CHAPTER 1THE ECONOMY IS US!Nature of Economics!Why is the economy us?

What kind of economy do we have?

Why do some economies work better than others?

Definition of Economics?

Do all countries regardless of type of economy deal with scarcity?

Scarcity of what?Even the U.S. has a problem with this?

The scarcity of resources causes most things to have a cost.

 

Definition of Economics

The study of how people, both individually and in groups, deal with the problem of scarcity.

Why is economics considered a social science?

Scarcity forces human beings to make choicesWhy has there always been an economic problem?

man’s wants are virtually unlimited scarcity of resources

*Have to prioritize

Remember****Society has virtually unlimited wants BUT limited resources

This means prioritization!When did you last have to prioritize?

Companies? Are you seeing them prioritize? Where

What about government?

What is your choice? Why?

Scarcity forces individuals and groups to do what?

All economies evolve around a basic conflict.. Want more than we can have.

What is the difference between Micro and Macroeconomics?

Micro vs Macro

Economists do not formulate economic objectives Economist’s job is to design policies that best

achieve economic goals. (who establishes those goals?) Name one in existence today…..

Microeconomics = study of individual behavior in the economy by parts that comprise the larger economy… businesses, individuals, govt agencies.) (CocaCola output/hour)

Macroeconomics = study of the aggregate economic behavior of economy as a whole (inflation/unemployment)

Choices- Trade-offs (giving up one thing to get another)

Example: Barrel of crude oil?What is thing given up called?Examples of Opportunity Cost

Reality of Trade-offsJust a few of the products getting a start from a

barrel of oil:Aspirin furniture not to mention

gasolineCandles hair dryers carpetsCD players lipstick paintsClothing luggage fertilizerCompact discs perfumes oils of all kindsComputers photographsCredit cards piano keysDeodorant roller bladesDiapers shampooDinnerware soft contact lensesDVDs toothpasteEyeglass frames vitamin capsules

Economics is a Social Science

What does that mean?

Economics is NOT Pure!!

Hypothesis are formed (what if? This should?Models are Created (trial and error)

Assumptions are made Trial and error (revisited)

Rational Self-Interest Individuals act as if motivated – self interest Idea first brought forth- Adam Smith- Wealth

of Nations. Father of Market Economics.

Did you arise this a.m. and say>>>> I want to make terrible decisions all day that are NOT in my self-interest???

Assumption then is that you will make decisions in your best self-interest based on incentive.

BUT… bottom line is we don’t always do that!

Rational Self-interest

What is your incentive to brush your teeth?Why did you begin that habit?Did you continue to do it later?Do you think about it now?

So rationally you have deduced that it is in your best interest to brush daily- preserving your self-interest.

RATIONAL BEHAVIOR/ CONSUMERS/GOVERNMENT

If analyzing is so important to economics, what are the pit falls in formulation of decisions?

How were those decisions derived?

• Emotion• Biases• Illiteracy• Political• Some person you hear speak• Text from some book• Periodicals• Peers

Behavioral Economics

3 Characteristics:1)Unbounded selfishness (People only interested

in own satisfaction2)Ubounded willpower (choices always consistent

with long-term goals)3)Unbounded rationality (Able to consider every

relevant choice)

But truth is most of us do not act exclusively to any of 3… we have a combined decision-making rational.

Some people just can’t make a decision.ARE WE RATIONAL IN OUR DECISION-MAKING?

Rational Decisions involve all aspects of society! Governments – (guns v butter) Individuals – (buy or rent house) Businesses – (expand or lay off) Non-profits – (providing for greater good)

Economic Wants These wants vary from culture to culture. One culture’s ideas may not be the goals of

another cultures’. Ones we satisfy in the economic system. Ones that money will buy.

Do incentives work? Give me some examples. What about negative incentives? Any ideas? Is Self-interest always a concept of greed? Can charitable acts be in one’s self-interest?

Guns vs Butter?

What does that mean?

Economic wants vs non-economic wants

Economics Wants a concept underlying for all mankind. things we feel we need to have so we

can live the style of life we want to enjoy.

What are some non-economic wants?

Friendship Health Self Esteem Love

Are non-economic wants important????

Two things that allow economies to progress

This is an Adam Smith concept:Division of laborSpecialization of labor

4 Types of economic wants1. Basic or subsistence

difference between developed and underdeveloped countries is whether basic wants are taken care of.) (U.S. poor are not as poor as other poor- relative to poor in U.S. difference from absolute poverty like in Haiti , Afghanistan, or Iraq.

U.S. citizens have a higher plan of basic wants which includes “social” wants. These wants come out of our culture. Such as… air-conditioning, television, education, internet connections, going to dinner ….vast majority of our wants are culturally determined.

2. Individual or Collective WantsIndividual = things we want as individuals

pizza vs hamburgers Ford truck vs Chevy truck most of our wants are individual, but some are

Collective such as:clean water good roads garbage collection

good schools

3. Public Wants Market does not take care of public

wants- these are decided usually by the federal government…

defense – homeland security. We all enjoy the benefits at the same time.

4. ConsumptiveWe want to be able to consume (buy

things)Basic or ultimate aim of any economic system is

consuming goods and services.

Consumption is how we satisfy our wants.

But can’t completely satisfy all of our wants because___??????_ ????

Economics depends on models

Models are used to predict behavior.Models are simplified replica of real worldEmpirical Evidence and data- material

gathered by observation or experience. Usually a working hypothesis that is testable.

Enter Ceteris ParibusEconomicsts models do not relate to how

people think, but how they behave.Economic models have to be tested on real

world.

Marginalize in Economics

Keeping decisions within perspective involves marginal analysis.

Marginal Benefits vs Marginal Costs – is the benefit greater than the cost or vice-versa. Obviously, either can elicit changes in status quo.

You have an opportunity to go to Rose Bowl game!You know it will cost you $1,000. Do you want to go to the RB Parade while you are there? That is going to cost another $300… On margin? Is it worth it?

Scarcity is the key ingredient here also.

SO…..Are You Rational?What is rational?

Are you pursuing opportunities to increase your utility?

Are you allocating your time, energy and money to maximize your well-being?

Do you weigh your decisions looking at costs vs benefits? If you do you are rational.

If you do not… you may be random or haphazard with your decisions.

So… if you are rational, are you selfish?We all make decisions for a reason

Answer: No………….Not necessarily…Rational in the sense we have discussed means that you are looking after your self interest…

Your self-interest decisions will change through your years…. Maybe it is in your best interest to work for yourself after working 15 years for IBM… Do you just whimsically decide or do you have a plan… cost of doing so vs benefit.

Terms to KnowPositive economics = deals with facts “what is”Normative economics = involves someone’s judgment

“what ought to be”Fallacy of Composition = it is not correct.. (the

validity of a particular generalization for an individual or part does not necessarily ensure its accuracy for the group or the whole) I stand up… everyone stands up…

Post Hoc Fallacy = Be careful concluding that because event A precedes event B that A is the cause of B. Wear purple shirt to ballgame…win.. Need to wear purple shirt again to win. Rooster crows before dawn… rooster responsible for sunrise.

Rational Behavior = based on rational self-interest. People make different choices because their circumstances and available information differs.

Marginalism = extra or less (one more unit, one less unit)

What is Standard of Living?How can you calculate it?

How well off people are!

How well off are you?

Divide total production by population…

If production is high and population is low…. “get more stuff.”

3rd world countries… high population/low production

What are the three questions every economy asks?

What to produce?How to produce?For whom to produce?

Why do econ texts always include these questions???????

Key is how the society or country answers these questions.

Traditional economic forms are not part of the 3 basic, but what does traditional entail?

3 Basic Economic Systems of the World

Capitalism

Socialism

Communism

Conventional wisdom accepts economic goals

Economic growthFull EmploymentEconomic EfficiencyPrice-level stabilityEconomic FreedomEquitable Distribution of Income * (author’s bias)

Economic SecurityBalance of trade

Any Questions?