P1Session 1 What is Economics?

The concept of scarcity Key concepts The concept of scarcity The economic problem: choice (trade-offs) in the face of scarcity The coexistence of unlimited human wants versus scarce economic resources The relevance of the economic problem to all communities Individuals and aggregates: microeconomics versus macroeconomics Opportunity cost: sacrifice of the next best alternative

Definition of Economics All economic questions arise because we want more than we can get. Our inability to satisfy all our wants is called scarcity. Wants are plentiful but the means are scarce. The r/ship between unlimited wants and scarce resources is central to economics. Because we face scarcity, we must make choices. Choices depend on incentives. An incentive is a reward that encourages or a penalty that discourages an action. Think of a subsidy(reward)vs a tax (penalty). These are ways in which government can affect the choices of society(individuals /firms) and therefore reallocate scarce resources.

Definition of Economics A social science that studies choices that individuals, businesses, governments, and entire societies make as they cope with scarcity and the incentives that influence and reconcile those choices. Is the study of the use of scarce resources to satisfy unlimited human wants.(Richard Lipsey) Divides into two main parts: Microeconomics - study of the choices that individuals and businesses make Macroeconomics - study of the performance of the national economy and the global economy.

The Economic Way of Thinking Choices and Trade-offs The economic way of thinking places scarcity and its implication, choice, at centre stage. You can think about every choice as a trade-off—giving up one thing to get something else. “Guns versus butter” is the classic trade-off. “Guns” and “butter” stand for any two goods.

Choices and tradeoffs What ? How? and For Whom? The questions what, how, and for whom become sharper when we think in terms of trade-offs. “What?” Trade-offs arise when people choose how to spend their incomes, when governments choose how to spend their tax revenues, and when businesses choose what to produce. “How?” Trade-offs arise when businesses choose among alternative production technologies. “For Whom?” Trade-offs arise when choices change the distribution of buying power across individuals. Government redistribution of income from the rich to the poor creates the big trade-off—the trade-off between equality and efficiency.

Choices Bring Change What, how, and for whom goods and services get produced changes over time and the quality of our economic lives improve. But the changing quality of our economic lives depends on choices that involve trade-offs. We face three trade-offs between enjoying current consumption and leisure time and increasing future production, consumption, and leisure time.

Choices Bring Change Savings: trade off current consumption for economic growth and higher future consumption Education: trade off current consumption and leisure time for economic growth and higher future consumption R&D: trade off current production for greater future production

Opportunity Cost Thinking about a choice as a trade-off emphasizes cost as an opportunity forgone. The highest-valued alternative that we give up to get something is the opportunity cost of the activity chosen. The opportunity cost of being in University is the highest-valued alternative that you would have done if you had dropped out.

Choosing at the Margin People make choices at the margin, which means that they evaluate the consequences of making incremental changes in the use of their resources. Benefit that arises from an increase in an activity is called marginal benefit Cost of an increase in an activity is called marginal cost

Responding to Incentives Can predict how choices will change by looking at changes in incentives For any activity, if marginal benefit exceeds marginal cost, people have an incentive to do more of that activity. If marginal cost exceeds marginal benefit, people have an incentive to do less of that activity. Incentives are also the key to reconciling self-interest and the social interest.

Human Nature, Incentives, and Institutions All people pursue their self-interest Institutions play a crucial role in influencing the incentives that people face as they pursue their self-interest Economists take human nature as given and view people as acting in their self-interest. Self-interested actions are not necessarily selfish actions. But if human nature is given and people pursue self-interest, how can the social interest be served? Private property protected by a system of laws and markets that enable voluntary exchange are the fundamental institutions.