Definition of economics

 the study of how individuals and societies use limited resources to satisfy unlimited wants.

Fundamental economic problem

 scarcity.
 individuals and societies must choose among available alternatives.

Economic goods, free goods, and economic bads

 economic good (scarce good) - the quantity demanded exceeds the quantity supplied at a zero
price.
 free good - the quantity supplied exceeds the quantity demanded at a zero price.
 economic bad - people are willing to pay to avoid the item

Economic resources

Land

 natural resources, the “free gifts of nature”

Labor

 the contribution of human beings

Capital

 plant and equipment

 this differs from “financial capital”

Entrepreneurial Ability
Resource payments

Economic Resource Resource payment

land rent
labor wages
capital interest
entrepreneurial ability profit

Rational self-interest

 individuals select the choices that make them happiest, given the information available at the
time of a decision.
 self-interest vs. selfishness

Positive and normative analysis

positive economics

 attempt to describe how the economy functions

 relies on testable hypotheses

normative economics

 relies on value judgements to evaluate or recommend alternative policies.

Economic methodology

scientific method

 observe a phenomenon,
 make simplifying assumptions and formulate a hypothesis,
 generate predictions, and
 test the hypothesis.

Microeconomics vs. macroeconomics

 microeconomics - the study of individual economic agents and individual markets

 macroeconomics - the study of economic aggregates

Scarcity

 Economics is the study of how individuals and economies deal with the fundamental problem of
scarcity.
As a result of scarcity, individuals and societies must make choices among competing
alternatives.

Opportunity Cost

 The opportunity cost of any alternative is defined as the cost of not selecting the "next-best"
alternative.

Marginal analysis

 Marginal benefit = additional benefit resulting from a one-unit increase in the level of an activity
 Marginal cost = additional cost associated with one-unit increase in the level of an activity

Net benefit

 Individuals are not expected to maximize benefit; nor are they expected to minimize costs.
  Individuals are assumed to attempt to maximize the level of net benefit (total benefit minus
total cost) from any activity in which they are engaged.

Law of diminishing returns

 Law of diminishing returns: output will ultimately increase by progressively smaller amounts
when the use of a variable input increases while other inputs are held constant.

Marginal opportunity cost = the amount of another good that must be given up to produce one more
unit of a good.

Law of increasing cost – marginal opportunity cost rises as the level of an activity increases

Reasons for law of increasing cost

 Law of diminishing returns

 Specialized resources (heterogeneous labor, land, capital, etc.)

Specialization and trade

 Adam Smith – economic growth is caused by increased specialization and division of labor.
 As noted by Adam Smith, specialization and trade are inextricably linked.
 Adam Smith and David Ricardo used this argument to support free trade among nations.

Gains from specialization and division of labor

 specialization in areas that match the skills and talents of workers

 “learning by doing” – increase in productivity from task repetition
 less time lost while switching from task to task

Absolute advantage – an individual (or country) is more productive than other individuals (or countries).
Comparative advantage – an individual (or country) may produce a good at a lower opportunity cost
than can other individuals (or countries).

Barter – goods are traded directly for other goods

Monetary economy has lower transaction and information costs

Relative price = price of a good in terms of another good
Nominal price = price expressed in terms of the monetary unit
Relative price is a more direct measure of opportunity cost
Markets- In a market economy, the price of a good is determined by the interaction of demand and
supply

Demand: A relationship between price and quantity demanded in a given time period
Demand Schedule

Demand Curve

Law of demand

An inverse relationship exists between the price of a good and the

quantity demanded in a given time period,

Determinants of demand

 tastes and preferences

 prices of related goods and services
 income
 number of consumers
 expectations of future prices and income

Prices of related goods

  substitute goods – an increase in the price of one results in an increase in the demand for the
other.
 complementary goods – an increase in the price of one results in a decrease in the demand for
the other.

A good is a normal good if an increase in income results in an increase in the demand for the good

A good is an inferior good if an increase in income results in a reduction in the demand for the good.

Expectations

 A higher expected future price will increase current demand.

 A lower expected future price will decrease current demand.
 A addhigher expected future income will increase the demand for all normal goods.
 A lower expected future income will reduce the demand for all normal goods.

International effects

 exchange rate – the rate at which one currency is exchanged for another.
 currency appreciation – an increase in the value of a currency relative to other currencies.
 currency depreciation – a decrease in the value of a currency relative to other currencies.
 Domestic currency appreciation causes domestically produced goods and services to become
more expensive in foreign countries.
 An increase in the exchange value of the U.S. dollar results in a reduction in the demand for U.S.
goods and services.
 The demand for U.S. goods and services will rise if the U.S. dollar
depreciates.

Supply

 the relationship that exists between the

price of a good and the quantity supplied in a given time period
Supply Schedule. Supply Curve

Law of supply
 A direct relationship exists between the price of a good and the quantity supplied in a given
time period
 The law of supply is the result of the law of increasing cost.
 As the quantity of a good produced rises, the marginal opportunity cost rises.
  Sellers will only produce and sell an additional unit of a good if the price rises above the
marginal opportunity cost of producing the additional unit.

Determinants of supply

 the price of resources,

 technology and productivity,
 the expectations of producers,
 the number of producers, and
 the prices of related goods and services
note that this involves a relationship in production, not in consumption

Prices of other goods

 Firms produce and sell more than one commodity.

 Firms respond to the relative profitability of the different items that they sell.
 The supply decision for a particular good is affected not only by the good’s own price but also by
the prices of other goods and services the firm may produce.

International effects

 Firms import raw materials (and often the final product) from foreign countries. The cost of
these imports varies with the exchange rate.
 When the exchange value of a dollar rises, the domestic price of imported inputs will fall and the
domestic supply of the final commodity will increase.

A decline in the exchange value of the dollar raises the price of imported inputs and reduce the
supply of domestic products that rely on these inputs.

Growth

 Gross Domestic Product (GDP): Market value of all final goods and services an economy
produces in one year
 Real GDP: GDP in constant prices
 GDP Per Capita = (Real GDP / Population) or income per person
 Economic Growth = percentage change in Real GDP per capita

Business Cycle
Economic Development

 Development = Growth plus Change

 Growth: sustained improvement in the level of per capita income
 Change: sustained improvement in institutions and organizations that support growth

Institutions

 Family: respect the authority & share resources

 Culture: propensity to save & invest
 Religion: ability to bring about change
 Law: protect property rights and civil liberties and enforce contracts

Organizations

 Government: produce public goods and regulate economic activities

 Education: increase productivity and expand the range of economic and social opportunities
 Health: enable proactive participation in economic and social activities
 Business: provide incentive for profit making, resulting in growth and expansion

TRADITIONAL ECONOMIES

 Traditional Economies depend on agriculture, fishing, hunting, gathering, or some combination

of the above.
 They use barter instead of money. Barter is exchange of goods and services between individuals,
including businesses.

Political Economy

 Political economy is concerned with the relationship between politics and economics, with a
special emphasis on the role of power in economic decision making.

Development Economics

 Is the process by which emerging economies become advanced economies.

 Economic Development Is all about improving living standards. Improved living standards refers
to higher levels of education and literacy, workers income, health, and lifespan.

The Important Role of Values In Development Economics

 Value premises
 To achieve what Mahatma Gandhi once called “realization of the human potential.”