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ECONOMICS ECONOMICS – – THE CORE ISSUETHE CORE ISSUE

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• Why are you in this class right now rather Why are you in this class right now rather than than doing something else?doing something else?

• What is college costing you?What is college costing you?

• Why will you major in electrical rather than Why will you major in electrical rather than different engineering courses?different engineering courses?

“Life is a series of choices. And economics is about how people choose"

EconomicsEconomics is the study of how best to allocate is the study of how best to allocate scarce resources among competing usesscarce resources among competing uses.

• What is What is scarcityscarcity, and why is it important even in, and why is it important even in relatively wealthy economies?relatively wealthy economies?• What is What is opportunity costopportunity cost? Why do economists ? Why do economists place so much emphasis on it?place so much emphasis on it?• What is different about the way economists look What is different about the way economists look at choices and human at choices and human decision makingdecision making??• What does a What does a production possibilitiesproduction possibilities curve curve demonstrate?demonstrate?• What is the difference between What is the difference between positive andpositive and normative economics?normative economics?• What are the two major What are the two major economic systems?economic systems?

Economist, n.- A scoundrel whose faulty Economist, n.- A scoundrel whose faulty vision sees vision sees things as they really are, not as they oughtthings as they really are, not as they ought to to be.be.

• Resources will always be scarce relative to our Resources will always be scarce relative to our desires.desires.• How we use those scarce resources will shape How we use those scarce resources will shape the future.the future.

A good is scarce when the human desire for it exceeds the amount freely available from nature.

ScarcityScarcity means having to make choices. means having to make choices.

                                                            

• LaborLabor• CapitalCapital• LandLand• Entrepreneurial AbilityEntrepreneurial Ability

                                                            

• LaborLabor: broad category of human effort: broad category of human effort- Physical and mental- Physical and mental- Time- Time- Scarcity of time - Scarcity of time scarcity of labor scarcity of labor

• CapitalCapital: Human creations used to produce goods and : Human creations used to produce goods and servicesservices

- Physical capital: factories, machines, tools, - Physical capital: factories, machines, tools, buildings, airports, highways and other buildings, airports, highways and other

manufactured manufactured items employed to produce items employed to produce goods and servicesgoods and services

- - Human capital: consists of the knowledge and skill Human capital: consists of the knowledge and skill people acquire to enhance their labor productivitypeople acquire to enhance their labor productivity

                                                            

• Land- Land and other natural resources- Gifts of nature including bodies of water,

trees, oil reserves, etc.•Entrepreneurial Ability

- Special kind of human skill- Talent required to dream up a new

product or find a better way to produce an existing one

                                                            

• WHATWHAT to produce with our limited resources. to produce with our limited resources.

• HOWHOW to produce the goods and services we to produce the goods and services we select.select.

•FOR WHOMFOR WHOM goods and services are produced; goods and services are produced; that is, who should get themthat is, who should get them

                                                            

• Every time we choose to use scarce resources in one way we give up the opportunity to use them in other ways.

OPPORTUNITY COST :The value of the best alternative forgone when an item or activity is chosen

                                                            

•Going to college vs. WorkingGoing to college vs. Working

•McDonalds vs. KopitiamMcDonalds vs. Kopitiam

•New computer vs. HolidayNew computer vs. Holiday

Note: The lecture notes are incomplete without having attended lectures

Examples of Opportunity CostExamples of Opportunity Cost

                                                            

Note: The lecture notes are incomplete without having attended lectures

Examples of Opportunity CostExamples of Opportunity Cost

• Opportunity Cost is SubjectiveOpportunity Cost is Subjective• Calculating OC Requires TimeCalculating OC Requires Time• Time is the Ultimate ConstraintTime is the Ultimate Constraint• OC May Vary with CircumstancesOC May Vary with Circumstances

                                                            

Principles of individual decision makingPrinciples of individual decision making:

• Trade offs – “gun and butter” - efficiency vs equity• The cost of something is what you give up to get it –opportunity cost• Rational people think at the margin• People respond to Incentives

                                                            

• States that the individual with the lower opportunity cost of producing a particular output should specialize in producing that output

• Absolute advantage means being able to produce a product using fewer resources than other resources require while comparative advantage focuses on producing where opportunity costs are lower

Law of Comparative Advantage

                                                            

• Comparative advantage between nations exists because ofComparative advantage between nations exists because of- Climate- Climate- Workforce skills- Workforce skills- Natural resources- Natural resources- Capital stock- Capital stock

• Resources will be allocated more efficiently when production Resources will be allocated more efficiently when production and trade conform to the law of comparative advantageand trade conform to the law of comparative advantage

Law of Comparative Advantage

                                                            

• BarterBarter- System of exchange in which products are traded System of exchange in which products are traded directly for other productsdirectly for other products

- Works best in simply economies with little - Works best in simply economies with little specialization and few goods specialization and few goods

•In advanced economies with specialization, money plays an In advanced economies with specialization, money plays an important role in facilitating exchange important role in facilitating exchange- Money serves as a medium of exchange because it is - Money serves as a medium of exchange because it is the one thing that everyone is willing to accept in the one thing that everyone is willing to accept in return for all goods and services. return for all goods and services.

Specialization and Exchange

                                                            

• Production possibilities are the alternative combination of final goods and services that could be produced in a given period of time with all available resources and technology.

• Each point on the production possibilities curve depicts an alternative mix of output.

The Economy’s Production Possibilities

                                                             The Economy’s Production Possibilities

                                                             The Economy’s Production Possibilities

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                                                             The Economy’s Production Possibilities

Production possibilities illustrates two essential principles: Scarce resources – there’s a limit to the amount we can produce in a given time period with available resources and technology Opportunity costs – we can obtain additional quantities of any desired good only by reducing the potential production of another good.

                                                            

Increasing Opportunity Costs

Step 1: give up one shoe

Step 2: get two TVsStep 3: give up another shoe

Step 4: get one more TV

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MicroeconomicsMicroeconomics• Examines the factors that influence individual Examines the factors that influence individual economic choices economic choices • Studies the individual pieces of the economic Studies the individual pieces of the economic puzzlepuzzle

MacroeconomicsMacroeconomics• Studies the performance of the economy as a Studies the performance of the economy as a wholewhole• Focuses on the big pictureFocuses on the big picture

                                                            

• Positive economic statement-Assertion about economic reality- Supported or rejected by reference to the facts

•Normative economic statement- Opinions- Cannot be shown to be true or false by reference to the facts

                                                            

• Economic SystemEconomic System is a set of mechanisms is a set of mechanisms and institutions that resolve the and institutions that resolve the whatwhat, , howhow, and , and for whomfor whom questions questions

• Criteria used to distinguish among Criteria used to distinguish among economic systemseconomic systems

- Who owns the resources- Who owns the resources- What decision-making process is - What decision-making process is used to allocate resources and used to allocate resources and productsproducts- What type of incentives guide the - What type of incentives guide the

economic decision makerseconomic decision makers

                                                            

• Private ownership of all resourcesPrivate ownership of all resources• Coordination of economic activity based on price Coordination of economic activity based on price signals generated in free, unrestricted marketssignals generated in free, unrestricted markets• Owners have property rights to use their resourcesOwners have property rights to use their resources and are free to supply those resources to the highestand are free to supply those resources to the highest bidderbidder• Voluntary buying and sellingVoluntary buying and selling• Market prices guide resources to their most Market prices guide resources to their most productive uses and channel goods and services productive uses and channel goods and services to consumers who value them mostto consumers who value them most• Laissez-faire: let people do as they choose Laissez-faire: let people do as they choose

without government interventionwithout government intervention

                                                            

• The The market mechanismmarket mechanism is the use of is the use of market prices and sales to signal market prices and sales to signal desired outputs (or resource desired outputs (or resource allocations).allocations).

• The essential feature of the market The essential feature of the market mechanism is the price signalmechanism is the price signal.

                                                            

free markets tend to concentrate wealth and power in the hands of the few, at the expense of the many.

The laissez-fair policy favored by Adam Smith has always had its share of critics

Karl Marx Karl Marx

Marx argued that the government not only had to intervene but had to own all the means of production.

                                                            

• Resources are directed and production is Resources are directed and production is coordinated not by markets buy by the coordinated not by markets buy by the “ “command,” or central plan, of governmentcommand,” or central plan, of government

• Public or communal ownership of propertyPublic or communal ownership of property

• Central plans spell out answers to three questionsCentral plans spell out answers to three questions

                                                            

• According to Marx, markets permit capitalists According to Marx, markets permit capitalists to enrich themselves while the proletariat to enrich themselves while the proletariat toiltoil long hours for subsistence wages.long hours for subsistence wages.

- Capitalists – those who own the machinery Capitalists – those who own the machinery and factories. and factories.

- Proletariat – the workers.- Proletariat – the workers.

                                                            

• John Maynard Keynes seemed to offer a less John Maynard Keynes seemed to offer a less drastic solutiondrastic solution

..The market was pretty efficient in organizing production and building better mousetraps.

.. However, individual producers and workers had no control over the broader economy.

                                                            

• Keynes believed the cumulative actions of so Keynes believed the cumulative actions of so many economic agents could easily tip the many economic agents could easily tip the economy in the wrong direction.economy in the wrong direction.

.. government should play an active but not an all-inclusive role in managing the economy.

                                                            

• A A mixed economymixed economy is one that uses both market is one that uses both market signals and government directives to allocate signals and government directives to allocate goods and resources.goods and resources.

• Most economies use a combination of market Most economies use a combination of market signals and government directives to select signals and government directives to select economic outcomes.economic outcomes.

                                                            

• A A market failuremarket failure is an imperfection in the market is an imperfection in the market mechanism that prevents optimal outcomes.mechanism that prevents optimal outcomes.

• If the market signals don’t give the best possible answers, we say that the market mechanism has failed.

                                                            

• A government failure is government intervention that fails to improve economic outcomes.