ECONOMICS What does it mean to me? Part I: Eleven Powerful Ideas of EconomicsEleven Powerful Ideas...

ECONOMICSECONOMICSWhat does it mean to

me?

Part I:Part I:•Eleven Powerful Ideas of EconomicsEleven Powerful Ideas of Economics

READ Krugman Section 1, Module 1Mankiw Ch 1, 2

DO Morton Unit 1

What you will learnWhat you will learn

in thisin this ModuleModule::• What a business cycle is and why policy makers

seek to diminish the severity of business cycles

• How employment and unemployment are measured and how they change over the business cycle

• The definition of aggregate output and how it changes over the business cycle

• The meaning of inflation and deflation and why price stability is preferred

• How economic growth determines a country's standard of living

• Why models - simplified representations of reality- play a crucial role in economics

ECONOMICS:The study of the allocation of

our scarce resources to satisfy our unlimited wants for goods

and services.

Economics is:

*A social science concerned with how resources are used to satisfy wants.

*A study of how people and countries use their resources to produce, distribute, and consume goods and services.

*An examination of behavior related to how goods and services are acquired.

*A study of how people decide who will get the goods and services.

BASIC ECONOMIC QUESTIONSBASIC ECONOMIC QUESTIONS

WHAT TO PRODUCE?WHAT TO PRODUCE?

HOW TO PRODUCE?HOW TO PRODUCE?

FOR WHOM TO FOR WHOM TO PRODUCE?PRODUCE?

ECONOMICS is concerned with

PRODUCTION

DISTRIBUTION

CONSUMPTION

of GOODS and SERVICES

The FACTORS OF PRODUCTION include:

LAND (natural resources)

LABOR (human resources)

CAPITAL (capital resources)

ENTREPRENEURSHIP

NATURAL RESOURCES:

Water, oil, gems, land, and trees.

RESOURCES: materials from which goods and services are produced.

Those things such as people, tools, machinery, and factories.

Human Resources: People at work--manual,

clerical, technical, professional, managerial.

Capital Resources: includes any good used to create a final good or

service.

CAPITAL RESOURCESCAPITAL RESOURCES are further divided into:

CAPITAL GOODS

Goods used in the production process that can be reused

for another product. (computers, trucks,

machines, et.al.)

INTERMEDIATE GOODS

Goods that are used up in the

production process. (paper, oil, ink,

et.al.)

ENTREPRENEURSHIP:ENTREPRENEURSHIP:*a particular

type of human

resource

*business innovator

*sees opportunity

to make a profit

*uses unexploited

raw materials

*takes RISK with new

product or process

*brings together land, labor, capital

FINANCIAL CAPITAL:

*NOT a real resource *ENABLES

ENTREPRENEURS AND MANAGERS TO

PURCHASE THE FACTORS OF

PRODUCTION

*Money to acquire capital goods and employ land and labor resources

How do we pay for resources?

RESOURCE PAYMENTS

LAND

LABOR

CAPITAL

ENTREPRENEUR

Rent

Wages & Salaries

Interest

Profit

There are 11 powerful ideas that serve as the foundation

of economics.

If you develop a good understanding of them and master the problem-solving skills inherent in them, they will serve you for the rest of

your life.

NUMBER 1:

WANTS AND DESIRES

How do we satisfy our unlimited wants and desires

in a world of limited resources?

“Goods” and “services” are those things that we value or desire.

GOODS tend to be TANGIBLETANGIBLE things--objects that can be seen, held, tasted, heard, or smelled.

INTANGIBLE GOODSINTANGIBLE GOODS are things we cannot reach out and touch, such as friendship, knowledge, and

fairness. SERVICES are intangible.

In contrast to goods, BADS are items that people do not desire or want---garbage, pollution, weeds, and crime.

The elimination of a bad becomes a good.

In economics, we assume that more goods lead to greater

satisfaction, or UTILITY, and that bads lead to dissatisfaction

or DISUTILITY.

Normal goodInferior good

http://www.yadayadayadaecon.com/clip/3/


NUMBER 2:

SCARCITY

We all face scarcity because it is not possible for an individual to have all

the goods and services that he or she desires.

However, because we all have differing wants and desires, scarcity

affects individuals differently.

The essential question in Economics is:

ScarcityScarcity

Insufficient supply of something Insufficient supply of something where “insufficient” is where “insufficient” is interpreted relative to the interpreted relative to the desires of a group of people.desires of a group of people.

For instance, antiques are valued For instance, antiques are valued for their scarcity. . .for their scarcity. . .

When our wants exceed our needs we have SCARCITYSCARCITY.

Scarcity Scarcity forcesforces us to us to make choices on make choices on

how to best use our how to best use our limited resources.limited resources.

the same as poverty. (eg. Goods can be scarce in United States AND Somalia. However, scarcity isn’t going away; poverty might.)

the same as shortage. (eg. Whether you have a shortage or not depends upon how you handle the rationing problem made necessary by scarcity)

Scarcity is NOT:

Oh, Scarcity(Tune: Oh, Christmas Tree)

Oh, scarcity! Oh, scarcity

We can't have all the things we want.Oh, scarcity! Oh, scarcity!

We cannot have it all.

We really want a lot of stuff.

But sometimes there's just not enough.Oh, scarcity! Oh, scarcity!

We cannot have it all.

Scarcity


NUMBER 3: CHOICESWe may all want a home, two cars,

gourmet food, all with a pristine environment with no pollution. If we had unlimited resources to produce

all of the goods and services everyone wanted, we would not have to choose

among these decisions.

If we did not have to make meaningful economic choices, the study of

economics would not be necessary.

Taken from “Economics by Example” by David Anderson

But a woman who waits ‘til the third time around…..She’s the girl he’s found……The girl who’s hard to get….. (taken from

Meredith Wilson’s The Music Man)

MARKETS AND MARRIAGE

As in markets for goods and services in which rare stuffed animals and exclusive doctors are prized, judgments about whom to pursue

may rest on signals of quality, such as how hard people are to attract. That is the crux of the social price theory, which considers

marriage through an economic (but human) lens.

Economics isn’t only about money. Economics is also about scarcity, choice and utility maximization. Ninety-five percent of Americans marry, so most of us become buyers and sellers in the

marriage market at some point……and the marriage market is alive and well in residence halls, nightclubs, churches and workplaces

across the country.

This concept also translates into the ROLE OF PRICE.

Searching for a marriage partner involves making a decision about whether to pursue a relationship on the basis of an initially meager number of signals. Just as you choose a

doctor, a college, or a bottle of wine, consumers seek indicators of the relative value of the available alternatives.

Suppose your boss asks you to buy an outstanding bottle of wine to impress a new client. To pick a winner, you might look at the bottles, survey the knowledge and opinions of

friends, look into the various reputations of various vineyards, and sample a few vintages. You would probably also use

price as a guide.


What does it take to win someone’s heart?

For some people the answer may involve money, but for many, it has more to do with kindness, intellect, humor, romantic gestures, appearance and ability to contribute.

People must decide what they value most. This standard has been called social price. As extremes, someone with high

standards has a high social price; someone with low standards has a low social price.

Sometimes parents know an individual’s prospects better than the individual. They may set a price floor (a minimum price). If a daughter announces her interest in an “inferior”

male, the parents may forbid her to see him because the “social price” is too low.


Scarcity (such as the one

you love) forces us to choose and choices

are costly because we always give up other

opportunities.

Economists call this OPPORTUNITY

COST.

Opportunity Cost:Opportunity Cost:

The next best The next best alternative given up alternative given up to get something.to get something.

Everyone must give up something to get more of other things, called

trade-offs.

Opportunity CostTrade-offs



Some economists argue that we are worse off because of the FDA (Food

and Drug Administration).

What are the “costs” of having a government administrative agency control the food and

drugs a society can consume?

TINSTAAFL

(There is no such thing as a free lunch)

This statement clarifies the relationship between scarcity and opportunity cost. If the cafeteria is offering “free” lunches, is it really free from society’s perspective?

Could the resources used to create the free lunch have been used to create something else of value?

Technically, this is called a “subsidized”

lunch.

Prices and Costs are NOT the same Prices and Costs are NOT the same thing.thing.

PRICES reflects the monetary value of a good or service, which is an objective fact.

COSTS are personal and subjective.

For example, would a $60,000 Lexus cost more to a poorer person than a richer one?

They both give up the same amount of money, however, the costs are different for

each person.

In market settings, goods have positive prices

x

Quadrant IQuadrant I

y

Quadrant IVQuadrant IV

Quadrant IIQuadrant II

Quadrant IIIQuadrant III

Economists generally use quadrant 1 to graph their equations.

Too often the long-termlong-term consequences of a choice is ignored.

“….must trace not merely the immediate results but the results in the long run, not merely the primary consequences but the secondary consequences, and not merely the effects on some special group but the effects on everyone.”

--Henry Hazlitt

Especially in politics there is a tendency to stress the short term

benefits while completely ignoring the longer-term

consequences. . . . we hear an endless pleading for proposals to help specific industries, regions, or groups without consideration

given to their impact on the broader community, including

taxpayers and consumers.

--Common Sense Economics

Consider the rent controls imposed on apartments. Cities like Berkeley and Santa Monica, California, as well as New York City have adopted such controls, usually in response to claims that rent controls will keep rents from rising and make housing more affordable for the poor.

True, in the short run…..but what about the long-run consequences:

1) Market for apartments will stagnate.

*existing apartments will not go to those who need them

*expensive for someone to give up a rent controlled apartment

*hard to find place closer to work because others are holding onto theirs

2) Reduce investment in new housing

*no incentive to build new apartments for the future.

NUMBER 4:

THINKING MARGINALLY

Choices are not all or nothing.

Most choices are of the “little more” or “little less”

variety.Most of us do not dine in the nude so we can afford food.--Common Sense Economics

Economists call this “marginal thinking” because the focus is on the

additional, or marginal, choices.

People will alter their behaviors if they expect the marginal benefits from doing so will outweigh the

expected marginal costs they will bear.

This is called theThis is called the

RULE OF RATIONAL CHOICE.

Thinking at the margin





NUMBER 5: INCENTIVES CREATE

RATIONAL BEHAVIOR

Much of human behavior can be explained and predicted as a response

to incentives.

Rational behavior exists as people respond to incentives--both positive

and negative--in the relative cost-benefit structure.

Why did the cashier let Biff Henderson eat all the free mints?

An integral part of the “Late Show with David Letterman” is stage manager Biff Henderson wandering around New York City timing things. How long would it take a shop owner to

stop Biff from drawing faces on watermelons? OR how long would a restaurant cashier let him eat free mints out of the

bowl at the counter?” In most cases, Biff was stopped after a short period of time. However, in this case, the cashier never stopped him and, just before he left, Biff emptied the bowl into

his pocket and walked out.


Why did the cashier let Biff Henderson eat all the free mints?

The answer: INCENTIVES MATTER.

With each watermelon Biff defaced, the shop owner risked financial loss. The shop owner had an incentive to protect his property.

If the cashier had a financial stake in the restaurant, perhaps he would have said something. However, while the cashier’s duty was to maximize her employer’s profits, her “incentive” was to avoid hassles and collect a fixed wage.


INCENTIVES are important in communist societies as well.

In the former Soviet Union, employees in a glass plant were rewarded by the number of tons of sheet

glass they produced.

This led to factories producing sheet glass so thick, one could barely see through it.

So they changed the strategy and employees were rewarded by the number of square meters they could

produce.

This led to production of glass so thin that it broke easily.

**Taken from “Common Sense Economics” 2005

Incentives can be either positive or negative.

POSITIVE incentives will either increase benefits or reduce costs.

NEGATIVE incentives will either decrease benefits or increase costs.

Would a tax on cigarettes be a negative or positive incentive?

Would a subsidy to electric cars be a positive or negative

incentive?

Incentives

http://www.spike.com/video-clips/duaf9s/shower-with-a-gorilla-program

Seinfeld



NUMBER 6:

SPECIALIZATION AND TRADE

People tend to dedicate their resources to one lifetime activity, whether it be teaching school,

child-rearing, or cooking food. Why is this?

The answer is simple: OPPORTUNITY COST.

By concentrating their energies into a single, best- suited activity, individuals

incur lower opportunity costs. In this way, they make better use of their limited

resources.

If a country, region, firm, or person can produce a good or

service for a lower cost, economists would say they have a COMPARATIVE ADVANTAGE.

The advantages of specialization include greater skill, lower costs,

greater efficiency, higher production, and increased wealth.

NUMBER 7:MARKETS AND THE PRICE SYSTEM

How do we determine who gets

what?

The market system allows communication between consumers and

producers regarding the allocation of scarce resources. This is done through PRICES.

The remarkable thing about an economy based on private

property is that self-interest will further the general

prosperity of a community or nation. The individual

“intends only his own gain” but he is directed by the

“invisible hand” of market prices to promote the goals of

others…….--Common Sense Economics

Every individual is continually exerting himself to find out the most advantageous employment for whatever capital he can command. It is his own advantage, indeed, and not that of the society which he has in view. But the study of his own advantage naturally, or rather necessarily, leads him to prefer that employment which is most advantageous to society….He intends only his own gain, and he is in this, as in many other cases, let by an invisible hand to promote an end which was not part of his intention.

--Adam Smith

Government policy sometimes interferes with the market

system.

Consider how minimum-wage legislation censors effective communication from

teenagers to employers.

While it is true that minimum wage protects teenagers from being paid extremely low wages for unskilled

labor, the increase in minimum wage has two effects on teenage

employment:

1) the higher minimum wage 1) the higher minimum wage increases the number of increases the number of teenagers who want jobs, teenagers who want jobs, sometimes even causing them sometimes even causing them to drop out of school,to drop out of school,

2) the higher minimum wage 2) the higher minimum wage for low-skilled workers for low-skilled workers discourages hiring.discourages hiring.

There are seven reasons to justify

government involvement into

the economic decision-making

process:

NUMBER 8:GOVERNMENT POLICIES

Governments are institutions devised by

humans to serve the collective group or will.

•government provides legal framework

•some goods and services are inherently “public”

•lack of competition has led markets to operate inefficiently

•government can help participants in market activity make better decisions

•the existence of externalities--like pollution--can cause inappropriate market signals

•income distribution as determined by the market may be considered unfair or inappropriate

•overall level of output may be viewed as inappropriate in the market.

NUMBER 9:

ECONOMIC GROWTH

Economic growth enhances the potential amount of individual consumption---the greater the economic growth, the more

goods we and our descendants will have to consume in the future.

Americans produce and earn approximately 30 times as much per person today as in 1750.

Why are Americans so much more productive than 250 years ago?

1) Scientific knowledge and technological abilities

2) Complex machines and factories, better roads, extensive systems of communication

3) Families in 1750 directly produced most of the items they consumed; today we purchase them from others

--Common Sense Economics

Other sources of economic growth:

1) Investments in people (skills) and machines (assets)

2) Improvements in technology (brain power, less cost)

3) Improvements in Economic Organization

*human activities

*entrepreneurship

*open markets promote free exchange of ideas

*competition

PRICE STABILITY

NUMBER 10:

When overall prices increase in an economy, it is called INFLATION.

When overall prices decrease, it is called

DEFLATION.

When either of these conditions exist, the

PURCHASING POWER of money is changing.

Inflation will cause the purchasing power of money to decrease.

It can raise one nation’s prices relative to prices in other countries , which will lead to difficulties in financing foreign goods.

In extreme situations, it can erode the faith the people have in the currency resulting in the refusal to accept paper money as a form of payment.

In a deflationary period, the purchasing power of an

individual will rise, however, businesses may be forced to lay off workers in an effort to

reduce costs to offset the lower prices of the product.

Ceteris Paribus: all other things equal

NUMBER 11:

The Use of Models in EconomicsThe Use of Models in Economics

•Models

•Other things equal assumption

•Ceteris Paribus

POSITIVE vs POSITIVE vs NORMATIVE NORMATIVE EconomicsEconomics

Positive Versus Normative Positive Versus Normative EconomicsEconomics

• Positive economics: questions that have definite right and wrong answers.

• Normative economics: economics analysis saying how the world should work.

• Examples: facts vs. predictions

• Economic model

ECONOMIC way of thinking

…….making use of a common set of tools for economic analysis.

Factual ToolsFactual Tools

Institutions

Theoretical ToolsTheoretical Tools

StatisticsStatistics

ConceptsConcepts

History

ModelsModels

WHY IS ECONOMICS WHY IS ECONOMICS A SOCIAL SCIENCEA SOCIAL SCIENCE????

Economics is very similar to the other Economics is very similar to the other social sciences--psychology, history, social sciences--psychology, history, sociology, anthropology, and political sociology, anthropology, and political science--in thatscience--in that it is concerned with it is concerned with

reaching conclusions based on human reaching conclusions based on human behavior.behavior.

Social scientists may study the same Social scientists may study the same issue but have a different perspective issue but have a different perspective

on the subject.on the subject.

The two main branches of

Economics are:

Macroeconomics--looks at problems in

the economy which affect society as a

whole.

Microeconomics--looks at the smaller areas in the economy trying to understand

how firms and businesses make their

decisions.

Despite the fact that the Despite the fact that the two areas stress different two areas stress different

topics, they both still strive topics, they both still strive to understand people’s to understand people’s

behavior.behavior.

The disciplined mind developed by the study of economics will give one the problem-solving

tools which will be valuable to anyone regardless of career

choice.

The study of economics can help you to

understand education, pollution concerns,

global warming, welfare reform, health care, in that we all must make choices between our

unlimited wants/desires and our basic needs.

Is it rational for people to strive for a better situation in their own lives?

Economists believe that

self-interest = rational behavior

They also believe that rational

behavior includes the idea that individuals will attempt to anticipate the

future consequences of

their acts.

Rationality


What tradeoffs occur when a driver with a suspended license

drives a car illegally?

What are the consequences of

smoking cigarettes?

What are the tradeoffs of not finishing high

school?

What are the consequences of not

going to college?

Not all humans react in similar ways, however, by looking at large groups of people, economists can make many reliable predictions about human behavior.

The End

Compiled by Virginia Meachum, Economics Teacher

Exploring Economics, Pathways to Problem Solving, by Robert L. Sexton (Dryden Press,

1999)

Principles of Economics, by N. Gregory Mankiw, 2nd & 3rd edition (Thompson, Southwest

Publishing, 2004)

Economics For AP, by Paul Krugman, Robin Wells, David Anderson, Margaret Ray

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