Basic Economic Concepts

Basic Economic Vocabulary Needs are Necessities for survival Wants are Ways of expressing needs and/or goods and services consumed beyond what is necessary for survival. Goods are physical objects that can be purchased Services are actions or activities performed for a fee

Economics is the study of scarcity and choice Economics is the study of scarcity and choice. We have limited resources and unlimited needs and wants. Every economics issue involves personal choice. Scarcity: there is not enough of “it” available to satisfy the way a society wants to use “it.” This leads us to making choices. Opportunity Cost is what is sacrificed when one choice is made over the “next best alternative” Every decision has an opportunity cost

Opportunity Cost to every decision!

The Six Core Principles of Economics People choose People’s choices involve costs. People respond to incentives in predictable ways. People create systems that influence individual choices and incentives. People gain when there is voluntary exchange. People’s choices have consequences that lie in the future.

1. People Choose We always WANT more than we can get and PRODUCTIVE RESOURCES (HUMAN, NATURAL, CAPITAL) are always limited. Therefore, because of this major economic problem of SCARCITY, we usually choose the alternative that provides the most BENEFITS with the least COST.

2. People’s choices involve costs. All Choices Involve Costs The OPPORTUNITY COST is the next best alternative you give up when you make a CHOICE. When we choose one thing, we refuse something else at the same time.

3. People respond to incentives in predictable ways. INCENTIVES are actions, awards, or rewards that determine the CHOICES people make. Incentives can be positive or negative. When incentives change, people change their behaviors in predictable ways.

4. People create systems that influence individual choices and incentives. People cooperate and govern their actions through both written and un written RULES that determine methods of ALLOCATING scarce resources. These RULES determine what is produced, how it is produced, and for whom it is produced. As the rules change, so do individual CHOICES, INCENTIVES, and behavior.

5. People gain when there is voluntary exchange. People SPECIALIZE in the PRODUCTION of certain GOODS and SERVICES because they expect to gain from it. People TRADE what they produce with other people when they think they can gain something from the EXCHANGE. Some BENEFITS of voluntary TRADE include higher STANDARDS OF LIVING and broader choices of GOODS and SERVICES.

6. People’s choices have consequences that lie in the future. Economists believe that the COSTS and BENEFITS of DECISION MAKING appear in the future, since it is only the future that we can influence. Sometimes our choices can lead to UNINTENDED CONSEQUENCES.

Key Assumptions in Economics People are rationally self-interested __They seek to maximize their utility (happy points) People generally make decisions at the margin __They weigh the marginal benefit against the marginal cost of a decision Ceteris Paribus _ Economists hold factors constant, except for what’s being considered.

“Beautiful, beautiful forest!. MACROECONOMICS... “Beautiful leaf!” MICROECONOMICS...

Microeconomics vs. Macroeconomics MICROeconomics (think of small picture) Individual markets The behavior of firms (companies) and consumers Supply and demand Competition Resource markets Market failures

Macroeconomics Examines: (Think of the Big Picture) National Markets Total output and income of nations Total supply and demand of the nation Taxes and government spending Interest rates and central banks Unemployment and inflation Income distribution Economic growth and development International Trade

“Doing the best with what we have.” Eight Economic Goals 1. Economic Growth [Increase in Real GDP or per capita GDP] 3% annual growth will increase our standard of living. 1929-Per capita=$792; 1933-Per capita=$430; 2007-per capita= $44,000 2. Full Employment – about 95-96% employment is full employment. In 1982, unemployment was 10.8% [12 M unempl.] 3. Economic Efficiency – “obtaining the maximum output from available resources” or “maximum benefits at minimum cost from our limited resources.” “Doing the best with what we have.”

In 1982, it took $2 to buy what $1 bought in 1972. Eight Economic Goals 4. Price Level Stability – sizable inflation or deflation should be avoided. We had over 10% in 73, 79, & 80. Inflation was 2% in the 1950s, 2.3% in 1960s and 7.4% in 80s. A person making $25,000 a year at age 30 would need (with average inflation of 5%) $125,000 a year at age 65 to have the same standard of living. 1972 – 82, $2.14=$1.00 2008 1982 In 1982, it took $2 to buy what $1 bought in 1972. In 1945, $1.50 bought what $1.00 did in 1860. Today, it takes $11 to buy what $1 bought in 1945.

Eight Economic Goals 5. An Equitable Distribution of Income. One group shouldn’t have extreme luxury while another is in stark poverty. The richest 1%(3 mil.) have as much total income after taxes [average $400,000 a year as the bottom 40% [100 million people]. The richest 1% have greater wealth than the bottom 90% of the population.

6. Economic Freedom – guarantee that businesses , workers, and consumers have a high degree of economic freedom. . 7. Economic Security – provision should be made for those not able to take care of themselves – handicapped, disabled, old age, chronically ill, orphans. Protection from lay-offs [unemployment insurance]. Also no discrimination. 43 million Americans have some type of disability. A. Hearing impaired: 22 million (including 2 million deaf) B. Totally blind: 120,000 (Legally blind: 60,000) C. Epileptic: 2 million D. Paralyzed: 1.2 million E. Developmentally disabled; 9.2 million F. Speech impaired: 2.1 million G. Mentally retarded: up to 2.5 million H. HIV infected: 900,000 8. Balance of Trade. Over $400 billion a year the last few years. Some of these goals are complementary [economic growth & F.E.] and some conflict [F.E. and price level stability].

ECONOMICS - “science of scarcity” -the study of the choices people make in an effort to satisfy their unlimited needs and wants from limited resources. The science of “scarcity” Individual Choice: Decisions by individuals about what to do, which necessarily involve decisions about what not to do. Think Target and the size of your house.

SCARCITY Marginal decision making = the result of an additional change Marginal benefits vs. marginal costs is the basis for making the decision Examples: 1 more hour of sleep vs. eating breakfast Part time job vs. goofing off College vs. full time job

WHAT IS AND WHAT SHOULD BE: Positive vs. Normative Economics: Positive economics deals with facts and therefore addresses “what is”. Normative economics attempts to determine “what should be” based on value judgment. Normative statements express an individual or collective opinion on a subject.

"with other things the same," or "all other things being equal or held constant."

Construction of Econ Graphs Table of Values INCOME (per week) CONSUMPTION (per week) $ 0 100 200 300 400 $ 50 100 150 200 250

Construction of Econ Graphs Table of Values INCOME (per week) CONSUMPTION (per week) Vertical Axis $400 300 200 100 $ 0 100 200 300 400 $ 50 100 150 200 250 CONSUMPTION (C)

Construction of Econ Graphs Table of Values INCOME (per week) CONSUMPTION (per week) Vertical Axis $400 300 200 100 $ 0 100 200 300 400 $ 50 100 150 200 250 CONSUMPTION (C) Horizontal Axis 0 100 200 300 400 INCOME (Y)

Exists Between Consumption & Income A Direct Relationship... Exists Between Consumption & Income INCOME (per week) CONSUMPTION (per week) $400 300 200 100 $ 0 100 200 300 400 $ 50 100 150 200 250 a CONSUMPTION (C) b C 250 c d e c d e 150 b a 0 100 200 300 400 INCOME (Y)

Direct(positive) Relationship Independent variable–“induces”(cause); Dependent variable– “responds”(effect) Direct – 2 variables move in same direction. “Econ, Econ” Econ

$50 40 30 20 10 4 8 12 16 20 Inverse (Negative) Relationship Inverse - 2 variables move in opposite directions TICKET PRICE ATTENDANCE (thousands) a $50 40 30 20 10 $50 40 30 20 10 4 8 12 16 20 In Economics the independent variable can be on either axis. a b b TICKET PRICE (P) c c d d e e f f 0 4 8 12 16 20 ATTENDANCE IN THOUSANDS (Q)

Construction of Econ Graphs INFINITE & ZERO SLOPES Slope = Infinite Y Y Price of Bananas Purchases of Watches Consumption Divorce Rate Slope = Zero X X Increasing “Y” has no effect on “X”. Increasing “X” has no effect on “Y”.

What you should know from Chapter One   Define economics Describe the “economic way of thinking” State some important reason for studying economics Explain the importance of ceteris paribus List eight economic goals and give examples Differentiate between micro – and macroeconomics Differentiate between positive and normative economics Explain and illustrate a direct relationship between variables, and define and identify a positive sloping curve Explain and illustrate an inverse relationship between two variables and a negative slope