1. INTRODUCTION TO ECONOMIC ANALYSIS
CHAPTER 1
INTRODUCTION TO ECONOMIC ANALYSIS
2nd Semester, S.Y 2013 – 2014

2. What is Economics?
The study of how individuals and societies choose to allocate and use scarce resources to satisfy unlimited wants.
Economics is about economizing; that is, about choice among alternative uses of scarce resources. Choices are made by millions of individuals, businesses, and government units. Economics examines how these choices add up to an economic system, and how this system operates. (L.G. Reynolds).

3. Scarcity exists because individuals want more than can be produced
Concept of Scarcity
Scarcity exists because individuals want more than can be produced
Scarcity means the goods available are too few to satisfy individuals’ desires
The degree of scarcity is constantly changing
The quantity of goods, services and usable resources depends on technology and human action

4. Microeconomics vs. 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
microeconomics - the study of individual economic agents and individual markets
macroeconomics - the study of economic aggregates
Macroeconomics - nation's unemployment rate, inflation, interest rate trends, government budgets, government fiscal policies, economic growth, and monetary policy, are topics discussed in
Microeconomics - Price elasticity (sensitivity) of demand for goods and services, firms’ production behavior, cost functions, income inequality, and protectionism, 13

5. Scope of Microeconomics
Microeconomics studies
Buying decisions of the individual
Consumers’ satisfaction
Buying and selling decisions of the firm
The determination of prices and in markets
The quantity, quality and variety of products
Profits
microeconomics - the study of individual economic agents and individual markets
macroeconomics - the study of economic aggregates
Macroeconomics - nation's unemployment rate, inflation, interest rate trends, government budgets, government fiscal policies, economic growth, and monetary policy, are topics discussed in
Microeconomics - Price elasticity (sensitivity) of demand for goods and services, firms’ production behavior, cost functions, income inequality, and protectionism, 13

6. Scope of Macroeconomics
Macroeconomics studies
Economic growth
Unemployment and inflation
Aggregate demand and aggregate supply
Economic policies – fiscal and monetary
International trade – exports and imports
Money supply
microeconomics - the study of individual economic agents and individual markets
macroeconomics - the study of economic aggregates
Macroeconomics - nation's unemployment rate, inflation, interest rate trends, government budgets, government fiscal policies, economic growth, and monetary policy, are topics discussed in
Microeconomics - Price elasticity (sensitivity) of demand for goods and services, firms’ production behavior, cost functions, income inequality, and protectionism, 13

7. Microeconomics vs. Macroeconomic Questions
Should I go to business school or take a job right now?
How many people are employed in the economy as a whole this year?
What determines the salary offered by San Miguel Corporation to Juan Dela Cruz, a new MBA?
What determines the overall salary levels paid to workers in a given year?
What determines the cost to a university or college of offering a new course?
What determines the overall level of prices in the economy as a whole?
What government policies should be adopted to make it easier for low-income
students to attend college?
What government policies should be adopted to promote employment and
growth in the economy as a whole?
What determines whether BPI opens a new Branch in Shanghai?
What determines the overall trade in goods, services, and financial assets between the Philippines and the rest of the world

8. Let’s Check Your Understanding!
Which of the following questions involve microeconomics, and which involve macroeconomics? In each case, explain your answer.
Why did consumers switch to smaller cars in 2012?
Why did overall consumer spending slow down in 2012?
Why did the standard of living rise more rapidly in the current administration compared to previous administration?
Why have starting salaries for students with geology degrees risen sharply of late?
What determines the choice between rail and road transportation?
Why has salmon got cheaper over the past 20 years?
Why did inflation fall in the 1990s?
CHECK YOUR UNDERSTANDING
1. a. This is a microeconomic question because it addresses decisions made by consumers about a particular product.
b. This is a macroeconomic question because it addresses consumer spending in the overall economy.
c. This is a macroeconomic question because it addresses changes in the overall economy.
d. This is a microeconomic question because it addresses changes in a particular market, in this case the market for geologists.
e. This is a microeconomic question because it addresses choices made by consumers and producers about which mode of transportation to use.
f. This is a microeconomic question because it addresses changes in a particular market.
g. This is a macroeconomic question because it addresses changes in a measure of the economy’s overall price
level.

9. Ten 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?

10. Ten 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.

11. Ten Principles of Economics
How people make decisions.
People face tradeoffs.
The cost of something is what you give up to get it.
Rational people think at the margin.
People respond to incentives.

12. Ten Principles of Economics
How people interact with each other.
Trade can make everyone better off.
Markets are usually a good way to organize economic activity.
Governments can sometimes improve economic outcomes.

13. Ten Principles of Economics
The forces and trends that affect how the economy as a whole works.
The standard of living depends on a country’s production.
Prices rise when the government prints too much money.
Society faces a short-run tradeoff between inflation and unemployment.

14. Principle #1: People Face Tradeoffs
“There is no such thing as a free lunch!”

15. Principle #1: People Face Tradeoffs
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.

16. Principle #1: People Face Tradeoffs
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

17. Principle #2: 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

18. Opportunity Cost
Opportunity cost is the benefit forgone of the next-best alternative to the activity you have chosen
Opportunity cost should always be less than the benefit of what you have chosen
Opportunity cost is the basis of cost/benefit economic reasoning

19. Marginal Costs and Marginal Benefits
Using economic reasoning, decisions are often made by comparing marginal costs and marginal benefits
Marginal cost is the additional cost or sacrifice one makes of participating in an activity or purchasing a product.
Marginal benefit is the additional satisfaction or value one obtains from an activity or product.

20. Marginal Costs and Marginal benefits
The economic decision rule:
If the marginal benefits of doing something exceed the marginal costs, do it.
MB > MC  Do it!
If the marginal costs of doing something exceed the marginal benefits, don’t do it.
MC > MB  Don’t do it!

21. Opportunity Cost Examples of opportunity cost: Individual decisions
The opportunity cost of college includes:
Items you could have purchased with the money spent for tuition and books
Loss of the income from a full-time job
2. Government decisions
The opportunity cost of money spent on the war on terrorism is less spending on health care or education

22. Principle #2: The Cost of Something Is What You Give Up to Get It.
LA Laker basketball star Kobe Bryant chose to skip college and go straight from high school to the pros where he has earned millions of dollars. 10

23. Principle #3: 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

24. Principle #4: 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

25. Principle #5: Trade Can Make Everyone Better Off.
People gain from their ability to trade with one another.
Competition results in gains from trading.
Trade allows people to specialize in what they do best. 15

26. Principle #6: Markets Are Usually a Good Way to Organize Economic Activity
A market economy is an economy that allocates resources through the decentralized decisions of many firms and households as they interact in markets for goods and services.
Households decide what to buy and who to work for.
Firms decide who to hire and what to produce. 16

27. Principle #6: Markets Are Usually a Good Way to Organize Economic Activity
Adam Smith made the observation that households and firms interacting in markets act as if guided by an “invisible hand.”
Because households and firms look at prices when deciding what to buy and sell, they unknowingly take into account the social costs of their actions.
As a result, prices guide decision makers to reach outcomes that tend to maximize the welfare of society as a whole. 16

28. Principle #7: Governments Can Sometimes Improve Market Outcomes
Market failure occurs when the market fails to allocate resources efficiently.
When the market fails (breaks down) government can intervene to promote efficiency and equity. 17

29. Principle #7: Governments Can Sometimes Improve Market Outcomes
Market failure may be caused by
an externality, which is the impact of one person or firm’s actions on the well-being of a bystander.
market power, which is the ability of a single person or firm to unduly influence market prices. 18

30. Principle #8: The Standard of Living Depends on a Country’s Production
Standard of living may be measured in different ways:
By comparing personal incomes.
By comparing the total market value of a nation’s production. 21

31. Principle #8: The Standard of Living Depends on a Country’s Production
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. 21

32. Principle #8: The Standard of Living Depends on a Country’s Production
Standard of living may be measured in different ways:
By comparing personal incomes.
By comparing the total market value of a nation’s production. 21

33. Principle #9: 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. 23

34. òInflation ð ñUnemployment
Principle #10: Society Faces a Short-run Tradeoff Bet. Inflation and Unemployment
The Phillips Curve illustrates the tradeoff between inflation and unemployment:
òInflation ð ñUnemployment
It’s a short-run tradeoff! 24

35. Thinking Like an Economist
Economics trains you to
Think in terms of alternatives.
Evaluate the cost of individual and social choices.
Examine and understand how certain events and issues are related. 2

36. The Economist As a Scientist
The economic way of thinking . . .
Involves thinking analytically and objectively.
Makes use of the scientific method. 3

37. Economic Model
This is a simple analytic frame which shows the relationship between the main factors, and explains the behavior of an economic theory or phenomenon.
Economists use economic models to simplify reality and to facilitate the understanding of the actual world economic inconveniences.

38. Types of Economic Model
Descriptive
Like the Circular Flow
Analytical
Assumptions
Mathematical model ( functions and equations)
Graphical analysis

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

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

41. General Features of Economic Model
All economic models incorporate three common elements:
The ceteris paribus (other things the same) assumption;
The supposition that economic decision makers seek to optimize something;
A careful distinction between “positive” and “normative” questions.
Ceteris Paribus – all other factors constant.

42. Ceteris Paribus Assumption
The ceteris paribus (other things the same) assumption – which allows analysis of the effect of a change in one factor by holding all other relevant factors unchanged.

43. Optimization Assumption
2. The supposition that economic decision makers seek to optimize something;
Many economic models start from the assumption that the economic actors being studied are rationally pursuing some goal.

44. Positive versus Normative Analysis
Positive economics are statements that attempt to describe how the economy functions and the the world as it is.
Called descriptive analysis
Normative economics are statements about how the economy or world should be which relies on value judgments to evaluate or recommend alternative policies.
Called prescriptive analysis 31

45. Positive versus Normative Analysis
Positive or Normative Statements?
If the minimum wage increases, then firms’ cost of production rises.
POSITIVE
Higher budget deficits will cause interest rates to increase. 32

46. Positive versus Normative Analysis
Positive or Normative Statements?
The minimum wage in Metro Manila should increase to P600.
NORMATIVE
The government should be allowed to collect from tobacco companies the costs of treating smoking-related illnesses among the poor. 32

47. Let’s Check You Understanding!
Which of the following statements is a positive statement? Which is a normative statement?
A. Society should take measures to prevent people from engaging in dangerous personal
behavior.
B. People who engage in dangerous personal behavior impose higher costs on society
through higher medical costs.