1 The Economic Problem

1.1 Scarcity: The Nature of the Problem1.1 Scarcity: The Nature of the Problem

‘Economics is the study of how scarce resources are allocated across competing uses’ (Ruffin/Gregory, 1987).

Economics is the (behavioral/social) science of how scare resources are (‘best’) used.

Scarcity is the imbalance between limited resources & unlimited desired uses for them. A resource is scarce (free) when its uses exceed (fall below) supply.

Although we can change economic outcomes, we cannot have all of everything we want: something must be foregone/choices must be made.

The consequence of scarcity is choice; the consequence of choice is (opportunity) cost.

ΕΚΩΝΩΜ-ΩΣ/-ΙΑ

1.2 Economic Systems1.2 Economic Systems

An economic system is one defined by who makes choices (allocates/organizes) scare resources (ownership).

Market economics are based on the principles of 1) Market economics are based on the principles of 1) individual self-governance & private property & 2) individual self-governance & private property & 2) allocational efficiency: property is (resources are) owned allocational efficiency: property is (resources are) owned privately (by households) & exchanged freely & more privately (by households) & exchanged freely & more efficiently in markets.efficiently in markets.

Owners of inputs/outputs (through optimization) make Owners of inputs/outputs (through optimization) make buy/sell (exchange) decisions & prices adjust (‘invisible buy/sell (exchange) decisions & prices adjust (‘invisible hand’) to reflect (‘signal’) relative scarcities (value): hand’) to reflect (‘signal’) relative scarcities (value): prices rise (fall) for goods/services whose demand is prices rise (fall) for goods/services whose demand is above (below) its supply. above (below) its supply.

In socialist economies, property is owned & distributed In socialist economies, property is owned & distributed by the state.by the state.

1.3 Micro- v Macro-economics1.3 Micro- v Macro-economics

Micro- (macro-) economics studies economic activity at the individual (aggregate) level.

Microeconomics studies the behavior of consumers & producers & how markets where they interact are organized.

Microeconomics models the economy without money. Macroeconomics includes money as affecting real economic behavior.

1.3 Micro- v Macro-economics1.3 Micro- v Macro-economics

Macroeconomics studies of the aggregate effects of the decisions of individuals, firms & governments in the economy.

Macroeconomics aggregates all product (output)/factor (input) markets into one called the economy.

Key aggregate macroeconomic effects or variables are interest rates, inflation, unemployment & GDP (total output of the economy).

1.4 Positive v Normative Analysis1.4 Positive v Normative Analysis

Positive (or descriptive or objective) Positive (or descriptive or objective) analysis describes the world as it is or analysis describes the world as it is or could be.could be.

Normative (or prescriptive or subjective) Normative (or prescriptive or subjective) analysis describes the world as it analysis describes the world as it shouldshould be.be.

If a good is scarce, If a good is scarce, cost must be incurredcost must be incurred.. Policies require goals which are by nature Policies require goals which are by nature

subjective & often conflicting.subjective & often conflicting.

1.4 Positive v Normative Analysis (cont)1.4 Positive v Normative Analysis (cont)

Government Government shouldshould raise taxes on tobacco raise taxes on tobacco companies to help pay for rising health care companies to help pay for rising health care costs.costs.

Higher government deficits will Higher government deficits will affect affect interest rates adversely.interest rates adversely.

The income gains from a higher minimum The income gains from a higher minimum wage are worth higher unemployment.wage are worth higher unemployment.

An increase in the minimum wage should An increase in the minimum wage should cause cause an increase in unemployment.an increase in unemployment.

Taxes on smoking will Taxes on smoking will reducereduce smoking. smoking. Education, employment, medical care & Education, employment, medical care &

housing are basic human/economic rights.housing are basic human/economic rights.

1.5 The Scientific Method & Rational 1.5 The Scientific Method & Rational Economic Economic BehaviorBehavior

The scientific method asserts ‘cause & effect’ (ie interdependence).

OHTAR Abstraction means simplification, where

scientists describe effects (‘dependent variables’) as the result of several logical causes (‘independent variables’). A model is an abstraction.

1.5 The Scientific Method & Rational 1.5 The Scientific Method & Rational Economic Economic BehaviorBehavior (cont) (cont)

Francis Bacon (b. 1561 d. 1626)Francis Bacon (b. 1561 d. 1626)

1.5 The Scientific Method & Rational 1.5 The Scientific Method & Rational Economic Economic BehaviorBehavior (cont) (cont)

Paul the Apostle: Paul the Apostle: Test all things; hold Test all things; hold fast to that which is goodfast to that which is good (true)(true). . 1Thes5.21 (circa 55ad)1Thes5.21 (circa 55ad)

1.5 The Scientific Method & Rational 1.5 The Scientific Method & Rational Economic Economic BehaviorBehavior (cont) (cont)

Peter the Apostle: Peter the Apostle: Be prepared at all Be prepared at all time to give reason (a logical time to give reason (a logical explanation) for the hope (faith in explanation) for the hope (faith in Jesus Christ) that lies within you.Jesus Christ) that lies within you. 1Pt3.15 (circa 55ad) 1Pt3.15 (circa 55ad)

1.5 The Scientific Method & Rational 1.5 The Scientific Method & Rational Economic Economic BehaviorBehavior (cont) (cont)

Ceteris paribus isolates one independent variable @ a time, that is, only that variable is analysed @ different values whereas all other possible causes are fixed @ a given value.

By understanding the forces that drive outcomes, scientists can make forecasts/ prescribe policies to address them. (Policies require goals which are often conflicting).

The economic law of maximization under constraints (income/technology; prices/ information) @ the margin describes ‘rational’ decision-making: maximizing (expected) benefits/minimizing (expected) costs

1.5 The Scientific Method & Rational 1.5 The Scientific Method & Rational Economic Economic BehaviorBehavior (cont) (cont)

Consumers maximize (optimize) their satisfaction (‘utility’) - constrained by their scarce resources - by equating marginal (not total) benefits (‘utility’) to marginal costs across goods.

Businesses maximize profits when they use scarce resources efficiently to produce goods, also by equating marginal benefits (revenue) to marginal costs across production lines.

Governments seek to maximize ‘general welfare’ of society, where the objective is rarely the efficient use of scarce resources (concentrate benefits/disperse cost).

1.6 Math review