1. Economics for the 21 st Century An Introduction (Part 1) Henry B. Stobbs, MFA

2. Copyright Notice Certain materials in this presentation are included under the fair use exemption of the U.S. Copyright Law and have been prepared with the multimedia fair use guidelines and are restricted from further use.

3. Three Insights The mutual determination insight: Everything depends on everything else.

4. Three Insights The mutual determination insight The subjective insight: There are no objective costs. –Things cannot have costs – only actions can have costs. –Costs accrue to the actor.

5. Three Insights The mutual determination insight The subjective insight. The marginal insight: –The “edge” is where we make decisions. –The only relevant value is the marginal value, the additional value we expect to gain from making a certain decision.

6. Three Insights The mutual determination insight The subjective insight. The marginal insight.

7. The word economics derives from the Greek oikonomikos, related to the management of a household, but the study and application of economics as we understand it is, historically speaking, quite recent.

8. The Study of Economics begins with a simple problem.

9. It’s referred to by economists as the economizing problem.

10. We live in a world of unlimited wants & needs; We live in a world of limited resources; When unlimited needs and wants are combined with limited resources, scarcity is created; In a world of scarcity, we must decide something…

11. What we must decide UTILITY. Economists refer to the satisfaction we gain from satisfying our needs and wants as UTILITY.

12. The mechanism we employ to organize the gathering of resources, production, and distribution of the goods and services we need and desire is referred to as an economic system.

13. Economics efficiently manage limited productive resources maximize our utility Economics is concerned with observing and figuring how best to adjust the economic system in order to efficiently manage limited productive resources, so that we can maximize our utility.

14. Therefore, we can say that… Economics Economics is the study of how humans behave in producing, distributing, and consuming material goods and services in a world of scarce resources.

15. Economists Economists do Economics Some famous economists whose names you will come to know include… Adam SmithAdam Smith David RicardoDavid Ricardo Henry HazlittHenry Hazlitt F. A. HayekF. A. Hayek John Maynard Keynes…John Maynard Keynes… … and many others…

16. John Maynard Keynes said… “The ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly understood. Indeed the world is ruled by little else. Practical men, who believe themselves to be quite exempt from any intellectual influences, are usually the slaves of some defunct economist.”

17. We can be slaves, or… We can gain a basic understanding of economics in order to… –Make more informed decisions as citizens –Gain insight about making wiser personal decisions What are some economic decisions we make in our daily lives?

18. A Matter of Methodology How exactly do economists do their work?

19. formulate economic principles…Economists formulate economic principles… to establish economic policiesThe principles are used to establish economic policies… to solve economic problemsEconomic policies are designed to solve economic problems.

20. Economists use Inductive reasoning to distill or create principles from facts. They also use deductive reasoning, called the hypothetical method, to form a tentative, untested principle, or hypothesis.

21. Economics is… a descriptive science It is empirical, meaning that it is based on facts (the observable and verifiable behavior of data or subject matter) It is a social science, meaning that it is concerned with human behavior

22. The goal of economics is to… Systematically arrange, interpret, and generalize upon facts in order to derive general principles, theories, and models.

23. General = Imprecise… Approximate… Close enough for government work… In the general vicinity… More, or less…

24. Economists like to use a Latin phrase a lot: ceteris paribus… other things being equal… in other words, we assume that all the variables of a problem except those under our immediate consideration are fixed, constant, unchanging.

25. Therefore, economic theories are abstractions that do not necessarily accurately reflect reality.

26. Two Levels of Analysis 1.Macroeconomics –Deals with the economy as a whole, or… –With the basic subdivisions or aggregates that make up the economy… –In other words, macroeconomics looks at forests, not trees…

27. Two Levels of Analysis 2.Microeconomics –Deals with specific economic units and… –A detailed consideration of these units.. –In other words, microeconomics looks at each tree, not at the whole forest…

28. Review Economics is concerned with the efficient management of scarce resources Induction is observing regularities in factual data and drawing from them generalizations Deduction uses logic to create hypotheses which are then tested with factual data

29. Review Economic theories (laws, principles, models) are generalizations, based on facts, concerning the economic behavior of individuals and institutions Macroeconomics deals with the economy as a whole or with the basic subdivisions (aggregates) of the economy Microeconomics focuses on detailed aspects of the specific units which comprise the economy

30. Time for A Mind-Probe What is the economizing problem? What is utility? What is the difference between macroeconomics and microeconomics? What does empirical mean? What must we decide in order to solve the economizing problem? What is meant by the phrase ceteris paribus? What is the goal of economic policy?

31. COMING NEXT Mankiw’s Ten Principles of Economics 10

32. Set 1: How People Make Decisions

33. Ten Principles of Economics Principle # 1: People face trade-offs. –Making decisions requires trading off one goal against another –To get one thing, you have to give up something else –Efficiency v. Equity: Efficiency means that society gets the most that it can from scarce resources Equity means that the benefits of resources are distributed fairly among members of society

34. Ten Principles of Economics Principle # 2: The cost of something is what you give up to get it –Decision-makers must consider both the obvious and implicit costs of their actions opportunity costs ncentives –Basketball stars who quit school early to turn pro understand all about opportunity costs and incentives

35. Ten Principles of Economics Principle # 3: Rational people think at the margin. –Marginal changes are small, incremental adjustments to an existing plan of action –People make decisions by comparing costs and benefits at the margin.

36. Ten Principles of Economics Principle # 4: People respond to incentives (in predictable ways!) –Marginal changes in costs or benefits motivate people to behave in certain ways –The decision to choose one alternative over another occurs when that alternative’s marginal benefits exceed its marginal costs –Behavior changes when costs or benefits change

37. Set 2: How the Economy Works As a Whole

38. Ten Principles of Economics Principle # 5: Trade can make everyone better off –People gain from their ability to trade with one another –Competition results in gains from trading –Trade allows people to specialize in what they do best

39. Ten Principles of Economics Principle # 6: Markets are usually a good way to organize economic activity. –Adam Smith observed that households and firms interact in markets as if guided by an “invisible hand.” Because households and firms look at prices when deciding what to by and sell, they unknowingly take into account the social costs of their actions. Thus, prices guide decision makers toward outcomes that tend to maximize the welfare of society as a whole.

40. Market Economies A market economy is one that allocates resources through the decentralized decisions of individuals, operating within households and firms, and interacting in markets for goods and services –Households decide what to buy and who to work for –Firms decide who to hire and what to produce

41. Market Failure Market failure may be caused by: –Externalities. An externality is the impact of a person’s or a firm’s actions on the well-being of a bystander. –Market power. Market power is the ability of a single person or firm to unduly influence market prices.

42. Ten Principles of Economics Principle # 7: Governments can sometimes improve market outcomes. – Market failure occurs when the market fails to allocate resources efficiently –When the market fails, government can intervene to promote efficiency and equity (But knowing when, if, how and how much to interfere is a bug of a different sort…)

43. Ten Principles of Economics Principle # 8: A country’s standard of living depends on its ability to produce goods and services – Standards of living may be measured by: Comparing personal incomes Comparing the total market value of a nation’s production: Wealth increases as productivity increases Variation in living standards between countries can be explained in terms of their productivities Productivity is the amount of goods and services produced from each hour of a worker’s time

44. Set 3: How People Interact

45. Ten Principles of Economics Principle # 9: Prices rise when governments print too much money – Inflation is an increase in the overall level of prices in the economy –One cause of inflation is the growth in the supply of money –When the government creates a large supply of money, the value of the money falls

46. Ten Principles of Economics Principle # 10: Society faces a short-run trade-off between inflation and unemployment