1 Introduction to Economics

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What Happens When U.S. High-Technology Firms Move to China? 1.1 Explain these three key economic ideas:

People are rational. People respond to incentives. Optimal decisions are made at the margin.

1.2 Understand the role of models in economic analysis.

1.3 Distinguish between microeconomics and macroeconomics.

1.4 Become familiar with important economic terms.

APPENDIX Review the use of graphs

and formulas.

Learning Objectives

Many U.S., Japanese, and European firms have been moving the production of goods and services outside their home country …

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What is Economics About?

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Introduction to Economics What is Economics about? Economics looks at the choices that

people have to make when faced with scarcity.

“Economics is a study of mankind in the ordinary business of life.”

-- Alfred Marshall, Principles of Economics (1890)

Economics is the study of how society manages its scarce resources, including• how people decide how much to work, save,

and spend, and what to buy• how firms decide how much to produce,

how many workers to hire• how society decides how to divide its resources between

national defense, consumer goods, protecting the environment, and other needs

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Microeconomics vs. Macroeconomics

Example: Economics can be divided into two main parts, micro and macro.

Some markets that Economists study include the labor market, health care market, International, Sports Economics, and Public (government decisions and how they affect society).

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The Scarcity Principle Scarcity refers to the situation in which unlimited wants

exceed the limited resources available to fulfill those wants.

Scarcity forces us to choose among available alternatives.

Scarcity and choice are the two essential ingredients of an economic topic.• Scarcity is central to the study of economics because it

implies that every choice involves an opportunity cost. • Therefore, having more of one thing usually means

having less of another thing.

Example: Compare scarce goods and free goods.

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Scarce GoodsFood (bread, milk, meat, eggs, vegetables, coffee, etc.) Clothing (shirts, pants, blouses, shoes, socks, coats, sweaters, etc.) Household (tables, chairs, rugs, beds, goods dressers, television sets, etc.)

Space exploration

Education

National defense

Recreation

Leisure time

Entertainment

Clean air Pleasant (trees, lakes, rivers, environment open spaces, etc.)

Pleasant working conditions

Limited Resources

Land (various degrees of fertility)

Natural (rivers, trees, minerals, Resources oceans, etc.)

Machines and other human-made physical resources

Non-human animal resources

Technology (physical and scientific “recipes” of history)

Human (the knowledge, skill, resources and talent of individuals)

Scarcity and Choice

History is a record of our struggle to transform available, but limited resources … into scarce goods – things that

we would like to have.

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Scarcity and poverty are not the same thing.• Absence of poverty implies some

basic level of need has been met.• An absence of scarcity would imply

that all of our desires for goods are fully satisfied.

Scarcity and Poverty

We may someday eliminate poverty, but scarcity will always be with us.

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Examples of Scarcity and Tradeoffs…

Any society faces the economic problem that it has only a limited amount of economic resources and so can produce only a limited amount of goods and services.

Society faces trade-offs. A trade-off is the idea that because of scarcity, producing more of one good or service means producing less of another good or service.

Every choice involves an opportunity cost.

Opportunity costs are subjective and vary across individuals.

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Opportunity Costs

What should be included when determining the opportunity cost of a decision?

• Someone must give up something if we are to have more scarce goods.

• The highest valued alternative that must be sacrificed is the opportunity cost of the choice.

The use of scarce resources to produce a good is always costly.

Examples:

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Economic Models

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Economic Models

Economic models are simplified versions of reality designed to analyze “what is” to explain human decision making in any context.

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Some Familiar Models

A model of human anatomy from high school biology class

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Some Familiar Models

A model airplane

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To develop a model, economists generally follow these steps:

1 Decide on the assumptions to be used in developing the model.

2 Formulate a testable hypothesis.

3 Use economic data to test the hypothesis.

4 Revise the model if it fails to explain well the economic data.

5 Retain the revised model to help answer similar economic questions in the future.

Economic Models

Learning Objective 1.3

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Economic models make behavioral assumptions about the motives of consumers and firms.

Economic Models

Learning Objective 1.3

The Role of Assumptions in Economic Models

Throughout this book, as we study how people make choices and interact in markets, we will return to three important ideas:

1 People are rational.

2 People respond to economic incentives.

3 Optimal decisions are made at the margin.

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Economic Models

Normative and Positive Analysis

Economists are frequently called on to make judgments on matters of public policy.• Should the government cut taxes? • Should Internet commerce be taxed? • Should the government impose environmental regulations?

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Positive economic statements can be proved either true or false.

Positive Economics: The scientific study of “what is” among economic relationships.

Positive Economics

• Example: The inflation rate rises when the money supply is increased

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Normative statements reflect subjective values. They cannot be proved true or false.

Normative Economics: Judgments about “what ought to be” in economic matters.

Normative Economics

• Example: The inflation rate should be lower.

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Which of the following are positive economic statements and which are normative?

a) The speed limit should be lowered to 55 miles per hour on interstate highways to reduce the number of deaths and accidents

b) Higher gasoline prices cause the quantity of gasoline that consumers buy to increase.

c) A comparison of costs and benefits should not be used to assess environmental regulations.

d) Taxes on alcohol result in less drinking and driving.

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Marginal Analysis

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Once you’ve decided to go to college, how many classes will you take each semester?

Once you’ve decided to work, how many hours will you work?

The all or nothing decisions are bigger decisions we make once in a while, but most of our day-to-day decisions concern how much or how little to take a particular action.

An important standard principle used in economics is that people make decisions at the margin.

When economists use the word marginal, they mean extra or additional.

Marginal Analysis: Analysis that involves comparing marginal benefits and marginal costs.

Marginal Analysis: Analysis that involves comparing marginal benefits and marginal costs.

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Example 1: American Boat Company

# of Workers Total Boats Produced

0 0

1 5

2 9

3 12

4 14

5 15

Questions:1) What is the marginal cost of the 2nd worker?2) What is the marginal benefit of the 2nd worker?3) What is the optimal number of workers to hire?

Each boat sells for $12 and each worker is paid $15 an hour.

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Example 2: American Boat Company

# of Total Boats Total TotalWorkers Produced Revenue Costs

0 0

1 5

2 9

3 12

4 14

5 15

0 0

$60 $15

$108 $30

$144 $45

$168 $60

$180 $75

Questions:1) What is the additional revenue and additional cost

from increasing production from 5 to 9 boats?2) What is the optimal number of boats to produce?

Total Profit

0

$45

$78

$99

$108

$105

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The economic decision rule: If the marginal benefits of doing something exceed the

marginal costs, do it.

If the marginal costs of doing something exceed the marginal benefits, don’t do it.

MB > MC Do it!

MC > MB Don’t do it!

Marginal Costs and Marginal Benefits

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Economic Terms

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Efficiency Measures

Productive Efficiency occurs when a good or service (such as the distribution of tickets) is produced at the lowest possible cost.

Allocative Efficiency means that every good or service is produced up to the point where marginal benefit is equal to marginal cost.

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Sunk Costs

What are sunk costs? How are they incorporated into economic decision making?

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Market A group of buyers and sellers of a good or service and the institution or arrangement by which they come together to trade.

4.1

Other Economic Terms

Economic variable Something measurable that can have different values, such as the wages of software programmers.

Ceteris paribus is a Latin term meaning “other things constant.”

- When describing the effect of a change, the outcome may be influenced by changes in other things.

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Why Economists Disagree

Economists often give conflicting policy advice.

They sometimes disagree about the validity of alternative positive theories about the world.

They may have different values and, therefore, different normative views about what policy should try to accomplish.

Yet, there are many propositions about which most economists agree.

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Propositions about Which Most Economists Agree (and % agreeing)

A ceiling on rents reduces the quantity and quality of housing available. (93%)

Tariffs and import quotas usually reduce general economic welfare. (93%)

A large federal budget deficit has an adverse effect on the economy. (83%)

A minimum wage increases unemployment among young and unskilled workers. (79%)

Effluent taxes and marketable pollution permits represent a better approach to pollution control than imposition of pollution ceilings. (78%)

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FYI: Who Studies Economics?

Ronald Reagan, President of the United States Barbara Boxer, U.S. Senator Sandra Day-O’Connor, Supreme Court Justice Anthony Zinni, General, U.S. Marine Corps Kofi Annan, Secretary General, United Nations Meg Witman, Chief Executive Officer, eBay Steve Ballmer, Chief Executive Officer, Microsoft John Elway, NFL Quarterback Tiger Woods, Golfer Ben Stein, Political Speechwriter, Actor,

Game Show Host Arnold Schwarzenegger, Governor of California,

Actor Mick Jagger, Singer for the Rolling Stones