Resources and Wants

• We have limited resources.

• We have wants which exceed those

resources.

• This leads to scarcity

– Scarcity exists when there are
insufficient resources to satisfy
people’s wants.
Economics:
The Social Science which studies social and
individual choices in a condition of scarcity with
the objective of maximizing the satisfaction of
human wants.
 Economic Resources

• Land - Natural Resources

• Labor - Skills of People
• Capital - Man made inputs to
production. (not money)
• Entrepreneurship - The organizing resource of
production; combines the other resources and
accepts risk.
Payment to the Resources
• Rent (for land)
• Wages (for labor)
• Interest (for
capital)
• Profit (for
entrepreneurial
ability)
Circular Flow of Economic Activity

Resource Wages, Interest,

Income $ Market Rent, & Profit

Factors of Production

Households Firms

Goods and
Services

Product Revenue $
Consumption $ Market
The Questions of Economics
Scarcity requires us to make choices
involving:
• What to produce?

• How to produce it?

• For Whom? (how it should be distributed?)

Methods of Social Choice
Society makes choices through:

• Market Forces

• Governmental Forces

• Social Forces
 Economic Choice
In Capitalist economies the Market is
the major rationing device:

• Markets ration through the forces of

Supply and Demand.

• If Demand > Supply the Price

and rations the shortage.
 Economic Choice
In Command Economies (centrally
planned), the Government make choices
which allocate resources and decide:

• What?

• How?

• For Whom?
 Economic Choice
In Mixed Economies (both market and government
combined), the society makes choices which allocate
resources through a combination of government
intervention and market forces.

Government Forces:
• Government Spending
• Regulation
• Taxes
• Subsidies
 Opportunity Costs
• Opportunity Cost - is the highest valued alternative
foregone when choosing between alternatives.
• When an activity is chosen, the opportunity cost is
the benefit expected from the best alternative
forgone.
• Example: If you choose to attend college this year,
your opportunity cost is the salary you would have
received from the best available full-time job.
 Economic Choice
• To choose, evaluate tradeoffs--the
opportunity cost of a choice is the value
of the best alternative you gave up
Rational Self-Interest

• Individuals rationally
select alternatives
they perceive to be in
their best interests
 Incentives

Economists believe that incentives work.

They believe that people respond to incentives (that they
weigh the costs and benefits rationally).
• If the cost of choices increase, less of that
choice will be made.

• If the benefit of a choice is increased, people will make that

choice more.
 Rational Choice
I will choose to make a choice if
MB > MC

Incentives change Benefit or Cost!

Incentives will cause:

MB > MC
 Rational Choice
I will choose not to make a choice if

MB < MC

Incentives change Benefit or Cost!

Disincentives will cause:

MB < MC
 How Do Economists Think: Utility and Rationality

• Economists assume that people act rationally

Economists assume that people act to maximize their
own happiness and minimize their costs.
• This happiness that economists assume people
maximize is called utility.
• This does not mean people are greedy - some people
get happiness from others happiness.
 Types of Economics

• Microeconomics - Studies the behavior of individual

decision units (people and firms).

• Macroeconomics - Studies the behavior of entire

economies as a whole.
 Types of Economics

• Positive Economics - The economics of what is. This is

descriptive of fact and theory without opinion.
– A positive economic statement can be proved or
disproved by reference to facts.

• Normative Economics - The economics of what should

be. This is economics where policy issues involve
evaluation and the opinion of the economist.
– A normative economic statement represents an
opinion, which cannot be proved or disproved.
ECONOMIC GOALS
What are our
goals and
objectives?
 ECONOMIC GOALS

ECONOMIC GROWTH
FULL EMPLOYMENT
ECONOMIC EFFICIENCY
PRICE LEVEL STABILITY
ECONOMIC FREEDOM
EQUITABLE DISTRIBUTION
ECONOMIC SECURITY
BALANCE OF TRADE
ECONOMIC GOALS
ECONOMIC GROWTH
FULL EMPLOYMENT
ECONOMIC EFFICIENCY
PRICE LEVEL STABILITY
ECONOMIC FREEDOM
EQUITABLE DISTRIBUTION
ECONOMIC SECURITY
BALANCE OF TRADE
 Economic Models
• An economic model is a
simplification of reality
designed to capture the
important elements of the
relationship under
consideration
• A model is usually a
graph or a set of
mathematical equations
 Scientific Reasoning Tools:
Inductive Reasoning:
• Reasoning from facts to generalizations.
- Gather, systematically arrange, and draw
conclusions from the analysis of facts and
data (empirical analysis). Test the theory
(hypothesis) against real-world situations.

• Deductive Reasoning:
- Starting with generalities of how the world
works, generate hypotheses and test those
predictions against real-world situations.
 What is the
Scientific Method?
• Problem
identification
• Model
development
• Testing a theory
Organized Facts Which Lead
to
Generalizations or Principles

THEORIES
INDUCTION

FACTS
 Theories Which Lead to
Verification or Rejection By
the Facts

THEORIES

THEORETICAL
DEDUCTION
INDUCTION

ECONOMICS

FACTS
Either Can Lead to Policies
POLICIES

THEORIES

THEORETICAL
DEDUCTION
INDUCTION

ECONOMICS

FACTS
Scientific Reasoning Issues
• In complicated, real-world systems, how
do you unscramble cause and effect?
– Hold other things equal (ceteris paribus).

• Fallacy of composition
• If A happens before B, did A cause B?
• Confusing correlation with causation
Scientific Reasoning Tool
Ceteris Paribus:
• It is Latin for “all else equal” and

• is a tool of scientific reasoning that

we will use OFTEN.

• it means that we are assuming that

all other variables which might be
related are held constant.
Scientific Reasoning Fallacies:
• Correlation vs. Causation :
Because two variables are systematically related,
(they may increase together or always seem to
move in opposite direction)
• this correlation is not proof of a cause-effect
relationship between them.

Example: Change in the Money Supply and

change in GDP, which causes which?
 Graphs Used in
Economic Models
• Patterns to Watch For:
– variables that move in the same direction
– variables that move in opposite directions
– variables that are unrelated
A Line with Positive Slope

change in y >0

change in x

x
Two-Variable Diagram Representing a
Direct Relationship

Consumption($)
C
360
F
300
E
240 Thevariables
D
180 incom eand
C consum ptionare
120 directlyrelated.
B
60 A
0
100 200 300 400 500
Income($)
 Direct Relationships
Variables Moving in the
Same Direction

A B
A Line with Negative Slope

change in y < 0

change in x

x
Two-Variable Diagram Representing an
Inverse Relationship

The variables price

Price of CDs ($) and quantity
demanded are
A
20 inversely related.
B
18
C
16
D
14
E
12 Demand for CDs
0
100 120 140 160 180
Quantity Demanded of CDs
 Inverse Relationships
Variables Moving in
Opposite Directions

A B
 Two Diagrams Representing
Independence between Two Variables
VariablesXandYare VariablesXandY
Y Y areindependent.
independent(neithervariable
isrelatedtotheother).
40 40 D

30 30 C

A B C D
20 20 B

10 10 A

0 X 0 X
10 20 30 40 10 20 30 40
(a) (b)
 Calculating the Slope of a Line
Y Y
∆Y –10 ∆Y +10
Slope= = =+2
Slope= ∆ =
X 10
=–1 ∆X +5
(negativeslope) (positive

A
40 40 D
∆Y
B 30
30 C
∆X
C
20 20 B

D
10 10 A

0 X 0 X
10 20 30 40 10 15 20
(a) (b)
 Calculating Slopes
∆Y +10
Slope= = =`
Y Y ∆X 0
(infiniteslope)

40 40 D

A B C D
30 30 C

20 ∆Y 20 B
0
Slope= ∆ = =0
X 10
(zeroslope)
10 10 A

0 X 0 X
10 20 30 40 10 20 30 40
(c) (d)
Calculating the Slope of a Curve at a
Y
Particular Point

Line drawntangent
tothe curve at
40 pointA.

C
30

A
20 20

∆Y 20
Slope= = = +.67
10 B ∆X 30

30
X
0 10 20 30 40
Graphing Relationships Among
More Than Two Variables

Price Ice cream consumption

(cents per scoop) (gallons per day)

30ºF 50ºF 70ºF 90ºF

15 12 18 25 50
30 10 12 18 37
45 7 10 13 27
60 5 7 10 20
75 3 5 7 14
90 2 3 5 10
105 1 2 3 6
Functional Relationships

DIC = f (P T)

• Ice Cream demand depends on

price and temperature.
• If temperature increases
• Demand Increases
 A Change in Demand
Ceteris paribus, if
Price 6 temperature rises,
5 people will buy
more Ice Cream at
4
each price
3
New Demand for
2
Ice Cream
Demand for
1
Ice Cream

Quantity
0 1 2 3 4 5 6 7 Ice Cream
A Movement Along a Curve vs.
A Shift in the Curve
Price

A change in
quantity
demanded
P0

P2

D0

Q0 Q2 Quantity
A Change in the Quantity Demanded
Versus a Change in Demand
Price

A change in
P1
quantity
demanded
P0

D0

Q1 Q0 Quantity
A Change in the Quantity Demanded
Versus a Change in Demand
Price

A change in
demand
Decrease in Increase in

demand demand

D1
D0
D2
Quantity
 Key Terms and Concepts
• Scarcity • Induction
• Economics • Deduction
• Utility • Fallacy of Composition
• Land • Ceteris Paribus
• Labor • Positive Economics
• Capital • Normative Economics
• Entrepreneurship • Microeconomics
• Opportunity Cost • Macroeconomics
• • Inverse Relationship
Marginal Analysis
• Direct Relationship
• Rational Behavior • Slope of a line