Chapter 1: The Economic ApproachECO2033 What is Economics About?Economics is about scarcity and the choices we have to make because our desire for goods and services is far greater than their availability from nature. Economics tries to explain and predict the behavior of consumers, firms, and government. Scarcity- indicates that there is less of a good freely available from nature than people would like. *Scarcity prevents us from being able to completely fulfill our desires.Scarcity leads to tradeoffs which results in making chocies. “Tradeoffs are inescapable” Scarcity requires that some wants remain unfulfilledEmbedded with scarcity: equity, justice, fairness. Choice- the act of selecting among alternatives. *It is the consequence of scarcity. Resource- ingredients, or inputs, used to produce economic goods. EX: land, labor, skills, natural resources, and human made tools. 3 Categories of Resources:1. Human Resources: productive knowledge, skill, and strength of human beings. 2. Physical Resources: tools, machines, and buildings that enhance our ability to produce goods. 3. Natural Resources: land, mineral deposits, oceans and rivers. Capital- human-made resources (such as tools, equipment, and structures) used to produce other goods and services. They enhance our ability to produce the future. *Human made resources Scarcity and poverty are not the same thing. Scarcity is an objective concept (based on a factual situation on observable phenomena) -> influenced by differences in personal opinionPoverty is a subjective concept (based on opinions and personal preferences and value judgments) Only goods that are scarce require rationing.Rationing- allocating a limited supply of a good or resource among people who would like to have more of it. When price performs the rationing function, the good or resource is allocated to those willing to give up the most “other things” in order to get it. When criterion is first-come, first-served, goods are allocated to those who are fastest at getting in line or willing to spend the longest time waiting in line. Economic Theory- a set of definitions, postulates, and principles assembled in a manner that makes clear the “cause and effect” relationships. *Some economic theories are simply common sense!Eight Guidelines of Economic Thinking: 1. There are ALWAYS tradeoffsExample: A parcel of land can be used to make a hospital; parking lot or it could be left undeveloped. No option is free of cost-there is always a trade off.Opportunity Cost- what you give up. Value of the next best alternative. Highest valued option given up when a choice is made. *** not the sum of alternatives, the NEXT BEST alternative. 2. Individuals choose purposely. Economizing Behavior- choosing an option that offers the greatest benefits at the least possible cost. Example: If pizza, a lobster dinner, and a steak all cost the same the person will choose what they like the best. If they did not all cost the same the person would choose the cheapest option. Utility- the subjective benefit or satisfaction a person expects from a choice or course of action. *** differs from person to person. When people weigh the benefits they receive from an activity against its costs, they are making a rational choice.3. Incentives MatterAs the incentive goes up you will be more likely to do something (or try to) and vice versa. Incentive doesn’t have to be money…it can be grades, food, etc .Example: Because consumers respond to incentives, store owners know they can sell off excess inventory by reducing prices. 4. Individuals make decisions at the marginWhen making a choice between two alternatives, individuals generally focus on the difference in the costs and benefits between alternatives.Marginal- the effects of a change in the current situation. - Margins means additional or incremental- Marginal benefits is additional benefits- Marginal costs is additional cost. Example: Diamond/Water ParadoxRULE:: Continue to engage in an activity as long as the expected marginal benefits are greater than the expected marginal cost. 5. More information leads to better decision-making, but more information is costly. - Information that helps us make better choices is valuable - Time used to gather the information is scarce. - Refer back to steps 1-4. 6. Many choices create secondary effects- Direct effects are often immediate and visible- “secondary effects” are visible with time. - The secondary effect usually comes later (sometimes years later) and it is not as visible (you have to look harder).One of the most common economic error is failure to consider economic secondary effects. Example: The immediate (direct) effect of aspirin is the bitter taste…The secondary (indirect) effect, which is not immediately visible, is relief from a headache. 7. The value of a good or service is subjective. - “beauty is in the eyes of the beholder”- preferences differ between individuals - value is determined by the purchaser. - Price doesn’t always match the value8. Economic thinking is scientific thinkingScientific thinking – developing a theory from basic principles and testing it against events in the real world. Good theories are consistent with and help explain real world problems. Theories that are inconsistent with the real world are invalid and must be rejected. - How useful the economic theory depends on how well it predicts the future consequences of economic action.- I the events in the real world are consistent with a theory, we say that the theory has predictive value and therefor it is valid. - It is impossible to test the theoretical relationships of discipline; the discipline does not qualify as a science. - Economists use data and information generated by people to explain and predict actions. - Lab experiments cannot duplicate ALL real economic interactionsPositive and Normative Economics:Positive Economics – the scientific study of “what is” among economic relationships. - A positive economic statement doesn’t have to be correct, it just has to be testable. Normative Economics – are judgments about “what ought to be” in economic matters. - Can neither be confirmed nor proven false by scientific testing. - Based on value judgments Pitfalls to Avoid in Economic Thinking: 1. Violation of the ceteris paribus - Ceteris paribus- Latin for “other things constant”- We typically want to isolate variables to allow only one change at a time – the others
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