Instructor Lecture: Nature of Economics
Content Author: Dr. Basma Bekdache This week we begin our introduction to the exciting world of economics. By the end of this semester, you will be able to read the daily economic news and understand what it means, how it impacts you, and how to analyze it using the economic way of thinking. You may even be able to make a prediction using one or more of the economic models that you will learn in this course! The first thing we have to do before we study a new subject matter is to introduce its language so that we are all on the same page. The language of economics includes several terms that you may also encounter in other disciplines, and some that will be unique to economics. In this lecture, we will discuss and define a number of concepts, which will be used throughout the semester and that are central to the study of economics. First and foremost let's define what economics is all about.

What is Economics?
Economics can be defined as the study of how we allocate scarce (or limited) resources to satisfy unlimited wants. It is the study of how people make choices. Resources are things that we use to make goods and services that people want. Examples of resources are: Time Materials Labor hours Land Capital Oil Et c.

Why do people have to make choices? That's right, we have to make choices because resources are limited or scarce. Think of the resource time. What kind of choices do you have to make everyday to satisfy your wants given your limited time? In making choices people respond to incentives, which are the rewards we receive when we choose to engage in particular activities.

Macroeconomics and Microeconomics
We can think of economics as consisting of two major branches: Macroeconomics and Microeconomics. Macroeconomics (macro for short) is the study of the economy as a whole or economic aggregate. Can you think of examples of topics that fall under the subject of macroeconomics? Correct. The unemployment rate, inflation, interest rates, the government budget deficit or surplus, and GDP (Gross Domestic Product) are all examples of topics that we study in macroeconomics. Microeconomics (micro for short) is the study of specific markets, individuals, and firms in the economy. A few examples of microeconomic topics are:
y y y

What determines the demand and supply for cars or pizza? How does an individual decide how much time to spend working or taking vacation? How does a business decide how much to produce?

We will see later as the semester progresses that often times, we need to blend Micro and Macro analyses in order to answer some questions about the economy. For example, to understand what determines the amount of jobs available in the economy, or unemployment, we use a demand and supply model of the labor market along with an aggregate demand and aggregate supply model of the aggregate economy's level of production.

equations. a clock is a model of time. Notice that in some cases (e..g. This is because we use economic models and test them using the scientific method. and prose that describe relationships among economic variables. Basma Bekdache Economics is often described as an empirical science. However. economics cannot be analyzed as an exact science (such as physics or chemistry). therefore. not necessarily related to economics? I can think of these models: a map is a model of roads. What is a model? A model is a simplified representation of a reality. our models will take a variety of forms that don't resemble the reality. They can be graphs (see lecture on graphs). Can you think of examples of models that you encounter in your daily life. since people's behaviors determine outcomes in the economy. We will refer to many of the economic terms we use this semester as economic variables since their values may . map) the model does not resemble the reality.WEEK ONE Instructor Lecture: How Do We Study Economics? Content Author: Dr. We have already used the term economic model. A variable is something that can change over time. we tend to describe economics as a mix of science and art. In economics. etc. clock time. tables. and a small car prototype is a model of actual size car.

A rational economic forecast does not repeat the same forecasting errors. Bounded rationality is an alternative assumption that states that people are not fully. and understand relationships among variables. Finally. Economists often have theories about how economic variables are related. Models are also used to forecast or predict future values of economic variables.change from period to period. Rational economic agents use all available information to update their models before they make predictions. This is referred to as the ceteris parebus assumption. as these should be taken into account in updating the model. but nearly rational since it is impossible for people to examine every choice available and know all information applicable to models. We might say that when the price of pizza decreases. Each model is usually based on a set of assumptions. Empirical economics is the application of statistical methods to the testing of economic models. In other words. An example from micro is the relationship between the price of a good and the quantity demanded and supplied for that good. When we are using models for forecasting. This statement is based on the assumption that peoples' preference for pizza has not changed. For example. theories are not taken to be true unless the models are empirically tested and supported by real-life data. Why do we use models? Since the economy and its various sectors are complicated. we had to make the assumption that income and tastes were held constant. since economics is an empirical science. when we modeled the demand for pizza. An example of an economic model from macro is the relationship between household spending and income. income or the interest rate you pay on your credit card are all examples of variables. A positive statement is one that describes "what is" and is a pure . let's say we are trying to model the relationship between price and the quantity that people want to purchase of a good or service. However. For example prices. we often assume that economic agents are rational. Models are used to analyze past situations. Models and the corresponding theories are useful only to the extent that they are representative of actual data on economic variables. people will want to buy more pizzas. or "other things held constant". in talking about economics we distinguish between positive and normative statements. Assumptions are things that we take to be true for the purpose of the model we are building. we use models to organize thoughts and narrow problems down so they are manageable and easy to understand. and that their incomes are staying the same. Theories are statements or ideas about how things should be.

It is "what ought to be" rather than "what is. The PPC represents the resource allocation for all the combinations of outputs between two goods or services. We take a static look-meaning we are looking at an economy in "a specific moment in time"-a snapshot look. A normative statement is one that introduces individuals' opinions or judgments about the situation. . and the choices made in the production of goods and services.description of the events or situation that are being studied. economics as a science is consistent with using positive statements to explain and describe economic models. it is a graphical illustration of the trade-offs that occur. let's keep in mind a few basic assumptions. Please continue to the next section of the chapter by clicking on the next item in this week's packet. WEEK ONE Course Lecture 1-1: Production Possibilities Curve (Frontier) Lecture Content Author: Dr. A PPC helps us see what is being given up (opportunity costs) as the trade-off in the production between two different goods or services. As an essential understanding of this important theoretical concept is important. As the Production Possibilities Curve (PPC) suggests. David Dieterle "The World of Trade-offs" This section is very important to an understanding of how "trade-offs" in economics work in the real world. There are several assumptions that are crucial to the interpretation of A PPC. y y All resources are fully employed." As you may have guessed. o The quantities of inputs (factors of production) are fixed for that moment in time.

of the assumptions change. It is important to keep these assumptions front and center as we look at a PPC. full use of resources Point B: Inside the curve inefficient and incomplete use of resources Point C: Outside the curve impossible to achieve An economy fully utilizing all of its resources in an efficient An economy falling short of full utilization of the resources for To say an economy is at a point OUTSIDE the PPC (Point C) is bit . The figure below provides a good example of the locations of three points relative to a PPC. we need to take a look at how we can use the PPC to determine whether an economy is being efficient or inefficient with the allocation of its resources in the output determinations for two goods. In a moment we will see what happens when one. or several. What story does each one of those points tell us about the resource allocation of this two good economy? Well. But first. let's take a look---- Point A: On the curve full production. These assumptions provide the basis for the PPC current ("static") state.o Technology does not change.

therefore Point C is impossible. The figure below provides a good illustration of how a PPC can show the economic growth of an economy. As Miller states. (i. all of the resources available to the economy for the production of the two goods is being fully utilized. and less than fully employed resources including technology.e.. or additional inputs efficiently added and used in the production of the two goods. given current set of assumptions." PPC can also be used to exhibit the economic growth of an economy through the changing of the assumptions. This less than full utilization could be for several reasons associated with our assumptions: poor economy. technology changes. is it possible to ever attain Point C? And to that the answer is an emphatic YES. tricky. leads us to a natural extension question. costs associated with the fixed quantity of inputs." If you think about the term frontier. Here is where I like the term "frontier. frontier of space. While the market will determine the relative combination between the two goods. more resources employed." Economic Growth and PPC Finishing up with a description of a production point OUTSIDE the Curve (Point C). producing the two goods will be reflected at a point INSIDE the PPC (Point B). "Over time it is possible to have more of everything. it means the far reaches of ability. If Point C is impossible. an economy producing the two goods inside the curve has a significant problem with under utilized capacity of inputs. time becomes dynamic. Whatever the reason. .manner will be producing the two goods at a point ON the PPC (Point A). by producing on the curve. It is because an economy cannot function outside the PPC. historically our western frontiers) It gives us that vision of being on the edge of possibility economically being a "Production Possibilities Frontier. frontier of the ocean.

With comparative advantage the rubber meets the road. or produce the same outputs with fewer inputs. Economically speaking. let's explore for the moment at least their definitions. for example. comparatively) Comparative advantage focuses on the more efficient allocation of inputs relative to the opportunity costs associated with how others allocate comparable inputs. and how they relate to our current discussion of the PPC. it just means I can produce more outputs with the same inputs.period. "I can do something better than you" . In a common sense sort of way. and in what combinations will the inputs be used? Comparative and Absolute Advantage This leads us to the concepts of absolute and comparative advantage. "I can do something with fewer opportunity costs than others." (i. an economy becomes more efficient. That is why we will be returning to them when we discuss global trade and globalization.e. These concepts become especially applicable when discussing trade and the global economy.So how does an economy decide which goods or services it will produce. While we are going to hold off on a more elaborate discussion of these for later in the course. By focusing on our comparative advantages. absolute advantage plainly is. . With comparative advantage you might hear.. reducing our opportunity costs.

Division of Labor. the number of hours worked for production. also called Factors of Production are things that we use to produce goods and services that the society wants. and interdependence. We will also discuss the law of increasing cost. Finally. equipment to be used in production Human capital: The level of education and training of the labor input. Basma Bekdache In this lecture we revisit the concepts of scarcity and opportunity cost and learn how to compute opportunity cost in various scenarios. machines. that resources. Factors of production generally fall into one of the following categories (more on this subject in week 7): Labor: The human resource.Specialization. For an economy to implement division of labor principles. This specialization by each worker means we are now interdependent with the other workers to obtain all the goods and services we choose to possess or implement. Usually. which explains the shape of the Production Possibilities Curve (PPC). we will use the PPC to illustrate the choices a society makes today regarding its production of consumer and capital goods and discuss its implications on future economic growth. . the workers involved in the economy will specialize in the production of a specific good or service. Capital: The amount of physical capital-plants. These three concepts are very much related to each other. Technology: The society's level combined of knowledge. and Interdependence The final concepts I want to present in this chapter are: specialization. division of labor. WEEK ONE Instructor Lecture: More on Opportunity Cost Content Author: Dr. Recall from the previous lectures. Please watch the following 3 minute presentation.

You have a choice to pursue a college degree but classes are only offered during the day when you can be working.Since resources are scarce. The value of good Y that could have been produced is the opportunity cost of the choice we made to produce good X. but for now let's review the PPC. The fact that the PPC is downward sloping shows that there is a tradeoff or opportunity cost which occurs due to scarcity. Suppose it takes you one hour to cut your grass. the opportunity cost of cutting your grass is one meal and one load of laundry because that is what you give up if you decide to spend your time cutting grass. If we want to produce more pocket PC's (as in moving from combination B to C) we have to give up some production of digital cameras. next best available alternative that must be given up to obtain something or satisfy a want. . In general. everything else held constant? You got it. Since resources are scarce. Suppose that your hourly wage is $20/hour. from the decision of an individuals of how much to decision to consumer or save to a firm's decision of how much to spend on capital good s to be used for production. The opportunity cost of taking the class is $40. what is your the opportunity cost (per day) of making the choice to take the class. when we choose to use a resource to produce good X. Think about how your answer would change if you can take classes after work. Law of Increasing Opportunity Cost Let's return to the example of digital cameras and pocket PCs that you considered in the last lecture to illustrate the PPC. Let's consider a couple of examples. we are giving up the option to use the same resource for the production of another good Y. Do you recall what we mean by scarcity? Right. scarcity is the fact that resources are limited and are insufficient to produce everything to satisfy the unlimited wants of society. What would be the opportunity cost of taking the class then? The concept of opportunity cost is very important to economic analysis. We will discuss more applications later. If the class takes up two hours a day. What is the opportunity cost of cutting your grass? Correct. You will see as the semester progresses that it applies to almost everything we study. In the same hour you can cook one meal and do a load of laundry. there is an opportunity cost associated with using our resources. we can say that: Opportunity cost is the highest valued. In panel (a ) we can see the production possibilities that are plotted in panel (b).

the opportunity cost of that good generally increases. is increasing as we produce more and more PCs. 14th edition) Specifically. The law of increasing costs refers to the fact that the more we produce of a good. It is the reason why the PPC is bowed out (decreasing slope) as illustrated in the graph below. Economics Today.(Reprinted from Roger LeRoy Miller. and the next 10 etc? What is happening to the opportunity cost of producing pocket PCs as we produce more and more pocket PC's? The opportunity cost of the first 10 PC's is 2 digital cameras (50-48). what is the opportunity cost of producing the first 10 pocket PCs (going from 0 to 10)? What about the next 10 PCs (going from 10 to 20). . the next 10 is 5 digital cameras (45-40) etc. The opportunity cost of producing more and more PCs. as measured by how many digital cameras we have to give up producing. looking at the table or the graph. This is called the Law of increasing costs. the next 10 is 3 digital cameras (48-45).

then the PPC will be less bowed out. This raise the opportunity cost of producing PC's. The more specialized the resources. as we produce more and more PC's. If resources are easily adaptable to the production of any good. we have to use to resources that were specialized in producing digital cameras and adapt them to the production of PC's. Economics Today. 14th edition) Why does this happen? Using the goods in this example. the more bowed out the PPC (reflecting greater increase in opportunity costs). .(Reprinted from Roger Le Roy Miller.

WEEK ONE Instructor Lecture: More on Saving and Economic Growth Content Author: Dr. Basma Bekdache This section illustrates the role of saving in economic growth. Consider the PPC for an example where the society has to choose to produce from one of two categories of goods: consumer goods and capital goods. which implies it can produce more of everything in the future. it will have more capital available for production in the future. Consumer goods are goods produced for personal satisfaction while capital goods are goods that are used to produce other goods. . We called this economic growth and it is shown as a shift to the right in the PPC. If a society produces more capital goods today.

Let's see if we can apply this concept to decide how one should spend their resources. WEEK ONE Instructor Lecture: More on Comparative Advantage and Specialization Content Author: Dr. .We can see that if we choose to consume less today (or save) as in point C (and compared to points A or point B). Let's consider a simple example. Basma Bekdache Earlier in this week. we defined comparative advantage as being the ability to produce a good or a service at lower opportunity cost. allowing us to produce more in the future. the capital stock will increase. we can achieve greater economic growth since by choosing more capital goods today.

For Ted. Bob has to give up the production a quarter of a table. Who has the comparative advantage in the production of chairs? Correct. Who has the comparative advantage in the production of chairs? To answer this question.Suppose.. So why do we care about who has the comparative advantage? . which is what Ted can produce in 1 hour if he does not make the chair. Who has the comparative advantage in making chairs? Suppose that Bob can make either four chairs or one table in an hour and Ted can make either three chairs or two tables in an hour. we have to calculate and compare the opportunity cost of producing a chair for both Bob and Ted individually. he has the comparative advantage in making chairs.. To produce one chair. Since Bob has the lower opportunity cost (2/3 > 1/4). making one chair means giving up making two-thirds of a table. Using similar reasoning we can show that Ted has the comparative advantage in producing tables.

In the case of specialization: TOTAL PRODUCTION IS: 4 chairs.5 chairs. 2 tables.5 chairs and 1. Using the same example. TOTAL PRODUCTION IS: 3. The concept of comparative advantage is applicable to trade between nations. In one hour Bob produces 4 chairs and Ted produces 2 tables. if they do not specialize). economic output increases leading to a higher average standard of living. Bob can produce 2 chairs. WEEK ONE Course Lecture 1-2: Consumer Choice Content Author: Dr.5 tables. In the second half hour Ted can produce 1 table.We do because we can show that if someone (or nations) specialize in the production of the good in which they have a comparative advantage. total production will be greater which benefits everyone.e. David Dieterle . they produce only the good in which they have a comparative advantage) to the total production when Bob and Ted split their time between the production of chairs and tables (e. let's compare the total number of chairs and tables produced in one hour if Bob and Ted specialize (i. Bob can produce ½ table. Ted can produce 1.g. When nations specialize in their comparative advantage and trade with the rest of the world. In the case of no specialization: In a half hour. Let's assume they each spend a half hour on each good. In a half hour. This is less than the production that can be attained if they specialize which is 4 chair and 2 tables. In the second half hour.

4. Utility Marginal analysis Diminishing marginal utility The difference between total and marginal While "utility" is the term used in economics to define a consumer¶s satisfaction. they are most concerned with what happens to the utility. "marginal". or production (producer side which we will discuss later). Now. the taste not have the zip it did with the first two. Even if we go on and eat three more pieces.There are four critical concepts you will need to become familiar with for future discussions: 1. Therefore. When economists study human behavior. total utility is irrelevant in marginal analysis. It can be said the third piece was where we reached DMU. 2. the economists view of human action is to study the results of adding one more unit. The first piece of pizza goes down well. we eat it a little slower. when one more unit is consumed (or produced). marginal analysis. We will look at the relationship between marginal and average later on. WEEK ONE . Take your time with this concept. The key to understanding marginal analysis is that we are studying behavior or production changes with the addition of ONE ADDITIONAL UNIT. For most of us. a good example of this is eating pizza. DMU is the idea that as utility increases with the continued consumption of a good. the total climbs. and our satisfaction level is less. So we have another. a point will be reached when the utility of the additional unit will be less then the one before it. Contrary to "normal" thinking. So we have a third. 3. complete total satisfaction. Marginal utility can be calculated by dividing the change in total utility by the change in number of units consumed. but we have reached maximum satisfaction. and "marginal analysis". suddenly. and satisfies completely. The last major concept of this chapter is diminishing marginal utility (DMU). Economists are always interested in what happens "at the margin" (adding one more unit). for a total of six! Conclude your initial introduction to marginal analysis and DMU with a review of DMU and the diamond-water paradox of Adam Smith. to measure this utility it is important to understand the difference between what economist¶s mean by the term. Again. tastes great.

how to calculate the slope of a line. You will learn how to plot points on a graph. click Here. Both of the examples show you step-by-step how to solve for the equation of a line. . Linda Wiechowski Please watch and listen to the following 7 minute VoiceOver PowerPoint for a discussion of graphs. For a printable version of this powerpoint. as well as create a formula for the line. You have two examples that you can work through.Course Lecture 1-3: Interpreting Graphs Content Author: Dr.


Four more practice problems are shown that you can try. Only the answer is given for these problems. You will need to work through the problems using the same steps as the previous sample problems. .

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