Economic Issues Economics is the study of how society allocates its scarce resources among competing demand to improve human welfare. Scarcity exists because human wants exceed the resources available to satisfy them. Scarcity implies that choices must be made and economics is the study of those choices. Specifically, economics studies how societies answer the following questions: –What will be produced? –How it will be produced? –For whom will it be produced?

Economic Thinking Economics as a social Science The scientific method –Observation, Theory, and Testing –Assumptions and ceteris paribus –Avoiding flaws in logical thinking Ergo hoc post proper hoc – Correlation does not equal causation Fallacy of Composition/Division Microeconomics vs. Macroeconomics

Economics and Economists Positive versus normative Avoiding unintended consequences Scientist, advisor and citizen Scientific judgment, values, perception versus reality

Economics Models and Issues an Introduction 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 factor markets Example: production possibilities frontier (PPF) -efficiency, tradeoffs, opportunity costs, law of increasing costs, economic growth.

Figure 1 The Circular Flow Copyright © 2004 South-Western Spending Goods and services bought Revenue Goods and services sold Labor, land, and capital Income = Flow of inputs and outputs = Flow of dollars Factors of production Wages, rent, and profit 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 Firms sell Households buy MARKETS FOR GOODS AND SERVICES

Figure 8 Illustrating Constant Opportunity Cost Production Possibilities Frontier Pizza Soda Opportunity Cost of going from 0 units of Pizza to 1 unit of pizza Opportunity Cost of going from 1 unit of Pizza to 2 units of pizza Opportunity Cost of going from 2 units of Pizza to 3 units of pizza

Figure 7 Illustrating Increasing Opportunity Cost Production Possibilities Frontier Pizza Soda Opportunity Cost of going from 0 units of Pizza to 1 unit of pizza Opportunity Cost of going from 1 unit of Pizza to 2 units of pizza Opportunity Cost of going from 2 units of Pizza to 3 units of pizza

The Power of Trade Voluntary versus involuntary exchange An intuitive approach to gains in trade Using an economic model to demonstrate the gains from trade

Voluntary Exchange All parties to a voluntary exchange must be made better off Allow for specialization and division of labor Increase interdependence Promote cooperation rather than conflict