PRINCIPLES OF ECONOMY

UNIT 1: INTRODUCTION, CONCEPTS AND MODELS OF TRADE

Definition of economics:
Economics studies the administration of resources

Why is this problem challenging?

Because resources are scarce
Economics studies how societies administer scarce resources
*scarce = escaso
So we have to choose and choosing means scarifying and that is the
OPPORTUNITY COST

THE OPPORTUNITY COST

Usually several alternatives, the opportunity cost is the best available
alternative, decisions are complex.

EFFICIENCY AND EQUITY

Societies have to choose: what? How? For whom?
EFFICIENCY (in production)
-A reallocation of resources increases efficiency when the production of, at
least, one good increases without decreasing the others.

EFFICIENCY (in consumption)

-A reallocation of resources increases efficiency (in consumption) when the
welfare of, at least, one individual increases without decreasing the others.

PARETO EFFICIENCY:
We sometimes refer to Pareto efficiency to emphasize the welfare criterion.
In economics, the main concern is how to achieve efficient allocations.

EQUITY
Efficiency differs from equity.
The size of the pie versus how it is distributed. Fairness, equality, justice

HOW ARE RESOURCES ALLOCATED IN REALITY?

In modern societies most resources are allocated by free trade in the MARKET

THE METHODOLOGY IN ECONOMICS

Economics is a social science that studies systematically how scarce
resources are allocated in a society.
-Systematic approach (the scientific method)
*Observe reality
*Formulate theories to explain reality
*Test the theories empirically

The set of assumptions that constitutes a theory is formulated through a

MODEL.
A model is a simplification of reality through assumptions to make it more
understandable.
 MODEL 1: THE MODEL OF PURE EXCHANGE

HOW COUNTRIES TRADE WHAT THEY HAVE?

Assumptions of the model
Two persons: Fiona and Charles
Two goods: Fishes and coconuts
Initial Distribution: Fiona has Fishes and Charles has coconuts
Preferences:
Fiona is willing to give up to 5 fishes for each coconut
Charles is willing to give up to 4 coconuts for each fish
d
Will Fiona and Charles trade?
Are they better off? Does efficiency increase?

MODEL 2: THE MODEL OF COMPARATIVE ADVANTAGE

Countries trade goods that can be produced everywhere, this model shows that
countries tend to specialize in the production and export of those goods that
they manufacture at a relatively lower cost than the rest of the world. those that
are comparatively more efficient than others.

USEFUL CONCEPTS
Micro and Macroeconomics

MICROECONOMICS studies the behaviour of the individual units in each

economy and how they interact in individual markets.
-How consumers choose their consumption, work...
-How firms chose production
-How they interact and trade

MACROECONOMICS studies
-Interactions between markets in an overall economy
-The processes that affect the economy as a whole
Examples of macroeconomic analysis:
.The effect of government spending
.The evolution of unemployment
.The causes of inflation

POSITIVE AND NORMATIVE ECONOMICS

-There are two kinds of analysis in economics
POSITIVE ANALYSIS tries to understand the world as it is. It is also called
descriptive analysis
Example: ‘The comparative advantage of the United Kingdom in banking
explains the decline of its industrial exports’

NORMATIVE ANALYSIS makes a claim about how the world ought to be. It is
also called prescriptive analysis
Example: ‘The government should regulate the banking industry to avoid
excessive risk taking’