Chapter 1 Economics the Study of Choice Hossain: MSMC

Economic Resources  Economics is all about alternative use of available resources.  There are four basic types of Economic Resources: I.Land II.Labor III.Capital IV.Entrepreneurial Abilities Hossain: MSMC2

Economic Resources I.Land Captures all natural resources available to human. Examples include land, water, air, sunlight, tree, plants, petroleum, iron ore, gold, silver, diamond and so on. II.Labor Captures all forms of human resource Dimensions: 1.Physical labor 2.Mental labor Hossain: MSMC3

Economic Resources  Physical labor primarily means muscular power  Examples of physical laborer Professional movers, homebuilders, and miners  Mental labors are knowledge, experience, skill and education  Examples of mental laborer Neurosurgeon, financial advisors, professional lobbyist, consultants Hossain: MSMC4

Economic Resources III. Capital Manmade implements used in production process. Examples: Tools, tractors, caterpillars, machines, factories, plants, highways, electric grid  if you use your computer to surf the web, this is a final consumption good  If you use it for your small business, it’s a capital Hossain: MSMC5

Economics Resources IV. Entrepreneurial abilities Include the innovativeness and risk taking attributes of human to combine a)Land b)Labor c)Capital and Technology to produce goods and services that consumers want. Hossain: MSMC6

Important Assumptions  In a production process, resources are transformed to produce final goods and services, which fulfill human wants  However, resources are scarce  Therefore, goods and services are scarce  Human wants, however, are unlimited  Scarcity is the main reason for studying economics  If there were no scarcity, there would have been no economics Hossain: MSMC7

Scarcity  Economic resources are scarce.  At any point in time, we have only so much of land, so many people, so much capital, so much time.  Scarcity forces us to make Choice  Because of scarcity, we can’t have it all.  If you use your parcel of land for potato, you can not use it for corn  If you use your time watching TV, you can’t use it for studying economics  We must give up something to gain something else Hossain: MSMC8

Scarcity  Because of scarcity, we must choose among alternatives We must choose:  how to use ours natural resources (land)  How to use our labors (physical and mental)  How to use our capitals  How to use our technology, entrepreneurial abilities  Or, our scarce resources  Economics tells us how to make this choice Hossain: MSMC9

Definition  Economics is all about making right choice  Economics studies how society choose to allocate its scare resources to satisfy unlimited human wants  It is a social science that examines how society choose among the alternatives available to them  Without scarcity, we would not have to make a choice. we could have it all. Hossain: MSMC10

Definition  Microeconomics Studies the choices made by individual consumers and firms The impacts those choices have on individual markets  Macroeconomics Studies the impact of choices on the total or aggregate level of economic activity Hossain: MSMC11

Keywords Social Science  Its social because it deals human behavior  Its science because it utilizes scientific methods and models to  Form hypothesis  Test hypothesis  Develop theories and laws Hossain: MSMC12

Fundament Questions  Three Fundamental Questions of Economics  What should be produced ?  How should goods and services be produced?  For Whom should goods and services be produced? Hossain: MSMC13

Opportunity Cost  Economics is all about making the right choice  But, every choice has an opportunity cost  This is because, when we choose to get something using a resource, we must give up something else that could have been produced using that resource  What we give up is opportunity cost (opportunity lost) Hossain: MSMC14

Opportunity Cost  What is the O.C. of going to college? You could have been working for 15 an hour You could have been travelling the world You could have been playing basketball You could have been developing soft wares  O.C. is the highest valued alternative given up Hossain: MSMC15 Like Bill Gates did Like Kobe Bryant did

Economic way of Thinking  Decisions are made at the Margin  Most economics decisions deal with measuring the impact of additional output or incremental benefit  It is different from “yes or no” decisions.  If the town officials want to reduce households’ use of water, it might increase the price of water  Households will not stop using water  Households will use less water  This is a marginal response. Economists measure this marginal impact Hossain: MSMC16

Economic way of Thinking  Example  Suppose you run a t-shirt shop.  Currently you produce 500/month and it costs you $700 in machinery, labor, and materials  If I produce 600/month next month your cost increases to $750  Then, the marginal cost of the additional 100 shirts is $50  This decision only makes sense if your marginal revenue is more the $50 Hossain: MSMC17

Economists’ Tool kit  A variable is something whose value can change  A constant is something whose value does not change  Average annual temperature of Newburgh  Your GPA in Fall 2010  Your SSN  The scientific method is a systematic set of procedures through which new knowledge is created Hossain: MSMC18

Economists’ Tool kit  A hypothesis is an assertion of a relationship between two or more variables that could be proven false  A theory is a hypothesis that has not been rejected after widespread testing and that wins general acceptance  A law is a theory that has been subjected to even more testing and that has won virtually universal acceptance Hossain: MSMC19

Economists’ Tool kit  A model is a set of simplifying assumptions about some aspect of the real world  Campus map supplied to you is a location model of the Mount  Economic models describe relationships among economic variables  Example: interest rate and investment Hossain: MSMC20

Economists’ Tool kit  Models help us understand the economy by generating hypotheses about the economy  Low interest rate cause higher investment  The hypothesis eventually generates new knowledge  Knowledge guides economic policies to solve the problems of allocation of scarce resource Hossain: MSMC21

Independent and Dependent Variable  Consider the hypothesis: Low interest rate cause higher investment  Here, Interest rate is the independent variable Investment is the dependent variable Hossain: MSMC22

Ceteris Paribus  When testing a hypothesis, economists must make sure that other factors are held constant  If you want to know the impact of interest rates on investments, you must make sure all other factors that may have an impact on investment are unchanged  This is called “All else being equal”  In Latin, Ceteris Paribus Hossain: MSMC23

Positive and Normative Statements  A positive statement is a statement of fact or a hypotheses  Can be proven true or false using economic data  Describes an aspect of the reality  A normative statement is a statement that makes a value judgment.  Cannot be proven true or false using economic data  Describes a subjective believe or value judgement Hossain: MSMC24

Positive and Normative Statements  GDP grew 2.5% in the 2 nd quarter of 2010  GDP and unemployment rates positively related  Unemployment benefits encourages lower labor force participation  Government should limit the unemployment benefits to 6 months  Unemployment is a bigger problem than inflation Hossain: MSMC25