Introduction to Economics

Transcription

1 Introduction to Economics The foundation for economics as a discipline of systematic study was laid in 1776, when Adam Smith ( ) published An Inquiry Into the Natures and Causes of the Wealth of Nations. Of course, people have always utilized economic logic, but the discipline of economics dates from According to Smith, wealth does not consist of the quantities of gold and silver possessed by people, but rather in the good and services available to people. Smith coined the term "invisible hand", although it only appears twice in The Wealth of Nations. What is Economics? Economics is the study of how people choose to utilize their resources (land, labor, and capital are the traditional categories) to meet their individual and collective needs and wants. They transform the resources which they own or exercise stewardship over into other commodities which they hope to trade to others for different commodities the other people are creating. The nature of economics may be understood by analyzing the relationship between the following themes: scarcity choice specialization exchange scarcity -- the perpetual state of insufficiency of resources to satisfy people's unlimited wants scarcity -- not enough resources to meet peoples needs and wants scarcity must be understood in relative terms e.g. not enough food to eat in a less developed country, not enough time at Cedarville University 1

2 productive resources are limited, wants are effectively unlimited understanding scarcity in relative terms does not mitigate against the need for good economic decision making Economics deals with scarcity and how humans act in order to deal with this scarcity. Economics is the discipline that studies how humans may best use scarce resources to meet their needs and wants. economics -- when resources are scarce (limited) we must make choices (selecting alternatives) in order to make the best use of people's resources to meet their needs and wants economics -- the study of how people work together to transform and distribute resources into goods and services to satisfy wants people specialize (narrow their focus on how they spend their work time, perhaps focusing on one task exclusive of all others) and trade the results of this specialization (the commodities they have produced) to others who are specializing in other commodities themselves. Division of Labor and Specialization division of labor -- to break down the production of a commodity into series of specific tasks, each performed by a different person. people can produce more goods through cooperative effort specialization -- concentrate exclusively on the job one performs best. therefore take advantage of existing skills and therefore worker becomes more experienced and therefore may produce using complex production techniques not available to the individual Adam Smith observed a pin factory: without specialization pins/day with specialization pins/day What economics is all about: The choices one makes pertaining to how to use one's labor time (what and how) to produce, the person or persons for whom one is producing, and answering questions about how to exchange what they have made make up. 2

3 The Nature of Economic Theory ideas have consequences -- the ideas upon which political economy is built form the foundation for the specific type of economic organization (economic system - capitalism, socialism) the nation utilizes, therefore: academic disciplines are important! ECONOMICS IS A WAY OF THINKING! The ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly understood. Indeed, the world is ruled by little else. Practical men, who believe themselves quite exempt from any intellectual influences, are usually slaves of some defunct economist. -- Keynes It [economics] is a method rather then a doctrine, an apparatus of the mind, a technique of thinking which helps its possessor to draw correct conclusions. -- Keynes Economic reality is extremely complex, therefore we try to choose the factors that are the most important and base our "theory" on them. model -- abstraction from reality whereby one "chooses" the most relevant economic variables by reasoning (theory) and attempts to elucidate the relationship among the chosen variables economic theory -- a set of definitions, postulates, and principles (developed form human behavior) assembled in a manner that makes clear "cause and effect" relations positive economics -- descriptive statements about facts and their relationships -- "is", statistical analysis therefore potentially verifiable or refutable normative economics -- making judgments about which policies are good or bad -- "ought to be" uses ethical judgments given the philosophical views of the individual therefore cannot be verified or refuted positive -- "is" normative -- "ought" 3

4 Guideposts to Economic Thinking 1. scarce goods have a cost -- TANSTAAFL (There Ain't No Such Thing As AFree Lunch) In order to buy one good you must forgo the purchase of another good public ed -- give up what else the tax revenues buy economic goods are not free. 2. decision-makers economize (accomplish an objective at the least possible cost) incentives matter -- choice is predictable as costs go up it is less likely one will to choose an option 3. marginal analysis marginal means change, or addition marginal benefits vs. marginal costs What happens "at the margin?" An additional product increases marginal revenue (MR) by $3 and increases marginal cost (MC) by $2 means the firm should produce the product 4. information is scarce -- information is costly do not know future 5. remember the secondary effects (Frederic Basiat, Henry Hazlitt) initial effect -- additional effect -- additional effect -- additional effect e.g. broken window initial -- producer of glass window sells an additional window which he spends on other goods, taken in isolation this seems like it is good for the economy, but secondary -- loss to person who had to pay for the window. Short run effects of an economic policy may be very far removed from the long run effects. In fact, in the long run it is possible for secondary effects to cancel the intended initial effect. 6. value is subjective -- individuals impute value to goods 4

5 7. theories are evaluated on the basis of how well they explain reality A discipline must be able to make tests or it is not scientific difficult in the social sciences -- people will react in predictable ways on average therefore economics is testable scientific method o formulate theory o gather data o evaluate data o revise model 8. trade creates value -- preferences are subjective -- known only to each individual Value is subjectively imputed by individuals in the market. Goods and services are valuable because people demand them. Value may be created by trading (rearranging goods and services among people). In fact, for trade to occur value must be created or the transaction will not happen. The economic good must be worth more to the buyer (subjectively/internally determined) than to the seller. Fallacies Frequently Faced in Economics 1. association is not causation or the False-Cause fallacy -- assumption b/c two events occurred together, one event causes the other e.g. stock market -- hemlines go up, stock market goes up super bowls -- NFC wins, stock market goes up no logical connection -- doesn't "prove" anything to have a statistical relationship, sometimes difficult to disentangle economic relationships 2. fallacy of composition -- what is true of the part (individual) is true of the whole e.g. stand up at baseball game -- if I alone stand up, I can see better; if everyone stands up, we each have approximately the same view micro vs. macro application -- does the behavior of individuals aggregate? 5

6 3. ceteris paribus "other things constant," "other things remain the same" important assumption -- not an actual fallacy, but is often abused, usually will not hold in the real world, but we still may use statistical tests. Microeconomics versus Macroeconomics microeconomics -- (Gk. "small") therefore deals with choices made by "small" economic units (households, businesses, individuals, etc.) -- that is, choices made by individuals macroeconomics -- (Gk. "long, distant") therefore deals with large scale economic phenomenon, e.g. inflation, unemployment, etc. -- aggregated markets, does not focus on the individual, but rather on the society composed of the individuals Why should one study microeconomics before they study macroeconomics? Micro is the study of individual economic agents, while macro is the study of these individual economic units in the aggregate. To understand the whole it is best to attempt to understand the parts. Therefore one should study micro before macro. 6

7 The Use of Graphs in Economics positive (or direct) relationship" [graphs merely show (illustrate) relationships] exists between two variables if an increase in the value of one variable is associated with an increase" in the value of the other variables negative (or inverse) relationship exists between two variables if an increase in the value of one variable is associated with a decrease" in the value of the other variable 7

8 dependent variable -- the variable that changes as a result of a change in the value of another variable independent variable -- the variable that causes the change in the value of the dependent variable the higher one's speed in an automobile, the lower the miles per gallon for the car -- a higher speed causes lower miles per gallon - - miles per gallon depends on speed. In the this example "speed" would be considered the independent variable 8

9 an important part of economics is distinguishing between dependent and independent variables In economics we are very much interested in causality. We must always remember that correlation (two variables moving in a systematic relationship together) does not prove causality. When speed changes, we would assume miles per gallon would also change because speed has changed. slope -- is the ratio of rise over run The concept of slope is very important for marginal analysis. For example if our firm produces one more item for sale, does the item add more to revenue or more to cost? -- marginal benefits vs marginal costs Graphs do not substitute for economic thinking -- they only aid our understanding 9