CH8702- PROCESS ECONOMICS

Introduction to Economics

What is Economics?
Scarcity a basic human dilemma
Limited resources vs. unlimited wants
The human condition requires making choices

Definitions of Economics
Mankiws definition
is the study of how society manages its scarce resources

Hedricks definition
is how society chooses to allocate its scarce resources among
competing demands to improve human welfare

Alternative definitions
what economists do.
is the study of choice.

 Fundamental Questions of Economics - Scarcity

requires all societies to answer the following
questions:
What is to be produced?
How is to be produced?
For whom will it be produced

WHFM Questions

ESSENTIAL QUESTION How does scarcity lead to economic

rational decision making when making voluntary exchanges?

Economic Themes
SSEF1. The student will explain why limited
productive resources and unlimited wants
result in scarcity, opportunity costs, and
tradeoffs for individuals, businesses, and
government.

Scarcity
SSEF1a Define scarcity as a basic condition
that exists when unlimited wants exceed
limited productive resources.

Economics

Big
Picture
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economics The study of how people try to satisfy what
appears to be seemingly unlimited and competing
wants through the careful use of relatively scarce
resources
scarcity The condition that results from society not
having enough resources to produce all the things
people would like to have
NOTE: Scarce does not mean rare!
want desire to obtain something
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How Do Economists Study Human

Behavior?
Economics as a Science
The scientific method
ObservationTheoryDataTesting

Rational Behavior
Weighing benefits and costs and maximizing total net benefits
Marginal vs. Total Thinking

Economic Theory and Models

Simplification by assumption
Ceteris Paribus Holding other factors constant
Prediction vs. realism

Microeconomic versus Macroeconomics

 Bias towards use of natural rather than controlled

experiments
The specialized language of economics (e.g. He has
lots of money.)
Money medium of exchange
Wealth accumulated financial and non-financial assets
Income the purchasing power earned during a given period

Resources
Resources are things which humans can put
to productive use, including money, people,
time, information, machines, and natural
resources.
Natural resources are all of the gifts of
nature, both renewable and
nonrenewable.

Allocating Resources
SSEF1c List a variety of strategies for
allocating scare resources.

Strategies for Dealing with Scarcity

1. Higher Prices the market sets the price
which limits who can afford the product
2. Government Regulation
A. Price Ceiling sets a maximum price
B. Price Floor sets a minimum price
C. Rationing sets a maximum quantity
(number allowed to buy)

Opportunity Cost
SSEF1d Define opportunity cost as the next
best alternative given up when individuals,
businesses, and governments confront
scarcity by making decisions.

 trade-off is the act of giving up one thing of

value to gain another thing of value. The
trade-off is what was given up.
opportunity cost is the value of the alternative
option that is lost when a decision is made.

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Why do Economists Study Human

Behavior?
Scientists versus policy makers
Positive Economics
Descriptive - what the world is like.
Objective- value judgments need not be made
Positive statements can theoretically be tested by
appealing to the facts

Normative Economics
Prescriptive - what the world ought to be like
Subjective value judgments must be made
Normative statements cannot be tested appealing to
facts.

Categories of Basic Principles of

Economics
How do people make decisions?
How do people interact?
How does the economy work overall?

How Do People Make Decisions?

Principle #1 - People face tradeoffs
Time allocation an example of tradeoffs
Efficiency versus equity
Production Possibilities Frontier

 Principle #2 - The cost of something is what

you have to give up to get it
Opportunity costs come from Von Weiser, a
German economist late 1800s
Opportunity costs are independent of monetary
units
TINSTAAFL
The real costs of going to college

 Principle #3 - Rational people think at the

margin
Rational or irrational decision-making
Marginal benefits and costs versus total benefits
and costs
Weighing marginal costs and benefits leads to
maximizing net benefits (total welfare)
The boxes example

.
Principle #4 People respond to incentives
Reactions to changes in marginal benefits and costs
Increases (decreases) in marginal benefits mean more
(less) of an activity
Increases (decreases) in marginal costs mean less
(more) of an activity
Example of seat belts leading to increased speeds
Example of SUV (with child car seat) in Issaquah

How Do People Interact?

Principle #5 - Trade can make everybody
better off
Adam Smith author of the An Inquiry into the
Causes and Consequences of the Wealth of
Nations 1776
Gains from the division of labor and
specialization
Mercantilists perspectives
Example of why Ellensburg

 Principle #6 - Markets are usually a good way of

organizing economic activity
feudal times where feudal states were self-supporting, also
haciendas in the new world
the benefits of trade are so powerful that people began to
trade
markets for economists are more abstract than the notion of a
middle eastern bazaar or a flea market and simply determine
the prices and quantities traded of different goods and
services
the failure of centrally planned economies and the
movement towards markets for the WHFM questions

Markets
Principles 1-5 combine with markets to turn the pursuit
of self-interest into promoting the interests of society
Adam Smith and the invisible hand
creativity and productivity are stimulated by the pursuit
of self-interest into improving resource allocations
set it and forget it becomes compete or be obsolete
in some cases markets fail to allocate resources
effectively so,

 Principle #7 Governments can sometimes improve

interaction that occurs in markets
there are circumstances when market signals fail to
allocate resources efficiently or equitably
Public Goods, Externalities and Income Distribution
Some goods or services that people desire will not be
produced by markets (e.g. lighthouses).
Some goods or services will either be underproduced
(vaccines) or overproduced (pollution) because markets
fails to register certain benefits or costs.

 markets may also fail to provide an equitable or fair

distribution of resources
government intervention with its ability to coerce (the
opposite of voluntary) can regulate, tax and subsidize to
change market outcomes
efficiency and equity: the pie analogy
if government intervention always the proper solution?

How Does the Economy Work as

a Whole?
Principle # 8 A countrys standard of living
depends upon its ability to produce goods and
services
Adam Smiths An Inquiry into the Nature and the
Consequences of the Wealth of Nations
Materialism more toys mean more welfare
wealth: a necessary or sufficient condition for
happiness (are rich people happier, children with lots of
toys)
leisure time and productivity

 the factors of production: land or natural

resources, labor, capital, entrepreneurship
technology and productivity
the rule of 72 for growth rates

 Principle #9 The general level of prices rises

when the government prints and distributes too
much money
definition of money, the concept of snow to Inuits, and
economic language
inflation is an increase in the general or average level of
prices in an economy
not worth a continental and recent example in
Argentina
the establish of the Federal Reserve and the introduction
of sustained inflation in the US

 Principle #10 Society faces a short-run tradeoff

between inflation and unemployment
Short-run and the long-run
demand and supply shocks
short-run increases (decreases) in output above (below)
long-run potential output lead to adjustments
countercyclical stabilization versus pro-cyclical
destabilization
political business cycles