29/10/2022

1
Introduction to Economics and the
Economy

©McGraw-Hill/Irwin

Playlist (1/2)

• Economics and the Economic

Perspective
• Economic Methodology and Pitfalls to
Sound Economic Reasoning
• Microeconomics and Macroeconomics
• 2 Economising Problems

Playlist (2/2)

• Five Fundamental Questions

• Economic Systems
• The Circular Flow Model

1
 29/10/2022

Economics

• Definition of Economics
oEconomic wants exceed productive
capacity
oThe economising problem
oSocial science concerned with
making optimal choices under
conditions of scarcity

The Economic Perspective

Scarcity and Purposeful Marginal
Choice Behavior Analysis

• Resources • Rational self- • Marginal

are scarce interest benefit

• Choices must be • Individuals • Marginal cost

made and utility
• Opportunity cost • Firms and • Marginal
profit means extra
• There’s no • Desired • MB and MC
free lunch! outcomes
5

Theories, Principles, and Models

• The scientific method
Observe Formulate a hypothesis Test the hypothesis

Accept, reject, or modify the hypothesis

Continue testing, if necessary Theories, principles, models

• Features
oGeneralizations
oThe ceteris paribus assumption
oGraphical expression

2
 29/10/2022

Pitfalls to Sound Economic Reasoning

• Biases and preconceptions

• Loaded terminology
• Fallacy of composition
• Post hoc fallacy (post hoc ergo
propter hoc)
• Correlation vs. causation

Microeconomics and Macroeconomics

• Microeconomics
oDecision making by individual units
• Macroeconomics
oExamines either the economy as a
whole or its basic subdivisions
(aggregates)

Positive and Normative Economics

• Positive economics
oDeals with economic facts
• Normative economics
oA subjective perspective of the
economy

3
 29/10/2022

Individual’s Economising Problem (1/2)

• Unlimited wants
• Limited income
• Budget line
oAttainable and unattainable options
oTrade-offs and opportunity costs
• Make the best choice possible
• Change in income  new budget line

10

Individual’s Economising Problem (2/2)

Income of 120 leks 12
DVDs Books
20 leks 10 leks 10
6 0
Quantity of DVDs

8
5 2
Unattainable
4 4 6
3 6
4
2 8
1 10 2 Attainable

0 12
0
2       4       6 8 10     12     14
Quantity of Books

11

Society’s Economizing Problem

• Scarce resources
oLand (natural resources)
oLabour
oCapital (capital goods)
oEntrepreneurial Ability (takes
initiatives, makes decisions,
innovates, and takes risks)

12

4
 29/10/2022

Production Possibilities Model (1/3)

• Illustrates production possibilities

• Assumptions
oFull utilization (employment) of
resources
oFixed resources
oFixed technology
oTwo goods

13

Production Possibilities Model (2/3)

Production Alternatives
Type of Product A B C D E

Pizzas 0 1 2 3 4
(in hundred thousands)

Industrial Robots 10 9 7 4 0
(in thousands)

Plot the Points to Create the Graph…

14

Production Possibilities Model (3/3)

• Specialisati
14
13
12
11
on of
resources
A
10
B
Industrial robots

9
8
C Unattainable • Law of
7
6 increasing
5
4 U
D opportunity
3
2
costs
1 Attainable
E • Concave
0    1   2 3  4 5  6  7  8  9
Pizzas
10 11  12
PPC

15

5
 29/10/2022

A Growing Economy

14 A’
13 • Increase in
12
11
B’
Unattainable resource
10
A
B C’
supply
Industrial Robots

9
8
• Improveme
C
7
6
nt in
5
D
D’
resource
4
3 Now attainable
quality
2
1
Attainable • Technologic
al advance
E E’
0     1     2     3     4     5     6     7     8     9 
Pizzas

16

Present Choices, Future Possibilities

Compare Two Hypothetical Economies

Goods for the Future

Future Future
Goods for the Future

curve curve
A

Current T Current
curve curve

Goods for the Present Goods for the Present

Presentville Futureville

17

The Five Fundamental Questions (1/2)

• What goods and services will be

produced? (Allocation of resources)
• How will the goods and services be
produced? (Production of output)
• Who will get the goods and services?
For whom will those be produced?
(Distribution of products)

18

6
 29/10/2022

The Five Fundamental Questions (2/2)

• How will the system accommodate

change?
• How will the system promote
progress?

19

The Market System (1/2)

• Known as (pure) capitalism

• Private property
• Freedom of enterprise and choice
• Self-interest
• Competition
• Markets and prices

20

The Market System (2/2)

• Advanced technology and capital goods

are encouraged
• Specialisation
oDivision of labor
oGeographic specialisation
• Use of money
• Very limited government (laissez-faire)

21

7
 29/10/2022

What Will Be Produced?

• Goods and services that create a profit

• “Money-Votes”
oMethod for consumers to determine
which products will be produced
oDetermines which products and
industries survive or fail

22

How Will the Output Be Produced?

• Minimize the cost per unit by using the

most efficient techniques
oTechnology
oPrices of the necessary resources

23

Who Will Get the Products?

• Consumers with the ability and

willingness to pay
• Ability to pay depends on income

24

8
 29/10/2022

How Will the System Adjust to

Change?
• Economic agents change their
behaviour
oChanges in consumer tastes
oChanges in technology
oChanges in resource prices

25

How Will the System Promote

Progress?
• Technological advance
oNew methods and new products
oCreative destruction
• Capital accumulation

26

The “Invisible Hand”

• Adam Smith (1776): Wealth of Nations

• Unity of private and social interest
• Virtues of the market system
oEfficiency
oIncentives
oFreedom

27

9
 29/10/2022

Economic Freedom ̶ Global Panorama

Index of Economic Freedom 2022

• Singapore (1)
Free
• Switzerland (2)

• Albania (50)
Moderate • Kosova (86)

• Venezuela (176)
Repressed
• North Korea (177)

Source: The Heritage Foundation, 2022

28

Other Economic Systems

• Traditional systems
• Command systems
• Mixed systems

29

Demise of Command Systems (1/2)

• Soviet Union, Eastern Europe, and

China (prior to reforms)
• Failed system
• The coordination problem
oSetting output targets for all products
oQuantity as a success indicator

30

10
 29/10/2022

Demise of Command Systems (2/2)

• The incentive problem

oNo adjustments for surplus or shortage
oPolitical ability vs. Entrepreneurial
ability

31

Mixed Economy
• Active, but limited, government
• Government may be needed to alleviate
market failures
• Government can increase effectiveness
of a market system
• Beware of government failures!

32

The Circular Flow Model

RESOURCE
MARKETS
•Households sell
•Firms buy

FIRMS HOUSEHOLDS
• buy resources • sell resources
• sell products • buy products

PRODUCT
MARKETS
•Firms sell
•Households buy

33

11