Introduction to Economics

D.W. Hedrick

Instructional Method

• Primarily Lecture format with discussion, simulations, and video presentations

• Constructive discussion is welcomed

• Grading is based on Aplia Homeworks (20%), five of seven quizzes (20%), three midterms (20% each), and an optional comprehensive final (replaces lowest midterm) – NO MAKEUPS GIVEN

Instructional Method

• Suggestions for the study of economics– Read the book before coming to class– Recopy lectures and reread the book within

several hours of class– Identify what you don’t understand

• Ask questions in class• Use the Aplia and the study guide (optional)• Go to tutors in supplemental instruction (if offered)• Visit the professor during office hours

Definition of Economics

• Mankiw’s definition– How Society manages its scarce resources

• Hedrick’s definition– How society chooses to allocate its scarce resources

among competing demands to best satisfy human wants

• Alternative definitions– Economics is the study of choice.

– Economics is what economist do.

– Wikipedia's perspective

Scarcity and the Fundamental Questions of Economics

• Scarcity : Unlimited wants versus limited resources

• Choices and tradeoffs• Opportunity Costs• All societies must answer the WHFM questions

– What is to be produced?

– How is to be produced?

– For whom will it be produced?

Economics as a Science• The Scientific Method

– Observation →Hypothesis →Testing– Observation: identifying and measuring important variables – orderly loss of

information– Hypothesis: educated guesses about cause and effect with the variables

• Theories• Models: realism or usefulness

– Testing: theories can’t be proven and are supported by repeated failed attempts to disprove them.

• Microeconomics vs. Macroeconomics• The Assumption of Rational Behavior

– Max TNB = TB – TC– Boxes Example– MB=MC rule– People respond to incentives– Limits to the use of rational behavior (e.g. axe murders)

• Microeconomics versus macroeconomics

• Normative vs. positive approaches

• A brief history of economic thinking

• The language of economics

Mankiw’sTen Principles of Economic Thinking

Categories of Basic Principles of Economics

• How people make decisions?

• How people interact?

• How does the economy work overall?

How People Make Decisions

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

How People Make Decisions

• 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

How People Make Decisions

• 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)

How People Make Decisions• 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 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 Ellensburgians should trade

with others

How People Interact

• Principle #6 - Markets are usually a good way of organizing economic activity– Feudal times and haciendas in the new world– The power of trade: cooperation versus conflict– Markets: prices and quantities traded, typical

and abstract

How People Interact

• Principle #6 - Markets are usually a good way of organizing economic activity creativity and productivity and resource allocation– “Failure” of centrally planned economies – “set it and forget it” becomes “compete or be

obsolete”

How People Interact

• Principle #7 Governments can sometimes improve market outcomes– Market signals can fail to allocate resources

efficiently or equitably– Public goods, the exclusion principle, the free-

rider problem and non-rival consumption– External costs and benefits– Examples: vaccines, education, pollution

How People Interact

• Principle #7 Governments can sometimes improve market outcomes– Equitable or fair distribution of resources – Efficiency and equity: the pie analogy– Government Failure: is government

intervention always the proper solution?

How the Economy works 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)

How the Economy works as a Whole

• Principle # 8 – A country’s standard of living depends upon its ability to produce goods and services – leisure time and productivity– the factors of production: land or natural

resources, labor, capital, entrepreneurship – technology and productivity– the Rule of 72 and growth rates

How the Economy works as a Whole

• Principle #9 – The general level of prices rises when the government prints and distributes too much money– Definition of money, and economic language

How the Economy works as a Whole

• Principle #9 – The general level of prices rises when the government prints and distributes too much money– Examples: “Not worth a continental” and

Argentina– Establish of the Federal Reserve and the

introduction of sustained inflation in the US

How the Economy works as a Whole

• 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

How the Economy works as a Whole

• Principle #10 – Society faces a short-run tradeoff between inflation and

unemployment– Counter-cyclical stabilization versus pro-

cyclical destabilization – Political business cycles