Chapter 1: Economics: Foundations and...

EC202- Macroeconomics

Aaron Jenkins

Business Management

Linn-Benton Community College

Winter 2018

If not here,

where would

you be?

What’s your

opportunity

cost?

Opportunity cost =

highest valued alternative that

you give up to do something

Why are you here?

A

potentially

better

future! As a

college

grad!

Scope & Purpose of Class

• Build an understanding of Economics

• Only an introduction to macroeconomic

topics

• National income (GDP?!?!?)

• Employment

• Prices

• Banking system

• Role of govt and its policy

• Much more…

Which one is the top Economist

in the U.S.?

A B

Which one is the top Economist

in the U.S.?

A B

Ben Bernanke

Federal Reserve Chair

2006-2014

Janet Yellen

Federal Reserve Chair

2014 - present

Why study Economics?

• Understand better the world you live in,

and the forces that shape it

• Make you a savvier participant in the

economy

• More informed citizen/voter

– Potential & limits of economic policy

Did you know that ‘Economic

Sciences’ is a Nobel Prize

category!

Paul Krugman –

2008 Nobel Prize Winner

What is Economics?

• ECONOMICS:

– The science of how people, groups,

and societies deal with scarcity.

• GOAL (of economic actors):

– Achieve happiness in a world of full of

constraints.

Key Distinction

• Positive Analysis – What is

Vs.

• Normative Analysis – What ought to be

• Economics positive analysis where

costs and benefits of different policy

options or life decisions are measured

Basic Motivation• An economist assumes that a person’s

basic motivation is to be happy!

• Individuals act to make themselves as well off as possible (being “rational”)

• HOW? cost-benefit analyses of their decisions

– What trade-offs do I face?

– What is my best option given my constraints?

Types of Constraints

• Resources (e.g., money)

• Time

• Technology

• Opportunity Cost

My Background

• Lived in Oregon for ~6 years

• 7 different U.S. states

• 16 different countries

• B.A. Literary Studies & Spanish

• Investment Firm

• Masters in Applied Econ (UWisc-Madison)

• Environmental Policy Think Tank

• OR Dept of Fish & Wildlife

What about you?

• Name

• Where you’re from

• Major

• Survey – do at home

Review Syllabus

in Moodle

Remember to check your

LBCC email and/or

Announcements in Moodle

How to study the

textbook?!?!

• Chapter Outline & Learning Objectives

• Section Titles

• Terms defined in the margins

• Chapter Summary & Problems

21

Copyright © 2017 Pearson Education, Inc. All Rights Reserved

Economics6th edition

Chapter 1 Economics:

Foundations and

Models

22


Chapter Outline

• 1.1 Three Key Economic Ideas

• 1.2 The Economic Problem That Every Society Must Solve

• 1.3 Economic Models

• 1.4 Microeconomics and Macroeconomics

• 1.5 A Preview of Important Economic Terms

• Appendix Using Graphs and Formulas

23


What is this class about?

• People make choices as they try to attain their goals. Choices

are necessary because we live in a world of scarcity.

• Scarcity: A situation in which unlimited wants exceed the limited

resources available to fulfill those wants.

• Economics is the study of the choices people make to attain

their goals, given their scarce resources.

• Economists study these choices using economic models,

simplified versions of reality used to analyze real-world economic

applications.

24


Some typical “economics” questions

We will learn how to answer questions like these:

– How are the prices of goods and services determined?

– Why do countries trade with one another?

– How do we measure the strength of the economy?

– What is unemployment? Why is there unemployment when

the economy is strong?

– What’s the government’s role in the economy?

25


1.1 Three Key Economic Ideas

We interact with one another in markets.

Market: A group of buyers and sellers of a good or service and the

institution or arrangement by which they come together to trade.

In analyzing markets, we generally assume:

1. People are rational

2. People respond to economic incentives

3. Optimal decisions are made at the margin

26


Examples of Markets?

• Smartphones

• Automobiles

• Textbooks

• Water

• Rentals

• Stock

• Labor

27


1. People are rational

Rational: Using all available information to achieve your goals.

Rational consumers and firms weigh the benefits and costs of

each action, and try to make the best decision possible.

Example: Apple doesn’t randomly choose the price of its iPhones;

it chooses the price(s) that it thinks will be most profitable.

28


2. People respond to economic

incentives

As incentives change, so do the actions that people will take.

Example: When products go on sale--whether TVs or cars or

cereal--people tend to buy more of them.

Example: If I say that every student who attends the next class

will automatically get an A, attendance will probably be 100%.

…however, once students know that they’re guaranteed an A,

then attendance for the remaining classes will drop, perhaps to

0%.

29


3. Optimal decisions are made at the

margin

While some decisions are all-or-nothing – e.g., do I open a

business or not? -- most decisions involve doing a little more or a

little less of something.

Example: Should you watch an additional hour of TV, or study

instead?

Economists think about decisions like this in terms of the marginal

cost and benefit (MC and MB): the additional cost or benefit

associated with a small amount extra of some action.

Comparing MC and MB is known as marginal analysis.

30


Which sort of thinking goes on in the mind of a

hungry economist who has decided to satisfy his

hunger by eating potato chips?

a. The economist will buy the largest bag of potato chips he

can afford, and eat the whole thing, without wasting

anything.

b. The economist will stop after each additional chip is

consumed and examine the benefit and cost of that potato

chip before continuing on to the next one.

c. The economist would eat as many potato chips as are

available in a world of scarcity.

d. The economist will eat potato chips only after determining

that all alternative munchies are less preferred to potato

chips.

31


1.2 The Economic Problem That Every

Society Must Solve

In a world of scarcity, we have limited economic resources to

satisfy our desires.

• Therefore we always face trade-offs.

Trade-off: The idea that, because of scarcity, producing more of

one good or service means producing less of another good or

service.

32


1. What goods and services will be

produced?

Individuals, firms, and governments must decide on the goods and

services that should be produced.

An increase in the production of one good requires the reduction

in the production of some other good. This is a trade-off, resulting

from the reality that productive resources are finite.

The highest-valued alternative given up in order to engage in

some activity is known as the opportunity cost.

Example (Govt): the opportunity cost of increased funding for

space exploration might be decreased funding for cancer

research.

33


2. How will the goods be produced?

A firm might have several different methods for producing its

goods and services.

Example #1: A music producer can make a song sound good by

• Hiring a great singer, and using standard production techniques;

• Hiring a mediocre singer, and using Auto-Tune to correct the

inaccuracies.

34


2. How will the goods be produced?

A firm might have several different methods for producing its

goods and services.

Example #2: If the cost of workers increases, a firm might respond

by

• Changing its production technique to one that employs more

machines and fewer workers

• Moving its factory to a location with cheaper labor (e.g., China)

35


3. Who will receive the goods and

services produced?

The way we are most familiar with in the United States is that

people with higher incomes obtain more goods and services.

Changes in tax and welfare policies change the distribution of

income; though people often disagree about the extent to which

this “redistribution” is desirable.

36


Types of economies

Centrally planned economy: An economy in which the

government decides how economic resources will be allocated.

Market economy: An economy in which the decisions of

households and firms interacting in markets allocate economic

resources.

Mixed economy: An economy in which most economic decisions

result from the interaction of buyers and sellers in markets but in

which the government plays a significant role in the allocation of

resources.

• Example countries for each?

37


Efficiency of economies

Market economies tend to be more efficient than centrally-planned

economies.

Market economies promote:

• Productive efficiency, where goods or services are produced

at the lowest possible cost; and

• Allocative efficiency, where production is in accordance with

consumer preferences;

– E.g., jeans & Soviet Union

38


Source of economic efficiency

Productive efficiency comes about because of competition.

Allocative efficiency arises due to voluntary exchange…

Voluntary exchange: A situation that occurs in markets when

both the buyer and the seller of a product are made better off by

the transaction.

• Each transaction that takes place improves the well-being of the

buyer and seller; transactions continue until no further

improvement can take place.

• Examples?

39


Caveats about market economies

Markets may not result in fully efficient outcomes. For example:

• People or firms might not immediately do things in the most

efficient way

– Ex: Blu-Ray players – high cost at first

• Market outcomes might ignore the well-being of people who are

not involved in transactions

– Ex: Pollution from coal plant

40


Market economies and equity

Economically efficient outcomes are not necessarily the most

desirable.

• Less efficient outcomes may be more fair or equitable.

Equity: The fair distribution of economic benefits. Harder to

define than efficiency. Can mean different things to different folks.

An important trade-off for a government is that between efficiency

and equity.

Example: If we tax income, in theory people might work less or

open fewer businesses; however, those tax receipts can fund

programs that aid the poor.

41


1.3 Economic Models

Describe the role of models in economic analysis

Economists develop economic models to analyze real-world

issues.

Building an economic model often follows these steps:

1. Decide on the assumptions to use 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 the economic data

well.

5. Retain the revised model to help answer similar economic

questions in the future.

42


Important features of economic models

Models are simplifications of reality that include only

essential elements and exclude less relevant details.

• Assumptions and simplifications: every model needs them in

order to be useful.

• Testability: good models generate testable predictions, which

can be verified or disproven using data.

• Economic variables: something measurable that can have

different values, such as the incomes of doctors or revenues of

tech companies.

43


Positive and normative analysis

Economists try to mimic natural scientists by using the scientific

method. But economics is a social science; studying the behavior

of people is often tricky.

When analyzing human behavior, we can perform:

• Positive analysis: analysis concerned with what is

• Normative analysis: analysis concerned with what ought to be

Economists mostly perform positive analysis.

44


Making the Connection: Should medical

school be free?

Forecasts indicate a significant shortage of doctors, especially

primary care physicians, by 2020. Why?

High costs of medical school may:

• Prevent some people from becoming doctors

• Lead people to pursue lucrative specialties instead of primary

care (student debt)

Would more people become primary care physicians if medical

school were free? And if so, would it be worth the cost?

• Economic models can find answers to the positive aspects of

this debate.

45


1.4 Microeconomics & Macroeconomics

Microeconomics is the study of

• how households and firms make choices,

• how they interact in markets, and

• how the government attempts to influence their choices.

Macroeconomics is the study of the economy as a whole,

including topics such as inflation, unemployment, and economic

growth.

46


Table 1.1 Issues in Microeconomics and Macroeconomics47


1.5 A Preview of Important Economic

Terms (p.17-18)

Like all fields of study, economics uses terms or jargon with

specific, precise meanings.

Sometimes these terms will be familiar but used in a different way

in economics.

Examples:

• Technology: the processes a firm uses to produce goods and

services

• Firm = company = business

• Capital: physical, not financial capital. Manufactured goods that

are used to produce other goods and services.

– E.g., computers, factory buildings, machine tools

48


Appendix: Using Graphs and Formulas

Use graphs and formulas to analyze economic situations

A map is a simplified

model of reality,

showing essential

details only.

Economic models, with

features like graphs and

formulas, can help us

understand economic

situations just like a map

helps us to understand

the geographic layout of

a city.

49


Figure 1A.1 Bar Graphs and Pie Charts

Panel (a) shows a bar graph of market share data for the U.S.

automobile industry; market share is represented by the height of the bar.

Panel (b) shows a pie chart of the same data; market share is

represented by the size of the “slice of the pie”.

50


Figure 1A.2 Time-Series Graphs

Both panels present time-series graphs of Ford Motor Company’s

worldwide sales during each year from 2001 to 2010.

• Panel (b) has a truncated scale on the vertical axis, and panel (a)

does not.

• As a result, the fluctuations in Ford’s sales appear smaller in panel (a)

than in panel (b).

51


Formula for a percentage change

One important formula is the percentage change, which is the

change in some economic variable, usually from one period to the

next, expressed as a percentage.

52

100 periodfirst in the Value

periodfirst in the Valueperiod second in the Valuechange Percentage


Figure 1A.6 Graphing the Positive Relationship between

Income and Consumption

Positive relationship

between two economic

variables--as one variable

increases, the other

variable also increases.

In a negative relationship,

as one variable increases,

the other decreases.

53


Scatterplot - Midterm Score X Quiz Score

n = 26

y = 0.0062x + 0.3014R² = 0.6831

0%

20%

40%

60%

80%

100%

0 20 40 60 80 100

Cu

rve

d E

xam

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Quiz Score Avg (%)

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