ECON 2313: Fall Semester, 2008Welcome!

Economics is the studyof how individuals and

societies allocatescarce resources amongcompeting alternative

ends

Available resources are insufficient to satisfy wants.

We cannot produce enough goods and services to satisfy

everyone—we don’t have the resources!

What to produce?

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.

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

The production of goods and services

is impossible without economic

resources or factors of production

Economic Resources

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.

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

Income received by owners of economic resources

• Rent: Income paid for the use of land.• Wages (and salaries): income paid for the

services of labor.• Interest: income paid for the use of

capital.• Profit (or loss): Income earned by an

entrepreneur for running a business.

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Goods and Services

• Good: see, feel, touch• Service: intangible• Scarce good/service

– The amount people desire exceeds the amount available at a zero price

• Choice– Give up some goods and services

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Goods and Bads

• Bads– We want none of them; not even at a zero price

• Free goods and services• “There is no such thing as a free lunch”

– Involve a cost to someone

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Economic Decision Makers

• Households– Consumers

• Demand goods and services– Resource owners

• Supply resources

• Firms, Governments, Rest of the World – Demand resources– Produce goods and services

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Markets

• Bring together buyers and sellers• Determine price and quantity• Product markets

– Goods and services• Resource markets

– Resources

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A Simple Circular-Flow Model

• Flow of – Resources– Products– Income– Revenue

• Among economic decision makers

• Interaction– Households– Firms

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Exhibit 1The simple circular-flow model for households and firms

Households - Supply resources to resource market; earn income - Demand goods and services from product market; spend income

Firms - Demand resources to produce goods and services; payment for resources - Supply goods and services to product market; earn revenue

The Art and Science

of EconomicsEconomists assume that economic

decision-makers are rational and engage

in “maximizing” behavior

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Choice Requires Time and Information

• Time and information – scarce; valuable• Rational decision makers

– Willing to pay for information• Improve choices

– Acquire information:• Additional benefit expected exceeds the additional cost

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Economic Analysis Is Marginal Analysis

• Expected marginal benefit• Expected marginal cost• Marginal

– Incremental, additional, extra• Rational decision maker:

– Change the status quo if expected marginal benefit exceeds expected marginal cost

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Microeconomics and Macroeconomics

• Microeconomics– Individual economic choices– Markets coordinate the choices of economic

decision makers– Individual pieces of the puzzle

• Macroeconomics– Performance of the economy as a whole– Big picture

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

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 rise in interest rates is likely to depress housing construction.

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

It’s unfair to ask a person

to live on $6.55 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.

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The Scientific Method: Step by Step

1. Identify the Question and Define Relevant Variables

2. Specify Assumptions

or

3. Formulate a hypothesis

4. Test the hypothesis

Reject the hypothesis

Use the hypothesis until a better one shows up

Modify Approach

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

• Association-is-causation fallacy

• Fallacy of composition

• Ignoring secondary effects

Correlation versus Causation

Correlation is the tendency for the values of two variable 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?

• 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

Secondary effectsThe imposition of a luxury tax in 1990 (for items priced $100,000 or more was blamed for destroying jobs in the yacht-building industry.