Principals of Economics Law Class 1

1. Principals of Economics Law Class 1 By Edward Katwaza 12/03/2018 Lesson One

2. Fundamental economic concept 1.1. Meaning of Economics • What is Economics? We might take our definition from the father of modern economics, Adam Smith in his famous book “An inquiry Into the Nature and Causes of the Wealth of Nations”. • Smith was, in many ways, the founder of modern economics. He wrote at a time when the industrial revolution was just beginning to transform European society 1779. He observed that, in his own society, economic development could bring about a widespread prosperity, and yet other countries, and even some districts of an advanced country such as Britain, could lag behind in poverty

3. Meaning of Economics Cont’d • Smith’s objective was to learn more about the “multiplication of productions.” For him this was the point of economics. When the production of goods and services for the market grows bigger, this is what we call “economic growth.” If production grows fast enough, then we will have more production per person; and his is called a “rise in the standard of living.” • When Adam Smith talked about “the wealth of nations,” modern economists would talk about a high and rising standard of living. • What does it mean to study the nature and causes of the wealth of nations?

4. Meaning of Economics Cont’d • In his great book, Adam Smith took this question as his first subject: What causes production of goods and services to increase with time, so that nations become wealthy rather than poor ? • According to Smith, “It is the great multiplication of the productions of all the different kinds… which in many occasions, in a well-governed society, that universal opulence which extends itself to the lowest ranks of the people.” (Wealth of Nations, Modern Library edition, p. 11)

5. Meaning of Economics Cont’d • Economics as a discipline or a subject can be classified as a social science. Like political science, sociology and geography, it concerns people’s attempts to organize the environment to satisfy their needs. Economics concentrates on satisfying material needs such as needs for food and shelter. Specifically it concerns production, distribution and consumption of goods and services.

6. Meaning of Economics Cont’d • The word “economics” is based on Greek roots, The two Greek roots of the word “economics are oikos—meaning more or less the household or family estate—and nomos, which can mean rules, natural laws made by the government. Therefore, combining two words - Oikonomos, which means one who manages the house hold. • Economics, like other studies, can be broken down into more specialized sub fields. The broadest categories are just two: microeconomics and macroeconomics.

7. Ten principles of economics • How People Make Decisions • 1: People Face Trade-offs • 2: The Cost of Something Is What You Give Up to Get It • 3: Rational People Think at the Margin • 4: People Respond to Incentives • How People Interact • 5: Trade Can Make Everyone Better Off • 6: Markets Are Usually a Good Way to Organize Economic Activity • 7: Governments Can Sometimes Improve Market Outcomes • How the Economy as a Whole Works • 8: A Country’s Standard of Living Depends on Its Ability to Produce Goods and Services • 9: Prices Rise When the Government Prints Too Much Money • 10: Society Faces a Short-Run Trade-off between Inflation and Unemployment

8. Ten Principals of economics • Economy is composed of households and firms. • Economics is the study of how households and firms make decisions under scarcity. • Scarcity – all resources are scarce (finite) • Decisions about how to use them implies tradeoffs are involved.

9. Ten Principles of Economics • Scarcity - limited nature of society’s resources • Economics • Study of how society manages its scarce resources • Economists study: • How people make decisions • How people interact with one another • Analyze forces and trends that affect the economy as a whole

10. Ten principles of economics Cont’d • How People Make Decisions • 1: People Face Trade-offs • 2: The Cost of Something Is What You Give Up to Get It • 3: Rational People Think at the Margin • 4: People Respond to Incentives • How People Interact • 5: Trade Can Make Everyone Better Off • 6: Markets Are Usually a Good Way to Organize Economic Activity • 7: Governments Can Sometimes Improve Market Outcomes • How the Economy as a Whole Works • 8: A Country’s Standard of Living Depends on Its Ability to Produce Goods and Services • 9: Prices Rise When the Government Prints Too Much Money • 10: Society Faces a Short-Run Trade-off between Inflation and Unemployment

11. How People Make Decisions Principle 1: People face trade-offs • Making decisions • Trade off one goal against another • Society • National defense vs. consumer goods • Clean environment vs. high level of income • Efficiency vs. equality • Efficiency • Society - maximum benefits from its scarce resources • Size of the economic pie • Equality • Benefits - uniformly distributed among society’s members • How the pie is divided into individual slices

12. How People Make Decisions The Economist as a Scientist • Efficient levels of production • Economy’s getting all it can • From the scarce resources available • Points on the production possibilities frontier • Trade-off: • The only way to get more of one good • Is to get less of the other good • Inefficient levels of production • Points inside production possibilities frontier 12

13. How People Make Decisions Principle 2: The cost of something is what you give up to get it • People face trade-offs • Make decisions • Compare cost with benefits of alternatives • Opportunity cost • Whatever most be given up to obtain one item • PPF – Opportunity cost is what you give up as you produce more of another good. Principle 3: Rational people think at the margin • Rational people • Systematically & purposefully do the best they can to achieve their objectives • Marginal changes • Small incremental adjustments to a plan of action • Rational decision maker – take action only if • Marginal benefits > Marginal costs

14. How People Make Decisions Principle 4: People respond to incentives • Incentive • Something that induces a person to act • Higher price • Buyers - consume less • Sellers - produce more • Public policy • Change costs or benefits • Change people’s behavior

15. Incentives for Firms First Law of Supply: the higher the market price the greater the quantity supplied by each firm How People Make Decisions

16. Incentives - Consumers First Law of Demand The higher the price, the lower is quantity demanded How People Make Decisions

17. How People Interact Principle 5: Trade can make everyone better off • Trade • Specialization • Allows each person/country to specialize in the activities he/she does best • People/countries can buy a greater variety of goods and services at lower cost Principle 6: Markets are usually a good way to organize economic activity • Communist countries – central planning • Government officials (central planners) • Decided • What goods & services were produced • How much was produced • Who produced & consumed these goods & services

18. How People Interact Principle 6: Markets are usually a good way to organize economic activity • Theory: only the government could organize economic activity to promote economic well-being for the country as a whole. • Market economy - allocates resources • Decentralized decisions of many firms and households • As they interact in markets for goods and services • Guided by prices and self interest • Adam Smith’s “invisible hand”

19. How People Interact Principle 7: Governments can sometimes improve market outcomes • We need government • Enforce the rules • Maintain institutions - key to market economy • Enforce property rights • Property rights • Ability of an individual to own and exercise control over scarce resources • Government intervention • Change allocation of resources • To promote efficiency • Avoid market failure • To promote equality • Avoid disparities in economic wellbeing

20. How People Interact • Market failure • Situation in which the market on its own fails to produce an efficient allocation of resources • Causes for market failure • Externality • Impact of one person’s actions on the well-being of a bystander • Market power • Ability of a single person (or small group) to unduly influence market prices • Disparities in economic wellbeing • Market economy • Rewards people - ability to produce things that other people are willing to pay for • Government intervention • Public policies • May diminish inequality • Process far from perfect

21. Kinds and applied Fields of Economics … • Microeconomics is the of how house-holds and firms make decisions and how they interact in markets. So the micro economists studies the working of markets for particular goods and services, and the interdependencies among these, and the supplies and demands of individual enterprises and consumers. • Macroeconomics is the study of economy – wide phenomena, including inflation, unemployment and economic growth. So the macroeconomist studies phenomena, which seem to affect or arise from the operation of the market system as a whole: unemployment, inflation, the workings of the monetary system, and the determinants of economic growth.

22. Thinking Like an Economist • Economics is a science but a social science. It strives use scientific reasoning and methods of inquiry. Since the subjects of inquiry are human beings, the results usually very. That’s why economists do often differ. However a common goal of all economists is to be as objective as possible. • Every field of study has its own terminology • Mathematics • integrals  axioms  vector spaces • Psychology • ego  id  cognitive dissonance • Law • promissory  estoppels  torts  venues • Economics • supply  opportunity cost  elasticity  consumer surplus  demand  comparative advantage  deadweight loss

23. 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. • Economics as a science: The economic way of thinking . . . • Involves thinking analytically and objectively. • Makes use of the scientific method. • Uses abstract models to help explain how a complex, real world operates.Develops theories, collects, and analyzes data to evaluate the theories.

24. The Role of Assumptions • Economists make assumptions in order to make the world easier to understand. • The art in scientific thinking is deciding which assumptions to make. • Economists use different assumptions to answer different questions.

25. Agents of production • Capital Capital consists of all goods produced by human labor (with other resources) and used in the production of still more goods and services; in other words, produced means of production, some examples are: • Machinery • Houses and other buildings • Grapevines, fruit trees and hogs on the hoof • And human capital

26. Agents of production cont’d • Labour But, from several points of view, labour is the most important resource. From the Point of view of cost, it is quite important. Labour is also important to most of us because it is the resource from which we expect to get our living. It is the totality of mental and physical energy employed in producing goods and services. It is either skilled or unskilled.

27. Agents of production cont’d • Land By convention, economists include in the category “land” both: • The “original and indestructible powers of the soil” and • Natural resources, such as coal, oil, and metallic ores. There are, of course, some important differences. Coal and oil, once they are dug out or the ground and burned, are gone forever. In other words, they are “wasting resources.” On the other hand, the fertility of the soil does not have to be a wasting resource, if the farmer uses farming methods, which maintain fertility. But this difference is not absolute, Copper ores, for example, may be used and then recycled.

28. Scarcity, choice and opportunity cost • Scarcity in ordinary language is about shortage and scantiness. In economics it is a law of nature. It means that goods and services are always limited in availability while wants and needs are even unlimited. Resources are too few to satisfy wants. • Therefore choices have to be made so as to know how to allocate scarce resources to maximize satisfaction of our wants. Economics as a discipline provides a way of determining how to allocate our scare resources effectively and efficiently. If effective we will be producing products that will best satisfy our wants. If efficient we will be getting the most value (output) from our resources. • Economics can also be defined as is the study of choosing among alternative ways in which scarce resources may be allocated to maximize the satisfaction of wants.

29. Scarcity, choice and opportunity cost cont’d.. • The law of scarcity and the imperative for choice had led to another concept- opportunity cost. • To a businessman cost is the price on a tag of a good in shop or a super market. • To a book keeper the value of a good is reflected buy the accounting value entered in the book of account. • In economics value is determined by scarcity. • To economists the real value of a thing is the opportunity of having an alternative good that is forgone. If there was no scarcity two or more goods could be had. Opportunity cost is the value of what is given up or lost by a resource or individual when it is used in the next best alternative way.

30. Positive and Normative Economics. • Now we must consider another great dichotomy. Positive versus normative economics. This is an idea we owe to the great conservative social philosopher and economic theorist and statistician, Milton Friedman. • According to Friedman, positive economics has to do with “what is,” while normative economics has to do with “what ought to be.” Positive economics is a social science, and as such is subject to the same checks on the basis of evidence as any science. By Contrast, normative economics has a moral or ethical aspect, and as such goes beyond what a science can say.

31. Positive and Normative Economics cont’d... • It is true that economics cannot rely on experimental methods to verify its hypotheses, in many cases. (Experimental economics is now a growing field, but still somewhat limited in scope). However, the same is true of some of the sciences, ranging from astronomy to ecology. These are observational sciences, and so is positive economics. • Let us illustrate the distinction – and some of its pitfalls – by an example. A person might say “Everybody ought to be paid the same hourly wage, because it is just that each person should be rewarded in proportion to her labour.” This is clearly normative economics – it has to do with what should be.

32. Positive and Normative Economics cont’d... • Now, a “positive” economist might observe that these rules would be inefficient, in the following sense. Some occupations require more training, more effort, ore more talent than others; or they are more responsible. If these occupations are better rewarded they will be better performed, and overall productivity of labour will increase as a result. This increase in productivity will be more than enough to pay the higher wages for the skilled, talented, effortful and responsible occupations, with something left over that might make everyone better off. This is positive science, it might be either true or false.

33. Positive and Normative Economics cont’d... • Positive or Normative Statements? • An increase in the minimum wage will cause a decrease in employment among the least-skilled. • POSITIVE • Higher budget deficits will cause interest rates to increase. • POSITIVE