ECON 2313: Fall , 2011

Welcome!

Economics is the studyof how individuals and

societies allocatescarce resources among(competing) alternative

uses.

Available resources are insufficient to satisfy wants.

We cannot produce enough goods and services to satisfy

everyone—we don’t have the resources!

Congress made supplemental

appropriations for the Iraq effort of $110 billion June

2003 and March 2004. We should ask the question: what could we have for

$110 billion?

• 628 Boeing 7E7 Aircraft

• Construct three (3) 700 mile bullet trains (includes the cost of inner-city land acquisition).

• 4,075 “high quality” educational facilities to accommodate 1,000 students.

• Write a $379 check to every U.S. citizen.

• Fund 1,000 universities the size of Arkansas State for one year.

Economics Webster’s Ninth New Collegiate Dictionary. eco• nom • ic 1. archaic: of or relating to a household or its management. eco = oikos, meaning “house” or “household”  nom = nemein, meaning “to manage” ic = ic, mean “of” or “relating to”

The geneology of economics

Finley. The World of Odysseus.

LO1

The Economic Perspective

• Thinking like an economist

• Key features:

• Scarcity and choice

• Purposeful behavior

• Marginal analysis

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Economics: The Big Questions

• How do choices end up determining what, how, and for whom goods and services are produced?

• When do choices made in the pursuit of self-interest also promote the social interest?

Economic Resources

• Land• Labor • Capital• Entrepreneurship

Things that give us the physical means to produce and distribute goods and services.

Land or natural resources

Labor or “human resources”

Capital or “manmade instruments of production”

Human Capital

Human capital is the knowledge and skill people

obtain from education, on-

the-job training, and work

experience.

Entrepreneurship Entrepreneurship is the willingness and ability to combine land, labor and capital into productive enterprises.

• Entrepreneurs identify profitable business opportunities and mobilize and coordinate resources to take advantage.

• Entrepreneurs have a key role in the commercialization of new knowledge

• Sam Walton, Michael Dell, Martha Stewart, and Bill Gates are examples of highly successful entrepreneurs.

What, How, For Whom?

Because resources are scarce, growing more corn means growing less wheat, building more SUV’s means

building fewer military vehicles, and building more prisons means we have to sacrifice something else—

like new schools.

How to produce?

• In France, basket-carrying workers pick the grape crop by hand. Grape picking in California is often mechanized.

• GM uses workers to weld body parts together in some plants and uses robots in others.

Occupation Mean Annual Income ($)Chief Executives $139,810Airline Pilots and Co-Pilots 135,040Dentists 133,680Marketing Managers 101,190Actuaries 90,760Speech Pathologists 58,000Registered Nurses 56,880Funeral Directors 56,540Food Service Managers 44,930

Source: Bureau of Labor Statistics 2005 Occupational Survey

For whom are goods produced?

The personal distribution of income describes the

distribution of income among households or individuals

1967 1990 20080

2

4

6

8

10

12

Household Income Ratios of Selected Percentiles, the United States

90th/10th80th/50th

Year

Ratio

Source: Bureau of the Census

1967 1990 20080

10

20

30

40

50

60

Shares of Household Income Quintiles,the United States

LowestSecondMiddleFourthHighest

Year

Shar

e (P

erce

nt)

Source: Bureau of the Census

When is the Pursuit of Self-Interest in the Social Interest?

• Subprime mortgage brokers and underwriters behaved in their own interests—but contributed to the housing prices bust.

• BP scrimped on deep water drilling safety measures—with catastrophic results.

• Farmers on the high plains draw from the Ogallala Aquifer—but the water is rapidly running out.

MicroeconomicsThe study of the choices that individuals and

businesses make and the way these choices respond to incentives, interact, and are influenced by government

Examples of microeconomic questions?

• What determines the price of gasoline?

• Why is housing so much more expensive in San Francisco compared to Dallas?

• Will more students enroll in nursing schools in response to rising incomes of nurses?

• Will the “free” availability of Linux affect sales of Windows?

Macroeconomics

The study of the aggregate (or total) effects on the national economy and the global economy of the choices that individuals, businesses, and governments make.

Macroeconomic Questions

• The standard of living

• The cost of living

• Economic fluctuations—recessions and expansions

The Standard of Living

The standard of living is (imperfectly) measured by the average quantity of goods and services per person (or per capita).

Issues:

• How to explain changes over time in the standard of living?

• How to explain cross-national differences in the standard of living?

The Cost of Living

The cost of living refers to the prices of goods and services that are typically purchased by households.

Issues:

• How to explain changes over time in the cost of living?

• How to explain cross-national differences in the cost of living?

The Business Cycle

The term business cycle is used to describe observed fluctuations in key macroeconomic measures such as real GDP, personal income, profits, or employment.

A full cycle consists of an expansion and a contraction (or recession).

Business cycles are recurring phenomena; however, they are irregularly recurring.

Time

Real G

DP

Tot

al P

rod

uct

ion

Year

Business Cycle Phases and Turning Points

Expansion

ExpansionPeak

Peak

Recession

Recession

Trough

2 4 8

USA Employment is down 7.7 million since December 2007

Recessions shaded pink

LO1

Purposeful Behavior

• Rational self-interest

• Individuals and utility

• Firms and profit

• Desired outcomes

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Economists assume that economic

decision-makers are rational and engage

in purposeful, “maximizing”

behavior

Rationality means:• The ability to make comparisons and

form preferences.• Choice consistency

Economics deals with questions of “what is”

and “what ought to be.” The former set of

questions belong to positive economics; the

latter to normative economics

Positive and normative economics

A B

1. I prefer A to B2. I prefer B to A3. I am indifferent between A

and B4. I prefer B to C5. Therefore, I prefer A to C

C

Gift Baskets

“All swans are white.”

“Pink swans are prettier than white swans.”

Positive economics attempts set forth scientific statements--that is, statements subject to verification or falsification

For instance:

• “ If they raise tuition again at ASU, enrollment will decline.”

• The recent fall in interest rates is likely to stimulate housing construction.

• Total employment in the U.S. fell in the year 2002.

It’s unfair to ask a person

to live on $7.25 an hour.

I shouldn’t have the government telling me how much I should pay for fast

food cooks or any other type of labor service.

Who is right? It is a normative issue.

An economic model is a simplified substitute

for economic reality.

What is an Economic Model?

This map of Arkansas is a good example of a “model”

Ceteris Paribus “All other things being equal” or “All other factors held constant.”

Simplification in model building is achieved by the ceteris paribus assumption. It allows us to reason about

the relationship between two variables without the

intrusion of other variables.

Economic reasoning:Some pitfalls

• Post hoc fallacy

• Association-is-causation fallacy

• Fallacy of composition

• Ignoring secondary effects

Post hoc fallacy

I washed my car today, and that is why it

rained.

Correlation versus Causation

Correlation is the tendency for the values of two variables to move in a

predictable and related way. For example, beer consumption tends to

rise when unemployment rises—that is, these variables are correlated. Does it follow that beer consumption causes

unemployment?

Sleeping with one's shoes on is strongly correlated with waking up with a headache.

Therefore, sleeping with one's shoes on causes headache.

• Researchers at the Aabo Akademi found that Finns who speak the language of their Nordic neighbors were up to 25 percent less likely to fall ill than those who do not.

• My rooster died—the sun won’t come up tomorrow.

• Crimes rates tend to be higher in cities with more police per capita.

Association-is-causationfallacy: More examples

To commit the fallacy of composition is to suppose that what is true in the individual case also holds true for the group.

• Example: “The best way to leave a burning theater is to run for the exit.”

Fallacy of composition

LO4

Individual’s Economizing Problem

• Limited income

• Unlimited wants

• A budget line

• Attainable and unattainable options

• Tradeoffs and opportunity costs

• Make the best choice possible

• Change in income

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LO4

Individual’s Economizing Problem

6543210

02468

1012

DVDs$20

Books$10

$120 Budget 12

10

8

6

4

2

02 4 6 8 10 12 14

Quantity of Paperback Books

Qu

an

tity

of

DV

Ds Income = $120

Pdvd = $20= 6

Income = $120

Pb = $10= 12

Attainable

Unattainable

1-50

LO4

Global Perspective

1-51

LO5

Production Possibilities Model

• Illustrates production choices

• Assumptions:

• Full employment

• Fixed resources

• Fixed technology

• Two goods1-52

Technology

Technology is the application of scientific or other types of know-how to practical tasks.• “A sharp axe is better than a dull axe.”

• Improved technology enables us to produce more with the same resources.

• “Specialization is the inevitable counterpart of technology.”

John K. Galbraith. The New Industrial State (1967).

Model T : 1903

Ford Mustang: 1964

Important technical innovations

• Internal combustion engine• Cotton harvester• Transistor• Internet browser software• Air conditioning• Satellite communication• Antibiotics• Genetically modified seeds

LO5

Production Possibilities Table

Type of Product

Pizzas (in hundred thousands)

Industrial Robots (in thousands)

Production Alternatives

A B C D E

10 9 7 4 0

0 1 2 3 4

Plot the Points to Create the Graph…

1-56

LO5

Production Possibilities Curve

Pizzas

Ind

ustr

ial R

ob

ots

Attainable

0 1 2 3 4 5 6 7 8 9

1413121110 9 8 7 6 5 4 3 2 1

Unattainable

AB

C

D

E

U

The law of increasing opportunity costs makes the PPC concave.

1-57

Optimal Allocation

LO5

a

b

c

d

e

MB = MC

MC

MB

15

10

5

0

1 2 3Quantity of Pizza

Marg

inal B

en

efi

t &

Marg

inal

Cost

1-58

LO6

A Growing Economy

• Economic Growth

• More resources

• Improved resource quality

• Technological advances

1-59

Type of Product

Pizzas (in hundred thousands)

Industrial Robots (in thousands)

Production Alternatives

A' B' C' D' E'

14 12 9 5 0

0 2 4 6 8

A Growing Economy

LO6 1-60

LO6

A Growing Economy

Pizzas

Ind

ustr

ial R

ob

ots

Attainable

0 1 2 3 4 5 6 7 8 9

1413121110 9 8 7 6 5 4 3 2 1

Unattainable

AB

C

D

E

EconomicGrowth

Now Attainable

A’

B’

C’

D’

E’

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