Unit 1. Economic Fundamentals. Module 1. Krugman, pp What is Economics? The Fundamental Economic Problem

Transcription

1 Unit 1 Economic Fundamentals Module 1 Krugman, pp What is Economics? The Fundamental Economic Problem 1

2 Unlimited Wants Scarce Resources What do economists study? How people make choices. 2

3 How do we make the most Efficient Use of our Scarce Resources to Maximize the Satisfaction of our Unlimited Wants? MSUW=EUSR MOST=LEAST 3

4 The Six Basic Principles of Economics The 6 Basic Principles of Economics 1. Because of Scarcity, people have to make Choices 2. Choices have Costs 3. Profit Matters. 4. People are Rational. 5. People make decisions at the Margin 6. Trade is Good. Principle #1: CHOICES Because time is limited, people face trade-offs To get something, we usually have to give up something else: Guns v. Butter Food v. Clothing Party v. Study Making CHOICES requires trading off one goal against another. 4

5 People Face Tradeoffs. There is no such thing as a free lunch! tinstaafl Principle #2: OPPORTUNITY COST All decisions have consequences. 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? The opportunity cost of an item is what you gave up, it is the NEXT BEST ALTERNATIVE. Principle #3: PROFIT MATTERS People seek to maximize Profit Profit is not always money; it is where benefit is greater than cost Profit is NORMATIVE Changes in costs or benefits motivate people to respond to maximize their benefit and minimize their costs. 5

6 Principle #4: RATIONAL BEHAVIOR Rational Thinking involves making long-term decisions rather than short-term gain. Giving up something NOW in expectation of greater gain in the future is called an INVESTMENT Imperfect Information means there is always RISK in making choices People make decisions by thinking of the future costs and benefits. Principle #5: MARGINAL THINKING Rational People Think at the Margin. Decisions are NOT all or nothing actions Marginal changes are incremental adjustments to an existing plan of action based on longterm analysis. People make decisions by comparing costs and benefits at the margin. Principle #6: TRADE IS GOOD People gain from their ability to trade with one another. Both sides in a trade gain it is not a zero sum. Trade allows people to specialize in what they do best. Trade Can Make Everyone Better Off. 6

7 The Basic Principles of Economics 1. Scarcity -Choices: There is no such thing as a free lunch. 2. Opportunity cost -What you give up to get something. 3. People try to maximize their Profit. -Decisions are based on Cost/Benefit Analysis -All decisions have Risks. 4. People are Rational -They make Long-term investments 5. People make decisions at the Margin -Don t look back, always look forward 6. Trade is a Win/Win situation. Brewster s Choice ECONOMICS IS A SOCIAL SCIENCE 7

8 MACROECONOMICS... MACROECONOMICS... MICROECONOMICS... ECONOMICS IS A SCIENCE 8

9 ECONOMIC METHODOLOGY Scientific Method Theoretical Economics Theories Deduction Induction Facts SOCIAL SCIENCE NORMATIVE ECONOMICS Policy Economics Theoretical Economics Theories Facts 9

10 POLICY ECONOMICS STATING GOALS POLICY OPTIONS DECISION POSITIVE and NORMATIVE NORMATIVE Policy POSITIVE Facts Positive Economics Absolute Facts Normative Economics What Ought to be 10

11 Positive and Normative Economics Barak Obama is President of the United States Not everyone in the United States can afford health insurance. Positive Statements: Capable of being verified or refuted by resorting to fact or further investigation Barak Obama is the best/worst President of the United States ever. The government ought to provide affordable health care for everyone Normative Statements: Contains a value judgement which cannot be verified by resort to investigation or research PITFALLS TO OBJECTIVE THINKING Bias Definition Fallacy of Composition Post Hoc (Causation) Four Fundamental Questions What Will Be Produced? How Will It Be Produced? Who Gets It? How Do We Get More? 11

12 6 ECONOMIC GOALS Growth Efficiency Freedom Stability Equity Security 3 ECONOMIC SYSTEMS TRADITIONAL Irrational? MARKET Capitalist COMMAND Socialist Resources (Factors of Production) Resources used to make goods and services which provide satisfaction: LAND (A) Gifts : All natural resources LABOR (L) Sweat : Human effort that is compensated CAPITAL (K) Tools : Human and Physical Enterprise (Er) Risk : ideas, management, organization 12

13 ENTREPRENEURS INNOVATE ORGANIZE RESOURCES TAKE RISKS KEEP PROFITS ECONOMIC MODELS SIMPLIFY OUR ALTERNATIVES CLARIFY OUR CHOICES Production Possibilities Table Your Opportunity Cost is ALWAYS the next best alternative Your alternatives would be listed. Choices are not all or nothing; decisions are marginal. YOUR POSSIBILITIES 13

14 John s Possibilities Given: $20 cash Pizzas Burritos $2 pizza $1 burrito Pizzas John s Production Possibilities Burritos In this case, we have a straight line because opportunity costs are constant; his resource is perfectly interchangeable Production Possibility Frontiers Show the different combinations of goods and services that can be produced with a given amount of resources Normative: no ideal point on the curve Any point inside the curve: resources are not being used efficiently Any point outside the curve not attainable with the current level of resources The curve can shift through changes in resources, technology, and trade Useful to show opportunity cost and economic growth 14

15 Production Possibility Frontiers Capital Goods Ym Assume a country can produce two types of goods with its resources capital goods and consumer goods 0 Xm Consumer Goods Production Possibility Frontiers Capital Goods Ym If it devotes all resources to capital goods it could produce a maximum of Ym. If it devotes all its resources to consumer goods it could produce a maximum of Xm 0 Xm Consumer Goods Production Possibility Frontiers Capital Goods Ym. A point inside the curve is inefficient. A point outside the curve is unattainable.. 0 Xm Consumer Goods 15

16 Production Possibility Frontiers Capital Goods Ym If the country is at point A on the PPF It can produce the combination of Y1 capital goods and X2 consumer goods Y1 A 0 X2 Xm Consumer Goods Production Possibility Frontiers Capital Goods Ym Y2 B If it reallocates its resources From C to K (point A to B) it can only produce more capital goods by producing fewer consumer goods. The opportunity cost of extra capital goods is lost consumer goods. Y1 A 0 X1 X2 Xm Consumer Goods Production Possibility Frontiers Capital Goods Ym Y3 Y2 B C When an economy grows, the production possibilities curve shifts to the right. More of everything can be produced. The curve shifts due to changes in resources, technology, or trade. 0 X1 X3 Consumer Goods 16

17 Production Possibility Frontiers Capital Goods When a country s production capacity decreases, the curve shifts to the left. Ym Y3 Y2 B C 0 X1 X3 Consumer Goods The Law of Increasing Cost Resources are not perfectly interchangeable, as costs increase when you move from producing one good to the other. 0 17