Economic Issues 101 D.W. Hedrick

Instructional Method Primarily Lecture format with discussion, simulations, and video presentations Constructive discussion is welcomed Grading is based on six Mini-exams – NO MAKEUPS GIVEN Suggestions for the study of economics

Definition of Economics Traditional Definition How society chooses to allocate its scarce resources among competing demands to best satisfy human wants Alternative definitions How society manages its scarce resources. Economics is the study of choice. Economics is what economist do.

Scarcity and the Fundamental Questions of Economics Unlimited wants versus limited resources WHFM What is to be produced? How is to be produced? For whom will it be produced?

Economics as a Science Macroeconomic vs. Microeconomics The scientific method Economic models Normative vs. positive approaches A brief history of economic thinking The language of economics

Economic Thinking How do people make decisions? How do people interact? How does the economy work overall?

How Do People Make Decisions? People face tradeoffs The cost of something is what you have to give up to get it Opportunity Costs Rational people think at the margin Marginal Benefits vs. Marginal Cost and Maximum Net Benefits People respond to incentives

How Do People Interact? Trade can make everybody better off Voluntary Exchange = Mutually Beneficial Exchange Markets are usually a good way of organizing economic activity Markets are institutions that have evolved as human society has developed Governments can sometimes improve market outcomes Governments can wisely, or unwisely, coerce the individual to act in the common interest.

How Does the Economy work overall? A country’s standard of living depends upon its ability to produce goods and services Adam Smith (1776) and the “Wealth of Nations” The general level of prices rises when the government prints and distributes too much money Inflation versus hyperinflation Society faces a short-run tradeoff between inflation and unemployment Recessions and expansions and the business cycle.

Economics Models and Issues: Putting Economic Tools to Work The art of making models = making them simple and effective Example: circular flow – what, how and for whom questions. overall economy, role of economic agents, output and income, product and resource markets Resources: labor, capital, natural resources, entrepreneurship Circular flow model indicates that consumers ultimately answer the WHAT question – consumer sovereignty, and markets determine the how and for whom.

Figure 1 The Circular Flow Firms sell Households buy MARKETS FOR GOODS AND SERVICES Revenue Spending Goods and services sold Goods and services bought FIRMS Produce and sell goods and services Hire and use factors of production Buy and consume goods and services Own and sell factors of production HOUSEHOLDS Households sell Firms buy MARKETS FOR FACTORS OF PRODUCTION Factors of production Labor, land, and capital Wages, rent, and profit Income = Flow of inputs and outputs = Flow of dollars Copyright © 2004 South-Western

Issue: An Economy in Transition (always) 1700s – WWII: agrarian to a manufacturing economy WWII – present: manufacturing to a service economy Change in consumer demands as income increase combined with technological change increased productivity in the agricultural sector spurred on by competition Resources shifted from agricultural uses to manufacturing sector.

Changes in consumer demands and technological change in the informational sector, have led competitive markets to move from manufacturing goods to producing services. In 2002, total consumption consisted of Durable Goods (12%), Non-Durable Goods (28%), and Services (52%). Resources are shifting from manufacturing industries to service sectors. Market or laissez-faire versus command or planned economy Capitalism and socialism and the mixed economy

Issue: Economic Growth and Human Welfare Example: production possibilities frontier (PPF) -scarcity: inputs labor, capital, natural resources, entrepreneurship - technology, tradeoffs, efficiency and unemployment, opportunity costs, law of increasing costs, and economic growth.

Causes of Economic Growth Increased number of resources: L, K, NR, E Investment Growth in Labor Force Increased productivity of resources: Work Ethic Technology Education Risk-taking and innovation Social system that allows the efficient use of resources and promotes productivity Market system and self-interest Laws, property rights, and public order Political and economic freedom

Production possibilities curve Opportunity Cost Production possibilities curve Computers (mill.) Computers (mill.) Attainable and unattainable production combinations Possible combinations of computers and VCRs A A Production possibilities curve (PPC) B Production possibilities curve (PPC) B F unattainable Points along PPC imply no unemployed resources and efficient production C C Foregone output E D inefficient D

Law of increasing opportunity cost Computers (mill.) A A bowed outward PPC illustrates increasing opportunity costs B C D

Economic growth & the PPC Changes in the PPC Economic growth & the PPC Computers (mill.) E Economic growth is illustrated by an outward shift in a nation’s PPC F G C PPC0 PPC1

Consumption trade-offs & growth Economic Growth Consumption trade-offs & growth Consumer goods (hamburgers) Consumer goods (hamburgers) United States Japan Next year's production possibilities Next year's production possibilities Japan's choice to favor capital goods (point A) will shift its future PPC farther out The US choice to produce more consumer goods (point A) limits future production growth A PPC0 PPC0 PPC1 This year's production possibilities A PPC1 This year's production possibilities

Economic Growth Gross Domestic Product Real Gross Domestic Product Real Gross Domestic Product Per Capita Growth Rates = percentage change in the above variables. Rule of 70 = 70 = Doubling %Growth Rate Time