1. Introduction to Economics

2. Economy. . .
. . . The word economy comes from a Greek word for “one who manages a household.”

3. PRINCIPLES OF ECONOMICS
A household and an economy face many decisions:
Who will work?
What goods and how many of them should be produced?
What resources should be used in production?
At what price should the goods be sold?

4. PRINCIPLES OF ECONOMICS
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.

5. PRINCIPLES OF ECONOMICS
Economics is the study of how society manages its scarce resources.

6. People Face Trade-offs.
To get one thing, we usually have to give up another thing.
Guns v. butter
Food v. clothing
Leisure time v. work
Efficiency v. equity
Making decisions requires trading off one goal against another.

7. People Face Trade-offs
Efficiency v. Equity
Efficiency means society gets the most that it can from its scarce resources.
Equity means the benefits of those resources are distributed fairly among the members of society. 9

8. The Cost of Something Is What You Give Up to Get It.
Decisions require comparing costs and benefits of alternatives.
Whether to go to college or to work?
Whether to study or go out on a date?
Whether to go to class or sleep in?
The opportunity cost of an item is what you give up to obtain that item. 10

9. 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. 11

10. People Respond to Incentives.
Marginal changes in costs or benefits motivate people to respond.
The decision to choose one alternative over another occurs when that alternative’s marginal benefits exceed its marginal costs! 12

11. Economic Models
Economists use models to simplify reality in order to improve our understanding of the world.
Two of the most basic economic models are:
The Circular Flow Diagram
The Production Possibilities Frontier

12. Our First Model: The Circular-Flow Diagram
The circular-flow diagram is a visual model of the economy that shows how dollars flow through markets among households and firms. 6

13. The Circular Flow Firms sell Households buy MARKETS FOR
GOODS AND SERVICES
Revenue
Spending
Goods
and services
sold
Goods and
services
bought
FIRMS
Produce and sell
goods and services
Hire and use factors
of production
Buy and consume
goods and services
Own and sell factors
of production
HOUSEHOLDS
Households sell
Firms buy
MARKETS
FOR
FACTORS OF PRODUCTION
Factors of
production
Labor, land,
and capital
Wages, rent,
and profit
Income
= Flow of inputs
and outputs
= Flow of dollars

14. Our First Model: The Circular-Flow Diagram
Firms
Produce and sell goods and services
Hire and use factors of production
Households
Buy and consume goods and services
Own and sell factors of production 7

15. Our First Model: The Circular-Flow Diagram
Markets for Goods and Services
Firms sell
Households buy
Markets for Factors of Production
Households sell
Firms buy 7

16. Our First Model: The Circular-Flow Diagram
Factors of Production
Inputs used to produce goods and services
Land, labor, and capital 7

17. Our Second Model: The Production Possibilities Frontier
The production possibilities frontier is a graph that shows the combinations of output that the economy can possibly produce given the available factors of production and the available production technology. 14

18. The Production Possibilities Frontier
Quantity of
Computers
Produced
3,000 C A
2,200
600 B
700
2,000
Production
possibilities
frontier
1,000
300 D
Quantity of
1,000
Cars Produced

19. Our Second Model: The Production Possibilities Frontier
Concepts illustrated by the production possibilities frontier
Efficiency
Trade-offs
Opportunity cost
Economic growth 21

20. A Shift in the Production Possibilities Frontier
Quantity of
Computers
Produced
4,000
3,000
1,000
2,300
650 G
2,200
600 A
Quantity of
Cars Produced

21. Microeconomics and Macroeconomics
Microeconomics focuses on the individual parts of the economy.
How households and firms make decisions and how they interact in specific markets
Macroeconomics looks at the economy as a whole.
Economy-wide phenomena, including inflation, unemployment, and economic growth 13

22. Managerial Economics
Integrates and applies microeconomic theory and methods to decision making problems faced by private, public, and not-for-profit organizations.
Managerial economics deals with microeconomic reasoning on real world problems such as pricing decisions selecting the best strategy in different competitive environments. 3

23. Three Questions
How an economy selects the most preferred combination will depend on the decision-making rules employed
Regardless of how decisions are made, each economy must answer three fundamental questions
What goods and services will be produced?
How will they will be produced?
For whom will they be produced?

24. Economic System
Economic System is a set of mechanisms and institutions that resolve the what, how, and for whom questions
Criteria used to distinguish among economic systems
Who owns the resources
What decision-making process is used to allocate resources and products
What type of incentives guide the economic decision makers

25. HOW THE ECONOMY AS A WHOLE WORKS
A country’s standard of living depends on its ability to produce goods and services.
Prices rise when the government prints too much money.
Society faces a short-run trade-off between inflation and unemployment.

26. A Country’s Standard of Living Depends on Its Ability to Produce Goods and Services.
Standard of living may be measured in different ways:
By comparing personal incomes.
By comparing the total market value of a nation’s production.

27. A Country’s Standard of Living Depends on Its Ability to Produce Goods and Services.
Almost all variations in living standards are explained by differences in countries’ productivities.
Productivity is the amount of goods and services produced from each hour of a worker’s time.

28. Prices Rise When the Government Prints Too Much Money.
Inflation is an increase in the overall level of prices in the economy.
One cause of inflation is the growth in the quantity of money.
When the government creates large quantities of money, the value of the money falls.

29. Society Faces a Short-run Trade-off between Inflation and Unemployment.
The trade-off between inflation and unemployment:
Inflation or Unemployment
It’s a short-run trade-off!
The trade-off plays a key role in the analysis of the business cycle—fluctuations in economic activity, such as employment and production