Macroeconomics Principles Applications 09 11 2011 Definition Economics is the study of choice under conditions of scarcity Scarcity and Individual Choice We all face the problem of scarcity Definition scarcity a situation in which the amount of something available is insufficient to satisfy the desire for it As individuals we face a scarcity of time and spending power Given more of either we could each have more of the goods and services that we desire Limited hours less time to satisfy desires Limited spending power less satisfaction of desires Scarcity causes choices which cause preferred allocation of time The Concept of Opportunity Cost Definition opportunity cost of any choice is what we must give up when we make that choice most accurate and complete concept of cost when the alternatives to a choice are mutually exclusive only the next best choice the one that would actually be chosen is used to determine the opportunity cost of the choice EXAMPLE opportunity cost of college Definition explicit cost the paid out for a choice o Cost of college tuition fees books 26 197 Definition implicit cost the value of something sacrificed when no direct payment is made foregone income o Full time job Sept June 20 000 Opportunity cost is the sum of implicit and explicit costs o OP of 1 year of college 40 197 TIME IS MONEY the explicit direct money cost of a choice may only be a part and sometimes a small part of the opportunity cost of a choice Scarcity and Social Choice Society s problem is the scarcity of resources Definition resources the labor capital land including natural resources and entrepreneurship that are used to produce goods and services The Four Resources 1 Labor the time human beings spend producing goods and services 2 Capital any long lasting tool that is itself produced and helps us make other goods and services lasting at least a year physical capital the part of the capital stock consisting of physical goods such as machinery equipment and factories human capital the skills and training of the labor force capital stock the total amount of capital in a nation that is productively useful at a particular point in time both human and physical 3 Land the physical space on which production takes place as well as the natural resources that come with it 4 Entrepreneurship the ability and willingness to combine the other resources into a productive enterprise resources vs inputs inputs include resources and other things made from them a good or service Definition input anything including resources used to produce Opportunity Cost and Society s Tradeoffs for society as a whole opportunity cost arises from the scarcity of resources virtually all production carries an opportunity cost To produce more of one thing society must shift resources away from producing something else The World of Economics Definition microeconomics the study of the behavior of individual households firms and governments the choices they make and their interaction in specific markets Definition macroeconomics the study of the behavior of the overall economy positive Positive Normative Economics deals with the purpose of analysis Definition positive economics explains HOW the economy works the statement does not need to be accurate or sensible to be classified as Definition normative economics the practice of recommending policies to solve economic problems branch of philosophy goes beyond just the facts and tells us what we should do requires us to make judgments about different outcomes and therefore depends on our values positive and normative rely on each other WHY ECONOMISTS DISAGREE ABOUT POLICY 1 positive disagreements about what the outcome of different policies will be 2 differences in values how those outcomes are evaluated Why Study Economics to understand the world better understand wars famines epidemics and depressions global issues to achieve social change work to improve unemployment hunger poverty disease child abuse drug addiction violent crime to help prepare for other careers most career paths confront economic issues to become an economist advise companies government international organizations media etc The Methods of Economics features of the real world Definition model an abstract representation of reality leaves out The Art of Building Economic Models A model should be as simple as possible to accomplish its purpose the model should only contain necessary details EXAMPLE maps do not contain height values Assumptions and Conclusions Every economic model makes two types of assumptions simplifying assumptions and critical assumptions Definition simplifying assumption any assumption that makes a model simpler without affecting any of its important conclusions o We make assumptions not because we think they are true but because they make a model easier to follow and do not change any of the important insights we can get from it o EX we might assume that there are only two goods that a household can choose from or that there are two nations in Definition critical assumption any assumption that affects the conclusions of a model in an important way o If this assumption is wrong then you conclusion might be o EX when we study the behavior of business firms our model will assume that firms try to earn the highest possible profit the world wrong as well for their owners