Chapter 1

Economics the Study of Choice

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Economic Resources Economics is all about alternative

use of available resources. There are four basic types of

Economic Resources:I. LandII.LaborIII.CapitalIV.Entrepreneurial Abilities

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Economic ResourcesI. Land

Captures all natural resources available to human.Examples include land, water, air, sunlight, tree, plants, petroleum, iron ore, gold, silver, diamond and so on.

II. Labor Captures all forms of human resourceDimensions:

1. Physical labor2. Mental labor

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Economic Resources Physical labor primarily means

muscular power Examples of physical laborer

Professional movers, homebuilders, and miners

Mental labors are knowledge, experience, skill and education

Examples of mental laborerNeurosurgeon, financial advisors, professional lobbyist, consultants

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Economic ResourcesIII. Capital

Manmade implements used in production process.Examples:Tools, tractors, caterpillars, machines, factories, plants, highways, electric grid if you use your computer to surf the

web, this is a final consumption good If you use it for your small business,

it’s a capitalHossain: MSMC 5

Economics ResourcesIV. Entrepreneurial abilities

Include the innovativeness and risk taking attributes of human to combine

a) Landb) Laborc) Capital and Technology

to produce goods and services that consumers want.

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Important Assumptions In a production process, resources are

transformed to produce final goods and services, which fulfill human wants

However, resources are scarce Therefore, goods and services are

scarce Human wants, however, are unlimited

Scarcity is the main reason for studying economics

If there were no scarcity, there would have been no economics

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Scarcity Economic resources are scarce.

At any point in time, we have only so much of land, so many people, so much capital, so much time.

Scarcity forces us to make Choice Because of scarcity, we can’t have it all.

If you use your parcel of land for potato, you can not use it for corn

If you use your time watching TV, you can’t use it for studying economics

We must give up something to gain something else

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Scarcity Because of scarcity, we must choose

among alternatives We must choose: how to use ours natural resources (land) How to use our labors (physical and mental) How to use our capitals How to use our technology, entrepreneurial

abilities Or, our scarce resources

Economics tells us how to make this choice

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Definition Economics is all about making right

choice Economics studies how society choose

to allocate its scare resources to satisfy unlimited human wants

It is a social science that examines how society choose among the alternatives available to them

Without scarcity, we would not have to make a choice. we could have it all.

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Definition Microeconomics

Studies the choices made by individual consumers and firms The impacts those choices have on individual markets

MacroeconomicsStudies the impact of choices on the total or aggregate level of economic activity

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Keywords

Social Science Its social because it deals human

behavior Its science because it utilizes

scientific methods and models to Form hypothesis Test hypothesis Develop theories and laws

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Fundament Questions

Three Fundamental Questions of Economics What should be produced ? How should goods and services be

produced? For Whom should goods and

services be produced?

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Opportunity Cost

Economics is all about making the right choice

But, every choice has an opportunity cost This is because, when we choose to get

something using a resource, we must give up something else that could have been produced using that resource

What we give up is opportunity cost (opportunity lost)

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Opportunity Cost

What is the O.C. of going to college?You could have been working for 15 an hourYou could have been travelling the worldYou could have been playing basketball

You could have been developing soft wares

O.C. is the highest valued alternative given up

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Like Bill Gates did

Like Kobe Bryant did

Economic way of Thinking

Decisions are made at the Margin Most economics decisions deal with measuring

the impact of additional output or incremental benefit

It is different from “yes or no” decisions. If the town officials want to reduce

households’ use of water, it might increase the price of water

Households will not stop using water Households will use less water This is a marginal response. Economists

measure this marginal impact Hossain: MSMC 16

Economic way of Thinking

Example Suppose you run a t-shirt shop. Currently you produce 500/month and it

costs you $700 in machinery, labor, and materials

If I produce 600/month next month your cost increases to $750

Then, the marginal cost of the additional 100 shirts is $50

This decision only makes sense if your marginal revenue is more the $50

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Economists’ Tool kit

A variable is something whose value can change

A constant is something whose value does not change Average annual temperature of Newburgh Your GPA in Fall 2010 Your SSN

The scientific method is a systematic set of procedures through which new knowledge is created

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Economists’ Tool kit

A hypothesis is an assertion of a relationship between two or more variables that could be proven false

A theory is a hypothesis that has not been rejected after widespread testing and that wins general acceptance

A law is a theory that has been subjected to even more testing and that has won virtually universal acceptance

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Economists’ Tool kit

A model is a set of simplifying assumptions about some aspect of the real world

Campus map supplied to you is a location model of the Mount

Economic models describe relationships among economic variables

Example: interest rate and investmentHossain: MSMC 20

Economists’ Tool kit

Models help us understand the economy by generating hypotheses about the economy

Low interest rate cause higher investment

The hypothesis eventually generates new knowledge

Knowledge guides economic policies to solve the problems of allocation of scarce resource

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Independent and Dependent Variable

Consider the hypothesis:Low interest rate cause higher investment

Here, Interest rate is the independent variableInvestment is the dependent variable

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Ceteris Paribus

When testing a hypothesis, economists must make sure that other factors are held constant

If you want to know the impact of interest rates on investments, you must make sure all other factors that may have an impact on investment are unchanged

This is called “All else being equal” In Latin, Ceteris Paribus

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Positive and Normative Statements

A positive statement is a statement of fact or a hypotheses Can be proven true or false using economic

data Describes an aspect of the reality

A normative statement is a statement that makes a value judgment. Cannot be proven true or false using economic

data Describes a subjective believe or value

judgementHossain: MSMC 24

Positive and Normative Statements

GDP grew 2.5% in the 2nd quarter of 2010

GDP and unemployment rates positively related

Unemployment benefits encourages lower labor force participation

Government should limit the unemployment benefits to 6 months

Unemployment is a bigger problem than inflation

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