EC111 Introduction to Economics

Announcements:

Course materials for Ec111:

http://orb.essex.ac.uk/EC/EC111

You should read/should have attended the introductory presentation.

Read the course outline if you have not done so already.

Exercise 1 -- posted on website and due next week in class

Advanced Class – 12-1 Mondays, 6.126A. Start next week; not all weeks

Lecture1: Introduction to MicroeconomicStudy, Basic Concepts, and Tools

Reading: Ch 1, Ch 28, 633-641 Begg et al

or…

Ch 1, Ch 24 pp. 672-677 Sloman and Wride,

and… Ec 111 lecture 1 notes (on website)

Outline

Microeconomic Study: The Sources of Well-Being

Material Well-Being:

Production: Production Potential, Production Choices and the Role of Resources Trade: Gains from Trade and Gains from Specialisation Market Incentives and Allocation Methods

Microeconomic Study (1)

Suppose we wish to fulfill human wants. These are potentially unlimited…

…but the resources to fulfill them are scarce: human wants often exceed our capacity to meet them.

Because of scarcity, choices must be made among alternative plans to meet wants.

Microeconomic Study (2)

What sort of plans might we consider? One would be a production plan.

• what goods and services to produce• how to produce them • for whom to produce them

Microeconomic Study (3)

To make such decisions we need a framework to represent production, scarcity and what we sacrifice when we choose particular production plans. We introduce tools to partially address issues of concern:

Production Possibility FrontiersOpportunity CostResource Constraints

Food output

A

Clot

hing

Out

put

14

14

Production possibility frontier

The production possibility frontier

This tells us the maximum amount the economy can produce using all available resources.

B

Food output

C

Clot

hing

out

put

1

14

An Example of a PPF (4)

The opportunity cost of food in terms of clothing is lower for red than for blue, so red has a comparative advantage in producing food.

Blue has a comparative advantage in producing clothing.

100

50

50

100

Food output

C

Clot

hing

out

put

1

14

An Example of a PPF (5)

Blue now has an absolute advantage in producing clothing and food…

But red still has the comparative advantage in producing food!

100

25

50

100

Microeconomic Study (5)

So we know that production and trade can both potentially contribute to fulfilling wants with our limited resources. But how could trade be organised and implemented? How could we implement production plans? For this we need new tools:

Market EconomiesCommand EconomiesMixed Economies

Markets can be central to economies

• Markets are the means by which … households’ decisions about consumption of

alternative goodsfirms’ decisions about what and how to

produceand workers’ decisions about how much and

for whom to work• … These can all be reconciled and incentivised

by the adjustment of prices in free markets.

Allocation is through decentralised decision- making.

The command economy• Is an alternative to the market economy

• A government planning office decides: what will be produced, how it will be produced, for whom it will be produced.

• Detailed instructions are then issued to households, firms and workers. Incentives are rewards and

sanctions for not fulfilling plans. Allocation is directly controlled.

The invisible hand

Adam Smith in the Wealth of Nations (1776) argued that individuals pursuing their self-interest would be led ‘as by an invisible hand’ to do things that are in the interests of society as a whole.

The command economy has been used in a variety of contexts (Incas in 16th century, US in wartime, Soviet Union), although it tends to bea temporary measure. See works of Grossman, 1960s.

Market vs. CommandCommand economies perform well if well-being requires that individuals take more than self-interest into account.

For example, a market economy may not result in equal distribution of wealth. A market economy may notlimit pollution. Market economies do well at aggregating information and providing incentives.

For example, a market economy may respond quickly tochanging consumer tastes for a new electronic device.

A mixed economy

• In a mixed economy the government and private sector jointly solve economic problems.

• The government influences decisions through taxation, subsidies, and provision of free services such as defense and the police.

• It also regulates the extent to which individuals may pursue their own self-interest.

• Incentives are modified through modification of the price system. Allocation is both direct and through this modified set of prices.

UK

USAChina

Cuba

Commandeconomy

Freemarketeconomy

Hungary

Sweden

Market orientation

Microeconomic Study (7)

Hence, there are many ways to implement the production and trading plans we design.

This course will study a variety of market structures as well as the tools to analyse production and trading plans.

We will use models to do this – deliberate simplifications of reality – to focus on core concepts that you will develop in future courses.

Positive and normative• Positive economics studies objective

or scientific (testable) observations about how the economy works. (“GDP has increased”; “Exports have risen because exchange rates have been favourable”)

• Normative economics offers recommendations based on (non-testable) value judgments. (“We should tax the rich more than the poor”; “Exports should rise”)

Microeconomics

• Microeconomics is concerned with choices and behaviour of individual economic units, whether consumers, firms, households, or industries.

Macroeconomics

• Macroeconomics studies economic aggregates, their behaviour and movements (such as inflation, aggregate output, employment)

Well Being

Material Well Being

Production

Resources

Markets

Limits, potential

Potential, choices Gains from trade

specialisation

Regulation

Incentives, allocations