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What is
ECONOMICS about?
T.J. Joseph
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Why Study Economics?
Economics helps to solve complex problems that aregreat importance to society
Economists are concerned with why the world is
what it is
Examine how individuals and firms make decisions
about consumption, investment, pricing, etc.
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The Economic ProblemTwo general observation:
(1) Resources are limited.
What are resources?
(2) Human wants are abound/unlimited
ScarcityWe cannot have everything we want allthe time
Scarce Resources - not enough to satisfy all wants
So choiceshave to be made
Any choice involves an opportunity cost- the value of
the best alternative foregone
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Unl imited Wants (Scarce goods)
Food (bread, milk, meat, eggs,vegetables, coffee, etc.)
Clothing (shirts, pants, sarees, shoes,socks, coats, sweaters, etc.)
Household (tables, chairs, sofas, beds,goods dressers, television sets, etc.)
Space exploration
Education
National defense
Recreation
Leisure time
EntertainmentClean air
Pleasant (trees, lakes, rivers,environment open spaces, etc.)
Pleasant working conditions
L imited Resources
Land (various degrees of fertility)
Natural (rivers, trees, minerals,Resources oceans, etc.)
Machines and otherhuman-made physical resources
Non-human animal resources
Technology
Human (the knowledge, skill,
resources and talent of individuals)
Scarcity and Choice
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Fundamental Economic Questions
Scarcity and choice raises several unavoidable
questions to the society
What to produce?
More guns or more breads? More books or more
movies?
How to produce? (optimization)
Use more labour and less machines?
For whom to produce (distribution)
Distribute equally? Then on what basis?
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Economics Defined
Economics is the study of how people cope with
scarcity
Economics deals with the problem of how to allocate
the limited resourcesamong competing wants in order
to satisfy as many of those wants as possible
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Every society must have a means to ration scarceresources among competing uses.
Scarcity Necessitates Rationing
In a market setting,priceis used to ration goods
and resources.
When price is used, the good or resource is
allocated to those willing to give up other things
in order to obtain ownership rights.
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Emergence of Markets
Markets(and its components) emerge in directresponse to scarcity.
In a market, people exchange things that they like lessor have more, for things they like more or have less
Reallocation of their resources and enhance their
individual welfare
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Fundamental Economic Questions
How shall we answer the three basic economic
questions?
Shall we allow for individual freedom of choice? Orshall we make all these decisions collectively?
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Market Economy
Market mechanism or Price mechanismcoordinates the decision making of various economic
agents
Also known as Free-enterprise economyone in
which government does not control economic activity
The three fundamental economic questions are solved
by theprice mechanism(through demand and supply)
Adam Smith and Invisible Hand
Perfectly competitive market
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Command Economy
Also known as Centralized economy The determination of What, How, For Whomgoods &
services are produced is done by
a dictator or
a planning committee appointed by the dictator or
using a hierarchical organizational structure
State owns all the productive resourceslike land,
factories, financial institutions, etc
Authoritarian methods are used to determine resource
use and prices
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Mixed Economy
Most of the world economies use a mix of both
market and command systems
The government modifies (through taxes, subsidies,etc.) and in some cases replaces (through direct control
of resources) the operation of price mechanism
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EconomicsA Social
Science
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Economics as a Social Science
What differentiate economists from other socialscientists?
Economic analysis is based on certain presupposition
about human behavior Tries to understand why the world is what it is
Example (propositions enabling Law of Demand):
People prefer more to fewer;people seek to maximize welfare by making reasonable and
consistent choices
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Developing Economic Theories
The real world of economic is very complex, therefore,economists turn to theory
A theoryis a set of abstractions about the real world
Economic theories are simplified models abstractedfrom the complexity of the real world
Tries to explainobserved behavior and make
predictionsabout the future
Assumption of Ceteris paribus (other things remain the
same)
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Positive and
Normative Economics
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Positive Economics
The scientific study of what is, what was and whatwill bethe economic relationships
Explanation and prediction (deals with actual
observed phenomena); can be proven right or wrong.
Example:
The inflation rate rises when the money supply is increased
What will be the impact of an import quota on foreign cars?
What will be the impact of an increase in the gasoline excisetax?
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Normative Economics
What oughtto be (deals with opinions andrecommendations); reflects value judgments.
Normative statements reflect subjective values. They
cannotbe proved true or false.
Example:
The inflation rate should be lower.
The two can be hard to disentangle.
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Common Mistakes
Pitfalls to Avoidin Economic Thinking
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Violation of the ceteris paribuscondition. Ceteris paribusis a Latin term meaning other things
constant.
When describing the effect of a change, the outcomemay be influenced by changes in other things.
Three Pitfalls
Association is not causation.
Statistical associationalone cannot establish
causation.
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Thefallacy of compositionis the erroneous view
that what is true for the individual (or the part)is
also be true for the group (or the whole).
Microeconomicsfocuses on narrowly defined units,
while macroeconomicsis focused on highly
aggregated units.
One must beware of the fallacy of composition when
shifting from micro-to macro-units.
Fallacy of composition
Three Pitfalls
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Microeconomics
andMacroeconomics
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Microeconomics and Macroeconomics
Microeconomics is the study of economics at the levelof the individual economic entity
Examples: the behavior of individual consumer,
individual firm, etc.
Macroeconomics deals with the sum of the behaviour
of all economic entities together (the economy as a
whole or about economic aggregates)
Examples: Study of national income (GDP),
employment, Inflation (price level), etc.
T.J. Joseph 26
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Micro Vs. Macro
Microeconomics
Studies the economy at the level of individual
consumers, workers, firms, goods, and markets
Macroeconomics
Studies the economy at the aggregate level, at the
level of the economy as a whole.
Examines total consumer behavior, total
employment, total production, total sales, etc.
27
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Basic Concepts
Opportunity cost: the value of the highest-valued
alternative that must be forgone when a choice is
made. It is the evaluation of a trade-off.
Marginal benefits and costs: the benefits and
(opportunity) costs associated with one additional
unit of the good.
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Decision Making
Decision-making is the main job of management It involves evaluating various alternatives and
choosing the best among them
Decision making is done at the margin
Decision makers evaluate a fixed array of
alternatives.
Decision makers compare the marginal costs to
marginal benefits to determine the best alternative
This is economic decision making.
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Questions for Thought
1. Which of the fo l lowing are posi t ive econom icstatements and which are normat ive?
(a) The speed l im it should be lowered to 55 m iles per
hour on interstate highways to reduce the number
of deaths and accidents
(b) Higher gaso l ine prices cause the quanti ty o f
gasol ine that con sum ers buy to inc rease.
(c) A compar ison of costs and benef its shou ld not beused to assess environmental regu lat ions .
(d) Taxes on alcohol resul t in less d r inking and dr iv ing.
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Questions for Thought
1. Suppose Am y is a doctor who has reco rds that need to
be entered. Doing th is wo rk hersel f wou ld take 10
hours per week. She is contemp lat ing hir ing an
assistant cou ld do the same work in 40 hou rs. If Am y
can make $80 per hour seeing patients, shou ld she
hire the assistant at $10 an hou r?
2. Do you make the food that you consume and the
clo th ing you wear for you r self? Would modern l iv ing
standards be possib le withou t trade?
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References
1. Dom inick Salvatore (DS): Principles of
Microeconomics, 5th edn., Oxford Higher Education.2. Chapters 1 and 2 in Wil l iam Boyes and Michael Melvin
(2009), Textbook of Economics, 6thedit ion, Biztantrapubl icat ions.
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