INTRODUCTION TO ECONOMICS

 
DEFINTION OF ECONOMICS
 
The definition I believe helps students best understand Economics is:
 
“Economics is the study of the behavior of people producing, distributing and consuming products
 
(goods and services) in a world where “economic” resources are “scarce”.
 
   1).  social science
 
            a).  economics is a social science because it studies the behavior of people as other
                  social sciences do such as psychology, sociology and anthropology.
 
                      -  the difference is that economics studies the behavior of people producing,
                          distributing and consuming goods and services.
 
                      -  the other social sciences study the behavior of people in terms of their
                         motivations and emotions (PSYCOLOGY), in groups (SOCIOLOGY), or in past
                         civilizations (ANTHROPOLOGY).
 
   2). economic activities    
 
         a). the economic activities that people conduct can be grouped into three broad
              categories.
 
                      -  production of products (the supply of products)
                      -  distribution of products
                      -  consumption of products (the demand for products)
 
   3).  products
 
           a).  tangible (goods) and intangible (services) items created using economic resources.
                 Both goods and services are products. 
 
   4).  scarce resources
 
           a). resources needed to create products are limited or scarce in their quantity and must
                be used wisely to provide consumers with the greatest benefit. 
 
In summary, all material in this course will in some way relate to the study of the behavior of
people producing, distributing or consuming products using resources that are limited in quantity.
 
DIFFICULTIES IN LEARNING ECONOMICS
 
Economics like other subjects has certain characteristics that make it confusing or more difficult
 
to understand.  These characteristics are discussed below.
 
1).Terminology Issues
 
·  new words, terms and phrases in Economics that are unfamiliar and that will have to
                be learned, e.g. “comparative advantage, ceteris paribus, elasticity, spillovers, etc.
 
·  familiar words, terms and phrases, but which have a “different” meaning e.g. capital,
                 labor, investment, marginal, land, efficiency, profit, demand, supply, utility, etc.
 
   2).  Understanding the Economic Method of Analysis
 
          a). extensive use of assumptions.
 
                -  necessary because there are so many variables that affect how people behave in
conducting economic activities.
               -  since it is impossible to control all of these variables in a laboratory or otherwise,  
                   economists use assumptions to control the many variables.
               -  these assumptions enable economists to make generalized statements (theories,
                    laws, principles, hypothesis) about economic behavior that is logically consistent
                     based upon the assumptions.
 
          b).  Akey assumption underlying economics is that those involved in economic activity act
                rationally in making economic decisions or choices. If the players involved in  
                economic activity don’t act rationally, then the capability to predict future economic
                behavior and outcomes is impossible.
By recognizing and overcoming the above difficulties in learning economics, students will be more
successful in mastering the subject of economics. 
 
ECONOMIC CHOICES AND DECISION MAKING
 
   1).  choices or trade offs are at the heart of economics
         a). in fact economics is often called the science of making choices.
         b). choices must be made where two courses of action can not both be simultaneously
             pursued. Examples of situations requiring choices are when:
 
                -  a person can’t be in two places at once (can’t be at the movies and home studying
                    economics at the same time).
                -  a person can’t do two things at once (e.g. swimming and reading a book)
                -  products can’t be produced in unlimited quantity because resources to produce
                   them are scarce or limited in quantity.
          c).  when a course of action is chosen, the alternative course of action not chosen is
                referred to as the “trade off”.  In other words, possible choices are trade offs for each
                other.
  2).  benefits vs. costs of choices or trade offs (cost benefit analysis)
          a).  every choice yields benefits and involves costs.
           b).  net benefits = benefits less costs.
           c). key decision making concept in economics
 
                  -  if the net benefits of a choice are positive (benefits > costs), the choice should be
                     made as total net benefits will increase.
                  -  if more than one choice is considered, the choice with the greatest positive net
                      benefits should first be chosen to maximize net benefits.
3).  marginal analysis approach
 
          a).  marginal or “at the margin” analysis refers to analyzing the benefits and costs of a
                choice involving the “next”, “last” or “incremental” quantity of a variable.
          b).  suppose, for example, that the second cup of coffee in the morning provides you with   
                a benefit worth $2.50 and costs $1.50. Since we are only talking about the second
                cup, the second cup is the “marginal or incremental” cup and its benefit/cost are the
                “marginal benefit/cost”.
           c).  should the second cup above be purchased and consumed? 
 
ECONOMIC METHODOLOGY(APPROACH USED TO REACH CONCLUSIONS)
 
1).  Scientific Method
 
       a).  the scientific method is used by economists to develop theories (generalizations) that
             explain in simple terms how rational people behave in conducting economic activities. 
       b). these theories or generalizations do not reflect actual realty which is more complex,
             but are abstractions or simplifications of reality.
       c). since there are so many variables in economics that can’t be controlled, assumptions
              must be made about the multitude of variables.  Obviously, the more assumptions
              about variables underlying a theory, the more unlikely the theory will reflect reality.
-  assumptions are still useful however and are an everyday fact of life. When you
   drive a car you assume other drivers will follow the traffic laws. And for the most     
  part they do.  When you buy a product you assume it will perform as advertised.
  And for the most part they do.
 
  d).  in spite of the fact that assumptions limit an accurate description of reality they are
        helpful in developing theories which explain economic behavior.
 
   2). Ceteris Paribus
              a). in beginning economics, it is extremely important to understand that for the most
                   part, the theories covered are based upon the interaction of “two” main variables
                   and assume that all other “outside” variables are CETERIS PARIBUS or fixed and
                   don’t change as the two main variables change. Ceteris paribus applies only to
                   “outside” variables.
 
              b). one of the two main variables is called the independent variable whose change
                   “causes” the second variable, the dependent variable, to change (the effect).
 
   3).  CORRELATION VS. CAUSATION
 
              a).  changes in two “main” variables that follow a pattern are said to be
CORRELATED until it is proven to the extent possible that a change in one, causes
the change in the other.
               b).  It is frequently the case, that the pattern of change in the two main variables is
                     caused by changes in the other outside variables, and that the pattern of change
                     between the two is coincidental (correlated) and not causative.
 
               c).  note that the terminology “independent” and “dependent” variables indicates
                     causation.
               d).  Economics is concerned with theories that reflect cause and effect, i.e. dealing with
                     independent and dependent variables.
 
   4).  What Are the “Steps” Involved in the “Scientific Method”?
 
           a). OBSERVATION of an event and outcome that occurs in reality.
           b). DEVELOPMENT OF AN EXPLANATION that explains the observed event and
                outcome.
           c). TESTING OF AN EXPLANATION’S accuracy thru more observations of the
                 event/outcome.
 
   5). Types of “Scientific” Observations
 
          a).  controlled observations, i.e. lab experiments which control variables.
          b).  uncontrolled observations, i.e. simply observing what is happening in the real world.
 
   6).  Levels of Reliability of Explanations of Reality
 
           a).  hypothesis – a supposed or educated guess explanation.
           b).  theory – thoroughly tested explanation.
           c).  law or principle – extensively tested explanation to point of being accepted as fact.
 
   7).  Models
 
a).  models are tools used to communicate theories, laws and principles.
 
           b).  models are representations of reality.
           c).  examples of models are diagrams, equations, graphs and maps.
 
   .  Problem in Using Scientific Method in Economics to Arrive at sound Explanations of
         Economic Reality
 
           a). can’t conduct controlled lab experiments to control the variables.
           b).  problem is resolved by “artificially controlling” variables.
 
   9).  How Are Variables Artificially Controlled?
 
a).  by making the assumption that variables not under evaluation are fixed or frozen in
     time and do not change, that is are CETERIS PARIBUS.
 
ECONOMIC POLICY
 
1).  economic policy involves decisions made based upon scientific facts and upon the
          value judgment of those setting the policy.
 
                         economic policy = facts + value judgments
 
   2).  value judgments are based upon a variety of personal values held by those setting
          policy, e.g. religion, ethics, politics, etc.
   3).   policy decisions involve actions taken to change economic outcomes to what those in
           control think they “ought to be”.
   4).  “positive statements” involve scientific fact; economic policy involves normative
         statements.
 
POSITIVE VS. NORMATIVE STATEMENTS
 
1).  positive statements are statements of fact. They make a statement about how the
          world is.  Positive statements are based upon science.
 
                          Example:  The unemployment rate in the U.S. is 6%.
 
   2).  normative statements are statements of opinion.  They are not based upon science or
          fact, but rather upon personal values. They reflect a judgment on how things “ought to  
          be or should be”.
 
                          Example: The unemployment rate in the U. S. should be 4%.
 
WIDELY ACCEPTED ECONOMIC GOALS            
 
The following goals involve normative economic statements and therefore involve value
judgments and economic policy decisions.
   1).  full employment of all workers who are willing and able to work.
   2).  price- level stability that minimizes inflation or deflation.
   3).  economic efficiency that results in maximum consumer satisfaction using available
         resources and technology.
   4).  economic growth
   5).  equitable distribution of income.
   6).  balance of international trade.
 
Attempts to achieve economic goals require economic policy action to change economic 
variables and outcomes.
 
MACROECONOMICS VS MICROECONOMICS
 
Both deal with analyzing economic behavior, but from a different viewpoint or perspective.
 
      I----------------------------------------------------------------------------------------------------------I
MACRO                                              (gray area)                                                    MICRO      
 
Macro:  Looks at the behavior of all (aggregate) consumers or producers in the economy.
 
   1).  major issues: output of all products, unemployment and inflation.
   2).  major tool: aggregate demand and supply analysis.
 
Micro:   Looks at behavior of the individual consumer or producer in the economy.
   1).  major issues: single consumer demand for a single product and single producer supply
          of a single product.
   2).  major tool:  market demand and supply analysis.
 
PITFALLS OF SOUND OR LOGICAL REASONING IN DETERMINING FACTS
 
The following list ways in which the facts and truth can be distorted.
 
   1).  biases involve the use of value judgments, loaded terminology involves inflammatory
         words, and definitions involve unique terminology to distort facts and truth.
   2).  fallacy of composition
           “What is true for the individual is true for the whole.”  This is a fallacy!
   3).  causation fallacies
           a).  post hoc or “after this because of this” fallacy.
                    -  because an event follows another event, does not mean the first event caused the
                      second event.
            b).  an event may be “correlated” to another event, but may not be the “cause” of the
                  event.