Section 1 Thinking like an economist

4 Scarcity: limited nature of society’s resources 4 Economics: the study of how society manages its scarce resources 4 An economic model is a simplified version of reality used to analyze real world economic situations. Why is economics important? Economy: one who manages household

Economics and Individual Decision 4 People (buyers and sellers) interact in markets. 4 When studying their interactions we apply 3 important ideas: 4 1) People are rational 4 Individuals and firms use all available information as they act to achieve their goals. 4 We act if the benefits of our actions outweigh the costs.

Economics and Individual Decision 4 People (buyers and sellers) interact in markets. 4 When studying their interactions we apply 3 important ideas: 4 2) People respond to incentives 4 Moral incentives 4 Social incentives 4 Economic incentives

Economics and Individual Decision 4 People (buyers and sellers) interact in markets. 4 When studying their interactions we apply 3 important ideas: 4 3) Optimal decisions are made at the margin 4 Marginal decision vs. all or nothing decisions 4 Optimal decision is to continue any activity up to the point where the marginal benefit equals the marginal cost.

4 Economics is the study of how human beings coordinate their wants and desires. 4 1) What and how much to produce? –Butter or guns? 4 2) How to produce? –Locally or offshore? 4 3) Who should consume what is produced? –Income distribution 4 Planned vs. Market Economics The fundamental problem

Efficiency and Equity 4 Productive efficiency –When production takes place at the lowest possible cost 4 Allocative efficiency –When production reflects consumer preferences 4 Equity –The fair distribution of economic benefits

4 Is it a science? 4 Economics uses scientific methods –Using assumptions we develop economic models –we collect data –using the data we test hypotheses –we then revise our models if necessary. ECONOMICS

4 Microeconomics vs Macroeconomics –Microeconomics: the study of how households and firms make decisions –Macroeconomics: The study of economy-wide phenomena (inflation, unemployment…) 4 Positive statement vs Normative statement –Positive: Claims that attempt to describe the world as it is. –Normative: Claims that attempt to prescribe how the world should be.

? ? Positive or Normative Statements? 4 An increase in the minimum wage will cause a decrease in employment among the least-skilled.

? ? ? Positive or Normative Statements? 4 Higher federal budget deficits will cause interest rates to increase.

? ?? ? Positive or Normative Statements? 4 The income gains from a higher minimum wage are worth more than any slight reductions in employment.

? ? ? Positive or Normative Statements? 4 State governments should be allowed to collect from tobacco companies the costs of treating smoking-related illnesses among the poor.

4 Why economists disagree? 4 Different values  different normative views 4 they may disagree on theories about how the world works

Problems 4 20/8 4 20/ /18