1. Chapter 1 - The Nature of Economics
Learning Objectives
Discuss the difference between microeconomics and macroeconomics
Evaluate the role that rational self-interest plays in economic analysis
Explain why the study of economics is a science
Distinguish between positive and normative economics
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2. Chapter 1 - The Nature of Economics
Defining Economics
Economics
The study of how people allocate their limited resources to satisfy their unlimited wants
The study of how people make choices
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3. Chapter 1 - The Nature of Economics
Defining Economics
Resources
Things used to produce other things to satisfy people’s wants
Wants
What people would buy if their incomes were unlimited
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4. Chapter 1 - The Nature of Economics
Defining Economics
With limited income (resources), people must make choices to satisfy their wants.
We never have enough of everything, including time, to satisfy our every desire.
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5. Chapter 1 - The Nature of Economics
Defining Economics
Individuals, businesses, and nations face alternatives, and choices must be made.
Economics studies how these choices are made.
Chapter 1 - The Nature of Economics

6. The Power of Economic Analysis
The economic way of thinking is a framework to analyze solutions to economic problems.
How much time to study
Choosing which courses to take
Whether troops should be sent abroad
Incentives
Rewards for engaging in a particular activity
Chapter 1 - The Nature of Economics

7. The Power of Economic Analysis
The economic way of thinking gives you the power to reach informed conclusions about what is happening in the world.
Economic analysis helps you make better decisions, and increases your understanding when watching, listening to, or reading the news.
Chapter 1 - The Nature of Economics

8. The Power of Economic Analysis
Economic analysis is a way of thinking about all decisions.
Your education, career, financing your home, family
Your involvement in the business world, or in politics as a voter
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9. Microeconomics versus Macroeconomics
The study of decision making undertaken by individuals (or households) and by firms
Like looking though a microscope to focus on the smaller parts of the economy
Decision of a worker to work overtime or not
A family’s choice of having a baby
An individual firm advertising
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10. Microeconomics versus Macroeconomics
The study of the behavior of the economy as a whole
Deals with economy wide phenomena
The national unemployment rate
The rate of growth in the money supply
The national government’s budget deficit
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11. Microeconomics versus Macroeconomics
Macroeconomics deals with aggregates, or totals, such as total output in an economy.
Modern economic theory blends micro and macro concepts.
Chapter 1 - The Nature of Economics

12. The Economic Person: Rational Self-Interest
Economists assume that individuals act as if motivated by self-interest and respond predictably to opportunities for gain.
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13. The Economic Person: Rational Self-Interest
Rationality Assumption
The assumption that people do not intentionally make decisions that would leave them worse off
Chapter 1 - The Nature of Economics

14. The Economic Person: Rational Self-Interest
Questions
Does the fact that some people make apparently irrational choices invalidate the rationality assumption in economics?
Can economic models be applied to situations in which behavior is at odds with what we expect from rational people?
Chapter 1 - The Nature of Economics

15. The Economic Person: Rational Self-Interest
Responding to incentives
Rationality and the use of incentives
Making choices
Balancing cost and benefits
Chapter 1 - The Nature of Economics

16. The Economic Person: Rational Self-Interest
Some examples of incentives
Responding to positive incentives
Schoolchildren getting gold stars, working to have a “better life” for yourself
Responding to negative incentives
Penalties, punishments, using credit cards to avoid check overdrafts
Chapter 1 - The Nature of Economics

17. The Economic Person: Rational Self-Interest
Defining self-interest
The pursuit of one’s goals, does not always mean increasing one’s wealth
Prestige
Friendship
Love
Chapter 1 - The Nature of Economics

18. Example: The Perceived Value of Gifts
Often, the recipient of the gift places a value on it far less than the market value.
Should we substitute gift certificates for physical gifts?
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19. Chapter 1 - The Nature of Economics
Economics as a Science
Models or Theories
Simplified representations of the real world used as the basis for predictions or explanations
A map is the quintessential model
Chapter 1 - The Nature of Economics

20. Chapter 1 - The Nature of Economics
Economics as a Science
Assumptions
The set of circumstances in which a model is applicable
Every model, or theory, must be based on a set of assumptions.
Chapter 1 - The Nature of Economics

21. Example: Getting Directions
A map is a simplifying model of reality.
The degree of simplification varies across maps; some contain more detail than others.
Economic models attempt to focus on what is relevant to the problem at hand and omit what is not.
Chapter 1 - The Nature of Economics

22. Chapter 1 - The Nature of Economics
Economics as a Science
Ceteris Paribus Assumption
Nothing changes except the factor or factors being studied.
“Other things constant”
“Other things equal”
Chapter 1 - The Nature of Economics

23. Chapter 1 - The Nature of Economics
Economics as a Science
Economics is an empirical science.
Real-world data is used to evaluate the usefulness of a model.
Models are useful if they predict economic phenomena.
Economic models predict how people react, not how they think.
Chapter 1 - The Nature of Economics

24. Chapter 1 - The Nature of Economics
Economics as a Science
Behavioral Economics
Approach to the study of consumer behavior
Emphasizes psychological limitations and complications which may interfere with rational decision making
Chapter 1 - The Nature of Economics

25. Chapter 1 - The Nature of Economics
Economics as a Science
Bounded Rationality
Hypothesis that people are nearly, not fully, rational
They cannot examine every choice available to them
Use simple rules of thumb to sort alternatives
Chapter 1 - The Nature of Economics

26. Positive versus Normative Economics
Positive Economics
Purely descriptive statements or scientific predictions; “If A, then B,” a statement of what is
Normative Economics
Analysis involving value judgments; relates to whether things are good or bad, a statement of what ought to be
Chapter 1 - The Nature of Economics

27. Summary Discussion of Learning Objectives
Microeconomics versus macroeconomics
Economics is the study of how individuals make choices to satisfy wants.
Microeconomics is the study of decision making by individual households and individual firms.
Macroeconomics is the study of nationwide phenomena, such as inflation and unemployment levels.
Chapter 1 - The Nature of Economics

28. Summary Discussion of Learning Objectives
Self-interest in economic analysis
Rational self-interest is the assumption that individuals behave in a reasonable (rational) way in making choices to further their interests.
Chapter 1 - The Nature of Economics

29. Summary Discussion of Learning Objectives
Economics as a science
Economists use models, or theories, that are simplified representations of the real world to analyze and make predictions about the real world.
Chapter 1 - The Nature of Economics

30. Summary Discussion of Learning Objectives
The difference between positive and normative economics
Positive economics deals with what is, whereas normative economics deals with what ought to be.
Positive statements are of the “if…then” variety, while normative ask what “should, or could” be.
Chapter 1 - The Nature of Economics

31. Chapter 2 - Scarcity and the World of Trade-Offs
Learning Objectives
Evaluate whether even affluent people face the problem of scarcity
Understand why economists consider wants but not needs
Explain why the scarcity problem induces individuals to consider opportunity costs
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32. Chapter 2 - Scarcity and the World of Trade-Offs
Learning Objectives
Discuss why obtaining increasing increments of any particular good entails giving up more and more units of other goods
Explain why society faces a trade-off between consumption goods and capital goods
Distinguish between absolute and comparative advantage
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33. Chapter 2 - Scarcity and the World of Trade-Offs
Is the most basic concept in all of economics
Occurs when the ingredients for producing things that people desire are insufficient to satisfy all wants
Means we never have enough of everything, including time, to satisfy our every desire
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34. Chapter 2 - Scarcity and the World of Trade-Offs
What scarcity is NOT
It is not a shortage.
It is not the same thing as poverty.
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35. Chapter 2 - Scarcity and the World of Trade-Offs
Production
Any activity that results in the conversion of resources into products that can be used in consumption
Resources or Factors of Production
Inputs that are used to produce things that people want
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36. Chapter 2 - Scarcity and the World of Trade-Offs
Resources or Factors of Production
Land
Natural resources or the gifts of nature
Labor
The human resource
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37. Chapter 2 - Scarcity and the World of Trade-Offs
Resources or Factors of Production
Physical Capital
All manufactured resources
Human Capital
Accumulated training and education of workers
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38. Chapter 2 - Scarcity and the World of Trade-Offs
Resources or Factors of Production
Entrepreneurship
Person who organizes, manages, and assembles the other resources
Risk taker
Maker of basic business policy decisions
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39. Chapter 2 - Scarcity and the World of Trade-Offs
Economic Goods
Scarce goods, for which the quantity demanded exceeds the quantity supplied at zero price.
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40. Chapter 2 - Scarcity and the World of Trade-Offs
Services
Tasks that are performed for someone else
Can be referred to as intangible goods
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41. Chapter 2 - Scarcity and the World of Trade-Offs
Scarcity occurs when the ingredients (resources) for producing things that people desire are insufficient to satisfy all wants.
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42. Chapter 2 - Scarcity and the World of Trade-Offs
Wants and Needs
Needs
To economists, the term need is not definable.
Wants
Goods and services on which we place a positive value
People have unlimited wants.
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43. Scarcity, Choice, and Opportunity Cost
The highest-valued, next-best alternative that must be sacrificed to obtain something or to satisfy a want
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44. Scarcity, Choice, and Opportunity Cost
Questions
What is the opportunity cost of attending this economics class?
What is the opportunity cost of attending a concert by your favorite band?
What is the opportunity cost of increasing research for an AIDS vaccine?
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45. Scarcity, Choice, and Opportunity Cost
Limited Resources & Unlimited Wants
Scarcity
Choices
Opportunity Cost
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46. Chapter 2 - Scarcity and the World of Trade-Offs
E-Commerce Example: Making It Easier to Get to the “Submit Order” Button
About half of all consumers who placed items in online “shopping carts” abandon them before authorizing payment.
To reduce the opportunity cost of purchasing online, Internet sellers are simplifying the checkout process.
For an Internet retailer, what is the opportunity cost of failing to simplify its software in a way that encourages consumers to finalize orders?
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47. The World of Trade-Offs
Whenever you engage in any activity, using any resource, you are trading off the use of that resource for one or more alternative uses.
The value of the trade-off is represented by the opportunity cost, (that which you give up to obtain something else).
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48. The World of Trade-Offs
Opportunity cost graphically
The production possibilities curve (PPC) represents all possible maximum combinations of total output that could be produced.
Along the production possibilities curve, there is a fixed quantity of productive resources of a given quality being used efficiently.
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49. Chapter 2 - Scarcity and the World of Trade-Offs
Production Possibilities Curve for Grades in Mathematics and Economics (Trade-Offs)
Chapter 2 - Scarcity and the World of Trade-Offs

50. Production Possibilities Curve (PPC)
Questions
What would happen to the production possibilities curve if you spent more time studying?
What would happen to your potential grades?
Is it possible that terms of the trade-off might not be constant?
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51. The Choices Society Faces
PPC is used to demonstrate related concepts of scarcity, choice, and trade-offs
At the individual level
At the societal level
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52. Society’s Trade-Off Between Digital Cameras and Pocket PCs
Chapter 2 - Scarcity and the World of Trade-Offs

53. Society’s Trade-Off Between Digital Cameras and Pocket PCs
Chapter 2 - Scarcity and the World of Trade-Offs

54. The Choices Society Faces
Production possibilities assumptions
Resources are fully employed
Production takes place over a specific time period
Resources are fixed for the time period
Technology does not change over the time period
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55. The Choices Society Faces
Technology
Society’s pool of applied knowledge concerning how goods and services can be produced
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56. The Choices Society Faces
Efficiency
The case in which a given level of inputs is used to produce the maximum output possible
Alternatively, the situation in which a given output is produced at minimum cost
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57. The Choices Society Faces
Inefficient Point
Any point below the production possibilities curve at which the use of resources is not generating the maximum possible output
Law of Increasing Relative Cost
As society attempts to produce more of a good, the opportunity cost of additional units of that good generally increases
Accounts for bowed shape of the PPC
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58. The Law of Increasing Relative Cost
Chapter 2 - Scarcity and the World of Trade-Offs

59. The Choices Society Faces
In general, the more specialized the resources, the more bowed the PPC
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60. Economic Growth and the Production Possibilities Curve
Increases the production possibilities of digital cameras and pocket PCs
Occurs over a period of time
Is illustrated by an outward shift of the production possibilities curve
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61. Economic Growth Allows for More of Everything
Chapter 2 - Scarcity and the World of Trade-Offs

62. The Trade-Off Between the Present and the Future
PPC
Can be used to illustrate the trade-off between present and future consumption
Consumption
The use of goods and services for personal satisfaction
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63. Capital Goods and Growth
Consumer goods
Goods produced for personal satisfaction
Capital goods
Goods used to produce other goods
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64. Capital Goods and Growth
Observations
Increase in capital goods stimulates economic growth
An increase in capital goods at present will lead to a higher rate of economic growth in the future.
In the future, the economic system can produce more consumer goods.
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65. Specialization and Greater Productivity
Organization of economic activity among different individuals and regions
Leads to greater productivity
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66. Specialization and Greater Productivity
Comparative Advantage
The ability to produce a good or service at a lower opportunity cost
Is always a relative concept
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67. Specialization and Greater Productivity
Absolute Advantage
The ability to produce more units of a good or service using a given quantity of labor or resource inputs
Equivalently, the ability to produce the same quantity of a good or service using fewer units of labor or resource inputs
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68. Chapter 2 - Scarcity and the World of Trade-Offs
Division of Labor
Rational individuals choose their comparative advantage and specialize.
Specialization leads to division of labor.
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69. Chapter 2 - Scarcity and the World of Trade-Offs
Division of Labor
Division of Labor
Assigning different workers different tasks to produce a good or service
Organizing a division of labor within a firm to increase output
Examples
Automobile production
Hospital operating room
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70. Comparative Advantage and Trade Among Nations
Recall
Analysis of absolute advantage, comparative advantage, and specialization—applicable to individuals and nations
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71. Comparative Advantage and Trade Among Nations
When nations specialize where they have a comparative advantage and then trade with the rest of the world
Economic efficiency improves
Output increases
Average standard of living rises
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72. Chapter 2 - Scarcity and the World of Trade-Offs
International Example: Multiple Comparative Advantages in Dishwasher Production
Maytag dishwashers assembled in Jackson, Tennessee contain components manufactured throughout the world.
Some may consider it a plus to buy an appliance labeled “Made in the USA,” but the overall cost of the dishwasher is lower than it would be if all the individual parts were manufactured within U.S. borders.
Chapter 2 - Scarcity and the World of Trade-Offs

73. Summary Discussion of Learning Objectives
The problem of scarcity, even for the affluent
Scarcity and poverty are not synonymous.
Why economists consider individuals’ wants but not their needs
Needs are not objectively definable.
Wants are things on which we place a positive value.
Chapter 2 - Scarcity and the World of Trade-Offs

74. Summary Discussion of Learning Objectives
Why the scarcity problem leads people to evaluate opportunity costs
Allocating resources to producing one good means losing the opportunity to have another one.
Why getting more units of one good requires giving up more and more of another
Resources are specialized
Chapter 2 - Scarcity and the World of Trade-Offs

75. Summary Discussion of Learning Objectives
There is a trade-off between consumption goods and capital goods.
As more resources are devoted to the production of capital goods, we can expect the rate of economic growth to increase.
Chapter 2 - Scarcity and the World of Trade-Offs

76. Summary Discussion of Learning Objectives
Absolute versus comparative advantage
One finds one’s absolute advantage by producing more of a specific good than someone else who uses the same amount of resources.
One finds one’s comparative advantage by looking at the activity that has the lowest opportunity cost.
Chapter 2 - Scarcity and the World of Trade-Offs

77. Chapter 4 - Extensions of Demand and Supply Analysis
Learning Objectives
Discuss the essential features of the price system
Evaluate the effects of changes in demand and supply on the market price and equilibrium quantity
Understand the rationing function of prices
Chapter 4 - Extensions of Demand and Supply Analysis

78. Chapter 4 - Extensions of Demand and Supply Analysis
Learning Objectives
Explain the effects of price ceilings
Explain the effects of price floors
Describe various types of government- imposed quantity restrictions on markets
Chapter 4 - Extensions of Demand and Supply Analysis

79. Chapter 4 - Extensions of Demand and Supply Analysis
Did You Know That...
The inflation-adjusted value of the U.S. minimum wage peaked at about $8 in 1964?
We can use supply and demand analysis to analyze effects of the minimum wage?
The model of supply and demand can explain instances of a gap between quantity supplied and quantity demanded?
Chapter 4 - Extensions of Demand and Supply Analysis

80. The Price System and Markets
Price System or Market System
An economic system in which relative prices are constantly changing to reflect changes in supply and demand
Prices signal what is relatively scarce and relatively abundant.
Prices provide information to individuals and businesses.
Chapter 4 - Extensions of Demand and Supply Analysis

81. The Price System and Markets
Emphasize voluntary exchange
Determine the terms of exchange
Facilitate exchange
Chapter 4 - Extensions of Demand and Supply Analysis

82. The Price System and Markets
Voluntary Exchange
Acts of trading between individuals that make both parties to the trade better off
Terms of Exchange
The prices we pay for the desired items
Chapter 4 - Extensions of Demand and Supply Analysis

83. The Price System and Markets
Transaction Costs
The costs associated with exchange
Examples
Price shopping
Determining quality
Determining reliability
Service availability
Cost of contracting
Chapter 4 - Extensions of Demand and Supply Analysis

84. The Price System and Markets
The role of middlemen
Middlemen (intermediaries) or brokers reduce transaction costs by providing information to buyers and sellers
Examples
Real estate brokers
Stock brokers
Consignment shops
Car dealerships
Chapter 4 - Extensions of Demand and Supply Analysis

85. Changes in Demand and Supply
Changes in supply and demand can create a disequilibrium.
The market price and quantity can/will adjust to a new equilibrium.
Chapter 4 - Extensions of Demand and Supply Analysis

86. Shifts in Demand and in Supply: Determinate Results
Chapter 4 - Extensions of Demand and Supply Analysis

87. Shifts in Demand and in Supply: Determinate Results
Chapter 4 - Extensions of Demand and Supply Analysis

88. Shifts in Demand and in Supply: Determinate Results
Chapter 4 - Extensions of Demand and Supply Analysis

89. Shifts in Demand and in Supply: Determinate Results
Chapter 4 - Extensions of Demand and Supply Analysis

90. Changes in Demand and Supply
Summary
Increases in demand increase equilibrium price and quantity.
Decreases in demand decrease equilibrium price and quantity.
Chapter 4 - Extensions of Demand and Supply Analysis

91. Changes in Demand and Supply
Summary
Increases in supply decrease equilibrium price and increase equilibrium quantity.
Decreases in supply increase equilibrium price and decrease equilibrium quantity.
Chapter 4 - Extensions of Demand and Supply Analysis

92. Changes in Demand and Supply
When both demand and supply shift
Simultaneous changes in demand and supply put conflicting pressure on price or quantity.
The resulting effect depends upon how much each curve shifts.
Either equilibrium price or quantity will be indeterminate.
Chapter 4 - Extensions of Demand and Supply Analysis

93. Changes in Demand and Supply
When both demand and supply increase
Change in price is indeterminate
Quantity will increase
When both demand and supply decrease
Quantity will decrease
Chapter 4 - Extensions of Demand and Supply Analysis

94. Changes in Demand and Supply
When supply decreases and demand increases
Price will increase
Change in quantity is indeterminate
When supply increases and demand decreases
Price will decrease
Chapter 4 - Extensions of Demand and Supply Analysis

95. Example: Why Gasoline Prices Have Increased
One factor—an increase in demand, shown by a rightward shift in the demand curve
Another factor—a reduction in supply, shown by a leftward shift in the supply curve
As a result, the market clearing price of gasoline increased.
Chapter 4 - Extensions of Demand and Supply Analysis

96. Chapter 4 - Extensions of Demand and Supply Analysis
The Effects of a Simultaneous Decrease in Gasoline Supply and Increase in Gasoline Demand
Chapter 4 - Extensions of Demand and Supply Analysis

97. The Rationing Function of Prices
Synchronization of decisions of buyers and sellers that leads to equilibrium is called the rationing function of prices.
Chapter 4 - Extensions of Demand and Supply Analysis

98. The Rationing Function of Prices
Methods of non-price rationing
Rationing by queues (waiting in line)
Rationing by random assignment, and/or coupons
Chapter 4 - Extensions of Demand and Supply Analysis

99. The Rationing Function of Prices
The essential role of rationing (with scarcity rationing must occur)
We must choose the rationing mechanism: price or non-price.
Price rationing leads to most efficient use of available resources; all gains from mutually beneficial trade are captured.
Chapter 4 - Extensions of Demand and Supply Analysis

100. The Rationing Function of Prices
Question
If price rationing is the most efficient is it the “best” way to ration?
Answer
Economists cannot say which system is “best.” They can say rationing via the price system leads to the most efficient use of available resources.
Chapter 4 - Extensions of Demand and Supply Analysis

101. The Policy of Government-Imposed Price Controls
Government-mandated minimum or maximum prices
Price Ceiling
A legal maximum price
Price Floor
A legal minimum price
Chapter 4 - Extensions of Demand and Supply Analysis

102. The Policy of Government-Imposed Price Controls
Price ceiling and black markets
Price ceilings may prevent the equilibrium price from being achieved if it is above the ceiling price.
Chapter 4 - Extensions of Demand and Supply Analysis

103. The Policy of Controlling Rents
Effects on the existing supply of housing and current use of housing
Property owners cannot recover costs
Maintenance, repairs, capital improvements
Rations the current use of housing
Reduces mobility, e.g., New York’s “housing gridlock”
Chapter 4 - Extensions of Demand and Supply Analysis

104. Price Floors in Agriculture
Support Price
The governmentally established price floor
Associated with agricultural products
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105. Agricultural Price Supports
Chapter 4 - Extensions of Demand and Supply Analysis

106. Price Floors in the Labor Market
Minimum Wage
A wage floor, legislated by government, setting the lowest hourly wage rate that firms may legally pay their workers
Chapter 4 - Extensions of Demand and Supply Analysis

107. The Effect of Minimum Wages
Chapter 4 - Extensions of Demand and Supply Analysis

108. Quantity Restrictions
Governments can impose quantity restrictions, most obvious—banning ownership or trading of a good
Human organs
Drugs
Hospital beds
Chapter 4 - Extensions of Demand and Supply Analysis

109. Quantity Restrictions
Government Prohibitions and Licensing Requirements
Some commodities cannot be purchased at all legally; others require a license
Import Quota
Supply restriction that prohibits the importation of more than a specified quantity of a particular good
Chapter 4 - Extensions of Demand and Supply Analysis

110. Summary Discussion of Learning Objectives
Essential features of the price system
A price system (market system) allows prices to respond to changes in supply and demand for different commodities.
The terms of exchange—prices—are communicated in markets that tend to minimize transactions costs.
Chapter 4 - Extensions of Demand and Supply Analysis

111. Summary Discussion of Learning Objectives
How changes in demand and supply affect market price and equilibrium quantity
Increases in demand increase equilibrium price and quantity; decreases in demand decrease equilibrium price and quantity.
Increases in supply decrease market price and increase equilibrium quantity; decreases in supply increase market price and decrease equilibrium quantity.
Chapter 4 - Extensions of Demand and Supply Analysis

112. Summary Discussion of Learning Objectives
How changes in demand and supply affect market price and equilibrium quantity
When both demand and supply shift at the same time, the result is indeterminate.
Chapter 4 - Extensions of Demand and Supply Analysis

113. Summary Discussion of Learning Objectives
The rationing function of prices
In a market system, prices ration scarce goods and services.
Other ways of rationing include first come, first served; political power; physical force; random assignment; and coupons.
Chapter 4 - Extensions of Demand and Supply Analysis

114. Summary Discussion of Learning Objectives
The effects of price ceilings
A price ceiling set below the market (equilibrium) price results in a shortage.
The resulting shortage can lead to non-price rationing devices and black markets.
Chapter 4 - Extensions of Demand and Supply Analysis

115. Summary Discussion of Learning Objectives
The effects of price floors
If the price floor is set above the market price, a surplus results.
A price floor can take the form of a government-imposed price support or minimum wage.
Chapter 4 - Extensions of Demand and Supply Analysis

116. Summary Discussion of Learning Objectives
Government-imposed restrictions on market quantities
Bans on sale or ownership
Licensing restrictions
Import quotas
Chapter 4 - Extensions of Demand and Supply Analysis