OSU ECON 2002.01 - Chapter 1: The Nature of Economics

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Macroeconomics Notes 1Chapter 1: The Nature of Economics The Power of Economics Analysis Incentives: rewards for engaging in a particular activity The starting point for economic analysis Economic Way of Thinking: framework to analyze solutions to economic problems Gives you the power to reach informed conclusions about what is happening in the world Make better decisions Increases your understanding when reading news or on the internet Defining Economics Economics: study of how people allocate their limited resources to satisfy their unlimited wants Study of how people make their choices Resources: Things used to produce other things to satisfy people’s wants Wants: What people would buy if their incomes were unlimited With limited income (resources), people must make choices to satisfy their wants We never have enough of everything, including time, to satisfy our every desire Individuals, businesses, and nations face alternatives, and choices must be made  Economics studies how these choices are made Microeconomics: The study of decision making undertaken by individuals (or households) and by firms Like looking though a microscope to focus on the smaller parts of the economy- The effects of changes in gasoline prices- A family’s choice of having a baby- An individual firm’s decision to advertise Macroeconomics: The study of the behavior of the economy as a whole Deals with economy-wide phenomena- The national unemployment rate- The rate of inflation- The yearly output of goods and services in a nation Macroeconomics deals with aggregates, or totals—such as total output in an economy Modern economic theory blends micro and macro concepts The 3 Basic Economic Questions and 2 Opposing Answers Economic System The institutional mechanism through which resources are utilized to satisfy human wants Three Economic Questions 1. What and how much will be produced? 2. How will items be produced? 3. For whom will items be produced? Two opposing answers in the form of economic systems: Centralized command and control (central planning): Authority that makes all economic decisions Price system (market system): Decentralized decision making process in which prices are terms (signals) under which people agree to make exchanges The Economic Approach: Systematic Decisions Economists assume that individuals act as if motivated by self-interest and respond predictably to opportunities for gain Rationality Assumption: The assumption that people do not intentionally make decisions that would leave themselves worse off Responding to incentives Rationality and the use of incentives- Positive incentives (gold stars)- Negative incentives (punishments) Making choices Balancing cost and benefits Defining self-interest The pursuit of one’s goals, does not always mean increasing one’s wealth- Prestige- Friendship- Love Economics as a Science Economics is a social science that employs the same kinds of methods used in other sciences, such as biology Economics uses models to explain economic phenomena in the real world Models or Theories Simplified representations of the real world used as the basis for predictions or explanations Should capture only the essential relationships that are sufficient to analyze a problem Cannot be faulted as unrealistic simply because they do not capture all details of the real world- A map is the quintessential model Assumptions: The set of circumstances in which a model is applicable Every model, or theory, must be based on a set of assumptions Ceteris Paribus Assumption [KAY-ter-us PEAR-uh-bus] Nothing changes except the factor or factors being studied. “Other things constant” / “Other things equal” Economics is an empirical science Real-world data is used to evaluate the usefulness of a model Models are useful if they predict economic phenomena Economic models predict how people react, not how they think Behavioral Economics: Approach to the study of consumer behavior  Emphasizes psychological limitations and complications which may interfere with rational decision making Advocates believe that it is “unrealistic” to assume:- Unbounded selfishness, Unbounded willpower, Unbounded rationality Bounded Rationality Hypothesis that people are nearly, not fully, rational - They cannot examine every choice available to them- They appear to use rules of thumb to sort alternatives  Positive vs. Normative Economics Positive Economics Purely descriptive statements or scientific predictions, such as: “If A, then B.”  A statement of what is Normative Economics Analysis involving value judgments; relates to whether things are good or bad.  A statement of what ought to beChapter 2: Scarcity and the World of Trade-Offs Scarcity: Occurs when the ingredients for producing things that people desire are insufficient to satisfy all wants Means we never have enough of everything, including time, to satisfy our every desire NOT a shortage or poverty Production Any activity that results in the conversion of resources into products that can be used in consumption Resources or Factors of Production Inputs that are used to produce things that people wantThings that go into the funnel, outputs are what come out- Land: Natural resources or the gifts of nature- Labor: The human resource- Capital: stuff used to make other stuffo Physical Capital: All manufactured resourceso Human Capital: Accumulated training and education of workers- Entrepreneurship: Person who organizes, manages, and assembles the other resourceso Risk takero Maker of basic business policy decisions Goods versus Economic Goods Goods are all things from which individuals derive satisfaction or happiness. Economic goods are scarce goods, for which the quantity demanded exceeds the quantity supplied at a price of zero. Services: Tasks that are performed for someone else Can be referred to as intangible goods Wants and Needs Needs: To economists, the term need is not definable. Wants: Goods and services on which we place a positive value People have unlimited wants. Scarcity, Choice, and Opportunity Cost Opportunity Cost: The highest-valued, next-best alternative that must be sacrificed to obtain something or to satisfy a want The next-highest-ranked

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