1. Introduction to Economics
Barbulean

2. Instructional Method Suggestions for the study of economics
Read the book before coming to class
Recopy lectures and reread the book within several hours of class
Identify what you don’t understand
Ask questions in class
Use the online study guide
Visit the professor during office hours

3. Definition of Economics
Mankiw’s definition
How Society manages its scarce resources
Hedrick’s definition
How society chooses to allocate its scarce resources among competing demands to best satisfy human wants
Alternative definitions
Economics is the study of choice.
Economics is what economist do.
Wikipedia's perspective

4. Scarcity and the Fundamental Questions of Economics
Scarcity : Unlimited wants versus limited resources
Choices and tradeoffs
Opportunity Costs
All societies must answer these questions
What is to be produced?
How is to be produced?
For whom will it be produced?

5. Economics as a Science The Scientific Method
Observation →Hypothesis →Testing
Observation: identifying and measuring important variables – orderly loss of information
Hypothesis: educated guesses about cause and effect with the variables
Theories
Models: realism or usefulness
Testing: theories can’t be proven and are supported by repeated failed attempts to disprove them.
Microeconomics vs. Macroeconomics
The Assumption of Rational Behavior
Boxes Example
People respond to incentives
Limits to the use of rational behavior (e.g. axe murders)

6. Greg Mankiw’s Ten Principles of Economic Thinking

7. Categories of Basic Principles of Economics
How people make decisions?
How people interact?
How does the economy work overall?

8. How People Make Decisions
Principle #1 - People face tradeoffs
Time allocation – an example of tradeoffs
Production Possibilities Frontier
Efficiency versus equity

9. How People Make Decisions
Principle #2 - The cost of something is what you have to give up to get it
Opportunity costs come from Von Weiser, a German economist late 1800s
Opportunity costs are independent of monetary units
TINSTAAFL
The real costs of going to college

10. How People Make Decisions
Principle #3 - Rational people think at the margin
Rational or irrational decision-making
Marginal benefits and costs versus total benefits and costs
Weighing marginal costs and benefits leads to maximizing net benefits (total welfare)

11. How People Make Decisions
Principle #4 –People respond to incentives
Reactions to changes in marginal benefits and costs
Increases (decreases) in marginal benefits mean more (less) of an activity
Increases (decreases) in marginal costs mean less (more) of an activity
Example of seat belts leading to increased speeds
Example of SUV (with child car seat) in Issaquah

12. How People Interact
Principle #5 - Trade can make everybody Society better off
Adam Smith author of the “An Inquiry into the Causes and Consequences of the Wealth of Nations” 1776
Gains from the division of labor and specialization
Mercantilists perspectives
Example of why Ellensburgians should trade with others

13. How People Interact
Principle #6 - Markets are usually a good way of organizing economic activity
Feudal times and haciendas in the new world
The power of trade: cooperation versus conflict
Markets: prices and quantities traded, typical and abstract

14. How People Interact
Principle #6 - Markets are usually a good way of organizing economic activity creativity and productivity and resource allocation
“Failure” of centrally planned economies
“set it and forget it” becomes “compete or be obsolete”

15. How People Interact
Principle #7 Governments can sometimes improve market outcomes
Market signals can fail to allocate resources efficiently or equitably
Public goods, the exclusion principle, the free- rider problem and non-rival consumption
External costs and benefits
Examples: vaccines, education, pollution

16. How People Interact
Principle #7 Governments can sometimes improve market outcomes
Equitable or fair distribution of resources
Efficiency and equity: the pie analogy
Government Failure: is government intervention always the proper solution?

17. How the Economy works as a Whole
Principle # 8 – A country’s standard of living depends upon its ability to produce goods and services
Adam Smith’s “An Inquiry into the Nature and the Consequences of the Wealth of Nations”
Materialism – more toys mean more welfare
wealth: a necessary or sufficient condition for happiness (are rich people happier, children with lots of toys)

18. How the Economy works as a Whole
Principle # 8 – A country’s standard of living depends upon its ability to produce goods and services
leisure time and productivity
the factors of production: land or natural resources, labor, capital, entrepreneurship
technology and productivity
the Rule of 72 and growth rates

19. How the Economy works as a Whole
Principle #9 – The general level of prices rises when the government prints and distributes too much money
Definition of money, and economic language

20. How the Economy works as a Whole
Principle #9 – The general level of prices rises when the government prints and distributes too much money
Examples: “Not worth a continental” and Argentina
Establish of the Federal Reserve and the introduction of sustained inflation in the US

21. How the Economy works as a Whole
Principle #10 – Society faces a short-run tradeoff between inflation and unemployment
Short-run and the long-run
Demand and supply shocks
Short-run increases (decreases) in output above (below) long-run potential output lead to adjustments

22. The Concept of Opportunity Cost
Opportunity cost of any choice
What we forego when we make that choice
Most accurate and complete concept of cost
Direct money cost of a choice may only be a part of opportunity cost of that choice
Opportunity cost of a choice includes both explicit costs and implicit costs
Explicit cost—dollars actually paid out for a choice
Implicit cost—value of something sacrificed when no direct payment is made

23. Opportunity Cost and Society
All production carries an opportunity cost
To produce more of one thing
Must shift resources away from producing something else
The Principle of Opportunity Cost
The concept of opportunity cost sheds light on virtually every problem that economists study, whether it be explaining the behavior of consumers or business firms or understanding important social problems like problems like poverty or racial discrimination
Basic Principle #2: Opportunity Cost
All economic decisions made by individuals or society are costly
The correct way to measure the cost of a choice is its opportunity cost—that which is given up to make the choice

24. Figure 1: The Production Possibilities Frontier
Number of Lives Saved per Period
Quantity of All Other Goods per Period
100,000
200,000
300,000
400,000
500,000
1,000,000
950,000
850,000
700,000
At point A, all resources are used for "other goods." A
Moving from point A to point B requires shifting resources out of other goods and into health care. B C D
At point F. all resources are used for health care. W E F

25. Increasing Opportunity Cost
According to law of increasing opportunity cost
The more of something we produce
The greater the opportunity cost of producing even more of it
This principle applies to all of society’s production choices

26. Recessions
A slowdown in overall economic activity when resources are idle
Widespread unemployment
Factories shut down
Land and capital are not being used
An end to the recession would move the economy from a point inside its PPF to a point on its PPF
Using idle resources to produce more goods and services without sacrificing anything
Can help us understand an otherwise confusing episode in U.S. economic history

27. Recessions
During early 1940s, standard of living in U.S. did not decline as we might have expected but actually improved slightly. Why?
U.S. entered World War II and began using massive amounts of resources to produce military goods and services
Instead of pitting “health care” against “all other goods,” we look at society’s choice between military goods and civilian goods
U.S. was still suffering from the Great Depression when it entered WWII
Joining war effort helped end the Depression and moved economy from a point like A, inside the PPF, to a point like B, on the frontier
Military production increased, but so did the production of civilian goods
Although there were shortages of some consumer goods
Overall result was a rise in the material well-being of the average U.S. citizen
War is only one factor that can reverse a downturn
No rational nation would ever choose war as an economic policy designed to cure a recession
Alternative policies that virtually everyone would find preferable

28. Figure 2: Production and Unemployment
1. Before WWII the United States operated inside its PPF . . .
Civilian Goods per Period
Military Goods per Period
2. then moved to the PPF during the war. Both military and civilian production increased. B A

29. Economic Growth If economy is already operating on its PPF
Cannot exploit opportunity to have more of everything by moving to it
But what if the PPF itself were to change? Couldn’t we then produce more of everything?
This happens when an economy’s productive capacity grows
Many factors contribute to economic growth, but they can be divided into two categories
Quantities of available resources—especially capital—can increase
An increase in physical capital enables economy to produce more of everything that uses these tools
More factories, office buildings, tractors, or high-tech medical equipment
Same is true for an increase in human capital
Skills of doctors, engineers, construction workers, software writers, etc.
Technological change enables us to produce more from a given quantity of resources

30. Economic Growth
Increases in capital and technological change often go hand in hand
For instance, PET body scanners will enable us to save even more lives than our current set of resources
Moving horizontal intercept of PPF rightward, from F to F‘
Impact of PET scanners stretches PPF outward along horizontal axis
How can a technological change in lifesaving enable us to produce more goods in other areas of the economy?
Society can choose to use some of increased lifesaving potential to shift other resources out of medical care and into production of other things
Because of technological advance and new capital, we can shift resources without sacrificing lives

31. Economic Growth
If we can produce more of the things that we value, without having to produce less of anything else, have we escaped from paying an opportunity cost?
Yes and no
Figure 3 tells only part of story
Leaves out steps needed to create this shift in the PPF
For example, technological innovation doesn’t just “happen”—resources must be used to create it
Mostly by research and development (R&D) departments of large corporations
In order to produce more goods and services in the future, we must shift resources toward R&D and capital production
Away from production of things we’d enjoy right now

32. Figure 3: The Effect of a New Medical Technology
Number of Lives Saved per Period
Quantity of All Other Goods per Period
2. But not its vertical intercept.
4. or more lives saved and greater production of other goods. A
1,000,000
3. The economy can end up with more lives saved and un-changed production of other goods . . . J H
700,000 D
1. A technological advance in saving lives increases this PPF's horizontal intercept . . . F F'
300,000
500,000
600,000

33. Efficiency
In production, we’d like to have productive efficiency – achieving as much output as possible from a given amount of inputs or resources.
Efficiency involves achieving a goal as cheaply as possible.
Efficiency has meaning only in relation to a specified goal.

34. Efficiency
Any point within (INSIDE) the production possibility curve represents inefficiency.
Inefficiency – getting less output from inputs which, if devoted to some other activity, would produce more output.
Unattainable -Any point outside the production possibility curve represents something unattainable, given present resources and technology.

35. Efficiency and Inefficiency
Guns 10 8 6 4 2
Butter C D A B
Unattainable point,
given available technology,
resources and labor force
Efficient
points
Inefficient
point

36. Tom’s Trade-offs: The Production Possibility Frontier

37. Shifts in the Production Possibility Curve
Society can produce more output if:
Technology is improved.
More resources are discovered.
Economic institutions get better at fulfilling our wants.

38. Economic Growth
Production is initially at point A (20 fish and 25 coconuts),  it can move to point E (25 fish and 30 coconuts).
Economic growth results in an outward shift of the PPF because production possibilities are expanded.
The economy can now produce more of everything.

39. Shifts in the Production Possibility Curve
Neutral Technological Change
Butter C D A B
Guns

40. Shifts in the Production Possibility Curve
Biased Technological Change
Butter C B A
Guns

41. Specialization and Exchange
Method of production in which each person concentrates on a limited number of activities
Exchange
Practice of trading with others to obtain what we want
Allows for
Greater production
Higher living standards than otherwise possible
All economics exhibit high degrees of specialization and exchange

42. Further Gains to Specialization
Absolute Advantage: A Detour
Ability to produce a good or service using fewer resources than other producers use
Comparative Advantage
If one can produce some good with a smaller opportunity cost than others can
Total production of every good or service will be greatest when individuals specialize according to their comparative advantage
Another reason why specialization and exchange lead to higher living standards than self-sufficiency

43. Resource Allocation Problem of resource allocation
Which goods and services should be produced with society’s resources?
Where on the PPF should economy operate?
How should they be produced?
No capital at all
Small amount of capital
More capital
Who should get them?
How do we distribute these products among the different groups and individuals in our society?

44. The Three Methods of Resources Allocation
Traditional Economy
Resources are allocated according to long-lived practices from the past
Command Economy (Centrally-Planned)
Resources are allocated according to explicit instructions from a central authority
Market Economy
Resources are allocated through individual decision making

45. The Nature of Markets
A market is a group of buyers and sellers with the potential to trade with each other
Global markets
Buyers and sellers spread across the globe
Local markets
Buyers and sellers within a narrowly defined area

46. The Importance of Prices
A price is the amount of money that must be paid to a seller to obtain a good or service
When people pay for resources allocated by the market
They must consider opportunity cost to society of their individual actions
Markets can create a sensible allocation of resources

47. Resource Allocation in the United States
Numerous cases of resource allocation outside the market
Such as families
Various levels of government collect about one-third of our incomes as taxes
Enables government to allocate resources by command
Government uses regulations of various types to impose constraints on our individual choice
The market is the dominant method of resource allocation in United States
However, it is not a pure market

48. Resource Ownership Communism Socialism Capitalism
Most resources are owned in common
Socialism
Most resources are owned by state
Capitalism
Most resources are owned privately

49. Types of Economic Systems
An economic system is composed of two features
Mechanism for allocating resources
Market
Command
Mode of resource ownership
Private
State

50. Figure 4: Types of Economic Systems
Resource Allocation
Market
Command
Private
State
Resource Ownership
Market Capitalism
Centrally Planned Capitalism
Centrally Planned Socialism
Market Socialism

51. Transactions: The Circular-Flow Diagram
Trade takes the form of barter when people directly exchange goods or services that they have for goods or services that they want.
The circular-flow diagram is a model that represents the transactions in an economy by flows around a circle.

52. Circular-Flow of Economic Activities
A household is a person or a group of people that share their income.
A firm is an organization that produces goods and services for sale.
Firms sell goods and services that they produce to households in markets for goods and services.
Firms buy the resources they need to produce—factors of production—in factor markets.
Factor Market- A market used to exchange the services of a factor of production: labor, capital, land , and entrepreneurship.

53. The Circular-Flow Diagram

54. Factor Market
Factor markets, also termed resource markets, exchange the services of factors, NOT the factors themselves. For example, the labor services of workers are exchanged through factor markets NOT the actual workers. Buying and selling the actual workers is not only slavery (which is illegal) it's also the type of exchange that would take place through product markets, not factor markets. More realistically, capital and land are two resources than can be and are legally exchanged through product markets. The services of these resources, however, are exchanged through factor markets. The value of the services exchanged through factor markets each year is measured as national income.

55. Wages, rents, interest, profits
The Circular Flow
Wages, rents, interest, profits
Firms (production)
Household
Factor services
Goods
Government Spending
Other countries
Financial markets
Government
Taxes
Savings
Investment
Personal consumption
Exports
Imports

56. Growth in the U.S. Economy from 1962…

57. …to 1988