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Applied Economics Lecture 1

Economic Activity

Satisfy human wants/needs with goods and services

1. Human needs and wants = unlimited  Basic needs vs higher needs
What are these things?  What do you value the most today?

2. the use of resources


Basic economic resource = Land, labor, Capital (K) and Entrepreneurs We need to allocate them properly because they are limited But are all resources limited What resources have no limit If resources are irreplaceable KNOWLEDGE and TECHNOLOGY

3. technique of production

How resources are used and combined Before we talk of capital-intensive vs labor intensive Today, what?

Basic Ideas


Budget maximization maximize satisfaction through proper allocation or mix of expenditures within the budget Opportunity Cost value of a foregone alternative

Alternative Economics is

peoples incentives and choices and what happens to coordinate their decisions and activities Organization and information are crucial aspects Economic failures are mostly failures of coordination Social Institutions are involved

c. Incentive Structure people are assumed to be rational and will respond d. Income = rent, wages, interests, profits

Goals of Economic Activity

A channel to improve the peoples standards of living within the limit of available resources Solve the problems of society
1. 2. 3.

Unemployment Inflation Inequitable income distribution

Economic Analysis and Policy

Draw conclusions from particular to general (Case and anecdotal evidences) Deductive general to particular (usual) Tool is logic and mathematics

Basic Economic Problem


What to produce? Dictated by advertisement? How much to produce? How to produce? technology For whom to produce? who will buy? When to produce? fast food delivery

Types of Economic System


Traditional non-innovative Command Govt answers the basic economic problem Market consumer is king, price mechanism is respected, selfinterest as motivating factor Mixed

Basic Circular Flow

Resources Goods and services Business Firms


Consumption Expenditures Wages, Interest, rent

Rational Behavior


People do the best that they can based on the best information available and the values they believe in, under the circumstances they face SELF INTEREST CONSISTENCY


Most economic decisions are affected by human emotions, e.g. splurging when broken-hearted But, economics is not a straight jacket, rationality is not all about the profit motive Rationality is about self-interest, but it is not about selfishness


Finding fulfillment and satisfaction

E.g. helping the poor is pursuing selfinterest

Consistency means preferences are ordered

If you like banana over mango, and mango over pineapple, you should prefer banana over pineapple

Money Illusions

What is your preference?

1) A rise in money wage and an even higher increase in money expense  Vs 2) No rise in money wage and a small increase in money expense  Vs 3) Lower money wage and no change in money expense



Which is a better deal? Selling a house with a 23% money profit and 2% real loss Vs 23% money loss and 2% real profit CONCLUSION: People often think in nominal terms

This is why a good policy on controlling inflation is important Low inflation makes money illusion less costly in terms of misallocated resources nominal and real values are almost the same

Information Problems

People making decisions in uncertain conditions weigh prospective losses twice as heavily as putative gains People pay too much attention on recent data rather than long term trends They make people crowd together and follow trends

Financial and asset markets can then be dominated by prevailing moods forming bubbles! WHY? Because information is expensive The same is true with savings we are easily tempted to use what we save for today

Rational Addicts?

Assumption is that addictive goods is insensitive to price Once a person is hooked, he will keep on consuming regardless of the price. However, Gary Becker found that by studying the response of consumers to pre-announced increase in taxes on cigarettes caused demand to fall

Therefore, while demand for addictive good is insensitive to current prices, it will be sensitive to future ones

The future

The greater somebodys future wellbeing, the more he will invest in thinking about the future hence, rich people think more about the future than the poor If you expect to go to heaven, your well-being is infinite so you care equally about your present and your futureotherwiseyou live for today!

Use and Abuse of Economics


Superpower of the social sciences? Exercising powerful influence on the lives of ordinary people But while economists exaggerate their differences, it is people who use and abuse economics It is hard, because sometimes its counter-intuitive


One sided coin Economics established that there are always two sides to a coin, but politicians only look to one E.g. a rise in interest rates

Bad news for borrowers Good news for savers and lenders

Falling land prices


Bad news to current owners Good news to first time buyers Protects affected industries Harms other consumers and industries

Import tariffs

Politicians always play the game to appease the powerful (usually the producer)

Shoot the messenger

Confuses consequences and cause

Blaming Thailand as the cause of the Asian Financial Crisis When the problem is partly the flawed internal policies of all affected countries Claim that some basic rule of economics no longer applies when making policies

Allergy to Change