ECON 1202 1st Edition Lecture 3Outline of Lecture 2 (Principles of Macroeconomics)I. Why do we study macroeconomics?II. What do we study in macroeconomics?III. Why are some nations wealthy and others not?IV. What is scarcity?a. Implications of scarcityV. What do we mean by costs in economics?a. Define opportunity costOutline of Lecture 2 (Principles of Macroeconomics (continued))I. Adam SmithII. 3 Fundamental Questions every society facesa. It is important how we answer these questionsIII. Rules of the gameIV. Incentivesa. Define competition V. Markets VI. We are tradingVII. Economics and the study of human choicePrinciples of Macroeconomics (continued)I. Adam Smitha. An Inquiry into the Nature and Causes of the Wealth of Nations (1776)b. No Hamlet without the Prince=No economics without understanding peoplei. We must understand people in order to understand economicsc. Human Nature is the basic desire to better themselvesII. 3 Fundamental Questions that every society facesa. What goods and services are produces?b. Who will receive the goods and services produced?c. How will the goods and services be produced?i. It is important who we answer these questions1. The problems are usually the same, but the solutions are often different because societies have adopted their own “rules” to answer these questions2. The solutions are reflected in a society’s institutional framework (laws, policies, regulations, rules)III. Rules of the Game a. Because these rules determine who gets what, they are sometimes referred to as “rationing devices” or “Rules of the Game”b. The Rules of the Game reflect and incorporate a society’s production decisions when it comes to what gets produced, who decides what gets produced, and who gets whatever is producedc. Critically important because they put in place governing incentive structuresd. Rules of the Game for the what, how, and for whom of a society:i. Marketsii. Non-markets/GovernmentIV. Incentivesa. Incentives are the rewards and penalties that motivate human behavior b. They influence human conduct in predictable ways i. Relates back to Adam Smiths “no economics without the understanding of people”ii. When a payoff increases or opportunity cost falls, we are more likely to choose that activity 1. Example: You are more likely to pick up a quarter rather than a pennyc. They also channel the competitive behavior which arises from scarcityi. Competition means that when we alter the Rules of the Game, it doesn’t alter the fact that we compete for scare resources, however, it does alter how we compete for those resources1. Self-interested, competitive behavior leads to socially productive outcomes which is important to a nation’s overall economic performanceV. Marketsa. Markets are the individual decisions of buyers and sellers that determine the what, how, and for whom i. This means they are publicb. Markets generate pricesi. Prices ration or discriminate based on ability and willingness to payii. Prices are signals that create incentives1. They signal relative costs and valuesa. Prices tell us something very important about the value we place on a good or service (demand) and/or the costs to produce that good or service (supply)2. They also create incentives for individuals/ companies to engage in activities/investments to generate income VI. We are tradinga. We innovate and create new products that are more valuable to others, and trade those goods at prices high reflecting the higher valuei. We are making ourselves or our goods more valuable to others so that we can trade for things that we valueii. Self-interested conduct can lead to socially productive outcomes (as if by an invisible hand)iii. PricesSignalsIncentives1. When price is suppressed, the incentives and information that prices create and provide is likewise suppressed, yet the goods are still scarce and people are still competing forthem just on a different criteriaVII. Economics and the Study of Human Choicea. Methodology of choice and incentivesi. People are rational1. We act purposefully, seeking the best or most feasible option or choice, given the information and opportunities that we have a. Cost-Benefit Analysisi. Decisions are made at the margin when comparing benefits and costsii. People respond to economic incentives in predictable ways1. When the payoff decreases or opportunity cost increases, we are less likely to choose the activity iii. Optimal decisions are made at the margin when:1. If the marginal benefit (MB) exceeds marginal cost (MC), we do more of it 2. If MC exceeds MB, we do less of it3. If MB=MC, we can’t do anything more or