Introduction to Economics

Professor Hedrick

SS 424

Instructional Method• Primarily Lecture format with discussion,

simulations, and video presentations• Constructive discussion is welcomed• Grading is based on five mini-exams and Aplia

Homeworks. – NO MAKEUPS GIVEN• Professor available during office hours and by

appointment• Suggestions for the study of economics

What is Economics?

• Scarcity – a basic human dilemma– Limited resources vs. unlimited wants– The human condition requires making choices

• Definitions of Economics– Mankiw’s definition

• …is the study of how society manages its scarce resources

– Hedrick’s definition• …is how society chooses to allocate its scarce resources among

competing demands to improve human welfare

– Alternative definitions• … what economists do.• … is the study of choice.

• Fundamental Questions of Economics - Scarcity requires all societies to answer the following questions:– What is to be produced?

– How is to be produced?

– For whom will it be produced

WHFM Questions

How Do Economists Study Human Behavior?

• Economics as a Science– The scientific method

• Observation→Theory→Data→Testing– Rational Behavior

• Weighing benefits and costs and maximizing total net benefits• Marginal vs. Total Thinking

– Economic Theory and Models• Simplification by assumption• Ceteris Paribus – Holding other factors constant• Prediction vs. realism

– Microeconomic versus Macroeconomics

– Bias towards use of natural rather than controlled experiments

– The specialized language of economics (e.g. “He has lots of money.”)

• Money – medium of exchange• Wealth – accumulated financial and non-financial assets• Income – the purchasing power earned during a given period

Why do Economists Study Human Behavior?

• Scientists versus policy makers• Positive Economics

– Descriptive - what the world is like.– Objective- value judgments need not be made– Positive statements can theoretically be tested by

appealing to the facts • Normative Economics

– Prescriptive - what the world ought to be like– Subjective – value judgments must be made– Normative statements cannot be tested appealing to

facts.

Categories of Basic Principles of Economics

• How do people make decisions?

• How do people interact?

• How does the economy work overall?

How Do People Make Decisions?

• Principle #1 - People face tradeoffs– Time allocation – an example of tradeoffs– Efficiency versus equity– Production Possibilities Frontier

• Principle #2 - The cost of something is what you have to give up to get it– Opportunity costs come from Von Weiser, a

German economist late 1800s– Opportunity costs are independent of monetary

units– TINSTAAFL– The real costs of going to college

• Principle #3 - Rational people think at the margin– Rational or irrational decision-making– Marginal benefits and costs versus total

benefits and costs– Weighing marginal costs and benefits leads to

maximizing net benefits (total welfare)– The boxes example

.

• Principle #4 –People respond to incentives– Reactions to changes in marginal benefits and costs

– Increases (decreases) in marginal benefits mean more (less) of an activity

– Increases (decreases) in marginal costs mean less (more) of an activity

– Example of seat belts leading to increased speeds

– Example of SUV (with child car seat) in Issaquah

How Do People Interact?

• Principle #5 - Trade can make everybody better off– Adam Smith author of the “An Inquiry into the

Causes and Consequences of the Wealth of Nations” 1776

– Gains from the division of labor and specialization

– Mercantilists perspectives– Example of why Ellensburg

• Principle #6 - Markets are usually a good way of organizing economic activity– feudal times where feudal states were self-supporting, also

haciendas in the new world– the benefits of trade are so powerful that people began to

trade– markets for economists are more abstract than the notion

of a middle eastern bazaar or a flea market and simply determine the prices and quantities traded of different goods and services

– the “failure” of centrally planned economies and the movement towards markets for the WHFM questions

Markets

– Principles 1-5 combine with markets to turn the pursuit of self-interest into promoting the interests of society

– Adam Smith and the “invisible hand”

– creativity and productivity are stimulated by the pursuit of self-interest into improving resource allocations

– “set it and forget it” becomes “compete or be obsolete”

– in some cases markets fail to allocate resources effectively so,

• Principle #7 Governments can sometimes improve interaction that occurs in markets– there are circumstances when market signals fail to

allocate resources efficiently or equitably– Public Goods, Externalities and Income Distribution– Some goods or services that people desire will not be

produced by markets (e.g. lighthouses).– Some goods or services will either be underproduced

(vaccines) or overproduced (pollution) because markets fails to register certain benefits or costs.

– markets may also fail to provide an equitable or fair distribution of resources

– government intervention with its ability to coerce (the opposite of voluntary) can regulate, tax and subsidize to change market outcomes

– efficiency and equity: the pie analogy

– if government intervention always the proper solution?

How Does the Economy Work as a Whole?

• Principle # 8 – A country’s standard of living depends upon its ability to produce goods and services – Adam Smith’s “An Inquiry into the Nature and the

Consequences of the Wealth of Nations”– Materialism – more toys mean more welfare– wealth: a necessary or sufficient condition for

happiness (are rich people happier, children with lots of toys)

– leisure time and productivity

– the factors of production: land or natural resources, labor, capital, entrepreneurship

– technology and productivity– the rule of 72 for growth rates

• Principle #9 – The general level of prices rises when the government prints and distributes too much money– definition of money, the concept of snow to Inuits, and

economic language– inflation is an increase in the general or average level

of prices in an economy– “not worth a continental” and recent example in

Argentina– the establish of the Federal Reserve and the

introduction of sustained inflation in the US

• Principle #10 – Society faces a short-run tradeoff between inflation and unemployment– Short-run and the long-run

– demand and supply shocks

– short-run increases (decreases) in output above (below) long-run potential output lead to adjustments

– countercyclical stabilization versus pro-cyclical destabilization

– political business cycles