Chapter 1

Economics:The Science of Everyday Life

Positive and Normative Analysis

• Economic analysis is divided into two general categories: Positive economic issues are testable

or verifiable.

•What is

Normative economic analysis is subjective, requiring moral or ethical judgments.•What “ought” to be

Positive or Normative???

• The least expensive type of potato chip is made by Frito Lay.

Positive

• The government should put more money into funding higher education.

Normative

• A 10% increase in taxes on agricultural firms will not increase the price of their output.

Positive

• We should eliminate all product testing done on animals. Normative

The Allocation of Goods and Services

• Goods and services are all of those things that consumers, firms, and the government consider valuable.

• Resources • Land, Labor, Capital, and entrepreneurship

Resources are scarce, so we need a way to allocate the goods and services that are produced with them.

An economic system sets the ground rules for consumer and producer interaction.

The Allocation of Goods and Services (cont’d)

• There are two main types of economic systems: Market-Based Exchange Central Planning

Market-Based Exchange

• A market-based system allocates goods and services according to prices, which are determined by supply and demand.

Market-Based Exchange (cont’d)

• Supply—the quantity of a good or service that sellers are willing and able to produce at various prices over a given period of time.

• Demand—the quantity of a good or service that buyers are willing and able to buy at various prices over a given period of time.

Market-Based Exchange (cont’d)

• Market-based economies are demand-driven; that is, producers respond to the desires of consumers. Consumers are not forced to choose

the goods and services that firms want to produce.

Ford Motor Company says Let’s sell only pea green cars and trucks….

Market-Based Exchange (cont’d)

• Consumers are assumed to be rationally self-interested. They make choices that yield the

greatest satisfaction.

• Firms can earn profits by meeting consumer needs. People are constantly on the move and want to be

connected

• Result Cell phones can send and receive e-mails, browse the internet, take pictures…

Market-Based Exchange (cont’d)

• Sometimes market-based systems fail to allocate resources in the most socially desirable way. In a mixed economy, most goods and

services are allocated by markets, but some are allocated by the government.

Central Planning

• In a centrally planned economy, resources are allocated by the government Communist and socialist states

•Cuba and North Korea currently

No incentives•Firms don’t profit from satisfying consumers

•Workers don’t work hard because wage not tied to performance

Central Planning (cont’d)

• Transition economies are in the process of switching from a centrally planed economy to a market-based system. Examples: The Czech Republic, Poland and

Russia