What does “Economics” mean?

Introduction to Economics Lecturer: Alberto Romero Ania

It is a social science that studies the efficient allocation of scarce resources which is used to produce goods and

services that satisfy consumers' unlimited wants and needs.

Key points in the study of economics:

Introduction to Economics Lecturer: Alberto Romero Ania

• Social Science: Economics uses the scientific method to explain and study our society.

• Allocation: Economics studies allocation decisions about distributing resources, goods and services.

• Scarce Resources: The economy's resources are limited and related to their use.

• Production: We transform available resources into goods and services. That's production.

An understanding of economics also involves:

Introduction to Economics Lecturer: Alberto Romero Ania

• Scarcity. We have limited resources, but unlimited wants and needs.

• The study of economics is essentially the study of scarcity and Opportunity Cost.

• Using resources for one alternative prevents using them for another. Opportunity cost is the highest valued alternative.

• Economics is an analytical discipline:– Answers 'What if...?' questions.

Economics:

Introduction to Economics Lecturer: Alberto Romero Ania

• The basic definition of economics is the scientific study of scarcity and how society uses resources.

• Economics is also the study of how resources are used to produce goods and services, which are used to satisfy consumers' wants and needs.

• The three questions of allocation: What? How? Why?

• “Why ?” is related to motivation and incentives

The study of economics involves:

Introduction to Economics Lecturer: Alberto Romero Ania

• Positive economics, which uses the scientific method to uncover the basic mechanism of the economy. – It seeks to describe the way this world is.

• Normative economics, which is the policy side of economics.– It seeks to prescribe the way the world SHOULD BE.

The two broadest fields in Economics

Introduction to Economics Lecturer: Alberto Romero Ania

• Macroeconomics is the study of the aggregate economy, the entire pie, the whole forest. – Macroeconomics is interested in things like gross production,

unemployment, inflation, and recession.

• Microeconomics is the study of parts of the economy, the slices of the pie, the trees of the forest. – Microeconomics is interested in topics like market prices, consumer

behavior, production costs, and competition.

“History of Economy: Classical Trade Theory”

Introduction to Economics Lecturer: Alberto Romero Ania

• Classical authors were ambivalent regarding cross border trade.

• Mainly based on non-economic arguments

• “Nothing is produced by trade”

“History of Economy: Classical Trade Theory”

Introduction to Economics Lecturer: Alberto Romero Ania

• It was said that the total amount of goods of the two parties at the end of the exchange is the same as it was before

• If one country gains from a swap, the other will necessarily have to lose

• Improve its own welfare only by harming others

• Trade does not increase the physical quantities of the goods available, but…

Trade improves the allocation of goods and services

“History of Economy: Reasons for trade”

Introduction to Economics Lecturer: Alberto Romero Ania

• Every country lacks resources that it can get only by trading with others

• Each country´s climate, labor force and other “factor endowments” make it a relative efficient producer of some goods and an inefficient producer of other goods, due to natural factors

“History of Economy: Reasons for trade”

Introduction to Economics Lecturer: Alberto Romero Ania

• Specialization permits countries to acquire productivity gains (become more efficient in the production) through improving the work organization and through improving the skills or by clusters, like in Silicon Valley

Trade is about exploiting resources, differences and economies of scale

through specialization

“History of Economy: Reasons for trade”

Introduction to Economics Lecturer: Alberto Romero Ania

• Adam Smith (The Wealth of Nations, 1776):

“One country is said to have an absolute advantage over another in the production of a particular good if it can produce that good using smaller quantities of resources (with less factor input) than can the other country.”

“History of Economy: Mercantilism (Kameralismus)”

Introduction to Economics Lecturer: Alberto Romero Ania

• The mercantilism movement dominated the 16th-18th century

• National interest are best served by increasing exports and reducing imports

• Create works for peasants and craftsmen

• They finance army and nobility via the trade surplus and tariffs

“History of Economy: Mercantilism (Kameralismus)”

Introduction to Economics Lecturer: Alberto Romero Ania

• Trade policy: Colonies provide raw materials and trade monopolies

• The problem of mercantilism, inflation, was pointed out by David Hume (Price-specie-flow Mercantilism, 1752)

– What will happen if every country follows a Mercantilism trade policy?

INFLATION:

• In economics, inflation is a rise in the general level of prices of goods and services in an economy over a period of time.

• Inflation rates around the world:

Introduction to Economics Lecturer: Alberto Romero Ania

“History of Economy: Main Authors”

Introduction to Economics Lecturer: Alberto Romero Ania

• Opportunity cost is a concept created by Adam Smith

• This concept is the fundamental principle of all thinking on economy and international trade.

One question…

What is the cost of studying at the University?

Price, value and cost are different concepts.

“History of Economy: Main Authors”

Introduction to Economics Lecturer: Alberto Romero Ania

• The “law of comparative advantage” (David Ricardo, The principles of political economy and taxation)

• One country is said to have a comparative advantage over another in the production of a particular good relative to other goods if it produces, in comparison with the other country, that good more efficiently or less inefficiently”

• The miracle of trade: when every country does what it can do best, all countries can benefit because more of every commodity can be produced without increasing the amounts of labor and other factor input used.

“History of Economy: Who wins, who loses?”

Introduction to Economics Lecturer: Alberto Romero Ania

• Who wins, who loses from trade?

• Answer by Mercantilists: The exporting country wins and the importing one loses.

“History of Economy: Who wins, who lose?”

Introduction to Economics Lecturer: Alberto Romero Ania

• Answer by Physiocrats: Both countries win, – If they exploit an absolute (A. Smith) – Or a comparative advantage (D.Ricardo)

• David Ricardo demonstrated that

free trade increases welfare for everybody

ABSOLUTE ADVANTAGE:

Introduction to Economics Lecturer: Alberto Romero Ania

• The general ability to produce more goods using fewer resources than other people or countries.

• This idea of absolute advantage is important for trading, which occurs between both: people and nations.

• A nation can get an absolute advantage from: an advanced level of technology or higher quality resources.

• For a person, an absolute advantage can result from natural abilities or the acquisition of human capital (education, training, or experience). (Lawyer/attorney and secretary)

COMPARATIVE ADVANTAGE:

Introduction to Economics Lecturer: Alberto Romero Ania

• The ability to produce one good at a relatively lower opportunity cost than other goods.

• While economists developed this idea for nations, it's extremely important applied to people !!!

• A comparative advantage means that no matter how good (or bad) you are at producing stuff, there's always something you can do best (or worst).

COMPARATIVE ADVANTAGE:

Introduction to Economics Lecturer: Alberto Romero Ania

• Moreover, because you can produce this one thing by giving up less than others give up, you can sell it to them.

• This idea of comparative advantage means that people and nations can benefit by specialization and exchange.

• You do what you can do best, then sell to someone else for what he/she can do best.

– Both sides in this trade get more and are thus better off afterwards than before.

SPECIALIZATION:

Introduction to Economics Lecturer: Alberto Romero Ania

• The condition in which resources are primarily devoted to specific tasks.

• This is one of the most important and most fundamental terms in the study of economics.

• A long tome ago civilized human beings have recognized that limited resources can be used more effectively in the production of goods and services that satisfy unlimited wants and needs if those resources specialize.

“History of Economy: 20th century trade theory”

Introduction to Economics Lecturer: Alberto Romero Ania

• Neoclassical school of economics

• Concept: “Factor substitution” (Eli Heckscher, 1919)

– “Factor substitution asserts that different production methods allow to produce a good with different factor combinations”

– Not all factors can be substituted, especially in the short.

“The fails of the traditional trade theories”

Introduction to Economics Lecturer: Alberto Romero Ania

– “ Trade depends on natural causes”, but 90% occurs among developed countries.

– “ Trade based on comparative advantages remain constant over time”. But Switzerland was the biggest exporter of watches until Japan overtook in the 70´, and in the 90´ by HK, Taiwan and Korea.

– “ Trade will lead to inter-industry specialisation where one country specialises in”. But many times countries import and export the same good, within the intra-industry trade. Germay, biggest car importer-exporter.