© 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1 st ed. CHAPTER 1: Economics: Foundations and Models 1 of 28 Economics: Foundations and Models We use microeconomics to answer questions such as the following: “How are the prices of goods and services determined?” “How does pollution affect the economy, and how should government policy deal with these effects?” “Why do firms engage in international trade, and how do government policies affect international trade?” “Why does government control the prices of some goods and services, and what are the effects of those controls?”

© 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1 st ed. CHAPTER 1: Economics: Foundations and Models 2 of 28 Economics: Foundations and Models Scarcity A situation in which unlimited wants exceed the limited resources available to fulfill those wants. Economics The study of the choices people make to attain their goals, given their scarce resources. Economic model A simplified version of reality used to analyze real-world economic situations.

© 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1 st ed. CHAPTER 1: Economics: Foundations and Models 3 of 28 Microeconomics and Macroeconomics LEARNING OBJECTIVE 4 Microeconomics The study of how households and businesses make choices, how they interact in markets, and how the government attempts to influence their choices. Macroeconomics The study of the economy as a whole, including topics such as inflation, unemployment, and economic growth.

© 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1 st ed. CHAPTER 1: Economics: Foundations and Models 4 of 28 Microeconomics How do the decisions of individual consumers and producers, through the interaction of consumers, producers, and government in markets, determine the prices and quantities sold of goods and services as well as the material well-being of Society in general (“Social Welfare” or Economic Surplus)?

© 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1 st ed. CHAPTER 1: Economics: Foundations and Models 5 of 28 Why Study Microeconomics? It’s useful for Business Decisions Personal Decisions Political Decisions It pays Economics majors end up making more money on average relative to many other majors

© 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1 st ed. CHAPTER 1: Economics: Foundations and Models 6 of 28 Occupations of Economics Majors 20% Managers & Administrators 16% Sales or sales supervisors 8.5% Financial managers or officers 5% Accountants & Auditors 3% Engineering & Computer Systems 1.3% Teachers 46% Other

© 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1 st ed. CHAPTER 1: Economics: Foundations and Models 2008 Average Starting Salaries MajorSalary Computer Science$56,921 Engineering$56,336 Economics$52,926 Nursing$52,129 Chemistry$52,125 Finance$48,795 Accounting$47,413 Bus. Admin./Management$43,823 Political Science$43,594 Marketing$43,459 Liberal Arts$33,258 Source: MSN Careersmsn.careerbuilder.com 7 of 28

© 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1 st ed. CHAPTER 1: Economics: Foundations and Models 2009 Census Survey: Median Salaries MajorMedian Salary Engineering$75,000 Computer Science$75,000 Business Economics (BBA)$75,000 Highest Bus Major Economics (BA/BS)$70,000 Highest Soc. Sci. Finance$65,000 Accounting$63,000 Nursing$60,000 Political Science$59,000 Chemistry$58,000 Bus. Admin./Management$58,000 Marketing$58,000 Liberal Arts$45,000 Source: Chronicle of Higher Education edian-Earnings-by-Major and/ of 28

© 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1 st ed. CHAPTER 1: Economics: Foundations and Models 9 of 28 Success of Economics Majors with Higher Degrees Among MBA Degree holders, undergraduate Economics majors realize the same or higher wages than all other undergraduate majors Among Law Degree holders, Economics majors realize the same or higher wages than majors in Criminology, Business (including Finance and Accounting), Social Sciences, and Humanities

© 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1 st ed. CHAPTER 1: Economics: Foundations and Models 10 of 28 Building a Foundation: Economics and Individual Decisions LEARNING OBJECTIVE 1 Market An arrangement or institution that brings together buyers and sellers of a good or service. Marginal analysis Analysis that involves comparing marginal benefits and marginal costs. Three important ideas:  People are rational  People respond to economic incentives  Optimal decisions are made at the margin

© 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1 st ed. CHAPTER 1: Economics: Foundations and Models 11 of 28 The Economic Problem That Every Society Must Solve Centrally planned economy An economy in which the government decides how economic resources will be allocated. Market economy An economy in which the decisions of households and firms interacting in markets allocate economic resources. Centrally Planned Economies versus Market Economies Mixed economy An economy in which most economic decisions result from the interaction of buyers and sellers in markets, but where the government plays a significant role in the allocation of resources.

© 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1 st ed. CHAPTER 1: Economics: Foundations and Models 12 of 28 The Modern “Mixed” Economy Productive efficiency Occurs when a good or service is produced at the lowest possible cost. Allocative efficiency A state of the economy in which production reflects consumer preferences; in particular, every good or service is produced up to the point where the last unit provides a marginal benefit to consumers equal to the marginal cost of producing it. Voluntary exchange The situation that occurs in markets when both the buyer and seller of a product are made better off by the transaction. Equity The fair distribution of economic benefits. Efficiency and Equity There is often a trade-off between efficiency and equity.

© 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1 st ed. CHAPTER 1: Economics: Foundations and Models 13 of 28 Economic Models LEARNING OBJECTIVE 3 Economic model A simplified version of some aspect of economic life used to analyze an economic issue. To develop a model, economists generally follow these steps: 1.Decide on the assumptions to be used in developing the model. 2.Formulate a testable hypothesis. 3.Use economic data to test the hypothesis. 4.Revise the model if it fails to explain properly the economic data. 5.Retain the revised model to help answer similar economic questions in the future. Economic variable Something measurable that can have different values, such as the wages of software programmers. The process of developing models, testing hypotheses, and revising models is often referred to as the scientific method, which economics applies to the study of the interactions among individuals.

© 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1 st ed. CHAPTER 1: Economics: Foundations and Models 14 of 28 Positive analysis Analysis concerned with what is. Normative analysis Analysis concerned with what ought to be. Normative and Positive Analysis Economics as a Social Science Because economics studies the actions of individuals, it is a social science. Economics is therefore similar to other social science disciplines, such as psychology, political science, and sociology. As a social science, economics considers human behavior—particularly decision-making behavior—in every context, not just in the context of business. Economics is primarily about positive analysis, which measures the costs and benefits of different courses of action.

© 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1 st ed. CHAPTER 1: Economics: Foundations and Models 15 of 28 Your Questions – Fall 2012 We’re likely to cover: Insourcing/Outsourcing How businesses make money Stocks/stock market Gas Prices & OPEC Why does the U.S. not produce more goods? How business makes corporate-level decisions Taxes and prices Monopolies International Trade Positive government policies Oligopoly Not likely to cover: Why is the U.S. so deep in debt? Recession U. S. Economy How an economic crisis occurs and what can be done about it Inflation/Deflation Dot-com bubble

© 2006 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien—1 st ed. CHAPTER 1: Economics: Foundations and Models 16 of 28 Your Questions – Fall 2011 We’re likely to cover: Trade & Developing Countries Stocks/stock market Gas Prices Are Wal-Mart & Target an oligopoly? Why prices change Supply & Demand Competitive markets Lottery scholarships Micro v. Macroeconomics Not likely to cover: 3 rd party payment sys Politicians & the economy Inflation/Deflation Recent recession Total wealth of the planet U.S. budget deficit/cuts Global monetary standard Value of money (€ v. $) GDP changes & jobs S&P rating of U.S. bonds U.S. debt crisis/ceiling Repackaging of loans