Some definitions of economics

“Economics is a study of mankind in the ordinary business of life” Alfred Marshall

"the purpose of studying economics is not to acquire a set of ready-made answers to economic questions, but to learn how to avoid being deceived by economists." Joan Robinson

“Economics is what economists do” Jacob Viner

Economics (1) Study of the choices people make to attain their goals given their scarce resources.

Economics: Foundations and Models 1.What do economists study? gasoline prices, inflation, housing markets, international trade, income inequality, sports, families, smoking, health care, happiness decision-making or choices 2.How do they do it? by using theories and models theories are based on assumptions

What makes a good theory or a model? Models are not judged by their realism but by their usefulness What is the most useless map in the world? To be useful a model has to be refutable

Why study theory? “I don’t know how it is in theory but here is what I know from my 20 years of experience will happen “ Laura, Executive MBA student Theory saves time!

When Economists Disagree: A Debate over Outsourcing Making the Connection Learning Objective 1.3 Does outsourcing by U.S. firms raise or lower incomes in the United States?

Economics (2) Study of the choices people make to attain their goals given their scarce resources.

Economics When the price is zero there is not enough for everyone People behave as if they are comparing the costs and benefits Scarcity Choices Benefits Costs Unlimite d wants Limited availabilit y

Economics Everything has alternative uses Scarcity Tradeoffs Opportunity cost

Economics People are rational when they behave as if they were comparing costs and benefits Choices People respond to incentives Decisions are made on the margin

14 as if Does a pool player need to know the laws of trigonometry and physics to win?

as if “…getting out of bed in the morning and making breakfast involves more complex decisions than the average game of chess. (Will that fries egg kill me in twenty-eight years?)” Charles Wheelan

Economics (3) Study of the choices people make to attain their goals given their scarce resources.

Trade-offs force society to make choices, particularly when answering the following three fundamental questions: 1What goods and services will be produced? 2How will the goods and services be produced? 3Who will receive the goods and services produced? The Economic Problem That Every Society Must Solve

Centrally planned economy An economy in which the government decides how economic resources will be allocated. The Economic Problem That Every Society Must Solve 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 in which the government plays a significant role in the allocation of resources. The Economic Problem That Every Society Must Solve The Modern “Mixed” Economy

Positive analysis Analysis concerned with what is. Economic Models Normative and Positive Analysis Normative analysis Analysis concerned with what ought to be. Don’t Let This Happen to YOU! Don’t Confuse Positive Analysis with Normative Analysis

The Market System and the Circular Flow 2 C H A P T E R

PROPERTY RESOURCES 1. LAND 2. CAPITAL HUMAN RESOURCES 3. LABOR 4. ENTREPRENEURIAL ABILITY SCARCE RESOURCES ECONOMIC RESOURCES

Resource payments: correspond to resource categories RENTALINCOME INTERESTINCOME WAGES PROFIT & LOSS PROPERTY RESOURCES LAND CAPITAL HUMAN RESOURCES LABOR ENTREPRENEUR

Macroeconomics Starts Here

Economic Systems Definition: A particular set of institutional arrangements and a coordinating mechanism to respond to the economizing problem. Economic systems differ as to: 1) who owns the factors of production 2) the method used to motivate, coordinate, and direct economic activity.

The Command System The government owns most property resources and economic decision making occur through a central economic plan. The central planning board determines production goals for each firm and resources to be allocated.

The Market System There is private ownership of resources. Markets and prices coordinate and direct economic activity. Each participant acts in its own self-interest. In pure capitalism the government plays a very limited role.

Characteristics of the Market System Private Property. Freedom of firms to choose. Self interest. Competition. Markets and prices. Technology and capital goods. Specialization. Use of money. Active, but limited government.

The Circular Flow Model There are two groups of decision makers in the private economy: households (resource owners) and businesses (resource users)There are two groups of decision makers in the private economy: households (resource owners) and businesses (resource users) The market system (resource markets and product markets) coordinates these decisions.The market system (resource markets and product markets) coordinates these decisions.

What happens in the resource markets? a.Households sell resources directly or indirectly (through ownership of corporations) to businesses. a.Households sell resources directly or indirectly (through ownership of corporations) to businesses. b. Businesses buy resources in order to produce goods and services. c.Interaction of these sellers and buyers determines the price of each resource, which in turn provides income for the owner of that resource. d.Flow of payments from businesses for the resources constitutes business costs and resource owners’ incomes.

What happens in the product markets? a. Households are on the buying side of these markets, purchasing goods and services. b.Businesses are on the selling side of these markets, offering products for sale. c.Interaction of these buyers and sellers determines the price of each product. d.Flow of consumer expenditures constitutes sales receipts for businesses.

CIRCULAR FLOW MODEL BUSINESSES HOUSEHOLDS RESOURCE MARKET PRODUCT MARKET

BUSINESSES HOUSEHOLDS RESOURCE MARKET RESOURCESINPUTS PRODUCT MARKET CIRCULAR FLOW MODEL

BUSINESSES HOUSEHOLDS RESOURCE MARKET RESOURCESINPUTS $ COSTS$ INCOMES GOODS & SERVICES SERVICES PRODUCT MARKET CIRCULAR FLOW MODEL

BUSINESSES HOUSEHOLDS RESOURCE MARKET RESOURCESINPUTS $ COSTS$ INCOMES PRODUCT MARKET GOODS & SERVICES GOODS & SERVICES CIRCULAR FLOW MODEL

BUSINESSES HOUSEHOLDS RESOURCE MARKET RESOURCESINPUTS $ COSTS$ INCOMES PRODUCT MARKET GOODS & SERVICES GOODS & SERVICES $ CONSUMPTION$ REVENUE CIRCULAR FLOW MODEL

BUSINESSES HOUSEHOLDS RESOURCE MARKET RESOURCESINPUTS $ COSTS$ INCOMES PRODUCT MARKET GOODS & SERVICES GOODS & SERVICES $ CONSUMPTION$ REVENUE

More Realistic Circular Flow

Macroeconomic Policies

Limitations of the model: 1. Does not depict transactions between households and between businesses (inter- businesses). 2.Ignores government and the “rest of the world” in the decision-making process (we will take care of them later on). 3.Does not explain how prices of products and resources are actually determined.