© The McGraw-Hill Companies, 2008 Chapter 1 Economics and the Economy David Begg, Stanley Fischer and Rudiger Dornbusch, Economics, 9th Edition, McGraw-Hill Education, 2008 PowerPoint presentation by Alex Tackie and Damian Ward

© The McGraw-Hill Companies, 2008 Society and Scarce Resources: –The management of society’s resources is important because resources are scarce. –Scarcity... means that society has limited resources and therefore cannot produce all the goods and services people wish to have.

© The McGraw-Hill Companies, 2008 Economics is the study of how society manages its scarce resources.

© The McGraw-Hill Companies, 2008 What is Economics? ECONOMICS... is the study of how society decides: –What –For whom –How to produce...

© The McGraw-Hill Companies, 2008 The price of oil Tripled in , and doubled again in … and affected people all over the world.

© The McGraw-Hill Companies, 2008 An increase in the price of oil affects: What to produce –less oil-intensive products How to produce –less oil-intensive techniques For whom to produce –oil producers have more buying power; importers have less

© The McGraw-Hill Companies, 2008 The distribution of world population and GNP, 2007

© The McGraw-Hill Companies, 2008 Income Distribution and Three Questions Poor Countries which has 40% of the population has 3% of the total income Rich Countries has 15% of the population and get 80% of the total income What to produce –Whatever consumers in developed countries prefer. How to produce –Cheaper techniques (labor or capital intensive) For whom to produce: –Consumers in developed countries

© The McGraw-Hill Companies, 2008 Scarcity forces choices to be made Opportunity cost a crucial concept in economic analysis the quantity of other goods that must be sacrificed to obtain another unit of a good

© The McGraw-Hill Companies, 2008 The production possibility frontier (1) For each level of the output of one good, the production possibility frontier shows the maximum amount of the other good that can be produced.

© The McGraw-Hill Companies, 2008 The production possibility frontier (2) Film output (G) Food output (F) Production possibility frontier  G = 8  F= 4 A B    F/  G = opportunity cost (=1/2) Unattainable points Production possibilities set.

© The McGraw-Hill Companies, 2008 The production possibility frontier (3) The points on the curve are efficient points because these represents the maximum production given the limited resources. The points below the curve (in the set) are inefficient points. The points above the curve are unattainable points If the economy grows and have more capital, labor, land or technology, the PPF shift out and the previously unattainable points would be a possibility.

© The McGraw-Hill Companies, 2008 The production possibility frontier (5) Diminishing Marginal Returns The PPF is a curve (not a line !) because the opportunity cost of producing a product increases as we produce more of that product. As we produce more of a good, we have to use less productive inputs in production of that good. This increases the opportunity cost.

© The McGraw-Hill Companies, 2008 The operation of markets Market a shorthand expression for the process by which … –households’ decisions about consumption of alternative goods –firms’ decisions about what and how to produce –and workers’ decisions about how much and for whom to work … are all reconciled by adjustment of prices

© The McGraw-Hill Companies, 2008 Resource allocation (1) Resource allocation is crucial for a society and is handled in different ways in different societies, e.g.: –Command economy –Mixed economy –Free market

© The McGraw-Hill Companies, 2008 Resource allocation (2) In market economies, the prices are determined by supply and demand. The price is an important factor for resource allocation.

© The McGraw-Hill Companies, 2008 Efficiency or Equity ? In market economies, efficiency is more of a concern whereas the planned economies gives more emphasis on equity. Since the prices are not free in the planned economies a central office decides the prices and the production. A heavy bureaucracy is required for this process. Lack of competition decreases the productivity and quality in planned economies.

© The McGraw-Hill Companies, 2008 Market orientation Command economy Free market economy CubaChinaHungarySwedenUKUSA

© The McGraw-Hill Companies, 2008 Normative and Positive Economics Positive economics deals with objective explanation –e.g. if a tax is imposed on a good its price will tend to rise Normative economics offers prescriptions based on value judgements –e.g. a tax should be imposed on tobacco to discourage smoking

© The McGraw-Hill Companies, 2008 Micro and Macro (1) Microeconomics –offers a detailed treatment of individual economic decisions concerning particular commodities –Footballers’ wages and the price of oil, for example, are both microeconomic issues

© The McGraw-Hill Companies, 2008 Micro and Macro (2) Macroeconomics –emphasises the interactions in the economy as a whole –Gross domestic product, the aggregate price level and unemployment, for example, are all macroeconomic issues

© The McGraw-Hill Companies, 2008 Models and data If we investigate the relationship between unemployment and minimum wage, we should start with a model. Model –a framework based on simplifying assumptions –helps to organize our economic thinking Data –the economist’s link with the real world –time series –cross section

© The McGraw-Hill Companies, 2008 Real and nominal Many economic variables are measured in money terms Nominal values –measured in current prices –not good for time series analysis. Real values –adjusted for price changes compared with a base year –measured in constant prices –Good for time series analysis.