CHAPTER 1 INTRODUCTION TO ECONOMIC ANALYSIS 2 nd Semester, S.Y 2013 – 2014
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Transcript of CHAPTER 1 INTRODUCTION TO ECONOMIC ANALYSIS 2 nd Semester, S.Y 2013 – 2014
BACHELOR OF ARTS IN ECONOMICS Econ 111 – ECONOMIC ANALYSIS
Pangasinan State UniversitySocial Science Department – PSU Lingayen
CHAPTER 1 INTRODUCTION TO ECONOMIC ANALYSIS2nd Semester, S.Y 2013 – 2014
BACHELOR OF ARTS IN ECONOMICS Econ 111 – ECONOMIC ANALYSIS
Pangasinan State UniversitySocial Science Department – PSU Lingayen
What is Economics?
The study of how individuals and societies choose to allocate and use scarce resources to satisfy unlimited wants.
Economics is about economizing; that is, about choice among alternative uses of scarce resources. Choices are made by millions of individuals, businesses, and government units. Economics examines how these choices add up to an economic system, and how this system operates. (L.G. Reynolds).
BACHELOR OF ARTS IN ECONOMICS Econ 111 – ECONOMIC ANALYSIS
Pangasinan State UniversitySocial Science Department – PSU Lingayen
Concept of Scarcity
Scarcity exists because individuals want more than can be produced
The degree of scarcity is constantly changing
The quantity of goods, services and usable resources depends on technology and human action
• Scarcity means the goods available are too few to satisfy individuals’ desires
BACHELOR OF ARTS IN ECONOMICS Econ 111 – ECONOMIC ANALYSIS
Pangasinan State UniversitySocial Science Department – PSU Lingayen
Microeconomics vs. Macroeconomics
Microeconomics focuses on the individual parts of the economy.– How households and firms make decisions and
how they interact in specific markets Macroeconomics looks at the economy as a
whole.– Economy-wide phenomena, including inflation,
unemployment, and economic growth
BACHELOR OF ARTS IN ECONOMICS Econ 111 – ECONOMIC ANALYSIS
Pangasinan State UniversitySocial Science Department – PSU Lingayen
Scope of Microeconomics
Microeconomics studies Buying decisions of the individual Consumers’ satisfaction Buying and selling decisions of the firm The determination of prices and in markets The quantity, quality and variety of products Profits
BACHELOR OF ARTS IN ECONOMICS Econ 111 – ECONOMIC ANALYSIS
Pangasinan State UniversitySocial Science Department – PSU Lingayen
Scope of Macroeconomics
Macroeconomics studies Economic growth Unemployment and inflation Aggregate demand and aggregate supply Economic policies – fiscal and monetary International trade – exports and imports Money supply
BACHELOR OF ARTS IN ECONOMICS Econ 111 – ECONOMIC ANALYSIS
Pangasinan State UniversitySocial Science Department – PSU Lingayen
Should I go to business school or take a job right now? How many people are employed in the economy as a whole this year?
What determines the salary offered by San Miguel Corporation to Juan Dela Cruz, a new MBA?What determines the overall salary levels paid to workers in a given year?
What determines the cost to a university or college of offering a new course?What determines the overall level of prices in the economy as a whole?
What government policies should be adopted to make it easier for low-incomestudents to attend college?What government policies should be adopted to promote employment andgrowth in the economy as a whole?
What determines whether BPI opens a new Branch in Shanghai?What determines the overall trade in goods, services, and financial assets between the Philippines and the rest of the world
Microeconomics vs. Macroeconomic Questions
BACHELOR OF ARTS IN ECONOMICS Econ 111 – ECONOMIC ANALYSIS
Pangasinan State UniversitySocial Science Department – PSU Lingayen
Which of the following questions involve microeconomics, and which involve macroeconomics? In each case, explain your answer.
A. Why did consumers switch to smaller cars in 2012?B. Why did overall consumer spending slow down in
2012?C. Why did the standard of living rise more rapidly in the
current administration compared to previous administration?
D. Why have starting salaries for students with geology degrees risen sharply of late?
E. What determines the choice between rail and road transportation?
F. Why has salmon got cheaper over the past 20 years?G. Why did inflation fall in the 1990s?
Let’s Check Your Understanding!
BACHELOR OF ARTS IN ECONOMICS Econ 111 – ECONOMIC ANALYSIS
Pangasinan State UniversitySocial Science Department – PSU Lingayen
• A household and an economy face many decisions: – Who will work?– What goods and how many of them should be
produced?– What resources should be used in
production?– At what price should the goods be sold?
Ten Principles of Economics
BACHELOR OF ARTS IN ECONOMICS Econ 111 – ECONOMIC ANALYSIS
Pangasinan State UniversitySocial Science Department – PSU Lingayen
Society and Scarce Resources: – The management of society’s resources is
important because resources are scarce.– Scarcity. . . means that society has limited
resources and therefore cannot produce all the goods and services people wish to have.
Ten Principles of Economics
BACHELOR OF ARTS IN ECONOMICS Econ 111 – ECONOMIC ANALYSIS
Pangasinan State UniversitySocial Science Department – PSU Lingayen
Ten Principles of Economics
How people make decisions.– People face tradeoffs.– The cost of something is what you give up to
get it.– Rational people think at the margin.– People respond to incentives.
BACHELOR OF ARTS IN ECONOMICS Econ 111 – ECONOMIC ANALYSIS
Pangasinan State UniversitySocial Science Department – PSU Lingayen
• How people interact with each other.– Trade can make everyone better off.– Markets are usually a good way to organize
economic activity.– Governments can sometimes improve
economic outcomes.
Ten Principles of Economics
BACHELOR OF ARTS IN ECONOMICS Econ 111 – ECONOMIC ANALYSIS
Pangasinan State UniversitySocial Science Department – PSU Lingayen
The forces and trends that affect how the economy as a whole works. – The standard of living depends on a country’s
production.– Prices rise when the government prints too
much money.– Society faces a short-run tradeoff between
inflation and unemployment.
Ten Principles of Economics
BACHELOR OF ARTS IN ECONOMICS Econ 111 – ECONOMIC ANALYSIS
Pangasinan State UniversitySocial Science Department – PSU Lingayen
Principle #1: People Face Tradeoffs
“There is no such thing as a free lunch!”
BACHELOR OF ARTS IN ECONOMICS Econ 111 – ECONOMIC ANALYSIS
Pangasinan State UniversitySocial Science Department – PSU Lingayen
Making decisions requires trading off one goal against another.
Principle #1: People Face Tradeoffs
To get one thing, we usually have to give up another thing.– Guns v. butter– Food v. clothing– Leisure time v. work– Efficiency v. equity
BACHELOR OF ARTS IN ECONOMICS Econ 111 – ECONOMIC ANALYSIS
Pangasinan State UniversitySocial Science Department – PSU Lingayen
Principle #1: People Face Tradeoffs
Efficiency v. Equity– Efficiency means society gets the most that it
can from its scarce resources.– Equity means the benefits of those resources
are distributed fairly among the members of society.
BACHELOR OF ARTS IN ECONOMICS Econ 111 – ECONOMIC ANALYSIS
Pangasinan State UniversitySocial Science Department – PSU Lingayen
Principle #2: The Cost of Something Is What You Give Up to Get It.
Decisions require comparing costs and benefits of alternatives.– 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 give up to obtain that item.
BACHELOR OF ARTS IN ECONOMICS Econ 111 – ECONOMIC ANALYSIS
Pangasinan State UniversitySocial Science Department – PSU Lingayen
Opportunity Cost
Opportunity cost is the basis of cost/benefit economic reasoning
Opportunity cost should always be less than the benefit of what you have chosen
Opportunity cost is the benefit forgone of the next-best alternative to the activity you have chosen
BACHELOR OF ARTS IN ECONOMICS Econ 111 – ECONOMIC ANALYSIS
Pangasinan State UniversitySocial Science Department – PSU Lingayen
Marginal Costs and Marginal Benefits
Using economic reasoning, decisions are often made by comparing marginal costs and marginal benefits
Marginal cost is the additional cost or sacrifice one makes of participating in an activity or purchasing a product.
Marginal benefit is the additional satisfaction or value one obtains from an activity or product.
BACHELOR OF ARTS IN ECONOMICS Econ 111 – ECONOMIC ANALYSIS
Pangasinan State UniversitySocial Science Department – PSU Lingayen
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
BACHELOR OF ARTS IN ECONOMICS Econ 111 – ECONOMIC ANALYSIS
Pangasinan State UniversitySocial Science Department – PSU Lingayen
2. Government decisions
• The opportunity cost of college includes:• Items you could have purchased with the
money spent for tuition and books• Loss of the income from a full-time job
1. Individual decisions
Examples of opportunity cost:
• The opportunity cost of money spent on the war on terrorism is less spending on health care or education
Opportunity Cost
BACHELOR OF ARTS IN ECONOMICS Econ 111 – ECONOMIC ANALYSIS
Pangasinan State UniversitySocial Science Department – PSU Lingayen
LA Laker basketball star Kobe Bryant chose to skip college and go straight from high school to the pros where he has earned millions of dollars.
Principle #2: The Cost of Something Is What You Give Up to Get It.
BACHELOR OF ARTS IN ECONOMICS Econ 111 – ECONOMIC ANALYSIS
Pangasinan State UniversitySocial Science Department – PSU Lingayen
People make decisions by comparing costs and benefits at the margin.
Principle #3: Rational People Think at the Margin.
• Marginal changes are small, incremental adjustments to an existing plan of action.
BACHELOR OF ARTS IN ECONOMICS Econ 111 – ECONOMIC ANALYSIS
Pangasinan State UniversitySocial Science Department – PSU Lingayen
Principle #4: People Respond to Incentives.
• Marginal changes in costs or benefits motivate people to respond.
• The decision to choose one alternative over another occurs when that alternative’s marginal benefits exceed its marginal costs!
BACHELOR OF ARTS IN ECONOMICS Econ 111 – ECONOMIC ANALYSIS
Pangasinan State UniversitySocial Science Department – PSU Lingayen
Principle #5: Trade Can Make Everyone Better Off.
• People gain from their ability to trade with one another.
• Competition results in gains from trading.• Trade allows people to specialize in what
they do best.
BACHELOR OF ARTS IN ECONOMICS Econ 111 – ECONOMIC ANALYSIS
Pangasinan State UniversitySocial Science Department – PSU Lingayen
Principle #6: Markets Are Usually a Good Way to Organize Economic Activity
A market economy is an economy that allocates resources through the decentralized decisions of many firms and households as they interact in markets for goods and services.– Households decide what to buy and who to
work for.– Firms decide who to hire and what to produce.
BACHELOR OF ARTS IN ECONOMICS Econ 111 – ECONOMIC ANALYSIS
Pangasinan State UniversitySocial Science Department – PSU Lingayen
• Adam Smith made the observation that households and firms interacting in markets act as if guided by an “invisible hand.”– Because households and firms look at prices
when deciding what to buy and sell, they unknowingly take into account the social costs of their actions.
– As a result, prices guide decision makers to reach outcomes that tend to maximize the welfare of society as a whole.
Principle #6: Markets Are Usually a Good Way to Organize Economic Activity
BACHELOR OF ARTS IN ECONOMICS Econ 111 – ECONOMIC ANALYSIS
Pangasinan State UniversitySocial Science Department – PSU Lingayen
Principle #7: Governments Can Sometimes Improve Market Outcomes
• Market failure occurs when the market fails to allocate resources efficiently.
• When the market fails (breaks down) government can intervene to promote efficiency and equity.
BACHELOR OF ARTS IN ECONOMICS Econ 111 – ECONOMIC ANALYSIS
Pangasinan State UniversitySocial Science Department – PSU Lingayen
• Market failure may be caused by – an externality, which is the impact of one
person or firm’s actions on the well-being of a bystander.
– market power, which is the ability of a single person or firm to unduly influence market prices.
Principle #7: Governments Can Sometimes Improve Market Outcomes
BACHELOR OF ARTS IN ECONOMICS Econ 111 – ECONOMIC ANALYSIS
Pangasinan State UniversitySocial Science Department – PSU Lingayen
Principle #8: The Standard of Living Depends on a Country’s Production
Standard of living may be measured in different ways:– By comparing personal incomes.– By comparing the total market value of a
nation’s production.
BACHELOR OF ARTS IN ECONOMICS Econ 111 – ECONOMIC ANALYSIS
Pangasinan State UniversitySocial Science Department – PSU Lingayen
Principle #8: The Standard of Living Depends on a Country’s Production
• Almost all variations in living standards are explained by differences in countries’ productivities.
• Productivity is the amount of goods and services produced from each hour of a worker’s time.
BACHELOR OF ARTS IN ECONOMICS Econ 111 – ECONOMIC ANALYSIS
Pangasinan State UniversitySocial Science Department – PSU Lingayen
• Standard of living may be measured in different ways:– By comparing personal incomes.– By comparing the total market value of a
nation’s production.
Principle #8: The Standard of Living Depends on a Country’s Production
BACHELOR OF ARTS IN ECONOMICS Econ 111 – ECONOMIC ANALYSIS
Pangasinan State UniversitySocial Science Department – PSU Lingayen
Principle #9: Prices Rise When the Government Prints Too Much Money
Inflation is an increase in the overall level of prices in the economy.
One cause of inflation is the growth in the quantity of money.
When the government creates large quantities of money, the value of the money falls.
BACHELOR OF ARTS IN ECONOMICS Econ 111 – ECONOMIC ANALYSIS
Pangasinan State UniversitySocial Science Department – PSU Lingayen
Principle #10: Society Faces a Short-run Tradeoff Bet. Inflation and Unemployment
• The Phillips Curve illustrates the tradeoff between inflation and unemployment:
òInflation ð ñUnemploymentIt’s a short-run tradeoff!
BACHELOR OF ARTS IN ECONOMICS Econ 111 – ECONOMIC ANALYSIS
Pangasinan State UniversitySocial Science Department – PSU Lingayen
• Economics trains you to. . . . – Think in terms of alternatives.– Evaluate the cost of individual and social
choices.– Examine and understand how certain events
and issues are related.
Thinking Like an Economist
BACHELOR OF ARTS IN ECONOMICS Econ 111 – ECONOMIC ANALYSIS
Pangasinan State UniversitySocial Science Department – PSU Lingayen
The Economist As a Scientist
• The economic way of thinking . . .– Involves thinking analytically and objectively.– Makes use of the scientific method.
BACHELOR OF ARTS IN ECONOMICS Econ 111 – ECONOMIC ANALYSIS
Pangasinan State UniversitySocial Science Department – PSU Lingayen
Economic Model
This is a simple analytic frame which shows the relationship between the main factors, and explains the behavior of an economic theory or phenomenon.
Economists use economic models to simplify reality and to facilitate the understanding of the actual world economic inconveniences.
BACHELOR OF ARTS IN ECONOMICS Econ 111 – ECONOMIC ANALYSIS
Pangasinan State UniversitySocial Science Department – PSU Lingayen
Types of Economic Model
Descriptive– Like the Circular Flow
Analytical– Assumptions – Mathematical model ( functions and
equations)– Graphical analysis
BACHELOR OF ARTS IN ECONOMICS Econ 111 – ECONOMIC ANALYSIS
Pangasinan State UniversitySocial Science Department – PSU Lingayen
First Model: The Circular-Flow Diagram
• The circular-flow diagram is a visual model of the economy that shows how income flows through markets among households and firms.
BACHELOR OF ARTS IN ECONOMICS Econ 111 – ECONOMIC ANALYSIS
Pangasinan State UniversitySocial Science Department – PSU Lingayen
Income
Goods andservicessold
Spending
Goodsand servicesbought
Labor, land,and capital
Income
= Flow of inputs and outputs
= Flow of Money
Factors ofproduction
Wages, rent,and profit
FIRMS• Produce and sell
goods and services• Hire and use factors
of production
• Buy and consumegoods and services
• Own and sell factorsof production
HOUSEHOLDS
• Households sell• Firms buy
MARKETSFOR
FACTORS OF PRODUCTION
• Firms sell• Households buy
MARKETSFOR
GOODS AND SERVICES
First Model: The Circular-Flow Diagram
BACHELOR OF ARTS IN ECONOMICS Econ 111 – ECONOMIC ANALYSIS
Pangasinan State UniversitySocial Science Department – PSU Lingayen
General Features of Economic Model
All economic models incorporate three common elements:
1. The ceteris paribus (other things the same) assumption;
2. The supposition that economic decision makers seek to optimize something;
3. A careful distinction between “positive” and “normative” questions.
BACHELOR OF ARTS IN ECONOMICS Econ 111 – ECONOMIC ANALYSIS
Pangasinan State UniversitySocial Science Department – PSU Lingayen
Ceteris Paribus Assumption
The ceteris paribus (other things the same) assumption – which allows analysis of the effect of a change in one factor by holding all other relevant factors unchanged.
BACHELOR OF ARTS IN ECONOMICS Econ 111 – ECONOMIC ANALYSIS
Pangasinan State UniversitySocial Science Department – PSU Lingayen
Optimization Assumption
2. The supposition that economic decision makers seek to optimize something; Many economic models start from the assumption that the
economic actors being studied are rationally pursuing some goal.
BACHELOR OF ARTS IN ECONOMICS Econ 111 – ECONOMIC ANALYSIS
Pangasinan State UniversitySocial Science Department – PSU Lingayen
Positive versus Normative Analysis
Positive economics are statements that attempt to describe how the economy functions and the the world as it is.– Called descriptive analysis
Normative economics are statements about how the economy or world should be which relies on value judgments to evaluate or recommend alternative policies.– Called prescriptive analysis
BACHELOR OF ARTS IN ECONOMICS Econ 111 – ECONOMIC ANALYSIS
Pangasinan State UniversitySocial Science Department – PSU Lingayen
Positive or Normative Statements? If the minimum wage increases, then firms’ cost
of production rises.POSITIVE
Higher budget deficits will cause interest rates to increase.
POSITIVE
Positive versus Normative Analysis
BACHELOR OF ARTS IN ECONOMICS Econ 111 – ECONOMIC ANALYSIS
Pangasinan State UniversitySocial Science Department – PSU Lingayen
Positive or Normative Statements? The minimum wage in Metro Manila should
increase to P600.NORMATIVE
The government should be allowed to collect from tobacco companies the costs of treating smoking-related illnesses among the poor.
NORMATIVE
Positive versus Normative Analysis
BACHELOR OF ARTS IN ECONOMICS Econ 111 – ECONOMIC ANALYSIS
Pangasinan State UniversitySocial Science Department – PSU Lingayen
Which of the following statements is a positive statement? Which is a normative statement?
A. Society should take measures to prevent people from engaging in dangerous personalbehavior.B. People who engage in dangerous personal behavior impose higher costs on societythrough higher medical costs.
Let’s Check You Understanding!