what is Economics

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Thinking Like an Economist

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Thinking Like an Economist

Economists: – People who specialize in economics– People who have extensive knowledge in

economics– http://nobelprize.org/nobel_prizes/economics/

laureates/

Economics:– Subject about the economy

Economy:– A system that coordinates economic activities

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Core Economic Activities

Production:–Transforming inputs into outputs–Using resources to get products

Inputs (resources): L, K, N, etcOutput (products): goods and

servicesTechnology: the body of knowledge

and techniques used in the process of transforming inputs into outputs

Scarcity:The basis of all economic problems

Goal: – satisfy human needs and wants

• Unlimited

Means: resources– L, K, N, E

• Limited

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Principle of Scarcity

Scarcity: resources available are not enough to satisfy all human needs and wants

Since we have boundless needs and wants, but the resources available to us are limited, or the resources are not enough relative to our needs and wants. Therefore, having more of a good thing usually means having less of another.

When getting something good, there is always sacrifices involved.

Final Purpose of Production

To satisfy consumer desires (needs and wants): – To create what people want– To get what people want to the people who

want them– To get what people want to who want them

when they want them

Economics: Redefined

Economics is the subject that studies how to allocate and utilize the limited resources to produce goods and services that best satisfy the various, unlimited, competing human desires

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What to Do under Scarcity?

Having more of a good thing means having less of another– Choose

How to make choices?– Compare cost and benefit of having more

of a good thing Cost-benefit analysis: compare the

extra cost to the extra benefit of taking an action

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Principles of Cost-Benefit Analysis Compare marginal cost to marginal benefit:

– If MC < MB, should take the action– If MC > MB, should not take the action

Not to compare average cost to average benefit Higher average benefit does not mean higher extra benefit Marginal cost / benefit:

the increase in total cost / benefit that results from taking one additional unit of an activity

The additional cost incurred / benefit gained when taking one more unit of an activity

The extra cost / benefit from taking an action Average cost / benefit:

The total cost / benefit of undertaking N units of an activity divided by N

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Principles of Cost-Benefit Analysis

Should consider opportunity cost (example 1.3)– The value of the next-best alternative that has to

be forgone in order to take an activity– the value of the next best alternative sacrificed– the value of what must be given up to get what

you decide to have– The implicit value of the activity that did not

happen• The Value of best alternative, not combined value

of all alternative• “The dog that did not bark in the night ”

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Principles of Cost-Benefit Analysis

Should not consider sunk cost (example 1.4)– A cost that is beyond recovery at the time

when a decision must be made– Irrelevant to the decision of whether or not

to take an action• The only costs to consider when making a

decision about whether or not to take an action are those that we can avoid by taking no action

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Recap: Cost-Benefit Principle

Economic Surplus: – The benefit of taking an action minus the

cost of taking the action Cost-benefit analysis:

– An action should be taken if and only if the extra (marginal) benefit of taking the action is at least as great as the extra (marginal) cost of taking the action

– An action should be taken if and only if the economic surplus is non-negative

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Economist: specializes in Economics

Economics: – A study of mankind in the ordinary

business of life– How to use limited resources to satisfy

needs and wants as many and best as possible

• mainly concerned with ordinary things• not the body of concrete truth• a way of thinking• an engine for the discovery of concrete truth.

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Economics: a science of decision-making

Economic activities require decision making

Decision making because choices have to be made

Choices because resources are scarce relative to human needs and wants

(Scarcity Principle)

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Choices to make: what and how many

– Should I spend the money on a movie or on a dinner?

– Should the firm product chips for handphone or for computer?

– Should the country encourage more investment or more consumption?

How

– How goods and services are produced?

– How does the economic system work?

– When and why economic system does not work?

– When do people become counterproductive?

For whom

– How should the results of economic growth be distributed?How should the results of economic growth be distributed?

……

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Basic Fields of Economics:Macro vs. Micro

Macroeconomics: – overall ups and downs of the national economy

• GDP, growth, inflation, unemployment,• International trade. International finance• Monetary policies, fiscal policies•…

Microeconomics: – how individuals make decisions and how these

decisions interact• individual consumers and producers as decision

makers• single products• single market•…

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Microeconomics

Individual decisions about what to do and what not to do.

Decisions about production and consumption made by

individual firms and consumers (market economy)

How individuals’ pursuit of self interest leads to good

results as a whole (the invisible hand).

Market usually leads to efficiency, but not necessarily

equity.

When market fails, it calls for government interventions.

Proper “incentives” may help reach society’s goals.

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Homework

Exercise 1.6, P. 18 (Optional, extra credit)– In 500 words or less, use cost-benefit analysis to

explain some pattern of events or behavior you have observed in your own environment.

– Due Monday, 3/8/2010 Reading: REQUIRED

– Chapter 1: Thinking Like an Economist– Appendix to Chapter 1: Working with Equations,

Graphs, and Tables– Chapter 2: Comparative Advantage: the Basis for

Exchange