2. AHS IB Economics SL 0.2 What is Economics? Text pages 2-25

3. Perspective on events History tells us the when and what Economics tries to explain the why IB Business and Management Gives us the tools to analyze and decide whether we should or not IB Economics Teaches us To identify the problem To hear/see both sides of the argument To use models to analyze Why is something happening and/or what is likely to happen Evaluate the efficacy of an argument or position or action Does NOT focus on whether we should or should not take a particular course of action

4. The Economic Problem Unlimited needs and wants combined with limited resources to meet those needs and wants Unlimited needs and wants combined with limited resources to meet those needs and wants Humans live to eat: Over the Hedge Humans live to eat: Over the Hedge

5. What is economics? the study of how we as a society decide what to produce and who gets it. the study of how we as a society decide what to produce and who gets it. the study of how a given society allocates scarce resources to meet the unlimited wants and needs of its members. the study of how a given society allocates scarce resources to meet the unlimited wants and needs of its members.

6. Economics studies these questions academically: What do we produce?What do we produce? How do we produce it?How do we produce it? Who gets it?Who gets it?

7. Behavioral Assumptions Rational behavior Some think the father of economic thought, Adam Smith, theorized individuals will act rationally when choosing That our decisions will be in our own best interest His writings, taken as a whole do not necessarily support this position interestIf all decisions are in our own best interest, then it follows that the collection of decisions would then necessarily be in the group's best interest There are problems with this way of thinkingThere are problems with this way of thinking

8. Market system Adheres to this theory Adheres to this theory Individuals are ‘rational men’. The theory says we decide rationally.Individuals are ‘rational men’. The theory says we decide rationally. If we all do what is in our best interest, if the market provides what we want, then it will necessarily then be in our collective best interest.If we all do what is in our best interest, if the market provides what we want, then it will necessarily then be in our collective best interest. Capitalism (market theory) is based on the assumption of the ‘rational man’ Capitalism (market theory) is based on the assumption of the ‘rational man’ Unfortunately, individuals are seldom rational and often the ‘market’ does not always do what is in our collective best interest.Unfortunately, individuals are seldom rational and often the ‘market’ does not always do what is in our collective best interest. Pondering the rational man:Pondering the rational man: Braveheart video clip Braveheart video clip

9. Positive vs Normative Positive statementPositive statement objective objective Data to support; provable Data to support; provable 'is' 'is' Normative statementNormative statement Opinion Opinion subjective subjective 'should' 'should'

10. Economic Problem We have limited factors of production with which we have to provide unlimited wants We have limited factors of production with which we have to provide unlimited wants Factors of Production:Factors of Production: Land Land Labor Labor Capital Capital Human: Education, InnovationHuman: Education, Innovation Financial:Financial: Goods:Goods: Entrepreneurship Entrepreneurship

11. Dealing with The Economic Problem Limited resources to supply the unlimited needs and wants of an increasing world population. Limited resources to supply the unlimited needs and wants of an increasing world population. Production creates utilityProduction creates utility Utility is the value we place in goods and services Utility is the value we place in goods and services Scarcity of resources forces choice. Scarcity of resources forces choice. Choice forces opportunity costs. Choice forces opportunity costs. Opportunity costs mean that in every choice made, you have to give something up. Opportunity costs mean that in every choice made, you have to give something up.

12. Key Questions How are individual needs and desires communicated such that the correct mix of goods and services become available to those who need and want them? How are individual needs and desires communicated such that the correct mix of goods and services become available to those who need and want them? Needs: Needs: those goods and services required for human survival.those goods and services required for human survival. Needs are determined by nature, climate and region, and are often finite.Needs are determined by nature, climate and region, and are often finite. Wants Wants refer to everything else.refer to everything else. Human wants are determined by society and the culture in which an individual lives.Human wants are determined by society and the culture in which an individual lives. unlimitedunlimited the source of the problem facing all economic systems.the source of the problem facing all economic systems.

13. Is this solution worth the cost? If we do all of those things, we would have perfectly clean air and water and global warming would stop If we do all of those things, we would have perfectly clean air and water and global warming would stop In this case, perfectly clean air is non- optimal because all economic activity would stop.In this case, perfectly clean air is non- optimal because all economic activity would stop. But if we don't do something, global warming could affect our economic activity. But if we don't do something, global warming could affect our economic activity. Continued greenhouse gas pollution is also non-optimalContinued greenhouse gas pollution is also non-optimal

14. Economics is: Cost-Benefit Analysis and Marginal Analysis In every decision with which we are confronted, we have to compare the additional benefit of clean air to the additional costs of getting it. In every decision with which we are confronted, we have to compare the additional benefit of clean air to the additional costs of getting it. How much clean air do we want and at what cost? How much clean air do we want and at what cost?

15. Marginal Cost If we consume 20% of world oil production yet have only 5% of known world oil reserves, it is physically impossible to drill our way to energy independence Drilling is a supply side initiative Do we want to drill EVERYWHERE to get only marginally more oil? When drilling EVERYWHERE is not going to solve the problem A demand side initiative is also required

16. Marginal Analysis Marginal Analysis Pursuing the answer to this question is the essence of economic thinking.Pursuing the answer to this question is the essence of economic thinking. Weighing costs of doing something against the benefits of doing something is the essence of decision making. Weighing costs of doing something against the benefits of doing something is the essence of decision making. If we look only at the benefits of doing something, we will do almost anything because everything has some kind of benefit If we look only at the benefits of doing something, we will do almost anything because everything has some kind of benefit

17. No Free Lunch We cannot create stuff out of thin air. Everything has a cost We cannot create stuff out of thin air. Everything has a cost an opportunity cost.an opportunity cost. And a financial cost.And a financial cost.

18. Opportunity cost: The value of the next best alternative, that which you gave up to do something else

19. Measurement Matters There is often confusion between the real and nominal values of different variables There is often confusion between the real and nominal values of different variables inflation frequently isn't taken into account, and it should be.inflation frequently isn't taken into account, and it should be. The same applies to interest The same applies to interest when people contemplate a loan, for instance, they need to think about the real interest rate: the nominal interest rate charged on the loan minus expected inflation.when people contemplate a loan, for instance, they need to think about the real interest rate: the nominal interest rate charged on the loan minus expected inflation.

20. Terminology Real Real Takes into account the effect of inflationTakes into account the effect of inflation Nominal Nominal Inflated value or priceInflated value or price Inflation Inflation It takes more dollars to buy the same amount of goodsIt takes more dollars to buy the same amount of goods A rise in prices of a set of goods or servicesA rise in prices of a set of goods or services Cost push Cost push Demand pull Demand pull

21. Budget Deficits Budget Deficits are the difference between government receipts and expenditures in any given yearare the difference between government receipts and expenditures in any given year national debt national debt is the historical aggregation of annual deficits, the total amount owed by a government.is the historical aggregation of annual deficits, the total amount owed by a government. When the govt carries a debt, it has to borrow money. When the govt carries a debt, it has to borrow money. Borrowed money creates inflation Borrowed money creates inflation Terminology

22. Key Questions How does a society decide who gets stuff? How does a society decide who gets stuff? How does a society provide the incentives for these individuals to participate in the production and consumption of these goods? How does a society provide the incentives for these individuals to participate in the production and consumption of these goods? Does society OWE a living to anyone? Does society OWE a living to anyone? What is a standard of living? What is a standard of living? Is it possible to move everyone in the world to a standard of living like ours? Is it possible to move everyone in the world to a standard of living like ours?

23. Key Questions How is production organized such that maximum-possible quantities are made available given existing resources and production technology? How is production organized such that maximum-possible quantities are made available given existing resources and production technology? Why does the United States use more than it’s fair share of existing world resources? Why does the United States use more than it’s fair share of existing world resources? Is this fair? Does it matter?Is this fair? Does it matter? What sorts of conflicts arise out of disparity in resource allocation? What sorts of conflicts arise out of disparity in resource allocation? "Us/them" by Pink Floyd"Us/them" by Pink Floyd

24. Key Questions Given that individuals are at one time involved in the production process and at other times seeking to acquire the goods that have been produced, how are trading rules and exchange agreements established? Given that individuals are at one time involved in the production process and at other times seeking to acquire the goods that have been produced, how are trading rules and exchange agreements established? Should the market decide? Should the market decide? Markets require money and informationMarkets require money and information Should the government decide? Should the government decide? How does the government know what is best?How does the government know what is best?

25. Economics = Inductive Reasoning Induction Induction “facts to generalizations”“theory”from “facts to generalizations”, or “theory”. Generalizations are created from a careful evaluation of facts. cause and effect relationships From facts, economists note cause and effect relationships. From this, they derive theory. From theory, they develop economic policy relevant to the real world. not based on facts is not sound economics.Any economic theory not based on facts is not sound economics.

26. microeconomics The study of choice. The study of choice. Considers these questions: Considers these questions: What goods and services should be providedWhat goods and services should be provided When they should be providedWhen they should be provided How they should be providedHow they should be provided What enterprises should operateWhat enterprises should operate What techniques of productions should be usedWhat techniques of productions should be used At what pices should goods be soldAt what pices should goods be sold On what terms should goods and services be given awayOn what terms should goods and services be given away How should incomes be distributed amongst the members of societyHow should incomes be distributed amongst the members of society

27. Micro concerned with specific economic units or individual markets under a microscope. concerned with specific economic units or individual markets under a microscope. Emphasis is on individual households, industries, or firms Emphasis is on individual households, industries, or firms like the # of workers employed by Fordlike the # of workers employed by Ford Concerns the components of the economy Concerns the components of the economy Micro examines the “trees, leaves, & pieces of bark, rather than the forest.” It gives a “worm’s-eye view” of a specific component of our economy Micro examines the “trees, leaves, & pieces of bark, rather than the forest.” It gives a “worm’s-eye view” of a specific component of our economy

28. macroeconomics concerned with issues, objectives and policies that affect the whole economy. concerned with issues, objectives and policies that affect the whole economy. Economic analysis that refers to aggregates is macro. Economic analysis that refers to aggregates is macro. AD/ASAD/AS unemployment rateunemployment rate inflation rateinflation rate the rate of economic growththe rate of economic growth The four major macro objectives are: The four major macro objectives are: (i) Full employment (ii) Price stability (iii) A reasonably high, but sustainable, rate of economic growth (iv) Keeping the balance of payments in equilibrium.

29. Macro Macroeconomics is concerned with an overview of the economy. Macroeconomics is concerned with an overview of the economy. Examines the forest, not the trees, leaves, or specific pieces of bark.” Examines the forest, not the trees, leaves, or specific pieces of bark.” It gives us a “bird’s-eye view” of the economy. It gives us a “bird’s-eye view” of the economy.

30. I s the f ollowing Micro or Macro ? I s the f ollowing Micro or Macro ? 1. The price of digital cameras decreased 5% last year. 2. Unemployment was 5.4% for the U.S. workforce. 3. Unemployment in the auto industry was 8% last year. 4. Aspen N ational Bank lowered its interest rates on CDs to 8%. 5. The Consumer Price Index rose to 2.7% last year. 6. The computer industry laid off 8% of its workers last year. 7. The price of gasoline rose 25% last year. “What forest? Check these limbs, and leaves.”

31. growth Economic growth tends to be measured in terms of the rate of change of real GDP (Gross Domestic Product). Economic growth tends to be measured in terms of the rate of change of real GDP (Gross Domestic Product). When the word real accompanies any statistic, it means that the effects of inflation have been removed.When the word real accompanies any statistic, it means that the effects of inflation have been removed. GDP is a measure of the annual output (or income, or expenditure) of an economy. GDP is a measure of the annual output (or income, or expenditure) of an economy. Sometimes GNP (Gross National Product) is used, which is very similar to GDP. Sometimes GNP (Gross National Product) is used, which is very similar to GDP. The only difference is that income earned from assets held abroad is added and the income earned by foreigners who have assets in the UK is taken awayThe only difference is that income earned from assets held abroad is added and the income earned by foreigners who have assets in the UK is taken away

32. GDP Measures Economic Growth C + I + G + (x-m) C + I + G + (x-m) ConsumptionConsumption InvestmentInvestment Government spendingGovernment spending Exports minus importsExports minus imports

33. Economic Growth Occurs in Two Ways 1. More resources (Factors of Production) become available LandLand Just drill, baby Just drill, baby LaborLabor Immigration Immigration Babies Babies CapitalCapital Profit Profit Stocks Stocks Loans from banks Loans from banks 2. Improved Technology more outputs from same inputsmore outputs from same inputs Efficiency is producing maximum output with available resources and technology. Efficiency is producing maximum output with available resources and technology.

34. Production Possibilities Curve

35. development Focuses on not only GDP growth, but factors that enable a country’s standard of living to improve Focuses on not only GDP growth, but factors that enable a country’s standard of living to improve HDIHDI Infant mortality Infant mortality Longevity Longevity Literacy rate Literacy rate Per capita income Per capita income Growth is necessary for development Growth is necessary for development Growth alone is NOT development Growth alone is NOT development

36. sustainable development A level of improvement in HDI and GDP growth that can be continued indefinitely without impairing future productivity of any of the natural resources and/or factors of production used A level of improvement in HDI and GDP growth that can be continued indefinitely without impairing future productivity of any of the natural resources and/or factors of production used

37. Ceteris paribus Latin for “all else held constant” Latin for “all else held constant” Means “everything else being equal.” Means “everything else being equal.” is the most important assumption in economics.is the most important assumption in economics. Economists create models Economists create models allows us to reason about the relationship between “X” and “Y” without the intrusion of “Z”.allows us to reason about the relationship between “X” and “Y” without the intrusion of “Z”. The inevitable disagreements occur over the quantitative magnitudes The inevitable disagreements occur over the quantitative magnitudes

38. Unlimited Needs and Wants Demand “No horn of plenty” Scarcity Choices What is given up LimitedResourcesSupply ECONOMICS Choices

39. Scarcity: Quantity desired of a resource exceeds the quantity available in the absence of a rationing systemQuantity desired of a resource exceeds the quantity available in the absence of a rationing system Scarcity forces choicesScarcity forces choices Requires some sort of rationing system Requires some sort of rationing system

40. Rationing systems Tradition and culture Tradition and culture Command/socialism and communism Command/socialism and communism Central government planningCentral government planning Consensus Consensus VotingVoting Political proceduresPolitical procedures Markets/Capitalism Markets/Capitalism DemandDemand System of prices communicates the availability of resources and the desire for those resourcesSystem of prices communicates the availability of resources and the desire for those resources

41. Choice forces opportunity cost You must choose. You must choose. The value of the next best foregone alternative is opportunity cost The value of the next best foregone alternative is opportunity cost Marginal analysis Marginal analysis Analyzing the incremental cost/benefit ratio of each alternative choiceAnalyzing the incremental cost/benefit ratio of each alternative choice Marginal utility Marginal utility The value you receive by consuming or using the additional unit of a productThe value you receive by consuming or using the additional unit of a product Declining marginal utilityDeclining marginal utility As you consume a good, you get value As you consume a good, you get value But that value declines incrementally with each additional unit of consumption But that value declines incrementally with each additional unit of consumption

42. Economic Goods A good is any object or service that, upon consumption, increases utility, and therefore can be sold at a price in a market. A good is any object or service that, upon consumption, increases utility, and therefore can be sold at a price in a market.utility If an object or service is sold for a positive price, then it is most likely a good since the purchaser considers the utility of the object or service more valuable than the money. Some objects are very rarely traded, such as air: If an object or service is sold for a positive price, then it is most likely a good since the purchaser considers the utility of the object or service more valuable than the money. Some objects are very rarely traded, such as air:air it can be difficult to determine if such an object is a good or not.it can be difficult to determine if such an object is a good or not.

43. utility Utility = satisfaction or value What creates value or satisfaction? formpossessiontime you have a good or service when you need it. place your good or service is in a location where you can use it properly

44. Free Goods a good that is not scarce. a good that is not scarce.goodscarcegoodscarce A free good is available in as great a quantity as desired with zero opportunity cost to society.A free good is available in as great a quantity as desired with zero opportunity cost to society.opportunity costsocietyopportunity costsociety A good that is made available at zero price is not necessarily a free good. A good that is made available at zero price is not necessarily a free good. For example, a shop might give away its stock in its promotion, but producing these goods would still have required the use of scarce resources, so this would not be a free good in an economic sense. For example, a shop might give away its stock in its promotion, but producing these goods would still have required the use of scarce resources, so this would not be a free good in an economic sense. There are three main types of free goods: There are three main types of free goods: Resources that are so abundant in nature that there is enough for everyone to have as much as they want.Resources that are so abundant in nature that there is enough for everyone to have as much as they want. An example of this is the air that we breathe. An example of this is the air that we breathe. Resources that are jointly produced.Resources that are jointly produced. Here the free good is produced as a by-product of something more valuable. Here the free good is produced as a by-product of something more valuable. Waste products from factories and homes, such as discarded packaging, are often free goodsWaste products from factories and homes, such as discarded packaging, are often free goods Ideas and works that are reproducible at zero cost, or almost zero cost.Ideas and works that are reproducible at zero cost, or almost zero cost. Examples include computer programs and web pages. Examples include computer programs and web pages.

45. Public Goods Non Rivalrous Non Rivalrous Non Excludable Non Excludable Non payers cannot be prevented from using them or enjoying them Non payers cannot be prevented from using them or enjoying them Private Goods  Rivalrous  Excludable  Can prevent or reduce use through price

46. Is the sunset a public good or private good? Will this entrepreneur sell many tickets for $10? Why or why not?

47. Decreasing Marginal Utility A good is an object whose consumption increases the utility of the consumer. A good is an object whose consumption increases the utility of the consumer.utility Most goods usually have decreasing marginal utility. Most goods usually have decreasing marginal utility.decreasing marginal utilitydecreasing marginal utility Each additional unit of good consumed gives less value than the previous unit consumedEach additional unit of good consumed gives less value than the previous unit consumed The first car an individual purchases is very useful; the fourth is much less useful. The first car an individual purchases is very useful; the fourth is much less useful. Thus, in these and similar goods, the marginal utility of additional units approaches zero as the quantity consumed increases.Thus, in these and similar goods, the marginal utility of additional units approaches zero as the quantity consumed increases.

48. A Big Mac with supersized fries has more calories, but the law of diminishing marginal utility says that as a person increases consumption of a good, holding consumption of other goods constant, the marginal utility he or she gets from each additional unit of that good declines. This suggests that the marginal utility of the second egg will be smaller than that of the first, and the marginal utility of the third will be smaller still. For most people, the marginal utility of the tenth egg would likely be negative.

49. Unit 0 Concept Outline Definitions of social science and economics Definitions of social science and economics Definitions of microeconomics and macroeconomics Definitions of microeconomics and macroeconomics Definitions of growth, development and sustainable development Definitions of growth, development and sustainable development Positive and normative concepts Positive and normative concepts Ceteris paribus Ceteris paribus Scarcity Scarcity basic economic questions basic economic questions what to produce?what to produce? how to produce?how to produce? for whom to produce?for whom to produce? factors of production: factors of production: land, labor, capital, and management/entrepreneurshipland, labor, capital, and management/entrepreneurship payments to factors of production: payments to factors of production: rent, wages, interest, profitrent, wages, interest, profit Choice Choice

50. utility utility opportunity cost opportunity cost free and economic goods free and economic goods Production possibility curves: definition Production possibility curves: definition diagrams showing opportunity cost, actual and potential outputdiagrams showing opportunity cost, actual and potential output diagrams showing economic growth and economic developmentdiagrams showing economic growth and economic development Rationing systems Rationing systems mixed economies mixed economies public public private private central planning vs. free market central planning vs. free market economies in transition economies in transition