Introduction to Economics

The Field of Economics Given the fact of scarcity of resources, economic systems resolve 3 basic issues: What should be produced? How should it be produced? Who gets to consume what is produced? Different economic systems answer this differently Capitalism, Communism, Socialism, Mixed, Traditional

Economics is a framework for thinking about these problems. Characteristics of this framework include Statistics rather than anecdotes Belief in trade-offs (opportunity cost) Incentives and self-interest as motivators Prices do not reflect morality but interactions between buyers and sellers (supply and demand)

Branches of Economics Microeconomics is the study of how households and firms make decisions in goods, labor, and capital markets and the study of how and why those markets sometimes fail. Macroeconomics takes an overall view of the economy, focusing on policies with regard to such issues as unemployment, inflation, economic growth, and the balance of trade and how the policies of governments can affect outcomes in a global economy.

Division of Labor Concept illustrated by the founder of systematic study of economics, and father of modern capitalism (I don’t really have to tell you his name, do I?) Pin factory I, Pencil Increases productivity through specialization People specialize in what they produce and trade for what they need Decentralized economy – Why don’t you worry, that, without a central organizing force, we still have food in the supermarket?

Supply and Demand 1. Describe the three markets in terms of what is provided to whom. Think of examples in each case. 2. Thinking ahead: Define “capital” and what it is used for

Prices Have nothing to do with fairness or justice Outcome of supply and demand

Demand Demand is a relationship between quantity demanded and any given price. Demand curves slope down, which shows that quantity demanded tends to fall as price rises. Demand is not the same as quantity demanded. Demand is a relationship between quantity demanded and the range of possible prices; quantity demanded refers to a specific amount demanded at a certain price. Demand for a certain good can shift for a variety of reasons: changes in income, population, tastes, or prices of complement or substitute goods.

Supply Supply is the relationship between quantity supplied and any given price. Supply curves slope up, which means that quantity supplied tends to increase as price rises. Supply is not the same as quantity supplied. Supply is a relationship between quantity supplied and the range of possible prices; quantity supplied refers to a specific amount supplied at a certain price.

2008: Some basic ideas to understand about the financial capital market Households/individuals invest money for education, retirement, house, car, etc. Role of interest Investment vehicles: note definitions, relative liquidity, level of risk, and what is done with the money invested Savings account Money market funds CDs Bonds Stocks Mutual funds

US lives beyond its means Readily available foreign capital makes it easy for banks to lend money Mortgages Installment loans (cars, vacations, snowmobiles, etc.) Credit card debt increases Federal government runs large deficits financed in large part by foreign funds ie. China paid for the tax rebate in Spring 2008

Sub-prime mortgage crisis How do banks determine credit worthiness and credit risk? What are sub-prime borrowers? What is the relationship between interest rate and credit worthiness? What happens to price when demand increases?

Why did so many sub-prime borrowers default on their loans? Facts about mortgages Down payments Term Interest rate Fixed Variable Effects of inflation Oil – supply and demand

What happened to the banks that loaned to subprime borrowers? Foreclosures and their impact Impact of confidence on supply and demand for mortgage backed securities Decline in liquidity Value of bank assets decreases (DRAMATICALLY), so called illiquid assets Bankruptcies and insolvencies BearStearns, Fannie Mae, Freddie Mac, Lehman Brothers, et al.

Looking over the abyss Mutual funds “break the buck” – traditionally safe – but actually lose – run on the bank – more bank closures and capital evaporates Paper securities used by everyone (like ServiceMaster and other companies) for overnight loans are no longer available banks don’t have the capital to lend -- OUR FINANCIAL SYSTEM WAS ON THE VERGE OF A TOTAL STANDSTILL hp?storyId= hp?storyId=

The $700 Billion Policy Question Would people begin to lend again, and how soon, without the bailout? What kind of regulation is needed? Who is involved in making the aforementioned decisions? Who is responsible for the implementation of those decisions?