“Textbook definition” of economics: The study of how society manages its scarce resources.
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“Textbook definition” of economics:The study of how society manages its scarce resources.
“Resources” means anything that can be used in a productive way:natural resources, human labor, environmentalamenities, and “capital:”human-made tools of production:machines, factories, computers.
Who decides how resources are used (allocated) and how goods and services are distributed?
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For example: In the Soviet Union (now defunct), resources were allocated by decree of government authorities. “Command economy.”
“Market economy:”An economy that allocates resources through the decentralized decisions of many firms and households as they interact in markets for goods and services.
Microeconomics:The study of how households and firms make decisions and how they interact in markets.
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Macroeconomics:The study of economy-wide phenomena, including inflation, unemployment, and economic growth. (Econ 102)
To put it another way:Micro is the study of how individuals make decisions
. . . and how those decisions are coordinated by the market mechanism.
Macro is the study of the aggregate consequences of those decisions.
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What economics is not:It’s not a “how-to manual” for success in business or personal finance.
Objective of economics is government policy analysis.
One quick example from my research:
State “anti-corporate” farming laws
Do they lead to smaller average farm sizes?If so, is there a downside to smaller farms?
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Mankiw’s Ten Principles of Economics
First 4 principles relate to how people make decisions.
1. People face trade-offs.
Choosing one desirable alternative usually means forgoing another.
2. The cost of something is what you give up to get it.
The point: In many cases, the cost of some action is not as obvious as it may first appear.
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For example: The cost of a college education.
Obvious costs: tuition, books, student fees, transportation (probably not room and board)
Not-so-obvious costs: Forgone earnings.If you weren’t in college, you’d be in the labor force, working and earning.
For many students, forgone earnings represent the single largest component of college costs.
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Opportunity cost:The cost of an action measured in terms of what you give up to get it.
3. “Rational people think ‘at the margin’.”
Marginal changes: Small, incremental adjustments to a plan of action.
The point: To understand what decisions are best, it often helps to consider the impact of a marginal change.
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Example: A firm trying to decide how much output to produce. Currently producing 100 widgets/day. Is this the profit-maximizing output level?
Consider a marginal change from 100 widgets/day to 101 widgets/day.
Revenue (money from sale of output) will go up.
Cost will go up.
Revenue increase more or less than cost increase? Effect on profit?
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The effect of a marginal change is closely related to the calculus concept of a derivative.
Calculus is an indispensable tool of (higher-level) economic analysis . . .
. . . I’ll give a few illustrations of the usefulness of calculus as we proceed.
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4. People respond to incentives (like changing prices).
The point: In many cases, the response to incentives is more far-reaching than we might first assume.
Example: An increase in the level of gasoline excise taxes raises the price consumers pay for gasoline.
Responses: People drive less.Prefer more fuel efficient cars.Choose car-pooling, public transit.Spur development of “alternative” technologies for car engines.
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“Freakonomics – A Rogue Economist Explores the Hidden Side of Everything”
by Steven D. Levitt and Stephen J. Dubner(http://www.freakonomics.com/)
One theme: Explaining behavior in terms of the incentives people face.
The “dark side” of incentives: Cheating.
Cheating to lose in sports. (1919 “Black Sox” scandal)
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Sumo wrestling in Japan
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“Sumo wrestling” in USA
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In Japanese sumo wrestling, ranking is everything.
Each wrestler’s ranking based on performance in elite tournaments – 15 matches per tournament.
Finishing with a winning record is very important.
8-7 is much better than 7-8 . . .. . . but not much worse than 9-6.
An 8-6 wrestler enters final match against a 7-7 opponent.
Might he “cheat to lose” – allowing opponent to win?
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“Freakonomics” looked at the data from hundreds of matches in which a 7-7 wrestler faced an 8-6 opponent.
7-7 wrestler’s expected winning percentage:48.7%7-7 wrestler’s actual winning percentage: 79.6%!
What about next meeting of same two wrestlers, when neither one is “on the bubble”?
7-7 wrestler’s expected winning percentage:about 50%
7-7 wrestler’s actual winning percentage: 40%!
Is Japanese sumo wrestling rigged?
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Principles 5, 6, and 7 pertain to how people interact (how markets “work”).
5. Trade can make everyone better off.
Poker and other “zero sum” games.(Winners’ gains are exactly offset by
losers’ losses.)
Trade is a positive sum game.(Both parties to exchange can “come out
ahead.”)
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Briefly in chapter 3, “Interdependence and the gains from trade,” . . .
. . . and in detail in chapter 9, “International Trade.”
Note: Political candidates differ in the extent to which they believe in . . .
“free trade” (make it easy for foreign firms to sell their products here . . . and for our firmsto sell their products abroad), or
“protectionism” (shield U.S. firms from foreigncompetition).
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6. Markets are usually a good way to organize economic activity.
Remember: In a market economy, resource allocations result from the interaction of millions of independent decision-makers (households and firms).
No one is in charge!
Chaos results? -- no, usually the outcome is pretty
good. (We’ll see why later.)
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Adam Smith’s The Wealth of Nations, 1776.(http://www.econlib.org/LIBRARY/Smith/smWN.html)(Try “Search book” for “invisible hand.”)
Individual market participants motivated by own self-interest, not the greater good of society. Yet, the result of their actions is usually pretty good for society as a whole.
Market participants act as if “guided by an invisible hand” that leads them to desirable market outcomes.
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7. Governments can sometimes improve market outcomes.
Sometimes the “invisible hand” doesn’t work!
Market failure: A situation in which a market, left on its own, fails to allocate resources efficiently.
One example:Externality: the impact of one person’s
actions on the well-being of a bystander.
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One kind of externality: A person responsible for an action doesn’t bear the full cost of the action.
The possibility of market failure creates a role for government intervention in markets . . .
. . . and a role for economists to analyzegovernment economic policy!
Principles 8, 9, and 10 pertain to how the economy as a whole works.
(Review on your own -- they relate tomacroeconomics.)