8/30/12What is Economics?Economics is the study of the choices that people, businesses, governments, and entire societies make as they cope with scarcity and the incentives that influence and reconcile these choicesHow people decide what to buy, how much to work, save, and spendHow firms decide how much to produce, how many workers to hireHow governments and society more generally decide how to divide resources between consumer goods, protecting the environment, national defense, and other needsEconomists turn anything into a question of economicsEx. Super Bowl salaries: people respond to incentivesIncentives can create unintended consequencesMankiw’s 10 Principles of Economics1. People face trade-offsTrade-off: Giving up something we like to get something we like.Why are trade-offs an inevitable feature of decision-making? Trade offs result from scarcity.Efficiency v. EqualityEfficiency: when society gets the most from its scarce resourcesEquality: when prosperity is distributed uniformly among society’s membersTradeoff: to achieve greater equality, could redistribute income from wealthy to poor. But this reduces incentive to work and produce, shrinks the size of the economic “pie.”2. The costs of something is what you give up to get it.Making decisions requires comparing the costs and benefits of alternative choices.What is the relevant cost?The opportunity cost of any item is whatever must be given up to obtain it3. Rational people think at the margin.“Rational” – systematically taking the best possible course of action to achieve objectives“Marginal Change” – small and incremental adjustment to a plan or course of actionWhy does thinking at the margin help people identify the best possible course of action?Setting a derivative equal to zero to maximize a functionMarginal change vs. marginal cost. Does marginal change create enough new revenue to offset marginal cost? OPTIMIZE4. People respond to incentives5. Trade can make everyone better off.6. Markets are usually a good way to organize economic activity.7. Governments can sometimes improve market outcomes.8. A country’s standard of living depends on its ability to produce goods and services.Macro9. Prices rise when the government prints too much money.Macro10. Society faces a short run trade off between influences and unemployment.MacroPositive vs. Normative EconomicsAs scientists, economists make positive statements, which attempt to describe the world as it isAs policy advisors, economists make normative statements, which attempt to prescribe how the world should bePositive statements can be confirmed or refuted. Science.Normative statements cant be confirmed or refuted because they are based on peoples views or beliefeGovernment employs many economists to provide both positive (scientific) analysis and normative (policy) advice.Why Economists DisagreeEconomists often give conflicting policy adviceThey sometimes disagree about validity of alternative positive theories about the worldThey may have different values and therefore, different normative views about what policy should try to accomplishYet there are many policies about which most economists agree9/4/12The Market Forces of Supply and DemandThree Basic QuestionsWhat should we produce?How should we produce it?Who should consume what we produce?We rely on markets to figure this outMarkets have two sets of actors:Buyers – call this the demand side of the marketSellers – call this the supply side of the marketMarkets and CompetitionMarket – group of buyers and sellers of a particular productCompetitive Market – one with many buyers and sellers, each has a negligible effect on price. Each buyer and seller is so small that their decisions don’t matter to anyone elsePerfectly Competitive Market – all goods are exactly the same. Buyers and sellers are so numerous that no one can affect market price—each is a “price taker” Buyers and sellers are told what price the market is going to sell the product at, and what all buyers need to buy the product atWe assume markets are perfectly competitiveDeterminants of DemandPrice of gasPrices of other goods (strongly related goods, ex. Metro price v. gas price)Two goods are substitutes if an increase in the price of one causes an increase in demand for the otherChanges an entire demand curve, shifts it completely to the right & outEx. Pizza and hamburgers. An increase in the price of pizza increases demand for hamburgers, shifting hamburger demand curve to the rightOther examples: Coke & Pepsi; Car & MetroTwo goods are complements if an increase in the price of one causes a fall in demand for the otherEx. Computers and software. If price of computers rises, people buy fewer computers, and therefore less software. Software demand curve shifts less.Other examples: college tuition and textbooks, bagels and cream cheese, peanut butter and jellyIncomeA normal good is a good for which, other things being equal, an increase in income leads to an increase in demand (Angus Beef)If income increases, demand curve shifts to the rightAn inferior good is a good for which, other thing being equal, an increase in income leads to a decrease in demand (SPAM)If income increases, demand curve shifts to the leftTastes (preferences)Anything that causes a shift in tastes toward a good will increase demand for that good and shift its demand curve to the rightEx. Fashion is subject to demand shifts. Huge increase in demand for knock-off rings that looked like Kate Middleton’s sapphire engagement ring after Prince William proposed to her with itDemographic factorsEx. Aging of the population, growing Hispanic population…each affect demand for certain sets of goodsExpectationsExpectations affect consumers’ buying decisionsExamplesIf people expect their incomes to rise, their demand for meals at expensive restaurants may increase nowIf people think home prices will fall in the future, demand for homes now will fallIf people think gas prices will go up next week, they will increase their purchases of gas this weekWhen these things aren’t held constant, they become demand shiftersDemand Curve Nonsense (NEGATIVE CURVE)Demand Schedule – table that shows the relationship between the price of a good and the quantity demandedWriting down what is implicit in someone’s head about how much gas they will consume at different prices“At each price” = this person is a price taker. They have no control over the price of
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