Fundamental Economic Concepts

What is Economics? - The study of mankind’s unlimited desires in a world of limited resources. - Economics is a social science, dealing with how people react to changing variables. -Economists form theories, based on economic models in which they manipulate variables. -These theories, models and variables are used to describe what is (Positive Economics) and what ought to be (Normative Economics). Microeconomics deals with individual decisions, Macroeconomics looks at the economy as a whole

What is the Economy?

Why Do We Study It? 1. Description 2. Analysis 3. Explanation 4. Prediction What? or How Much? How? or Why? When? OR…

Why do we study Economics? So we don’t get screwed.

Book Auction What economic concepts were demonstrated by the book auction? ◦ Scarcity ◦ Value ◦ Choices ◦ Rationing ◦ Equity vs. Efficiency  Which was the sealed auction? ◦ Consumer surplus } Stay Tuned!

Scarcity Situation that occurs when wants are greater than available resources. Scarcity is the fundamental problem in economics.

In this classroom, is/are _________ scarce? Desks? Water? Books? Gasoline? Jolly Ranchers? … Good looking economics instructors? But not in the hallway… Wants are satisfied by available resources No want for it in classroom, but outside… yes Wants exceed available resources

Good looking economics instructors?

We always assume…. People make decisions based upon RATIONAL SELF-INTEREST

We must consider… Examples: Shelter is a need, a mansion is a want. Food is a need, a large pizza is a want.

Scarcity forces us to ask the following questions… WHAT to produce? HOW to produce? FOR WHOM to produce?

Imagine a scenario where… …we take an all-expenses- paid class trip to…

Australia!

Our plane is forced to make a “water landing,” and we are able to swim to an uncharted island. What will we need to do? What questions will we have to answer?

Specialization Allocating resources toward production for which they are best suited.

FACTORS OF PRODUCTION Land – all gifts of nature Labor – human efforts and abilities Capital – tools, equipment, space Entrepreneurship – risk taking, ideas –**The “spark” or driving force of the economy**

EXAMPLES:

Adam Smith “Wealth of Nations” ◦ 1776 Invisible hand ◦ Meat ◦ Bread ◦ Candles ◦ How do we decide to provide these?

CIRCULAR FLOW

Utility The satisfaction that consumption of a good or service provides

DIMINISHING MARGINAL UTILITY As you consume additional units of a good, at some point each additional unit will begin providing less utility than the one before it.

Paradox of Value Water vs. Diamonds Monetary Value ◦ Must be scarce ◦ Must give utility Are diamonds scarce? Do they give utility? Conspicuous consumption ◦ Examples?

Cost – Benefit Analysis Question? : What do you want RIGHT NOW?

Cost – Benefit Analysis Follow up question? : Why don’t you go get it?

Cost – Benefit Analysis We all make decisions in our own self-interest All decisions come with certain trade-offs and alternatives THERE IS NO SUCH THING AS A FREE LUNCH!!! SeinfeldSeinfeld example Opportunity Cost: the next-best alternative given up when making a choice

Opportunity Cost VS.

Marginal Cost Marginal = Additional, next Additional cost vs. additional benefit We constantly engage in marginal analysis

Production Possibilities Frontier Guns (thousands) Butter (tons) All possible combinations of two products that can be produced when employing 100% of available resources.

Production Possibilities Frontier