YouGive Up to Get It.
Yao Mingchose to skipcollege andgo to NBAwhere he hasearned
millions ofdollars.
Benefits
Costs
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Opportunity Cost: Economic Development and
Environment
Opportunity Cost
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Opportunity Cost
Suppose you find $20. If you choose to use the $20 to go
to the football game, your opportunity cost of going to
the game is:A. nothing, because you found the money
B. $20 (because you could have used the $20 to buy other things)
C $20 (because you could have used the $20 to buy other things) plusthe value of your time spend at the game
D. $20 (because you could have used the $20 to buy other things)
plus the value of your time spend at the game, plus the cost of the
dinner you purchased at the game
E. none of the above
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The Economic Way of Thinking
Choosing at the Margin
You can allocate the next hour betweenstudying
and instant messaging your friends.
The choice is not all or nothing, but you must
decide how many minutes to allocate to each
activity.
To make this decision, you comparethe benefitof a little bit more study time with its costyou
make your choice at the margin.
h i f hi ki
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The Economic Way of Thinking
To make a choice at themargin, you evaluate
the consequences of making incrementalchangesin the use of your time.
The benefit from pursuing an incrementalincrease in an activity is its marginal benefit.
The opportunity cost of pursuing anincremental increase in an activity is itsmarginal cost.
If the marginal benefit from an incrementalincrease in an activity exceedsits marginalcost, your rational choice is to do more of thatactivity.
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Rational people think at the margin
Economics normally assume that people are
rational ()
Rational peopleare self-interestandchoosethe more favorable alternative
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Rational people think at the margin
Marginal changesaresmall, incremental
adjustments to an existing plan of action.
People make decisions by comparing costs
and benefitsat the margin
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Rational people think at the margin
Rational people take an action if and only if
marginal benefit (
) of the action
exceedsthe marginal cost ()
Economic reasoning focuses onthe impact of
marginalchanges.
Decisions will be based on marginal costsandmarginal benefits
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The Economic Way of Thinking
Choices Respond to Incentives A changein marginal cost or a changein
marginal benefit changes the incentivesthat we face and leads us to change our
choice. The central idea of economics is that we
can predict how choices will change by
looking at changes in incentives. Incentives are also the key to reconciling
self-interest and the social interest.
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Two Roles of Economists
When economists are trying to explain the
world, they are scientists.
When they are trying to change the world,
they arepolicymakers.
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Positiveversus NormativeAnalysis
Positive statements() are statements that
describe the world as it is.
Called descriptiveanalysis(
)
Normative statements() are statements about
howthe world should be.
Calledprescriptive analysis( )
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Positiveversus NormativeAnalysis
Positive economicsconcerns the forces that affect
economic activity, and predictsthe consequences of
alternative actions
It is the focusof most modern economic reasoning.
Normative economicsanswers the question: What ought
to be?
Most economists shy away from normativequestions.
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?
?
Positive orNormative Statements?
An increase in the minimum wage willcause a
decrease in employment among the least-skilled.
Positive
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?
?
?
Positiveor NormativeStatements?
Higherfederal budget deficits will cause
interest rates to increase.
Positive
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?
??
Positiveor Normative Statements?
State governments should be allowed to collect
from tobacco companies the costs of treatingsmoking-related illnesses among the poor.
Normative
Economics:
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Economics:
A Social Science and Policy Tool
Economist as Social Scientist Economists two types of statement:
Positive statements
Normative statements Apositivestatement can be tested by checking it
against facts.
A normativestatement expresses an opinion andcannot be tested.
Economics:
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Economics:
A Social Science and Policy Tool
Unscrambling Cause and Effect
The task of economic science is
to discover positive statements that are
consistent with what we observe in the worldand that enable us to understand how theeconomic world works.
Economists create and test economic models.
An economic model
is a descriptionof some aspect of the economicworld that includes only those features that are
needed for the purpose at hand.
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Economics:
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A Social Science and Policy Tool
Economist as Policy Adviser
Economics is a toolkit for advisinggovernmentsand businesses and for making personaldecisions.
All the policy questions on which economistsprovide advice involve a blend of the positive andthe normative.
Economics cant help with the normative partthe goal.
But for a given goal, economics provides amethod of evaluating alternative solutionscomparing marginal benefits and marginal costs.