Part I: Introduction Chapter 1: Ten Principles of Economics Chapter 1: Ten Principles of Economics

ObjectivesObjectives 1. Understand the concept of scarcity and how it necessitates allocative decisions 2. Recognize that tradeoffs are a part of every decision 3. Learn the meaning of opportunity cost 4. Understand what decision making at the margin means 5. Recognize that incentives are an important part of the decision making process 1. Understand the concept of scarcity and how it necessitates allocative decisions 2. Recognize that tradeoffs are a part of every decision 3. Learn the meaning of opportunity cost 4. Understand what decision making at the margin means 5. Recognize that incentives are an important part of the decision making process

ObjectivesObjectives 6. Understand that specialization and exchange usually benefit all market participants 7. Begin to see how markets are an efficient way to organize production and allocate resources 8. Learn about the relationship among inflation, output and employment for the economy as a whole 6. Understand that specialization and exchange usually benefit all market participants 7. Begin to see how markets are an efficient way to organize production and allocate resources 8. Learn about the relationship among inflation, output and employment for the economy as a whole

What is Economics? Economics is the science that studies the administration of scarce resources and the determinants of employment and income.

ScarcityScarcity Human Wants ScarceResourcesScarceResources EconomicSystemEconomicSystem Allocation of WHAT?HOW? WHAT?HOW? Distribution FOR WHOM? Distribution

ScarcityScarcity n When wants exceed the resources available to satisfy them, there is scarcity. n People have unlimited wants. n Resources to satisfy those wants are limited. n When wants exceed the resources available to satisfy them, there is scarcity. n People have unlimited wants. n Resources to satisfy those wants are limited.

Scarcity & Poverty n Scarcity is not poverty. n The poor and the rich alike face scarcity. n Faced with scarcity, people must make choices. n “I cried because I had no premium channels until I met a man who had no cable.” n Scarcity is not poverty. n The poor and the rich alike face scarcity. n Faced with scarcity, people must make choices. n “I cried because I had no premium channels until I met a man who had no cable.”

The Central Economic Problem Scarcity and how to overcome itScarcity and how to overcome it Scarcity refers to economic resources (factors of production)Scarcity refers to economic resources (factors of production) any economic system must solve this central problem of economicsany economic system must solve this central problem of economics Scarcity and how to overcome itScarcity and how to overcome it Scarcity refers to economic resources (factors of production)Scarcity refers to economic resources (factors of production) any economic system must solve this central problem of economicsany economic system must solve this central problem of economics

Central Economic Problem Imposes certain basic questions With the resources available what should be produced?With the resources available what should be produced? Given a certain socially acceptable output objective, how should the society’s output be produced?Given a certain socially acceptable output objective, how should the society’s output be produced? After producing its output, who should receive what shares of the goods?After producing its output, who should receive what shares of the goods? With the resources available what should be produced?With the resources available what should be produced? Given a certain socially acceptable output objective, how should the society’s output be produced?Given a certain socially acceptable output objective, how should the society’s output be produced? After producing its output, who should receive what shares of the goods?After producing its output, who should receive what shares of the goods?

Answers to the 3 basic questions by a Market Economy What?What? In the long run only profitable goods and services should be produced.In the long run only profitable goods and services should be produced. How?How? Goods and services must be produced at the lowest production cost.Goods and services must be produced at the lowest production cost. What?What? In the long run only profitable goods and services should be produced.In the long run only profitable goods and services should be produced. How?How? Goods and services must be produced at the lowest production cost.Goods and services must be produced at the lowest production cost.

How?How? To reduce the cost of production of a good or service requiresTo reduce the cost of production of a good or service requires –a. the specialization and division of labor to increase efficiency –b. the introduction of capital goods to reduce labor costs and raise output How?How? To reduce the cost of production of a good or service requiresTo reduce the cost of production of a good or service requires –a. the specialization and division of labor to increase efficiency –b. the introduction of capital goods to reduce labor costs and raise output Answers to the 3 basic questions by a Market Economy

For whom?For whom? The factors of production will divide the share of goods or services depending on their contributions to the producing of these goods.The factors of production will divide the share of goods or services depending on their contributions to the producing of these goods. The value of each factors contribution will be found in the factor markets.The value of each factors contribution will be found in the factor markets. For whom?For whom? The factors of production will divide the share of goods or services depending on their contributions to the producing of these goods.The factors of production will divide the share of goods or services depending on their contributions to the producing of these goods. The value of each factors contribution will be found in the factor markets.The value of each factors contribution will be found in the factor markets. Answers to the 3 basic questions by a Market Economy

Factors of Production  Land is not just physical ground space, but the totality of the raw materials of the earth. 2Labor is the human physical exertion performed in the production of a good or service. 3Capital (physical) the tools, buildings, and machines used by labor to fashion goods and services from raw materials.  Land is not just physical ground space, but the totality of the raw materials of the earth. 2Labor is the human physical exertion performed in the production of a good or service. 3Capital (physical) the tools, buildings, and machines used by labor to fashion goods and services from raw materials.

4Entrepreneur is the human resource which has the following attributes: -organizes and directs the other factors of production. -Accepts the responsibility for all final decisions in the production process. -Accepts the risks for the firm in the dynamic and changing market situations. 4Entrepreneur is the human resource which has the following attributes: -organizes and directs the other factors of production. -Accepts the responsibility for all final decisions in the production process. -Accepts the risks for the firm in the dynamic and changing market situations. Factors of Production

Returns to the factors of production Land --rentLand --rent Labor -- wagesLabor -- wages Capital -- interestCapital -- interest Entrepreneur --profitsEntrepreneur --profits Land --rentLand --rent Labor -- wagesLabor -- wages Capital -- interestCapital -- interest Entrepreneur --profitsEntrepreneur --profits

ChoiceChoice n Economics is the study of the choices people make to cope with scarcity. n Economics is sometimes called the science of choice - the science that explains the choices that people make and predicts how choices change as circumstances change. n Economics is the study of the choices people make to cope with scarcity. n Economics is sometimes called the science of choice - the science that explains the choices that people make and predicts how choices change as circumstances change.

1. People face tradeoffs. “There is no such thing as a free lunch!”

1. People face tradeoffs. To get one thing, we usually have to give up another thing. u Guns v. butter u Food v. clothing u Leisure time v. work u Efficiency v. equity To get one thing, we usually have to give up another thing. u Guns v. butter u Food v. clothing u Leisure time v. work u Efficiency v. equity Making decisions requires trading off one goal against another.

TradeoffTradeoff 1.) Efficiency is the property of society getting the most it can from its scarce resources. 2.) Equity is the property of distributing economic prosperity fairly among all members of society. 1.) Efficiency is the property of society getting the most it can from its scarce resources. 2.) Equity is the property of distributing economic prosperity fairly among all members of society.

Rational Behavior n Economics is based on the assumption of rational self-interest. n Individuals make rational decisions to achieve maximum fulfillment of their goals. n Adam Smith and the “Invisible Hand”. n Economics is based on the assumption of rational self-interest. n Individuals make rational decisions to achieve maximum fulfillment of their goals. n Adam Smith and the “Invisible Hand”.

Choice and Opportunity Cost n Choosing more of one thing means having less of something else. n There is no such thing as a free lunch. Every choice involves an opportunity cost. n Choosing more of one thing means having less of something else. n There is no such thing as a free lunch. Every choice involves an opportunity cost.

Opportunity Cost Opportunity Cost of some decision is the value of the next best alternative which you have to give up because of the decision.

Marginal Analysis n Economic analysis uses marginal analysis to study choices made by people, businesses and governments. n Choices are made in small steps - at the margin. n Economic analysis uses marginal analysis to study choices made by people, businesses and governments. n Choices are made in small steps - at the margin.

3. Rational people think at the margin. Marginal changes are small, incremental adjustments to an existing plan of action. People make decisions by comparing costs and benefits at the margin.

Marginal Cost and Marginal Benefit n The cost of a small increase in an activity is called marginal cost. n The benefit that arises from a small increase in an activity is called marginal benefit. n The cost of a small increase in an activity is called marginal cost. n The benefit that arises from a small increase in an activity is called marginal benefit.

Substitution and Incentives n A central principle of economics - the principle of substitution - is that when the opportunity cost of an activity increases, people substitute other activities which have lower opportunity costs. n Every activity has a substitute. n A central principle of economics - the principle of substitution - is that when the opportunity cost of an activity increases, people substitute other activities which have lower opportunity costs. n Every activity has a substitute.

IncentivesIncentives n An incentive is an inducement to take a particular action. n Substituting away from more costly activities toward less costly ones is responding to incentives. n An incentive is an inducement to take a particular action. n Substituting away from more costly activities toward less costly ones is responding to incentives.

Incentives and Economic Analysis n Whenever some event disrupts the normal state of affairs, the economist always asks: How will opportunity costs change and what substitutions will arise from the changed incentives?

Ten Principles of Economics 1.) People face tradeoffs 2.) The cost of something is what you give up to get it 3.) Rational people think at the margin 4.) People respond to incentives 1.) People face tradeoffs 2.) The cost of something is what you give up to get it 3.) Rational people think at the margin 4.) People respond to incentives How People Make Decisions

Ten Principles of Economics 1.) People face tradeoffs 2.) The cost of something is what you give up to get it 3.) Rational people think at the margin 4.) People respond to incentives 1.) People face tradeoffs 2.) The cost of something is what you give up to get it 3.) Rational people think at the margin 4.) People respond to incentives How People Make Decisions

TradeoffTradeoff 1.) Efficiency is the property of society getting the most it can from its scarce resources. 2.) Equity is the property of distributing economic prosperity fairly among all members of society. 1.) Efficiency is the property of society getting the most it can from its scarce resources. 2.) Equity is the property of distributing economic prosperity fairly among all members of society.

Rational Behavior n Economics is based on the assumption of rational self-interest. n Individuals make rational decisions to achieve maximum fulfillment of their goals. n Adam Smith and the “Invisible Hand”. n Economics is based on the assumption of rational self-interest. n Individuals make rational decisions to achieve maximum fulfillment of their goals. n Adam Smith and the “Invisible Hand”.

Ten Principles of Economics 1.) People face tradeoffs 2.) The cost of something is what you give up to get it 3.) Rational people think at the margin 4.) People respond to incentives 1.) People face tradeoffs 2.) The cost of something is what you give up to get it 3.) Rational people think at the margin 4.) People respond to incentives How People Make Decisions

Choice and Opportunity Cost n Choosing more of one thing means having less of something else. n There is no such thing as a free lunch. Every choice involves an opportunity cost. n Choosing more of one thing means having less of something else. n There is no such thing as a free lunch. Every choice involves an opportunity cost.

Opportunity Cost Opportunity Cost of some decision is the value of the next best alternative which you have to give up because of the decision.

Kerry Kittles Villanova University Class of 1996 Kerry Kittles Villanova University Class of 1996

Tim Thomas VU Freshman, entered Fall, 1996 Tim Thomas VU Freshman, entered Fall, 1996

Alvin Williams Villanova University Class of 1997

Entered Villanova University 1999 Left V.U. June of 2001

Ten Principles of Economics 1.) People face tradeoffs 2.) The cost of something is what you give up to get it 3.) Rational people think at the margin 4.) People respond to incentives 1.) People face tradeoffs 2.) The cost of something is what you give up to get it 3.) Rational people think at the margin 4.) People respond to incentives How People Make Decisions

Marginal Analysis n Economic analysis uses marginal analysis to study choices made by people, businesses and governments. n Choices are made in small steps - at the margin. n Economic analysis uses marginal analysis to study choices made by people, businesses and governments. n Choices are made in small steps - at the margin.

Marginal Cost and Marginal Benefit n The cost of a small increase in an activity is called marginal cost. n The benefit that arises from a small increase in an activity is called marginal benefit. n The cost of a small increase in an activity is called marginal cost. n The benefit that arises from a small increase in an activity is called marginal benefit.

Ten Principles of Economics 1.) People face tradeoffs 2.) The cost of something is what you give up to get it 3.) Rational people think at the margin 4.) People respond to incentives 1.) People face tradeoffs 2.) The cost of something is what you give up to get it 3.) Rational people think at the margin 4.) People respond to incentives How People Make Decisions

Substitution and Incentives n A central principle of economics - the principle of substitution - is that when the opportunity cost of an activity increases, people substitute other activities which have lower opportunity costs. n Every activity has a substitute. n A central principle of economics - the principle of substitution - is that when the opportunity cost of an activity increases, people substitute other activities which have lower opportunity costs. n Every activity has a substitute.

IncentivesIncentives n An incentive is an inducement to take a particular action. n Substituting away for more costly activities toward less costly ones is responding to incentives. n An incentive is an inducement to take a particular action. n Substituting away for more costly activities toward less costly ones is responding to incentives.

Incentives and Economic Analysis n Whenever some event disrupts the normal state of affairs, the economist always asks: How will opportunity costs change and what substitutions will arise from the changed incentives?

Ten Principles of Economics 5.) Trade can make everyone better off 6.) Markets are usually a good way to organize economic activity 7.) Governments can sometimes improve market outcomes 5.) Trade can make everyone better off 6.) Markets are usually a good way to organize economic activity 7.) Governments can sometimes improve market outcomes How People Interact

Ten Principles of Economics 5.) Trade can make everyone better off 6.) Markets are usually a good way to organize economic activity 7.) Governments can sometimes improve market outcomes 5.) Trade can make everyone better off 6.) Markets are usually a good way to organize economic activity 7.) Governments can sometimes improve market outcomes How People Interact

5. Trade can make everyone better off. u People gain from their ability to trade with one another. u Competition results in gains from trading. u Trade allows people to specialize in what they do best. u People gain from their ability to trade with one another. u Competition results in gains from trading. u Trade allows people to specialize in what they do best.

Ten Principles of Economics 5.) Trade can make everyone better off 6.) Markets are usually a good way to organize economic activity 7.) Governments can sometimes improve market outcomes 5.) Trade can make everyone better off 6.) Markets are usually a good way to organize economic activity 7.) Governments can sometimes improve market outcomes How People Interact

Market Economy “Invisible Hand” / Prices Market economy - an economy that allocates resources through the decentralized decisions of many firms and households as they interact in markets for goods and services.

6. Markets are usually a good way to organize economic activity. Adam Smith made the observation that households and firms interacting in markets act as if guided by an “invisible hand.”

6. Markets are usually a good way to organize economic activity. uBecause households and firms look at prices when deciding what to buy and sell, they unknowingly take into account the social costs of their actions. uAs a result, prices guide decision makers to reach outcomes that tend to maximize the welfare of society as a whole. uBecause households and firms look at prices when deciding what to buy and sell, they unknowingly take into account the social costs of their actions. uAs a result, prices guide decision makers to reach outcomes that tend to maximize the welfare of society as a whole.

Ten Principles of Economics 5.) Trade can make everyone better off 6.) Markets are usually a good way to organize economic activity 7.) Governments can sometimes improve market outcomes 5.) Trade can make everyone better off 6.) Markets are usually a good way to organize economic activity 7.) Governments can sometimes improve market outcomes How People Interact

Government Intervention - Why? 2.) Externality - the impact of one person’s action on the well being of a bystander. 3.) Market Power - the ability of a single economic ( or a small group of factors) to have a substantial influence on market prices. 2.) Externality - the impact of one person’s action on the well being of a bystander. 3.) Market Power - the ability of a single economic ( or a small group of factors) to have a substantial influence on market prices. 1.) Market Failure - a situation in which a market left on its own fails to allocate resources efficiently.

Ten Principles of Economics 8.) A country’s standard of living depends on its ability to produce goods and services 9.) Prices rise when the government prints too much money 10.) Society faces a short-run tradeoff between Inflation and Unemployment 8.) A country’s standard of living depends on its ability to produce goods and services 9.) Prices rise when the government prints too much money 10.) Society faces a short-run tradeoff between Inflation and Unemployment How the Economy as a Whole Works

Ten Principles of Economics 8.) A country’s standard of living depends on its ability to produce goods and services 9.) Prices rise when the government prints too much money 10.) Society faces a short-run tradeoff between Inflation and unemployment 8.) A country’s standard of living depends on its ability to produce goods and services 9.) Prices rise when the government prints too much money 10.) Society faces a short-run tradeoff between Inflation and unemployment How the Economy as a Whole Works

8. The standard of living depends on a country’s production. Standard of living may be measured in different ways: uBy comparing personal incomes. uBy comparing the total market value of a nation’s production. Standard of living may be measured in different ways: uBy comparing personal incomes. uBy comparing the total market value of a nation’s production.

8. The standard of living depends on a country’s production. Almost all variations in living standards are explained by differences in countries’ productivities.

8. The standard of living depends on a country’s production. Productivity is the amount of goods and services produced from each hour of a worker’s time. Higher productivity  Higher standard of living

ProductivityProductivity n Productivity is the amount of output obtained from a given amount of inputs. n Labor Productivity is amount of output per worker hour. n Productivity is the amount of output obtained from a given amount of inputs. n Labor Productivity is amount of output per worker hour.

Ten Principles of Economics 8.) A country’s standard of living depends on its ability to produce goods and services 9.) Prices rise when the government prints too much money 10.) Society faces a short-run tradeoff between Inflation and unemployment 8.) A country’s standard of living depends on its ability to produce goods and services 9.) Prices rise when the government prints too much money 10.) Society faces a short-run tradeoff between Inflation and unemployment How the Economy as a Whole Works

InflationInflation n Inflation refers to a sustained increase in the average price level.

Ten Principles of Economics 8.) A country’s standard of living depends on its ability to produce goods and services 9.) Prices rise when the government prints too much money 10.) Society faces a short-run tradeoff between Inflation and unemployment 8.) A country’s standard of living depends on its ability to produce goods and services 9.) Prices rise when the government prints too much money 10.) Society faces a short-run tradeoff between Inflation and unemployment How the Economy as a Whole Works

10. Society faces a short-run tradeoff between inflation and unemployment. The Phillips Curve illustrates the tradeoff between inflation and unemployment:  Inflation   Unemployment It’s a short-run tradeoff! The Phillips Curve illustrates the tradeoff between inflation and unemployment:  Inflation   Unemployment It’s a short-run tradeoff!

SummarySummary u When individuals make decisions, they face tradeoffs. u Rational people make decisions by comparing marginal costs and marginal benefits. u When individuals make decisions, they face tradeoffs. u Rational people make decisions by comparing marginal costs and marginal benefits.

SummarySummary uPeople can benefit by trading with each other. uMarkets are usually a good way of coordinating trades. uGovernment can potentially improve market outcomes. uPeople can benefit by trading with each other. uMarkets are usually a good way of coordinating trades. uGovernment can potentially improve market outcomes.

SummarySummary uA country’s productivity determines its living standards. uSociety faces a short-run tradeoff between inflation and unemployment. uA country’s productivity determines its living standards. uSociety faces a short-run tradeoff between inflation and unemployment.