INTRODUCTION OF ECONOMICS Lecturer: Jack Wu

Economics 101

WHAT IS ECONOMY ( 經濟，經濟體 )?

The word economy originally comes from a Greek word for “one who manages a household.”

Broader definition: household, society, and country.

FUNDAMENTAL PROBLEM FACED BY ECONOMY Fundamental economic problem: scarce

resources. -- Scarcity. . . means that economy has

limited resources and therefore cannot produce all the goods and services people wish to have.

-- Resources : physical resource, financial resource, human resource, natural resource

WHAT IS ECONOMICS ( 經濟學 )?

Economics is the study of how society or economy manages its scarce resources.

It comprises of Microeconomics and Macroeconomics.

MICROECONOMICS 個體經濟學 ( 台灣 ) ，微觀經濟學 ( 大陸 ) Microeconomics: the study of how

households and firms make decisions and how they interact in markets (Econ 101: introductory Microeconomics, Econ 201: intermediate Microeconomics)

Examples: mobile phone consumption choice decision, mobile phone production decision, and mobile phone market

MACROECONOMICS 總體經濟學( 台灣 ) ，宏觀經濟學 ( 大陸 ) Macroeconomics: the study of economy-wide

phenomena including inflation, unemployment, and economic growth (Econ 102: Introductory Macroeconomics, Econ 202: Intermediate Macroeconomics)

Examples: Quantitative Easing (QE) Policy, Euro Zone Crisis, Abenomics, China Economy Soft Landing, Sluggish Income Growth of Taiwan

EVERYBODY SHOULD LEARN ECONOMICS <Reason>. Economics is a subject that we

must confront in our everyday lives. As a matter of fact, we already spend a great deal of our time thinking about economic issues: prices(inflation), incomes (economic growth), consumption decisions, use of our time, job opportunity (unemployment), and so on.

TEN PRINCIPLES OF ECONOMICS

PRINCIPLE #1: PEOPLE FACE TRADEOFFS. There is no such thing as a free lunch. To get one thing, we usually have to give up

another thing. Making decisions requires trading

off one goal against another.

SPECIAL EXAMPLE OF TRADEOFF Efficiency v. Equity

Efficiency means society gets the most that it can from its scarce resources.

Equity means the benefits of those resources are distributed fairly among the members of society.

Example: Tax paid by wealthy Taiwanese and then distributed to those less fortunate.

Outcome: Increased equity and reduced efficiency

PRINCIPLE #2: THE COST OF SOMETHING IS WHAT YOU GIVE UP TO GET IT. Decisions require comparing costs and

benefits of alternatives. Whether to go to college or to work?

The opportunity cost of an item is what you give up to obtain that item.

Opportunity cost comprises of both explicit cost and implicit cost.

PRINCIPLE #3: RATIONAL PEOPLE THINK AT THE MARGIN Many decisions in life involve incremental

decisions: should I take another course this semester?

Marginal changes are small, incremental adjustments to an existing plan of action.

People make decisions by comparing costs and benefits at the margin.

PRINCIPLE #4: PEOPLE RESPONDS TO INCENTIVES Because people make decisions by weighing

costs and benefits, their decisions may change in response to changes in costs and benefits.

Example: Seat Belt Laws increase use of seat belts and lower the incentives of individuals to drive safely.

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.

Examples: Most families do not build their own homes, make their own clothes, or grow their own food.

PRINCIPLE #6: MARKETS ARE USUALLY A GOOD WAY TO ORGANIZE ECONOMIC ACTIVITY A market economy is an economy that

allocates resources through the decentralized decisions of many firms and households as they interact in markets for goods and services.

Adam Smith made the observation that households and firms interacting in markets act as if guided by an “invisible hand”—Market Prices.

PRINCIPLE #7: GOVERNMENT CAN SOMETIMES IMPROVE MARKET OUTCOMES

Market failure occurs when the market fails to allocate resources efficiently.

Market failure may be caused by an externality, which is the impact of one

person or firm’s actions on the well-being of a bystander.

market power, which is the ability of a single person or firm to unduly influence market prices.

When the market fails (breaks down) government can intervene to promote efficiency and equity.

PRINCIPLE #8: THE STANDARD OF LIVING DEPENDS ON A COUNTRY’S PRODUCTION Standard of living may be measured in

different ways: By comparing personal incomes. By comparing the total market value of a

nation’s production (GDP, Gross Domestic Product).

Almost all variations in living standards are explained by differences in countries’ productivities.

Productivity is the amount of goods and services produced from each hour of a worker’s time.

PRINCIPLE #9:PRICES RISE WHEN THE GOVERNMENT PRINTS 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 quantity of money.

When the government creates large quantities of money, the value of the money falls.

PRINCIPLE #10: SOCIETY FACES A SHORT-RUN TRADEOFF BETWEEN INFLATION AND UNEMPLOYMENT

The Phillips Curve illustrates the tradeoff between inflation and unemployment:Inflation is lower Unemployment is higher

It’s a short-run tradeoff!

THINKING LIKE AN ECONOMIST

ECONOMIC MODELS Economists use models to simplify reality in

order to improve our understanding of the world

Economists make assumptions in order to make the world easier to understand.

Economists use different assumptions to answer different questions.

BASIC ECONOMIC MODELS

Two of the most basic economic models include: The Circular Flow Diagram The Production Possibilities Frontier

CIRCULAR-FLOW DIAGRAM

The circular-flow diagram is a visual model of the economy that shows how dollars flow through markets among households and firms.

Decision makers Firms & Households

Markets For goods and services For factors of production

THE CIRCULAR FLOW DIAGRAM

Spending

Goods andservicesbought

Revenue

Goodsand servicessold

Labor, land,and capital

Income

= Flow of inputs and outputs

= Flow of dollars

Factors ofproduction

Wages, rent,and profit

FIRMS•Produce and sellgoods and services

•Hire and use factorsof production

•Buy and consumegoods and services

•Own and sell factorsof production

HOUSEHOLDS

•Households sell•Firms buy

MARKETSFOR

FACTORS OF PRODUCTION

•Firms sell•Households buy

MARKETSFOR

GOODS AND SERVICES

PRODUCTION POSSIBILITIES FRONTIER

The production possibilities frontier is a graph that shows the combinations of output that the economy can possibly produce given the available factors of production and the available production technology.

Productionpossibilitiesfrontier

A

B

C

Quantity ofCars Produced

2,200

600

1,000

3000 700

2,000

3,000

1,000

Quantity ofComputers

Produced

D

EFFICIENT OR INEFFICIENT?

Efficient levels of production Economy’s getting all it can from the scarce

resources available Points on the production possibilities frontier Trade-off:

The only way to get more of one good is to get less of the other good

Positive opportunity cost

Inefficient levels of production Points inside production possibilities frontier. Zero opportunity cost.

SHAPE OF PRODUCTION POSSIBILITIES FRONTIER Concave curve (bowed outward): The opportunity cost of producing one good

increases as the production of this good rises.

REASON:Some resources are better suited to the

production of this good than another good (and vice versa).

Straight line: The opportunity cost of producing one good is

constant as the production of this good rises.

A SHIFT IN PRODUCTION POSSIBILITIES FRONTIER Resource Availability Changes (natural resources, human resources,

physical resources) Technology Changes

A SHIFT IN THE PRODUCTION POSSIBILITIES FRONTIER DUE TO A TECHNOLOGICAL ADVANCE IN COMPUTER INDUSTRY

30

Quantity ofComputersProduced

Quantity ofCars Produced

0 600 650 1,000

3,000

A2,2002,300

4,000

G

TECHNOLOGICAL ADVANCE

A technological advance in the computer industry enables the economy to produce more computers for any given number of cars. As a result, the production possibilities frontier shifts outward. If the economy moves from point A to point G, then the production of both cars and computers increases.

IMPORTANT CONCEPTS

Concepts illustrated by the Production Possibilities Frontier Efficiency Tradeoffs Opportunity Cost Economic Growth

POSITIVE AND NORMATIVE ANALYSIS

Positive statements are statements that attempt to describe the world as it is. Called descriptive analysis

Normative statements are statements about how the world should be. Called prescriptive analysis

GAINS FROM TRADE

AUTARKY ( 自給自足 )OR TRADE?

How do we satisfy our wants and needs in a global economy? We can be economically self-sufficient (Autarky). We can specialize and trade

with others, leading to economic interdependence.

CASE 1: THE SIMPLEST ECONOMY

only two goods: potatoes and meat only two people: a potato farmer and a cattle

rancher Each only works 8 hours/day

What should each produce? Why should they trade?

CASE 1 (CONTINUED)

Minutes needed to make 1 ounce of___________________________________ Meat Potatoes___________________________________Farmer 60min/oz 15min/ozRancher 20min/oz 10min/oz

CASE 1 (CONTINUED)

Amounts produced in 8 hours___________________________________ Meat Potatoes___________________________________Farmer 8 oz 32 ozRancher 24 oz 48 oz

THE FARMER’S PRODUCTION POSSIBILITIES FRONTIER

Potatoes (ounces)

8

320

Meat (ounces)

(a) The Farmer’ s Production Possibilities Frontier

THE RANCHER’S PRODUCTION POSSIBILITIES FRONTIER

Potatoes (ounces)0

Meat (ounces)

(b) The Rancher ’s Production Possibilities Frontier

48

24

OPPORTUNITY COST

Definition Whatever must be given up to obtain some item Measures the trade-off between the two goods

that each producer faces

CASE 1(CONTINUED): OPPORTUNITY COSTS

1oz of meat 1oz of potatoes

Farmer 4 oz of potatoes ¼ oz of meat

Rancher 2 oz of potatoes ½ oz of meat

ABSOLUTE ADVANTAGE

The comparison among producers of a good according to their productivity—absolute advantage Describes the productivity of one person, firm, or

nation compared to that of another. The producer that requires a smaller quantity of

inputs to produce a good is said to have an absolute advantage in producing that good.

COMPARATIVE ADVANTAGE

Compares producers of a good according to their opportunity cost. Whatever must be given up to obtain some item

The producer who has the smaller opportunity cost of producing a good is said to have a comparative advantage in producing that good.

SPECIALIZATION AND TRADE

Comparative advantage and differences in opportunity costs are the basis for specialized production and trade.

BENEFITS OF TRADE

Whenever potential trading parties have differences in opportunity costs, they can each benefit from trade.

Benefits of Trade Trade can benefit everyone in a society because

it allows people to specialize in activities in which they have a comparative advantage.

SELF-SUFFICIENCY (AUTARKY)

By ignoring each other: Each consumes what they each produce. The production possibilities frontier is also the

consumption possibilities frontier. Without trade, economic gains are diminished.

SELF-SUFFICIENCY (AUTARKY) IN CASE 1

Assume: Farmer spends 4 hours on meat and 4 hours on potatoes. Rancher spends 4 hours on meat and 4 hours on potatoes.

CASE 1 (CONTINUED): WITHOUT TRADE Production: Farmer produces 4 oz of meat

and 16 oz of potatoes. Rancher produces 12 oz of meat and 24 oz of potatoes.

Consumption: Farmer consumes 4 oz of meat and 16 oz of potatoes. Rancher consumes 12 oz of meat and 24 oz of potatoes.

THE FARMER’S PRODUCTION AND CONSUMPTION WITHOUT TRADE

Copyright©2003 Southwestern/Thomson Learning

Potatoes (ounces)

4

16

8

32

A

0

Meat (ounces)

(a) The Farmer’ s Production and Consumption

Farmer's production and consumption without trade

THE RANCHER’S PRODUCTION AND CONSUMPTION WITHOUT TRADE

Copyright © 2004 South-Western

Potatoes (ounces)

12

24

B

0

Meat (ounces)

(b) The Rancher’s Production and Consumption

48

24

Rancher's production and consumption without trade

ONE PROPOSAL FOR SPECIALIZATION

Farmer devotes all his time to growing potatoes.

Rancher spends 6 hours a day raising cattle and 2 hours growing potatoes.

PRODUCTION UNDER THIS PROPOSAL

Farmer’s production with Specialization: 0 oz of meat and 32 oz of potatoes

Rancher’s production with Specialization: 18 oz of meat and 12 oz of potatoes.

PROPOSAL FOR TRADE

The price of trade Must lie between the two opportunity costs

Trade deal: Farmer gives rancher 15 oz of potatoes, and rancher gives farmer 5 oz of meat in return.

Note: Trade Price of Meat: 2~4 oz of potatoes Note: Trade Price of Potatoes: 1/4 oz ~1/2 oz

of meat

CONSUMPTION WITH TRADE

Farmer’s consumption with trade: 5 oz of meat and 17 oz of potatoes

Rancher’s consumption with trade: 13 oz of meat and 27 oz of potatoes.

HOW TRADE EXPANDS THE FARMER’S SET OF CONSUMPTION OPPORTUNITIES

Potatoes (ounces)

4

16

5

17

8

32

A

A*

0

Meat (ounces)

(a) The Farmer’ s Production and Consumption

Farmer's production and consumption without trade

Farmer's consumption with trade

Farmer's production with trade

HOW TRADE EXPANDS THE RANCHER’S SET OF CONSUMPTION OPPORTUNITIES

Potatoes (ounces)

12

24

13

27

B

0

Meat (ounces)

(b) The Rancher’s Production and Consumption

48

24

12

18

B*

Rancher's consumption with trade

Rancher's production with trade

Rancher's production and consumption without trade

INTERNATIONAL TRADE

Each country has many citizens with different interests. International trade can make some individuals worse off, even as it makes the country as a whole better off. Imports—goods produced abroad and sold

domestically

Exports—goods produced domestically and sold abroad