1_introduction to economics
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Introduction to EconomicsTRANSCRIPT
What is Economics?
Economics is the study of how societies use scarce resources to produce valuable goods and services and distribute them among different individuals
Scarcity and efficiency
Equity
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How People Make Decisions? •People face trade-offs.•The cost of something is what you give up to get it.•Rational people think at the margin.•People respond to incentives.
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“There is no such thing as a free lunch!”
Principle #1: People Face Trade-offs
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Making decisions requires trading off one goal against another.
Principle #1: People Face Trade-offs
To get one thing, we usually have to give up another thing.Food v. clothingLeisure time v. workEfficiency v. equity
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Principle #1: People Face Trade-offs
Efficiency v. EquityEfficiency 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.
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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.
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Marginal changes are small, incremental adjustments to an existing plan of action.
People make decisions by comparing costs and benefits at the margin.
Principle #3: Rational People Think at the Margin
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Principle #3: Rational People Think at the Margin Extra year of education
Additional unit of chocolate
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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!
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Principle #4: People Respond to Incentives Important for policy makers
Income tax
Subsidy on petrol/ diesel
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Problem # 1 Describe some of the trade-offs faced by following:1. A family deciding whether to buy a new car
2. A company president is deciding whether to open a new factory
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How People Interact?•Trade can make everyone better off.•Markets are usually a good way to organize economic activity.•Governments can sometimes improve economic outcomes.
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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.
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Principle #5: Trade Can Make Everyone Better Off Trade and costs of productions
Absolute and comparative advantage
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Absolute and Comparative Advantage
Two ways to measure differences in costs of production:
The number of hours required to produce a unit of output (for example, one pound of potatoes).
The opportunity cost of sacrificing one good for another.
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Absolute Advantage
The comparison among producers of a good according to their productivity.
Describes the productivity of one person, firm, or nation compared to that of another.
The producer that requires a smaller quantity of inputs to produce a good is said to have an absolute advantage in producing that good.
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Opportunity Cost and Comparative Advantage Compares producers of a good according to their
opportunity cost, that is, what must be given up to obtain some item
The producer who has the smaller opportunity cost of producing a good is said to have a comparative advantage in producing that good.
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Comparative Advantage: Example
Students CS 101 HS 101
Mala 1 2
Manasi 2 3
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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.
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Principle #6: Markets Are Usually a Good Way to Organize Economic Activity.
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.
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Principle #7: Governments Can Sometimes Improve Market Outcomes. Markets work only if property rights are enforced. Property rights are the ability of an individual to own and
exercise control over a scarce resource
Market failure occurs when the market fails to allocate resources efficiently.
Government may intervene to promote efficiency and equity.
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Principle #7: Governments Can Sometimes Improve Market Outcomes. 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.
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How the Economy as a Whole Works? •A country’s standard of living depends on its ability to produce goods and services.
•Prices rise when the government prints too much money.
•Society faces a short-run trade-off between inflation and unemployment.
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Principle #8: A Country’s Standard of Living Depends on Its Ability to Produce Goods and Services.
Standard of living may be measured in different ways:
By comparing personal incomes. By comparing the total market value of a nation’s production.
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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.
Principle #8: A Country’s Standard of Living Depends on Its Ability to Produce Goods and Services.
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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.
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Principle #10: Society Faces a Short-run Trade-off between Inflation and Unemployment.
The Phillips Curve illustrates the trade-off between inflation and unemployment:
Inflation or Unemployment It’s a short-run trade-off!
The trade-off plays a key role in the analysis of the business cycle—fluctuations in economic activity, such as employment and production
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Thinking Like an Economist
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Thinking Like an Economist
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.
Economist as an scientist Scientific method: observation, theory, and more observation Role of assumptions Economic models
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Economists make assumptions in order to make the world easier to understand.
The art in scientific thinking is deciding which assumptions to make.
Economists use different assumptions to answer different questions.
The Role of Assumptions
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Economic Models Economists use models to simplify reality in order to
improve our understanding of the world.
Two of the most basic economic models are: The Circular Flow Diagram The Production Possibilities Frontier
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Simple Model of Economy
Market for Goods and Services
Market for Factors of Production
HouseholdsFirms
Flow of inputs and outputs
Flow of Money
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The Production Possibilities Frontier
The production possibilities frontier is a graph that shows the combinations of output that the economy can possibly produce given the available factors of production and the available production technology.
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The Production Possibilities Frontier
Productionpossibilitiesfrontier
B
D
A
Quantity ofCars Produced
2,200
600
1,000
3000 700
2,000
3,000
1,000
Quantity ofComputers
Produced
C
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The Production Possibilities Frontier
Concepts illustrated by the production possibilities frontier Efficiency Trade-offs Opportunity cost Economic growth
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Shift in the PPF
Quantity ofCars Produced
2,200
600
2,300
6500
4,000
3,000
1,000
Quantity ofComputers
Produced
A
G
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Microeconomics and 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
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Problem # 2
Classify the following topics as relating to microeconomics or macroeconomics. A worker’s decision to work or take care of her ill mother.
The effect of government spending on nation’s unemployment rate.
The optimal choice of output for a firm that produces mobile handsets.
Effect of Rashtriya Swasthya BimaYojana (RSBY) on household’s expenditure on health care.
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Positive vs Normative Analysis
Economist as Policy Adviser Positive analysis Normative analysis
Positive statements are statements that attempt to describe the world as it is.
Normative statements are statements about how the world should be.
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Problem # 3
Classify statements as positive or normative. An increase in the minimum wage will increase the rate of
teenage unemployment
The government should raise the tax on tobacco to reduce the quantity of cigarettes sold
The government should provide health care to anyone who does not have health insurance
An increase in the interest rate will cause a decline in investment
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Three Problems of Economic Organization
What?
How?
For whom?
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Economic Systems
Market economy
Command economy
Mixed economy
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Why Economists Disagree?
Differences in scientific judgments
Differences in values
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References
Samuelson P.A. and W.D. Nordhaus. 2010. Economics (19th Ed.) Tata McGraw Hill. New Delhi.
Mankiw N.G. 2007. Principles of Microeconomics (4th Ed.) Thomson South-Western. Delhi.
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