Chapter 1: Overview

Economics is defined as the study of choice under conditions of scarcity.

What is Scarcity?

Scarcity: is the problem of infinite human needs and wants, in a world of finite resources.

Society has insufficient productive resources to fulfill those wants and needs.

Individuals face scarcity.

Resource Categories (Factors of Production)

Land or Natural Resources: includes anything naturally occurring which can be used in production.

 Labor or Human Resources: including anything

that man brings to the production process.

Capital or physical capital: anything man-made that can be used again in production (durable: lasts over one year)

Not every input is a Resource!

o

o ex:

o o ex:

o

o ex:

ECONOMICS THEN STUDIES HOW ECONOMIC AGENTS USE THE RESOURCES

WITH WHICH THEY ARE ENDOWED TO THEIR BEST ABILITY IN ORDER TO

ACQUIRE THE GOODS AND SERVICES THEY MOST DESIRE.

 

Decision-Making

Assumptions about Decision-Making

every choice implies a trade-off (must give up something)

every choice therefore has a cost

people are rational:

people are self-interested:

altruism

people makes choices at the “margin”: we examine the incremental benefits (marginal benefit) and incremental costs (marginal cost)

THE MODEL ASSUMES PEOPLE WEIGH THE RELATIVE COSTS AND BENEFITS OF A DECISION AT

THE MARGIN. THE OPTIMAL LEVEL OF ACTIVITY WILL OCCUR WHERE MARGINAL BENEFIT =

MARGINAL COST

Economic Model of Decision-Making

Two Important Components of the Model

Marginal Benefit (MB): is the change in benefits (additional benefit or reduction in benefit) from changing the level of an activity by one unit (increasing or decreasing an activity by 1 unit). Ex

Marginal Cost (MC): is the change in costs (additional cost or reduction in cost) from changing the level of an activity by one unit (increasing or decreasing an activity by 1 unit). Ex:

The Intuition

As long as the Marginal Benefit (MB) of an activity is higher than the Marginal Cost (MC) more of the activity should be undertaken. As you increase an activity the marginal benefits will diminish

and the marginal costs will increase.

Eventually, the Marginal Benefit (MB) of an activity will be equal to the Marginal Cost (MC). This is the optimal level of an activity.

If you continue the activity past this point the Marginal Benefit (MB) of an activity will become lower than the Marginal Cost (MC) and less of the activity should be undertaken.

Applications of the Model

Individual: should you take an extra course a semester to graduate early?

Firm: demand for Dell computers has increased by 10,000 units. Should Dell increase production to maximize profit? By how many units?

Government: should the Federal Drug Administration have stricter regulations on genetically modified organisms (GMOs) in food products to increase food safety?

Evaluating Costs and Benefits

Cass Sunstein (Office of Information and Regulatory Affairs)—top regulator in Obama Administration.

Strong proponent of cost-benefit analysis.Difficulties: measuring costs and benefits in

dollars Ex:

EPA—acceptable mercury levels in products. Measure the cost of incremental exposure to mercury in terms of the reduction in IQ points of kids.

What is the cost? EPA valued 1 lost IQ point due to mercury poisoning at ___________.

Ex:

MACROECONOMICS FOCUSES ON THE OVERALL ECONOMY.

MICROECONOMICS FOCUSES ON SMALLER ECONOMIC UNITS SUCH AS INDIVIDUALS, HOUSEHOLDS, FIRMS, AND INDUSTRIES.

Macro Vs. Micro

MACROMACRO MICROMICRO

Inflation

Unemployment

Gross Domestic Product (GDP)

Trade Balance

Macro vs. Micro Topics

MICROECONOMICS STUDIES THE BEHAVIOR OF SMALLER ECONOMIC UNITS SUCH AS INDIVIDUALS,

HOUSEHOLDS, FIRMS, AND GOVERNMENT AND THEIR INTERACTIONS IN MARKETS.

The Role of Markets

Defining a Market

A market is an organized “place” where buyers and sellers voluntarily exchange goods and services. Examples:

Markets are defined in terms of:

1. 2. 3.

THE STUDY OF ECONOMICS INVOLVES DESCRIBING EVENTS, ANALYZING EVENTS, MAKING

PREDICTIONS, AND PRESCRIBING POLICY RECOMMENDATIONS.

Evaluating Outcomes

Positive vs. Normative Economics

Positive analysis or economics: is an objective description and/or evaluation of an event.

Ex: efficiency considerations—is a project produced at lowest cost?

Normative analysis or economics: provides a subjective description or evaluation of an event.

Ex: equity considerations—relating to fairness

Examples

1. A $0.50 tax on cigarettes will reduce smoking by teenagers by 12%.

2. The federal government should reform health care.

3. Rising paper prices will increase textbook prices.4. The price of coffee at Dividends is too high.5. The government will balance the budget this year.6. Tuition costs for higher education have increased

15% annually for the past 5 years. The state should increase subsidies on education to reduce the burden on families.