Section 1: Introduction to Economics

1.1 Definitions of Social Science and Economics

Social ScienceStudy of human society and of the relationships between people and organizations/institutions.

Fields of studyHistory, sociology, psychology, anthropology, political science, economics

Weaknesses of Social Sciences

Lack of absolute answersConflicting claims and conclusions

Natural sciences more absolute

Too many unknown variables

Assumptions must be made in order to derive a hypothesis (question to be proved).

Theories and models change with time.

Reliability and Validity of Data

Who, what, where, why, and how

Sources and motivations (agendas) are always important when viewing data.

Ex. Global warming debate

John Maynard KeynesEconomist

“Economics is the most difficult of sciences because one needs to be a mathematician, philosopher, politician, and psychologist.”

Economics (p. 6-8)

The study of society’s optimal use of scant resources focusing on societal systems of

Production

Consumption of goods and services

Distribution

Microeconomics

Def: Deals with the inter-relationship between individual components in the economy: firms, industries, and consumers (households). Firms output and pricing decisions vs. Individual purchasing decisions.Supply and DemandIndividual Markets

If gasoline reaches $10.00/gallon, how will that affect consumer behavior?

What reasons might there be for oil companies to raise prices to this point?

Macroeconomics

Def: The aggregate (sum) of all individual markets.Main issues:

OutputPrice levelsLabor marketsForeign sector dealings

Trade and exchange rates

Macro (cont.)

Business cycle: total output of economy over time.

Expansion vs. recession

Deals with all products and all consumers

Ex. Pepsi Co. vs. U.S. economy

Question p. 10

Explain the main difference between micro and macro using the term “aggregate”.

Macroeconomic Policy

Government attempts to influence economic activity

Demand Side PolicyInfluence spending level in society

Ex: interest rates, taxes, govt. spending

Supply Side PolicyCreate more output by increasing willingness and ability of

– firms to produce

– laborers to work

Growth p.12

Increase in national output within an economy during a time period.

Real growth (adjusted for inflation)

national output or GDP (Gross Domestic Product)-

Sum of all goods produced in a country

National income

Development (12-15)

Difficult to define when comparing MDCs and LDCs (more and less developed countries)

Goals 1. Increase basic necessities (food, water, shelter, health care, safety)

2. Raise living standards, employment, education.

3. Economic and Social Choice, freedoms, rule of law

What first hand examples do we have (among our class) of life in poor countries?

Examples pg. 15

Sustainable Development (14-15)

World Bank Def: Growth that “lasts” within the long-term capacity of the environment with respect to population and use of resources.

Ex: Amazon rain forests vs. short-term economic gain.

Ceteris Paribus (16-18)

Assumption in economic models that keeps certain variables (not addressed in the model) constant.

Ex. Change in weight by changing only eating habits, not exercise.

Positive and Normative Concepts

Positive- free from conjecture (speculation), judgements. Objective. Fact that can be proven.

The sun is in the sky.

Normative- subjective, opinionated, judgemental, cannot be proved

The war in Iraq is justified.

Toward which concept does economic theory strive to reach, positive or normative?

Factors of Production (18-19)

Land Raw materials, primary goods (dig it up, chop it down, pluck it)

Labor Transforms raw material to manufactured

CapitalItems used in the production of goods

Management/entrepreneurshipCreativity/Ambition +land, labor, capital

Scarcity

Lack of limited resources to satisfy the unlimited wants of people.

Central issue in economics

Faced by all nations.

Payments to Factors of Production (20-21)

Interaction between households and firms.

Firms pay Households for Factors of Production

Rent (Land)

Wages (Labor)

Interest (Capital)

Profit (Entrepreneur)

Households pay Firms for goods and services

Circular Flow Model (21)

What are the 2 sectors providing for each other?

Utility and Marginal Utility

Utility:

Benefit/satisfaction/usefulness one gets from consumption of a good.

Differs from person to person.

Impossible to measure

Key economic concept

Mmmmm Wings

Marginal UtilityThe addition to Total Utility by consuming one more good.

Opportunity Costs

The 2nd best alternative that is given up in order to obtain the 1st alternative.Permeates most economic issues.The decision about what is the 2nd best alternative is central to social and political debate.How do you rank the alternatives on page 27?

Production Possibility Frontier

Total attainable output based on the limits of available resource.

All output shown using two groups.Ex. Guns and Roses

What does A and B represent?

Are points a and b possible?

Opportunity Costs and the PPF

OC is on the PPF

If PPF is straightOC is constant

Why can’t OCs be incurred inside the PPF?

Increasing OC

How does this curved PPF represent an increasing OC?

Diminishing Returns

OC = Returns

Real world example?

Increasing Output

Growth (within the PPF)

Better utilization of available resources

Ex. Longer workdays, increasing land use.

What causes a shift of the curve?

Increasing Potential Output

Possible Growth

Shift PPF out

Real Output unchanged

Point F (inside PPF)

Potential Output improved.

How?

Changing Quality of FOP

Ex. Quality of LaborEducation, training, experience

LandNew farming methods

CapitalImproved technology

Potential to produce more.

Quantity of the FOP

More FOP means greater potential for growth.

PPF and Development

Public /Merit Goods/ InfrastructureIncreases Potential Output

Rationing Systems

How do we deal with scarcity?

Answer:

Choices

Economic systems deal with choices3 Basic Questions

Free Market Economy

Characteristics

Command Economy

Characteristics

All Countries are “mixed”

Public Ownership

Public Sector Vs. Public Ownership

PS Govt. Bureaucracy

Funding from Taxes

POGovt. control of firms

Nationalized industriesOften utilities

Justification for Public Ownership/Control

PoliticalBenefits reach all rather than the “few” =rich

Equality in societyRedistribution of wealth (taxation and social welfare)

Enlightenment

Economic Argument

Private ownership fails to provide goods at the right:

Quantity

Price

Under-Provision

Ex. Roads, Education, Health CareOver-provision of “harmful” goods

Govt. Influences w/o direct control

Sin Taxes

Subsidies

Private

Self-InterestAre all actions based on self-interest?

Profit= IncentivesHard work

Innovation

Private Ownership Rule of Law / Property Rights (vs. Corruption)

Essential element of free markets and democracies

Adam Smith 1723-1790

Father of Economics

Quote pg. 57

Wealth of NationsInvisible Hand

Self-Interest creates maximum efficiency

The Firm

Creates goods and services

Add value to resourcesLabour value-added

Provides national incomePromotes consumption

Tax base

New products and innovation.

New technology

Milton Friedman-Free to Choose

4 ways to spendOn oneself

On others

Others money on oneself

Others money on others

In terms of efficiency, which is most desirable? Why?