Introduction to Economics

1. Introduction to Economics Professor Hedrick SS 424

2. Instructional Method • Primarily Lecture format with discussion, simulations, and video presentations • Constructive discussion is welcomed • Grading is based on five mini-exams and Aplia Homeworks. – NO MAKEUPS GIVEN • Professor available during office hours and by appointment • Suggestions for the study of economics

3. What is Economics? • Scarcity – a basic human dilemma • Limited resources vs. unlimited wants • The human condition requires making choices • Definitions of Economics • Mankiw’s definition • …is the study of how society manages its scarce resources • Hedrick’s definition • …is how society chooses to allocate its scarce resources among competing demands to improve human welfare • Alternative definitions • … what economists do. • … is the study of choice.

4. Fundamental Questions of Economics - Scarcity requires all societies to answer the following questions: • What is to be produced? • How is to be produced? • For whom will it be produced WHFM Questions

5. How Do Economists Study Human Behavior? • Economics as a Science • The scientific method • Observation→Theory→Data→Testing • Rational Behavior • Weighing benefits and costs and maximizing total net benefits • Marginal vs. Total Thinking • Economic Theory and Models • Simplification by assumption • Ceteris Paribus – Holding other factors constant • Prediction vs. realism • Microeconomic versus Macroeconomics

6. Bias towards use of natural rather than controlled experiments • The specialized language of economics (e.g. “He has lots of money.”) • Money – medium of exchange • Wealth – accumulated financial and non-financial assets • Income – the purchasing power earned during a given period

7. Why do Economists Study Human Behavior? • Scientists versus policy makers • Positive Economics • Descriptive - what the world is like. • Objective- value judgments need not be made • Positive statements can theoretically be tested by appealing to the facts • Normative Economics • Prescriptive - what the world ought to be like • Subjective – value judgments must be made • Normative statements cannot be tested appealing to facts.

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

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

10. 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

11. 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) • The boxes example

12. . • 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

13. How Do People Interact? • Principle #5 - Trade can make everybody 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 Ellensburg

14. Principle #6 - Markets are usually a good way of organizing economic activity • feudal times where feudal states were self-supporting, also haciendas in the new world • the benefits of trade are so powerful that people began to trade • markets for economists are more abstract than the notion of a middle eastern bazaar or a flea market and simply determine the prices and quantities traded of different goods and services • the “failure” of centrally planned economies and the movement towards markets for the WHFM questions

15. Markets • Principles 1-5 combine with markets to turn the pursuit of self-interest into promoting the interests of society • Adam Smith and the “invisible hand” • creativity and productivity are stimulated by the pursuit of self-interest into improving resource allocations • “set it and forget it” becomes “compete or be obsolete” • in some cases markets fail to allocate resources effectively so,

16. Principle #7 Governments can sometimes improve interaction that occurs in markets • there are circumstances when market signals fail to allocate resources efficiently or equitably • Public Goods, Externalities and Income Distribution • Some goods or services that people desire will not be produced by markets (e.g. lighthouses). • Some goods or services will either be underproduced (vaccines) or overproduced (pollution) because markets fails to register certain benefits or costs.

17. markets may also fail to provide an equitable or fair distribution of resources • government intervention with its ability to coerce (the opposite of voluntary) can regulate, tax and subsidize to change market outcomes • efficiency and equity: the pie analogy • if government intervention always the proper solution?

18. How Does the Economy Work 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) • leisure time and productivity

19. the factors of production: land or natural resources, labor, capital, entrepreneurship • technology and productivity • the rule of 72 for growth rates

20. Principle #9 – The general level of prices rises when the government prints and distributes too much money • definition of money, the concept of snow to Inuits, and economic language • inflation is an increase in the general or average level of prices in an economy • “not worth a continental” and recent example in Argentina • the establish of the Federal Reserve and the introduction of sustained inflation in the US

21. 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 • countercyclical stabilization versus pro-cyclical destabilization • political business cycles