Introduction to Economics 1

Outline I. What is Economics A. Formal Definition B. Informal Definition 2

Outline (Cont.) II. How Do Economists Think? A. Scarcity 1. Goods 2. Utility 3. Resources 4. Rationing Device B. Opportunity Cost C. Decisions Made “At The Margin” D. Incentives 3

Outline (Cont.) III. Scientific Thinking IV. Types of Economics A. Fallacy of Composition B. Association vs. Causation C. Ceteris Paribus IV. Types of Economics A. Positive/Normative B. Macro/Micro 4

What is economics? Economics is the study of how to allocate scarce resources among competing needs. What does that mean? 5

Less Formally... There is not enough of everything that people want (and need) to go around. Some people will get things and others will not. That is a fact. The question is then, how do we determine who gets what. 6

How Do Economists Think - Scarcity and Goods Scarcity is at the heart of economics. If there were no scarcity, there would be no need for economics. Scarcity refers to the condition that arises because society does not have enough resources to produce or that there is a limited quantity of almost all the things people would like to have. These things are called goods. Goods are any items that are desired by people. Most goods are available in scarce quantities. 7

The Economic Questions What to Produce? How to Produce? For Whom to Produce?

How Do Economists Think - Utility and Rationality Economists assume that people act to maximize their own happiness This does not mean people are greedy - some people get happiness from others happiness This happiness that economists assume people maximize is called utility We also assume all people act rationally 8

How Do Economists Think - Resources The reason that there is scarcity of goods (and services) is that there is scarcity of resources that are used to make goods. Resources are all the raw elements that go into the production of a good or service. 9

Four Resources or Factors of Production Land - Natural Resources (raw materials) Labor - Skills of People Capital - Goods Used To Make Other Goods (not money) Entrepreneurs – Risk takers who start new businesses or bring in new products in search for profits. 10

How Do Economists Think - Rationing Device Since there are scarce resources and consequently scarce goods, how do we decide who gets what? A rationing device is a process by which we determine who gets what. It could be coupons, a line, height, or alphabetical order. What is the rationing device for most goods in the U.S. economy? -Price 11

There is no such thing as a free lunch! TINSTAAFL There is no such thing as a free lunch! What does this mean?

Trade Offs Making choices of how to spend money or time. You cannot have everything, so what is the best value.

Opportunity Cost Opportunity Cost is the next best alternative forgone when using a resource So your opportunity cost of seeing a movie might be studying or going on a date or maybe reading a book. But not all 3 -- only the one you value next best. 12

Decisions Made at “The Margin” An economist is always thinking dynamically. Asking themselves “what next?” Much like the Zen philosophy of not thinking about what is already done, but rather what lies ahead. 13

Incentives Economists always think about incentives. They believe that people respond to incentives - that they weigh the costs and benefits rationally. 14

Incentives - Example For instance, it is no surprise to economists that when some high schools attempted to improve the quality of teaching by rewarding teachers whose students scored high on proficiency tests that the teachers ended up teaching how to score well on the test instead of the material. 15

Scientific Reasoning, Tools, and Mistakes Sometimes you will see experts coming to scientific conclusions that may be flawed. You have to keep your eyes open to some common scientific mistakes made by everyone (including some economists!) 16

Scientific Reasoning The Fallacy of Composition: What is true for one is not always true for the whole. (Example: If there are 4 gas stations on each corner of an intersection and one lowers their price they will get a lot of new business. Does this mean that they will all get a lot of new business if they all lower their price?) 17

Scientific Reasoning (Cont.) Association vs. Causation: Just because one thing occurs before (or is somehow associated) another does not mean that it caused it. (Example: Doctors recently found that people who ate about a dozen hot dogs a week had a higher incidence of cancer. Does that mean that eating hot dogs caused cancer? Do you think that people who have a diet of 12+ hot dogs a week may do other things to jeopardize their health?) 18

Scientific Reasoning (Cont.) Ceteris Paribus: This is not a common mistake, but rather a tool of scientific reasoning that we will use OFTEN. It it Latin for “all things equal” and it means that we are to assume that nothing in the world changes. 19

Scientific Reasoning (Cont.) For example, I might say “Ceteris Paribus, if CDs get cheaper in the future people will buy more.” Meaning that if the only thing in the world that changes is the price of CDs, people will buy more. 20

Scientific Reasoning (Cont.) But what if the only CDs for sale in the future are Kermit and Miss Piggy’s Christmas Classics? Or what if we all lose our jobs in the future and have no income? We can’t account for that, so if we want to make a clear concise point about the relationship between things, it is easier to assume that nothing else changes. 21

Types of Economics Positive - The economics of what is. This is descriptive of fact and theory without opinion. Normative - The economics of what should be. This is economics where one’s opinion is offered. We will try to study more positive economics, but you will find that it is not so easy to avoid offering an opinion. 22

Types of Economics Microeconomics - Studies the behavior of individual people and firms. Macroeconomics - Studies the behavior of entire economies as a whole. 23