publisher’s powerpoint edited for econ1000 f& h prof. lanfranco

Publisher’s PowerPoint Edited for ECON1000 F& HProf. Lanfranco

1 1.What Is Economics?

2.What should you get from this Chapter?

After studying this introductory chapter you will:

Begin to understand economics as a discipline: (its scope and its limits)

Distinguish between microeconomics and macroeconomics

Begin to identify and explore some big questions of economics

Begin to understand what is meant by “the economic way of thinking” (choices, tradeoffs, and the margin)

Begin to understand economics as a social science and its uses for decision making and policy analysis (advice, analysis, evaluation)

Copyright © 2013 Pearson Canada Inc., Toronto, Ontario

This a good time for you to study economics

1. Massive economic problems (and opportunities) are confronting the world around you.

2. You will not escape their impact on your job, your future, and your personal life. (See: millions of U.S. citizens who have lost their homes, their jobs, and any secure future).

3. You will have to carve out a path through these economic challenges and opportunities.

4. Your strategy as an individual and a citizen will involve making personal choices, and supporting political alternatives, in conditions of uncertainty.


Definition of Economics

Economics as a discipline exists because of material and temporal scarcity. (not enough “things” to satisfy all wants, and not enough “time” to do everything).

Because of scarcity, choices must be made (by individuals, by companies, by governments)

Choices depend benefits and costs (and tradeoffs).

Benefits (pleasure, profits, votes) are an incentive/ reward that encourages an action. Costs are a dis-incentive/penalty that discourages an action.

Most decisions involve more or less, rather than all or none, and involve marginal analysis


Economics is the social science:

1. It is theory and logic based and relies on evidence based analysis.

2. It’s domain (scope of study) is the choices that individuals, businesses, governments, and entire societies make as they cope with scarcity and the incentives that influence and reconcile those choices.

3. It pays particular attention to the role of markets and prices as a “form follows function” human inventions (tools) to assist in choice making.



Microeconomics is the study of choices (individuals, businesses, gov’t) make, the way those choices interact in markets, and the influence/role of governments.

Example of a microeconomic question: Why are people buying more e-books and fewer hard copy books, and why are the prices what they are?

Macroeconomics is the study of the performance of the national and global economies at the aggregate level.

Example of a macroeconomic question: Why is the unemployment rate high in Canada?



Big Economic Questions*

Two big questions summarize the scope of economics:

How do choices end up determining what, how, and for whom goods and services get produced?

When do choices made in the pursuit of self-interest also promote the social interest?

Issues: Who’s self-interest counts here (the rich?, the homeless?) and who’s definition of social interest are we to use?


*The book likes to call this “The Two Big Questions”, but there are many more so we will just call them “Big Questions” since “social Interest” is not defined here (and can be defined in different ways).

What, How, and For Whom?

Goods and services are the objects that people value and produce to satisfy human wants.

What gets produce?

The text depicts Brazil, Canada and China showing dramatically different divisions between agriculture, manufacturing and services.

Why these differences: At the microeconomic level mainly market forces (& gov’t policy). At the macroeconomic level mainly levels of affluence and productivity, and foreign trade markets

Big Economic Questions


Note: Course exams will not ask questions about the numbers themselves


Figure 1.1 shows these numbers Canada, Brazil and China.

What determines these patterns of production?

How do choices end up determining the quantity of each item produced in Canada, and around the world?


How involves asking what inputs and in what combinations.

Economists call inputs factors of production.

Factors of production are grouped into four categories:

Land (natural resources – land, forest, minerals, etc.)

Labour (humans – skilled labour involves human capital

Capital (plants and equipment – not financial capital)

Entrepreneurship (ability to organize and orchestrate activity (entrepreneur is capitalist owner, but this ability can rest in an agency, or community, or other entity)



The “gifts of nature” (natural resources, forest, acreage) used to produce goods and services are land.

The work time and work effort that people devote to producing goods and services is labour.

The quality of labour depends on human capital, which is the knowledge and skill that people obtain from education, on-the-job training, and work experience.

The tools, instruments, machines, buildings, and other constructions that businesses use to produce goods and services are capital.

The human resource that organizes land, labour, and capital is entrepreneurship. This can be a capitalist owner, or a hired enterprise manager



Figure 1.2 shows the growth of human capital in Canada over the last 35 years: the percentage of the population that has completed different levels of education.

Economics explains what drives this and what these trends mean at the micro and the macro economic levels.

This is about you and what you are doing here?



For Whom?

Who gets the goods and services depends on “effective demand” in turn based on the income and wealth that people have.

Land earns rent. (which differs from “Economic Rent”)

Labour earns wages. (may include Economic Rent)

Capital earns interest. (PROBLEM! – will expand later)

Entrepreneurship earns profit as a residual

Two Big Economic Questions


Can the Pursuit of Self-Interest Promote the Social Interest (how defined – not defined here!)?

Every day millions of Canadians and billions of people globally make economic choices that result in What, How, and For Whom goods and services are produced.

Are the right things in the right quantities produced?

Do we use factors of production in the best way?

Do goods and services go to those who benefit most?

These are not Yes/No questions.

They are “how does the process work?” questions.



Self-Interest: choices you make in your self-interest —are choices that you think are best for you.

Social Interest

Choices that are best for society as a whole are said to be in the social interest. Social interest has two dimensions:

Efficiency: the best use of inputs to produce the outputs

Equity: Some notion of “fairness” or “social justice” as far as who does the work, and who gets what.



Efficiency is achieved when the available resources are used to produce goods and services:

1. At the lowest possible input cost, (or price if prices measure real costs) Problem of Externalities

2. In quantities that give greatest possible benefit. (How do markets help achieve this, or prevent this from occurring?)

Equity is about fairness.

1. Economics has nothing special to say about this.

2. Individual economists have a variety of views about what is fair.

Big Question

When can choices made in self-interest promote the social interest?



Four topics that generate discussion and that illustrate tension between self-interest and social interest are

Globalization: Where production and income occur

The information-age economy: Impact of ICT (information and communication technology)

Global warming: Extent, Causes, Effects, Actions

Economic instability: Causes, Effects, Actions



Globalization

Globalization: expansion of international trade (goods and services), in the flow and ownership of factors of production, and growth of global financial markets (borrowing, lending and investment).

Globalization:

1. Self-interest of consumers who buy low-cost imported goods and services. (What about “fair trade (coffee); locavour/100 mile diet)

2. Self-interest of the multinational firms that profit maximize producing in low-cost regions and selling in high-price regions.

In globalization who loses? Is it in the self-interest of workers in other countries, or of Canadian firms that can’t compete with low-cost imports?

Remaining Question: Is globalization in the social interest?



The Information-Age Economy: (ICT) expands time and space by adding virtual time/space to literal time/space to support organizations and processes.

ICT has created has been called the Information Revolution.

ICT has served self-interest: providing affordable cell phone, application, and Internet access

It has also brought wealth to innovators: Entrepreneurs behind Microsoft, Apple, and Intel have seen their wealth soar.

Has ICT served the social interest?



Climate Change

Self-interested choices to use electricity and gasoline contribute to carbon emissions, and leave a carbon footprint.

The carbon footprint can be reduced by walking, riding a bike, taking cold showers, or planting a tree.

But can each one of us be relied upon to make decisions that affect the Earth’s carbon-dioxide concentration in the social interest? What options or mechanisms are available to make the right (or better) decisions here?



Economic Instability

From 1993 to 2007 Canada and global economies grew.. Canadian incomes increased by 30%, China’s tripled.

In August 2007, a period of financial stress began that soon gripped the entire global financial system. (This was brought on mainly by housing markets)

Banks conducted self-interested borrowing & lending, people made self-interested home buying decisions.

How did, or did not, this lending and borrowing serve the social interest? What role did industry driven changes in the “rules of the game” contribute to this economic mess?



The Economic Way of ThinkingSix key ideas define the economic way of thinking:

A choice is a tradeoff.

People make rational choices by comparing benefits and costs.

Benefit is what you gain from something.

Cost is what you must give up to get something.

Most choices are “how-much” choices made at the margin.

Choices involve incentives, constraints, options, and information


The Economic Way of ThinkingA Choice Is a Tradeoff

The economic way of thinking places scarcity and its implication, choice, at center stage.

Every choice is a tradeoff — giving up one thing to get something else.

Tonight, will you study or have fun? You can’t study or have fun at the same time, so you must make a choice.

Whatever you choose, you could have chosen something else. Every choice is a tradeoff. When you think you have no choice it is usually because any other option is too costly.


The Economic Way of ThinkingEconomist’s Notion of Private Rational Choice

Rational choice: Compares costs and benefits and achieves the greatest total benefit, for those costs, as viewed by the person making the choice.

Only the wants of the person making a choice are relevant.

The idea of rational choice provides an answer to the first question: What goods and services will be produced and in what quantities?

Answer: Those that people choose to buy in the market.

Issues: Preferences come from where, and what about externalities and/or a social conscience?


The Economic Way of Thinking

What do Economists mean by: How do people choose rationally?

The answers turn on benefits and costs.

Benefit: What you Gain

The benefit of something is the gain or pleasure that it brings and is determined by preferences

Preferences are what a person likes and dislikes and the intensity of those feelings. (Preferences come from where?)

Origin of Idea: See Jeremy Bentham (Google him!)Copyright © 2013 Pearson Canada Inc., Toronto, Ontario


Relevant Cost: What is best thing you Must Give Up

Opportunity cost: the highest-valued alternative given up to get it.

What is your opportunity cost of taking ECON1000?

Opportunity cost has two components:

1. What you can’t afford to buy if you pay tuition, purchase text books, pay for transportation, etc. (things foregone).

2. The things you can’t do with your time if you study and go to class.

NOTE: Also, since education is building human capital the cost of not going is the prospect of a diminished future.


How Much? Choosing at the Margin

You can allocate the next hour between studying and instant messaging your friends.

The choice is not all or nothing, but you must decide how many minutes to allocate to each activity.

To make this decision, you compare the benefit of a little bit more study time with its cost—you make choices at the margin, so marginal analysis is central to decision making.

AND: Calculus is essential for an economics major!



To make a choice at the margin, you evaluate the consequences of making incremental changes in the use of your time.

The benefit from pursuing an incremental increase in an activity is its marginal benefit.

The opportunity cost of pursuing an incremental increase in an activity is its marginal cost.

If the marginal benefit from an incremental increase in an activity exceeds its marginal cost, your rational choice is to do more of that activity.

This assumes that the decision maker has good information, but assumes nothing about how the decision maker measures benefits and costs.



Choices Respond to Incentives

A change in marginal cost or a change in marginal benefit changes the nature/value of the incentives that we face and leads us to change our choice.

One central idea of economics is that we can predict how choices will change by looking at changes in incentives.

Incentives are also the key to reconciling self-interest and the social interest, given the right context and conditions.



A Social Science and Policy ToolEconomist as Social Scientist

Economists, Philosophers, Scientists and others distinguish between two types of statement:

Objective “What is” statements called positive statements (term from Logical Positivist School)

Subjective “What ought to be” statements called normative statements

A positive statement can be tested by checking it against facts.(e.g. Falling oil prices will drive down the Canadian dollar)

A normative statement expresses an opinion and cannot be tested. (e.g. Gasoline prices are too high)


Understanding Cause and Effect

Economic science: Discover positive statements (relationships/laws) that are consistent with:

what we observe in the world, enable us to understand how the economic world works, and carry out effective policies at the individual, organizational, and governmental levels.

To do this economists create and test economic models.

Economic model: Description of some aspect the economic world that includes only those features that are needed for the purpose at hand. (Occum’s Razor)

Economic Models: A Social Science and Policy Tool


A model is tested by comparing its predictions with the facts.

But testing economic models is difficult, so economists also use

Natural experiments: Mainly comparative data (US vs Canada contexts, same variables, different outcomes)

Statistical investigations: Work with time-series or cross section data (StatCan data, survey data, market data)

Economic experiments: Experimental Economics (run subjects through market scenarios to explore reactions)

Economics: A Social Science and Policy Tool


Economics: A Policy Tool

Economist as Policy Adviser

Economics is also a toolkit for advising governments and businesses and for making personal decisions.

All the policy questions involve a blend of the positive and the normative.

Economics can’t help with the normative part—the goal, other than assess marginal tradeoffs between goals.

For a given goal, economics provides a method of evaluating alternative solutions (how to’s)—comparing marginal benefits and marginal costs.

Now we look at how to build and use the toolkit: Read on


publisher’s powerpoint edited for econ1000 f& h prof. lanfranco

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