The Economic Way of Thinking People choose for good reasons. Everything has a cost. Incentives matter. People create economic systems to influence choices and incentives. People gain from voluntary trade. Economic thinking is marginal thinking. The value of a good or service is affected by people’s choices. Economic actions create secondary effects. The test of a theory is its ability to predict correctly.

Limits, Alternatives, and Choices Chapter 1 Limits, Alternatives, and Choices

Microeconomics vs. Macroeconomics Micro – part of economics concerned with individual units such as firms and consumers. (The view from Main Street) Macro – part of economics concerned with the economy as a whole. (The view from the space shuttle)

Economics is… The study of how people satisfy their needs and wants by making choices under conditions of scarcity.

Scarcity and Choice Resources are limited – as a society and as individuals we must make choices

Opportunity Costs & Trade-offs The amount of other products/services which must be forgone or sacrificed to obtain a unit of product/service “There is no such thing as a free lunch” NFL or TANSTAAFL

Rational Behavior In Economics we assume individuals act out of self interest Consumers want to maximize utility. Utility is a measure of the satisfaction or pleasure a consumer obtains from the consumption of a good or service Firms want to maximize profits.

Marginal Analysis  Economists measure the effects of unit changes, asking “what’s one unit more?” (Incremental thinking) Marginal Cost – the cost of producing one additional unit of a product Law of Diminishing Marginal Utility—the satisfaction of consumption declines (eventually)

Other Things Equal Assumption “ceteris paribus” Economic models examine two variables. Everything else is constant Dependent and Independent variables Think cause & effect! Price & Quantity or Income & Consumption Which is the dependent variable?

Correlation Dependable association between two variables Correlation does not always indicate causation!! X increases, Y increases, X may not cause Y although there may be a correlation X = educational level, Y = income, X may not cause Y

“The Economizing Problem” 1) Resources are limited (scarce) 2) Wants are unlimited (insatiable) The study of economics will begin to explain how this problem is resolved or minimized…

Resource Categories (Resources are also called “factors of production” or “factors” 1. Land – all natural resources “gifts of nature” arable land, forests, oil, etc. 2. Labor— “human capital” 3. Capital – manufactured aids to production i.e. tools, machinery, factories, trucks, technology (Money is not considered a capital resource!)

Resources (cont.) Capital goods vs. Consumer goods Consumer goods satisfy human wants directly while capital goods aid in the production of consumer goods and other capital goods 4. Entrepreneurial Ability –four factors separate the entrepreneur from traditional labor: takes the initiative makes policy decisions source of innovation risk bearer – no guarantee of profit

Investment refers to the purchase of capital goods. i. e Investment refers to the purchase of capital goods. i.e. “Investment in plant and equipment” 1) Property Resources: land and capital 2) Human Resources: labor and entrepreneurial ability

Production Possibilities Curve Model There are four assumptions in this model 1. Full Employment 2. Fixed Resources 3. Fixed Technology 4. Two Goods

Production Possibilities Table Possible combinations of coconuts and fish utilizing all available, known resources A B C D E Coconuts 0 20 25 28 30 Fish 40 30 20 10 0 At any point in time, a full employment/full production economy must sacrifice some of product X to get more of product Y

Production Possibilities Curve Graph Producing outside the curve is infeasible. Producing inside the curve is feasible but undesirable or not optimal. Producing ON the curve is productively efficient, not necessarily allocatively efficient (lots more on that in micro!)

Law of Increasing Opportunity Costs As production of a particular good increases, the opportunity cost of producing an additional unit also increases. Rationale: Resources are not completely adaptable to alternative uses. This explains why the curve is concave to the origin (bows out from the origin)

Optimal Allocation: MB=MC What combination of coconuts and fish should be produced?...it depends on society’s desires and values. Optimal output occurs where marginal cost = marginal benefit. General rule: as output increases, MB declines while MC increases… Graph

Economic Growth and PPC The growth of economic capacity can be depicted as an outward shift in PPC. Increases in resource supplies and improvements in technology are two factors that enable a PPC to shift outward. PPC may also contract (war, natural disaster)

Present Choices Impact the Future A production alternative favoring capital goods will enable the economy to grow more in the future as compared to an alternative favoring consumer goods.

All market economies have three primary goals Economic Goals All market economies have three primary goals

Economic Growth Measured as a percentage increase in Gross Domestic Product (GDP) GDP measures the total value of all final goods and services produced within the US C+I+G+XN Recession – defined by the National Bureau of Economic Research as “a significant decline in economic activity lasting more than a few months normally visible in real GDP”

Full Employment Jobs for all willing and able to work There will always be some unemployment The current unemployment rate is . . .

Price Level Stability Policy makers want to control inflation The most common measure used to gauge inflation is the Consumer Price Index (CPI), which measures a market basket of goods and services

Fiscal and Monetary Policy are used to achieve the goals of economic growth, full employment, and price level stability

Fiscal Policy Changes in taxes and/or government spending in order to influence the economy Enacted through Congress and President

Monetary Policy Actions of the Federal Reserve which alter interest rates (fed funds rate) and influence the economy Decreasing interest rates are intended to stimulate economic growth and employment while increasing rates are used to control inflation

Other generally accepted goals include Economic Efficiency Economic Freedom Economic Security