Understanding Economics. 4th edition by Mark Lovewell, Khoa Nguyen and Brennan Thompson

Transcription

1 Understanding Economics 4th edition by Mark Lovewell, Khoa Nguyen and Brennan Thompson

2 Chapter 1 The Economic Problem

3 Learning Objectives In this chapter, you will: 1. consider the economic problem that underlies the definition of economics 2. learn about the way economists specify economic choice 3. examine the production choices an entire economy faces, as demonstrated by the production possibilities model 4. analyze the three basic economic questions and how various economic systems answer them

4 1.1 Economic Way of Thinking Economics is the study of how people make choices under conditions of scarcity and the consequences of those choices for individuals and society Microeconomics the part of economics concerned with such individuals as industries, firms, and households Macroeconomics the part of economics concerned with the economy as a whole, or its basic subdivisions or aggregates such as the government, household and business sectors Aggregate a collection of specific economic units treated as if they were one unit The economic way of thinking, or economic perspectives, has three key features: Scarcity and choices Purposeful behaviour Marginal analysis

5 Scarcity and Choices Economists view the world through the lens of scarcity If there were no scarcity there would be no need to economize and therefore no need to make choices and no need for the discipline of economics

6 Purposeful Behaviour Economists assume that human behaviour reflects rational self-interest Individuals look for and pursue opportunities to increase their utilities or satisfaction, pleasure or happiness Because individuals consider costs and benefits their decisions are purposeful or rational rather than random or chaotic Having rational self-interest does not mean that we are completely selfish; often we derive satisfaction when we help others Rationality does not mean that we can t make wrong decisions; we do make wrong decisions, in part, because we don t have all the information we need

7 Marginal Analysis Every time we make a rational choice we weigh the marginal benefit and marginal cost of the action Marginal means additional or extra We will choose to do something if the marginal benefit is greater than the marginal cost because that will help us maximize satisfaction On the other hand, if a person says, That s not worth it, then in economic-speak, they are saying that the marginal cost is greater than the marginal benefit

8 Economic Way of Thinking Scarcity & choices Purposeful Behaviour Marginal Analysis Economist's View If there were no scarcity, there would be no need to economize so there would be no need to make choices Rational Self-Interest Economists assume that people are rational, weighing costs & benefits of alternatives Doesn t mean the decision is always correct Marginal means additional or extra. We will choose to do something if the marginal benefit is greater than the marginal cost Pleasure, happiness, selfsatisfaction

9 e.g. Find a Wallet with $1000 Options: Return wallet to the owner Return wallet to the owner without the $ Keep the $ and leave the wallet where it was found Leave the wallet and $ where it was found Which choice is rational depends on the individual decision maker

10 The Relevance of Economics Controversy One Economic growth is something that we should applaud and always strive to achieve Controversy Two The government should use its income redistribution tools such as Employment Insurance, welfare payment, and pensions to channel more income from the rich to the poor.

11 The Relevance of Economics Controversy Three The altruistic system of relying on donors for organ transplants has failed to provide enough organs to meet demand. The alternative, a free-market approach, where individuals can buy and sell their organs, should be allowed. Controversy Four Globalization benefits large multinational corporations, not ordinary people.

12 The Relevance of Economics Controversy Five Canadians must insist that free-market elements are never allowed to creep into our health care system. Controversy Six Establishing a carbon trading system is the most effective way of dealing with the serious problem of global warming. Almost any issue that faces us today as a society has an economic dimension.

13 The Economic Problem 1.swf Economists deal with the economic problem. Economic Problem having unlimited wants but limited resources to satisfy them with Economic agents must continually make choices. Their wants are unlimited. They face a limited supply of economic resources.

14 Economic Resources basic items used in all types of production Resource Categories Land resources from nature that are used in production, including land, forests, mineral and oil deposits and water resources Labour the physical and mental talents of individuals used in producing goods and services Capital resources materials, equipment and buildings used in production Entrepreneurial ability initiative, risk-taking and innovation necessary for production Because land, labour, capital, and entrepreneurial ability are combined to product goods and services, they are call the factors of production, or inputs

15 Economic Models Economic Models-- generalizations or simplifications of economic reality Also known as laws, principles or theories Help explain economic trends and behaviour by including two or more variables or factors Variables-- are connected by a causal relationship where one variable is assumed to affect another Propose what effect one variable will have on another

16 Cause and Effect show how dependent variables (the variable in a causal relationship that is affected by another variable) are affected by independent variables (the variable in a causal relationship that causes change in another variable) e.g. price (independent) of cell phones, # purchased (dependent)

17 Inverse and Direct Relationships Inverse: a relationship in which a change in the independent variable causes a change in the opposite direction of the dependent variable and/or Direct: a relationship in which a change in the independent variable causes a change in the same direction of the dependent variable relationships E.g. price of pizza and # of pizzas purchased Salary for baseball umpires and # of people training to be umpires

18 The Need for Assumptions In order to focus on the relationship between two variables, economists assume ceteris paribus the assumption that all other things remain the same

19 Positive and Normative Economics Two types of economic enquiry: positive economics : the study of economic facts and why the economy operates as it does) Also called descriptive economics Normative economics: the study of how the economy ought to operate) Also called policy economics Review and Practice Question 1.1 page 6

20 1.1 Practice Question Analyze the following statement: The economic welfare of a country s citizen falls if there is a reduction in the quantity of the country s economic resources. 1. The statement refers to two variables. What are they? 2. Which variable is independent and which is dependent? 3. Is the relationship between these variables direct or inverse? 4. Is the statement positive or normative? 5. How is the statement related to the economic problem?

21 Answer to Practice Question 1.1 a. The two variables are (i) the economic welfare of the country's citizens, and (ii) the quantity of the country's economic resources. b. The quantity of the country's economic resources is the independent variable (since it is the cause) and the economic welfare of the country's citizens is the dependent variable (since it is the effect). c. The relationship is direct, because a movement in the independent variable's value leads to a movement of the dependent variable's value in the same direction. d. The statement is positive, since it is a description of reality that does not depend on value judgements. e. For the country described in the statement, the economic problem of scarcity has become more severe.

22 1.2 Economic Choice Economists assume that economic decision-makers maximize their own utility. Decision-makers must keep in mind the opportunity cost of each alternative. Utility the satisfaction gained from any action ouse&utm_medium= &utm_campaign=ntu-2/13/2015 Self-interest motive the assumption that people act to maximize their own welfare

23 High School Economics Lesson 1 Scarcity not being able to have all of the goods and services one wants Exists because human wants for goods and services exceed the quantity of goods and services that can be produced using all available resources (Seinfeld) (scarcity and choice)

24 Activity Step 1 How many of you never seem to have enough time to do all the things you want to do? Imagine you find yourself with an hour of free time tonight that you did not expect to have What might you like to do with this hour of free time?

25 Activity Step 2 Why can t you do all of the things listed? Write down four or five activities you would most like to do with one hour of free time

26 Opportunity Cost Opportunity cost--the utility that could have been gained by choosing an actions best alternative Choices involve trading off the expected value of one opportunity against the expected value of its best alternative

27 Opportunity Cost Example: Amy is thinking about going to the movies tonight. A ticket costs $10 and she will have to skip her babysitting job that pays $40. What is the opportunity cost of seeing the movie tonight? Given that babysitting is her only alternative, it is the best alternative. If she should pick that alternative, she would save $10 and make $40. She would have $50 more in her pocket. The opportunity cost of seeing the movie is $50; the value of the best alternative given up (extreme couponing) (xbox)

28 Opportunity Cost The idea of opportunity cost involves more than money. The person who spends $2 to buy a pizza slice at the fast-food restaurant faces an opportunity cost equal to the utility that could have been gained by eating a low-calorie veggieburger instead If the person chooses the veggieburger, the opportunity cost is the sacrificed pleasure of eating a slice of pizza For a weight-conscious consumer, the utility gained from eating the veggieburger probably outweighs the pleasure from eating the slice of pizza The veggieburger s opportunity cost is lower than the opportunity cost of the pizza slice (even though both have the same monetary price), making the veggie burger the preferred choice for this individual

29 Activity Step 3 Place a star beside the one thing you would most like to do Circle your second choice Lesson 1 Activity 1 Groups A B C D E F Elise Ben Hoi Charmie Carson Shalin Izzy Bin Sangwoo Kim Jin Hong Hao Cheng Yan Lin Dao Zhi Jie Riya Akbar Farhan Fuquan Amanda Roni Jessica Raya Emmit Chloe Nathan

30 Presentation Tradeoff involves giving up some of one thing to get more of another. What tradeoffs did your group have to make? What was the opportunity cost of each of your decisions? (the 2 nd choice in each category) How did your group preferences influence decisions?

31 p Dance A Pumkin Choices The Hilton B C Chunkin Good vibrations Good Vibrations Hotel The Hilton hotel The Hilton Hotel Package Deal Package deal Catered (3,000) small gifts to everyone at the dance Raffle prizes at the dance ($635) Contest Giveaways Guitar 1135 Gift Cards 400 Bike 600 Xbox One 500 D Good Vibrations ($2000) Holiday Inn ($1500) Package deal ($5000) Class project ($1,135) E Good vibrations The hilton hotel Package deal Gym equipment ($635) F Our Rage (5000) Holiday Inn (1500) Catered (3000) Better food at FRC caf

32 1.3 The Production Possibilities Model The production possibilities model is based on three assumptions: 1. Full employment: the economy is employing all its available resources 2. Fixed resources and technology: the quantity and quality of the factors of production are fixed and the state of technology (the methods used to produce output) is constant 3. Two goods: the economy is producing only two goods Consumer goods: products that satisfy our wants directly Capital goods: products that satisfy our wants indirectly by making possible more efficient production of consumer goods The production possibilities model illustrates the tradeoffs that society faces in using its scarce resources It is an abstraction of the real world based on various simplifications (old) 5lYMQ&src_vid=SJQ56vJoy3Y&v=O6XL 2CDPU (new use this one)

33 The Production Possibilities Curve (a) The production possibilities curve shows a range of possible output combinations for an economy. It highlights the scarcity of resources. It has a concave shape, which reflects the law of increasing opportunity costs.

34 The Production Possibilities Curve (b) Figure 1.1, page 8 Production Possibilities Schedule Hamburgers Computers point on graph a b c 0 3 d Production Possibilities Curve Hamburgers a 1000 b f c e inef f icient Computers unattainable d

35 Law of Increasing Opportunity Costs The concept that as more of one item is produced by an economy, the opportunity cost of additional units of that product rises Economics resources do not transfer perfectly from one use to another e.g. making hamburgers requires different training/skills than making computers

36 The Law of Increasing Costs Figure 1.2, page 10 Production Possibilities Schedule Hamburgers Opportunity Computers point Cost of on graph Computers a b c d Production Possibilities Curve Hamburgers a b Computers c As the quantity of computers r ises, so does t heir opportunity cost. d

37 Interpretation of Production Possibilities Model A society must choose among possible combinations of two goods. These combinations are shown in the production possibilities curve. Both the schedule and the curve show that more computers can be assembled only if fewer hamburgers are produced. Any points within the curve (e), are feasible but those outside the curve are not (f).

38 The Role of Scarcity The production possibilities curve highlights the scarcity of economic resources The curve is a boundary between all those output combinations that are within the reach of an economy and all those combinations that are unattainable Anywhere inside the curve represents a feasible combination of the two products

39 Shifts in Production Possibilities Figure 1.2, page 10 Production Possibilities Curve Hamburgers 1000 Wit h more computers, the curve shifts out in the next period. 0 3 Computers

40 Economic Growth An increase in an economy s total output of goods and services Either due to a rise in the amount of available resources or an improvement in technology Both trends cause an outward shift in the production possibilities curve More of both items can now be produced Page 10 Thinking about Economics, page 11 Review, Practice Questions

41 Homework 88dc3f1240f186ea962752b7f17d Go to the graphing website shown on the wiki Choose a scatter graph Coconut data goes on the Y axis and Fish on the X axis your completed graph to smcrae@pembinatrails.ca

42 1.4 The Basic Economic Questions There are three basic questions any society must answer: what to produce decide how much of each possible good and service is to be supplied how to produce which resources should be employed and in what combinations for whom to produce how will the total output of goods and services distributed nomicsystemsbook2.swf

43 Economic Systems The organization of an economy which represents a country s distinct set of social customs, political institutions, and economic practices There are three systems to choose from: 1. Traditional economies focus on non-economic concerns and have tight social constraints An economic system in which economic decisions are made on the basis of custom Still used in some underdeveloped South American nations and Asian and African countries

44 Economic Systems (cont d) 2. Market economies are consumer-centered and innovative but create inequality and instability. An economic system based on private ownership and the use of markets in economic decision-making Market: a set of arrangements between buyers and sellers of a certain item Product Markets: markets in which consumer products are traded Resource Markets: markets in which economic resources are traded

45 Benefits of a Market Economy Consumer Sovereignty the decision of what to product is ultimately guided by the needs and wants of households in their role as consumers. The incentive to make a profit in a market economy encourages innovation and entrepreneurship which helps advances in technology

46 Drawbacks of a Market Economy Income Distribution if households incomes are based solely on the ability to supply economic resources, then some individuals in the economy might not earn enough to provide even for their basic needs Market Problems negative external effects of economic activity (e.g. pollution) may require intervention from government Instability in the total output produced from year to year with fluctuations affecting prices and employment levels

47 3. Command Economies equalize incomes but often have a lack of freedom Based on public ownership and central planning The former Soviet Union is the best example of a command economy North Korea and Cuba are examples of largely centrally planned economies

48 Benefits of Command Economy Income Distribution a country that adopts a command system can choose to distribute income among its citizens on the basis of considerations other than purely economic ones Economic Growth central planners can focus on promoting the rate of economic growth by devoting more resources to capital goods than would be the case in a market economy

49 Drawbacks of a Command Economy Planning Difficulties planning an entire economy is a difficult task Inefficiencies government ownership of productive property can lead to wast and inefficiency since command economies cannot depend on the lure of profit to promote the efficient use of resources No market control can lead to corruption of government officials Lack of Freedom too much power in the hands of government

50 The Range of Economic Systems (a) Most countries have mixed economies Modern mixed economies include both private and public sectors. Combines aspects of a market economy and a command economy; production decisions are made both in private markets and by government Traditional mixed economies combine traditional sectors with private and/or public sectors.

51 The Range of Economic Systems (b) Figure 1.4, page 16

52 Economic Goals There are seven major economic goals: economic efficiency income equity price stability full employment viable balance of payments economic growth environmental sustainability

53 Complementary and Conflicting Economic Goals Economic goals may be complementary. An example is the relationship between full employment and economic growth. Economic goals may be conflicting. An example is the relationship between price stability and full employment.

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55 The Founder of Modern Economics Adam Smith: explained how the division of labour increases production argued that self interest is transformed by the invisible hand of competition so that it creates significant economic benefits stressed the principle of laissez faire, which means that governments should not intervene in economic activity

56 Circular Flow Model

57 Economics as an Art While some economists view their subject as a science, others view it as a discipline. These economists stress the ways in which economic models are like artistic sketches, with the added need to include society s political and cultural aspects. When social surroundings change, economic models may therefore need to change as well.

58 The Rhetoric of Economics (a) (Online Learning Center) According to Deirdre McCloskey: Economics uses the same four tools of argument (fact, logic, metaphor, and story) as other fields of enquiry. Metaphors used in economics (e.g. human capital ) can both reveal and distort reality. So too can the use of stories, especially because stories implicitly reflect the values of their authors. Copyright 2008 by McGraw-Hill Ryerson Limited. All rights reserved.

59 The Rhetoric of Economics (Online Learning Center) McCloskey also concentrates on the role of gender in economics: She argues that male bias is at least partly responsible for the discipline s high level of abstraction. This focus may not be permanent, she contends. As more women become economists, this will allow the field to gain a closer connection with social realities. Copyright 2008 by McGraw-Hill Ryerson Limited. All rights reserved.

60 Understanding Economics Chapter 1 The End 4 th edition by Mark Lovewell, Khoa Nguyen and Brennan Thompson