INTRODUCTION Economy The word economy comes from a

INTRODUCTION

Economy. . . The word economy comes from a Greek word for “one who manages a household. ”

• A household an economy face many decisions: • Who will work? • What goods and how many of them should be produced? • What resources should be used in production? • At what price should the goods be sold?

Society and Scarce Resources: • The management of society’s resources is important because resources are scarce. • Scarcity. . . means that society has limited resources and therefore cannot produce all the goods and services people wish to have. • (tokyo ref. v)

Human history and economics • Just a few centuries ago… • Life expectancy at birth was about 25 years • More than 30% of newborns never made it to their 5 th birthdays • A woman had a one in ten chance of dying during childbirth • Most people had personal experience with horrible disease and /or starvation …. . unfortunately some of this is still true in India. . attributable to scarcity? ?

Economics is the study of how society manages its scarce resources. A few principles help us in understanding the basics of economics better…. .

Needs/wants • We have a compulsive need to satisfy our wants… • To do that what do we need?

References in music • • • Money, get away , Get a good job with more pay And your O. K. , Money, it's a gas Grab that cash with both hands And make a stash New car, caviar, four star daydream Think I'll buy me a football team Money get back I'm all right Jack Keep your hands off my stack Money, it's a hit Don't give me that Do goody good bullshit I'm in the hi-fidelity First class traveling set And I think I need a Lear jet Money, it's a crime Share it fairly But don't take a slice of my pie Money, so they say Is the root of all evil Today • But if you ask for a rise It's no surprise that they're Giving none away Away. . . • PINK FLOYD (ENGLISH ROCK BAND 1965)

Economics can entertain! • What makes some super stars…. and others just another star? ? • • Rajesh Khanna (INDIA) Lady GAGA , Justin Beiber …. . What determines who makes more money? ? Economics can answer these questions

Principle #1: People Face Tradeoffs. “There is no such thing as a free lunch!”

Principle #1: People Face Tradeoffs. To get one thing, we usually have to give up another thing. • Guns v. butter • Food v. clothing • Leisure time v. work • Efficiency v. equity • (ref. soak up the sun) Making decisions requires trading off one goal against another.

Principle #1: People Face Tradeoffs • Efficiency v. Equity • Efficiency means society gets the most that it can from its scarce resources. • Equity means the benefits of those resources are distributed fairly among the members of society.

Principle #2: The Cost of Something Is What You Give Up to Get It. • Decisions require comparing costs and benefits of alternatives. • • Whether to go to college or to work? Whether to study or go out on a date? Whether to go to class or sleep in? (Kareena Kapoor dilemma) • The opportunity cost of an item is what you give up to obtain that item.

Principle #2: The Cost of Something Is What You Give Up to Get It. Sachin Tendulkar – India’s foremost sportsman chose to skip college and go straight from high school to the pros where he has earned millions of dollars.

Principle #3: Rational People Think at the Margin. • Marginal changes are small, incremental adjustments to an existing plan of action. • Movies…… People make decisions by comparing costs and benefits at the margin.

Principle #4: Markets Are Usually a Good Way to Organize Economic Activity. • A market economy is an economy that allocates resources through the decentralized decisions of many firms and households as they interact in markets for goods and services. • Households decide what to buy and who to work for. • Firms decide who to hire and what to produce.

Principle #5: Governments Can Sometimes Improve Market Outcomes. • Market failure occurs when the market fails to allocate resources efficiently. • When the market fails (breaks down) government can intervene to promote efficiency and equity.

Principle #5: Governments Can Sometimes Improve Market Outcomes. • Market failure may be caused by • an externality, which is the impact of one person or firm’s actions on the well-being of a bystander. • market power, which is the ability of a single person or firm to unduly influence market prices.

Principle #6: The Standard of Living Depends on a Country’s Production. • Standard of living may be measured in different ways: • By comparing personal incomes. • By comparing the total market value of a nation’s production. • Almost all variations in living standards are explained by differences in countries’ productivities. • Productivity is the amount of goods and services produced from each hour of a worker’s time.

Principle # 7 People respond to incentives • The most important principle…. everything in the economy works because people respond to incentives. • (ref. navorski and the quarters)

Thinking Like an Economist

Thinking Like an Economist • Every field of study has its own terminology • Mathematics • integrals axioms vector spaces • Psychology • ego id cognitive dissonance • Law • promissory torts • Economics • supply opportunity cost elasticity consumer surplus demand comparative advantage deadweight loss

Thinking Like an Economist • Economics trains you to. . • Think in terms of alternatives. • Evaluate the cost of individual and social choices. • Examine and understand how certain events and issues are related.

THE ECONOMIST AS A SCIENTIST • The economic way of thinking. . . • Involves thinking analytically and objectively. • Makes use of the scientific method.

The Scientific Method: Observation, Theory, and More Observation • Uses abstract models to help explain how a complex, real world operates. • Develops theories, collects, and analyzes data to evaluate theories.

The Role of Assumptions • Economists make assumptions in order to make the world easier to understand. • The art in scientific thinking is deciding which assumptions to make. • Economists use different assumptions to answer different questions.

Economic Models • Economists use models to simplify reality in order to improve our understanding of the world • One of the most basic economic models is: • The Circular Flow Diagram

The Circular-Flow Diagram • The circular-flow diagram is a visual model of the economy that shows how dollars flow through markets among households and firms.

Figure 1 The Circular Flow MARKETS FOR GOODS AND SERVICES • Firms sell Goods • Households buy and services sold Revenue Wages, rent, and profit Goods and services bought HOUSEHOLDS • Buy and consume goods and services • Own and sell factors of production FIRMS • Produce and sell goods and services • Hire and use factors of production Factors of production Spending MARKETS FOR FACTORS OF PRODUCTION • Households sell • Firms buy Labor, land, and capital Income = Flow of inputs and outputs = Flow of dollars

Our First Model: The Circular-Flow Diagram • Firms • Produce and sell goods and services • Hire and use factors of production • Households • Buy and consume goods and services • Own and sell factors of production

Our First Model: The Circular-Flow Diagram • Markets for Goods and Services • Firms sell • Households buy • Markets for Factors of Production • Households sell • Firms buy

Our First Model: The Circular-Flow Diagram • Factors of Production • Inputs used to produce goods and services • Land, labor, and capital

Microeconomics and Macroeconomics • Microeconomics focuses on the individual parts of the economy. • How households and firms make decisions and how they interact in specific markets • Macroeconomics looks at the economy as a whole. • Economy-wide phenomena, including inflation, unemployment, and economic growth

THE ECONOMIST AS POLICY ADVISOR • When economists are trying to explain the world, they are scientists. • When economists are trying to change the world, they are policy advisor.

POSITIVE VERSUS NORMATIVE ANALYSIS • Positive statements are statements that attempt to describe the world as it is. • Called descriptive analysis • Normative statements are statements about how the world should be. • Called prescriptive analysis

POSITIVE VERSUS NORMATIVE ANALYSIS • Positive or Normative Statements? ? ? • An increase in the minimum wage will cause a decrease in employment among the least-skilled. POSITIVE • Higher federal budget deficits will cause interest rates to increase. POSITIVE ?

POSITIVE VERSUS NORMATIVE ANALYSIS • Positive or Normative Statements? ? ? • The income gains from a higher minimum wage are worth more than any slight reductions in employment. NORMATIVE • State governments should be allowed to collect from tobacco companies the costs of treating smoking-related illnesses among the poor. NORMATIVE ?

Economists • . . . serve as advisers in the policymaking process of the three branches of government: • Legislative • Executive • Judicial

WHY ECONOMISTS DISAGREE • They may disagree about the validity of alternative positive theories about how the world works. • They may have different values and, therefore, different normative views about what policy should try to accomplish.