Econ 110: Part 1 Twelve Key Elements of Economics

1. Build a bridge between common sense and economics applications 2. provide a solid foundation in economic reasoning 3. apply common sense to help readers make strategic, consumption, savings, investment, career and voting choices

Three Key Elements of Economics

Buyers and sellers spend scarce resources when they: -Search for exchange partners -Locate product information -Negotiate the terms of trade -Finalize and formalize contracts and agreements

Transaction Costs

People are different in many ways...and our differences are our greatest assets! Differences in income arise because our differences affect the value of goods and services we help create and supply. There is a direct link (ceteris paribus) between helping others in ways that they value and the income we earn. If you want a high income job, figure out how to help others in ways they value!!!

earning income by helping others

1. Understand how the world works 2. Economics is at the root of business decisions, government policy market and global economic relations. 3. Its a language we can all understand 4. understanding how markets work and the relationship between economic variable is necessary to understanding the economy, the economy is greater predictor of freedom. 5. economics is a key to understanding the press and our elected officials 6. economics helps you make better decisions

importance of studying economics

Opportunity cost is the costs of choices...it's what you give up!!! Think of a fork in the road, it's two decisions, you have to choose one. What's the opportunity cost for you taking our course?

opportunity cost

Society cannot get something for nothing, that producing one thing means society cannot produce something else

opportunity cost and society

Economic theory can make significant contributions to policy formulation. nAll policy decisions are ultimately a mix of politics and economic theory. The first law of economics is scarcity, and the first law of politics is to disregard the first law of economics. -Thomas Sowell

politics vs economics

Macroeconomics is the study of aggregate economic behavior, of the economy as a whole. Microeconomics is the study of individual behavior in the economy, of the components of the larger economy.

two branches of economics

Incentives matter to everyone, including volunteers and charitable organizations. What incentives do volunteers have? Are they only monetary? Describe some incentives offered to encourage people to volunteer, donate blood and assist Habitat for Humanity in the building of houses.

volunteerism and incentives

-Life is about choices and economics is about how incentives affect those choices and shape our lives. -incentives are the rewards and penalties associated with choices -thus, economics is about human decision making the analysis of the forces underlying choice and the implications with regard to how societies work

1. Why incentives matter

-our resources are limited but our desire for goods and services is virtually unlimited -something is scarce if it has more than one valuable use -when resources are used to do one thing they are unavailable to do others (think opportunity cost -when production costs are high it is because the resources can be used for other purposes

2. No such thing as a free lunch- the condition of scarcity

1. few if any decisions are "all or nothing" 2. marginal means additional or one more 3. we are constantly facing marginal choices 4. to get the most out of our resources we should only take an action when the additional benefits are greater than the additional costs

3. decisions are made at the margin. first slide labeled: Definition of Marginalism

Why do you buy things from others rather than producing them yourself? nAndy George of "How to Make Everything" spent $1,500 and 6 months making a single sandwich completely from scratch. Would you be better off if you purchased fewer items from others and produced more of what you consume? nWould Americans be better off if we produced more items domestically and purchased fewer from foreigners?

4. trade promotes economic progress first slide labeled: why do people engage in trade?

Transaction costs are costs that are incurred but don't go through a price mechanism. Resources spent when making an exchange or transaction. Coase (1937) realized that parties involved in trade experience costs that are not captured in the prices or production costs of goods. Fast food and making dinner at home.

5. transaction costs are an obstacle to trade first slide labeled: Transactions Costs means?

Both the buyer and the seller, not one or the other, are made better off as the result of any voluntary market exchange.

6. prices bring the choices of buyers and sellers into balance. first slide labeled: In a Market There is a Buyer and a Seller.

People of a nation are better off if their resources produce goods and services that are highly valued relative to costs. Productive projects will be encouraged and less productive use of resources will be discouraged. This is the function of profits and losses.

7. Profits direct business toward activities that increase wealth Why profits and losses are our friend

1. Decisions made at the margin leads to the optimal decisions being made, subject to preferences, resources and informational constraints. Mb>MC we keep adding until their equal not MC>MB 2. marginal analysis suggests that rational maximizing behavior is occurring when we are weighing "marginal benefits and marginal costs" when making decisions

Mas marginal analysis

The goals of this course are modest: Develop a reasonable perspective of economic behavior. Acquire an understanding of basic economic principles and concepts. Develop an economic way of thinking...the ability to think like an economist.

Modest Expectations

the most desired goods and services that are foregone in order to obtain something else. the next best alternative that you give up more than dollars

Opportunity Cost

opportunity cost is the costs of choices its what you give up.

Opportunity costs

Consider the impact of the following on demand, supply, and the equilibrium price. An increase in the income levels in China on the market for tourism in the U.S. An increase in the tax on gas on the market for fuel efficient cars. Political uncertainty, social unrest, and unsound legal institutions on markets in Afghanistan.

Our World is Ever Changing

Trade moves goods and services from people who value them less to people who value them more. nTrade makes larger output and consumption possible by allowing us to specialize in doing what we do best. Trade makes larger output and lower per-unit costs possible as a result of mass production. Trade ultimately results in higher levels of income.

People Gain When They Trade

Ceteris Paribus—the assumption of nothing else changing. The fallacy of composition—micro vs. macro. Association is not causation. Good intensions do not guarantee desirable outcomes.

Pitfalls and Tiger Traps

-incentives affect political as well as market choices -voters will consider how the expected actions of candidates will affect their personal well-being -Politicians will consider how their positions will affect their chances of being elected (and re-elected)

Politics and incentives

Investments in productive assets Physical capital (tools, machines, computers, buildings) and human capital (education, vocational training, professional development) Entrepreneurial discoveries and improvements in technology Internal combustion engine, assembly line, refrigerators, telephone, polio vaccine, microwave, minicomputer, by-pass surgery, franchising. Improvements in economic organization Rule of law, even handed enforcement, competitive markets, limited government and money of stable value

Sources of Economic Growth

Things constantly happen spontaneously to make both consumer and producers better off through exchange. When guided by market prices, self-interested individuals will move toward activities that will promote the general welfare. This occurs without any central planning.

Spontaneous Order

Economists often use graphics to illustrate the relationships among price, quantity demanded, and quantity supplied. The equilibrium price and quantity are at the intersection of the supply and demand curves.

Supply and Demand

-Scarcity forces us to make choices, to constantly make trade offs in our decisions -every time we choose to do one thing we give up doing something else

The problem of scarcity

Why cant we have everything we want -we live in a fallen world -our wants exceed our resources -there is a lack of available resources to satisfy all desired uses of those resources

The problem with scarcity

Simply states that individuals always make prudent and logical decisions. these decisions provide people with the greatest benefit or satisfaction given the choices available and are also in their highest self-interest.

The rule of rational choice

Reality is too complex to describe and explain in one course. Economists focus on basic relationships and use these to predict economic events and formulate economic policies. Pitfalls and tiger traps.

Theory vs. Reality

Scarcity > Choice > Opportunity cost + Self Interest

Basic Economic Paradigm

"When economists refer to the "opportunity cost" of a resource, they mean the value of the next-highest-valued alternative use of that resource. If, for example, you spend time and money going to a movie, you cannot spend that time at home reading a book, and you cannot spend the money on something else. If your next-best alternative to seeing the movie is reading the book, then the opportunity cost of seeing the movie is the money spent plus the pleasure you forgo by not reading the book."

Book says this

-Lead to changes in behavior -remember the record high nominal gas prices in the summer of 2008 -why was there no panic in the streets or lines at the gas pumps -incentives matter that is why

Changes in prices

Logic of choosing between choices... We must choose to have less of some other good or goods that I would also like to have... Choices at times are relegated to prices....to relevant costs which leads to another discussion about Opportunity Costs....later...

Choices

Consumption is the sole end and purpose of all production; and the interest of the producer ought to be attended to only so far as it may be necessary for promoting that of the consumer. —Adam Smith (1776)

Consumption

is the study of aggregate economic behavior, of the economy as a whole.

Definition of Macroeconomics

Is the study of individual behavior in the economy, of the components of the larger economy

Definition of Microeconomics

1. Assertion that for all people some goods are scarce, we would like to have more, especially at not cost. Therefore, demand would be greater than supply, which would lead to shortages. 2. Scarcity is the logical outcome or consequence of limited ability to produce, remember inputs are limited combined with the virtual unlimited desire to continue

Definition of Scarcity

the study of how best to allocate scarce resources among competing uses

Definition of economics

A free market is a market where the price of a good or service is in theory determined by supply and demand rather than being regulated to governmental intervention/regulation

Definition of free market

1. Demand Curve Shifters 2. Consumer tastes and preferences 3. demographics/lifecycles 4. economic 5. natural (inputs for the manufacturing/production process, triple bottom line of social costs, going "green") 6. technological 7. government/legal 8. social/cultural 9. competitors (what they are doing and planning to do) 10. substitute products 11. corporate social responsibility

Demand Shifters

-Consumers eliminate unnecessary trips, walk or car pool in the short run -They buy more fuel efficient vehicles in the long run -Producers increase production in the short run -They discover new energy sources in the long run

Difference between short run and long run changes in behavior

Politicians and proponents of government spending projects are fond of bragging about the jobs created by their spending programs and they exaggerate program benefits. Consider the following: Agricultural Adjustment Act (AAA) of 1933 2009 "Cash for Clunkers" Program Government Support for Ethanol Fuel Production

Do Spending Programs Create Jobs of Value?

In our economy how do we decide who gets what? nAnswer: Producers/manufacturers charge a price for certain products (differentiated products, not commodities). They are saying that whoever values those products at those prices will pay for it; this is how scarce resources in a fully functional economy are allocated, distributed efficiently.

Mas Scarcity

Compare and contrast free market with keynesian economics.

Mas free market

Equilibrium occurs at the price where the amount demanded by consumers is just equal to the amount sellers are willing to supply. In equilibrium, all mutually advantageous exchanges will occur.

Equilibrium

Free markets are where all suppliers and demands handle the market issues

Fact about free markets

It's all about the price system built into the free market. Price system that is not controlled is what gives free markets their "spontaneous order"

Free markets

Buyers and sellers are motivated to coordinate their actions, cooperate with each other, and work together harmoniously. The potential gains from trade are maximized.

In a Market Economy

Search for those opportunities where market conditions are such that they are able to generate revenue sufficient to cover their costs. Continue to produce a good or service if and only if consumers value it enough to pay prices sufficient to cover per unit costs.

In a Market Economy Firms Will

College students are rewarded for studying. Star athletes and entertainers are rewarded for their specialized skills. Entrepreneurs are rewarded for their productive innovations and risk-taking. Why does a famous singer earn more than a professor?

Income Variation and Incentives

The "invisible hand" of the supply/demand forces the market directs buyers and sellers toward activities that promote the general welfare

Invisible Hand

If jobs were the key to high incomes, we could easily create as many as we wanted. All of us could work one day digging holes and the next day filling them up. We would all be employed, but we would also be exceedingly poor because such jobs would not generate goods and services that people value.

It is Production of Value that Really Matters, Not Jobs

Believes the government (aka government intervention) can spend its way out of recession/depression. This is was tried during great depression in the late 1920.

Keynesian economics is

When a rise in the price of a good or service makes it more expensive for buyers to purchase it, they will normally choose to buy fewer units. The opposite is true when a price falls. Thus, there is an inverse relationship between the price of a good and the amount buyers will purchase. This is the law of demand.

Law of Demand

Higher prices will make it more attractive for sellers to provide the good or service. The opposite is true if prices fall. Thus, there is a positive relationship between the price of a good or service and the quantity sellers will be willing to supply. This is the law of supply.

Law of Supply

A basic technique used in the economics that analyzes small, incremental changes in key variables. the economic obsession with marginal changes exists for at least two reasons.

Marginal analysis

Through price signals, the primary function of markets is to provide information to buyers and sellers. The invisible hand of market prices directs millions of self-interested individuals into cooperative action and brings their choices into line with each other. -Friedrich von Hayek

Market Prices and the Invisible Hand

1. Spontaneity of the market according to Hayek means its "unplanned" the market was not designed by anyone but expands and contracts as the result fo human actions or inactions. 2. Human actions are guided by our invisible hand

Mas Free Market

KEY: Decisions made at the margin leads to the optimal decisions being made, subject to preferences, resources and informational constraints. MB>MC, we keep adding until their equal. We shouldn't decide to MC>MB, why? nThus marginal analysis suggests that rational maximizing behavior is occurring when we are weighing our "marginal benefits and marginal costs" when making decisions.

Mas Marginal Analysis

In our economy how do we decide who gets what? 1. Producers/manufacturers charge a price for certain products (differentiated products, not commodities). They are saying that whoever values those products at those prices will pay for it, this is how scarce resources in a fully functional economy are allocated, distributed efficently.

Mas Scarcity

1. Incentives matter 2. there is no such thing as a free lunch 3. decisions are made at the margin 4. trade promotes economic progress 5. transaction costs are an obstacle to trade 6. prices bring the choices of buyers and sellers into balance 7. profits direct businesses toward activities that increase wealth 8. People earn income by helping others 9. Production of goods and services people value, not just jobs, provides the sources of high living standards 10. Economic progress comes primarily through trade, investment, better ways of doing things, and sound economic institutions 11. the "invisible hand" of market prices directs buyers and sellers toward activities that promote the general welfare 12. Too often the long term consequences or the secondary effects of an action are ignored.

Twelve Key Elements of Economics

Macroeconomics and Microeconomics

Two branches of economics

1. Is that many economic decisions made in real world are made "at the margin" 2. using marginal analysis can best be termed analytical sophistication

Two reasons for the economic obsession with marginal changes exist because of

Well intended actions have secondary effects that impact others. Discuss the secondary effects of: Rent controls designed to make housing affordable for the poor. Tariffs and quotas designed to protect domestic industries. Government projects designed to increase employment in construction.

Unintended Consequences

Value/price

Value equation

The first goal of economic theory is to help society find better answers to the three basic questions. The second goal of economic theory is to predict how changes in government policy or market institutions will affect economic outcomes.

What Economics Is All About

The tendency of markets to direct individuals pursuing their own self interests into productive activities that also promote the economic well-being of society. This "directing" is provided by markets and is a key to economic progress.

What Is the Invisible Hand?

It is not simply more jobs that improve our economic well-being but jobs that produce goods and services people value and are willing to pay for. When that elementary fact is forgotten, people are often misled into acceptance of programs that reduce net wealth rather than create it

What Matters is Jobs of Value

-Incentives are factors that encourage or discourage various types of behaviors, actions, or activities -changes in incentives alter the way people behave -incentives influence behavior at all levels-personal, familial, business, government, and national

What are incentives

Weeds out inefficient firms

What does capitalism take out?

1. Human decision making 2. The analysis of forces underlying choice 3. the implications with regard to how societies work

What is Economics About?

1. People and the choices they make 2. unlimited wants and desires of people 3. scarcity of productive resources to satisfy unlimited wants and desires 4. individuals and how they group together to form collective organizations 5. developing an economic way of thinking the ability to think like an economist 6. developing a set of analytical tools to help you think like an economist.

What is Economics About?

"the study of people in the ordinary business of life, the study of how best to allocate scarce resources among competing uses, the study of how individuals, businesses and governments make decisions and tradeoffs in the face of scarce resources"

What is Economics?

Profit is a reward for transforming resources into something of greater value. Losses are just as important...they impose discipline on people, businesses and organizations that are not producing valuable goods and services.

What is the Function of Profit and Loss in a Market Economy?

Get the most of what they value from their expenditures

What is the incentive for the consumer

Provide consumers with what they value the most while covering their costs of production and making a profit. What they "value"

What is the main incentive for the producer

Government pays for these jobs either through taxes or borrowing. It crowds out private sector jobs and spending. There is nothing like profit and loss that will direct funding toward productive projects in government. There is nothing in government that directs resources toward projects that are valued more than cost.

When the Government "Creates" Jobs

They reduce the volume of trade and the gains it generates. Economic progress is helped by relatively low transaction costs. How has the Internet reduced transaction costs?

Why Do Transaction Costs Matter?

Physical objects—access, is there a cost. Lack of information—finding buyers, sellers, and the best deals. Middlemen—how do they affect transaction costs?

Why Do We Experience Transaction Costs?

Because countries have different natural, human, and capital resources and different ways of combining these resources, they are not equally efficient at producing the goods and services that their residents demand. The decision to produce any good or service has an opportunity cost, which is the amount of another good or service that might otherwise have been produced. Given a choice of producing one good or another, it is more efficient to produce the good with the lower opportunity cost, using the increased production of that good to trade for the good with the higher opportunity cost.

Why Trade?