Economic choices, scarcity and models

• People make choices to achieve goals due to scarcity
• Scarcity occurs when unlimited wants exceed limited resources
• Economics studies people's choices to achieve goals with scarce resources
• Economists use economic models, simplified versions of reality, to analyze real-world economic situations

Three Key Economic Ideas

• People are rational
• People respond to economic incentives
• Optimal decisions occur at the margin
• Economic agents interact in markets
• A market refers to buyers and sellers of goods/services and the arrangements that bring them together

People Are Rational

• Economists assume people are rational and use available information to achieve goals
• Rational consumers/firms weigh costs/benefits to make optimal decisions
• Apple chooses iPhone prices that maximize profit

People Respond to Economic Incentives

• Behaviors change as incentives change
• Requiring convicted felons to submit DNA samples reduced repeat convictions by 17%

Optimal Decisions Are Made at the Margin

• Most decisions entail doing a little more or less of something
• Economists consider marginal cost (MC) and marginal benefit (MB)
• Marginal analysis compares marginal benefits and costs

The Economic Problem Every Society Must Solve

• Societies answer questions such as What goods/services will be produced? How? Who receives them?
• Scarcity results in trade-offs
• Trade-off happens because scarcity means producing more of one good/service means producing less of another

What Goods and Services Will Be Produced?

• Individuals, firms, and governments decide what to produce
• Producing more of one good means producing less of another due to scarcity
• Opportunity cost is the highest-valued alternative given up for an activity
• Example: More space exploration funding means potentially less for cancer research

How Will the Goods and Services Be Produced?

• Firms can use different methods to produce goods/services
• Music producers can hire great singers with standard techniques or mediocre singers with Auto-Tune
• As manufacturing labor costs change, firms may use more machines/fewer workers, or relocate factories to cheaper labor locations

Who Will Receive the Goods and Services Produced?

• In the U.S., higher-income individuals typically obtain more goods/services
• Changes in tax/welfare policies can alter income distribution, but the desirability of "redistribution" is debated

Types of Economies

• Centrally planned economy: Government allocates economic resources
• Market economy: Decisions of households/firms in markets allocate economic resources
• Mixed economy: Most economic decisions result from buyer/seller interactions, but governments significantly affect resource allocation

Efficiency of Market Economies

• Market economies tend to be more efficient than centrally planned economies
• Market economies promote productive efficiency and allocative efficiency

Source of Economic Efficiency

• Productive efficiency results from competition
• Allocative efficiency arises from voluntary exchange
• Voluntary exchange occurs in markets when transactions benefit both buyer and seller

Caveats to Market Economies

• Markets may not always result in fully efficient outcomes
• People might not immediately adopt the most efficient practices
• Governments may interfere
• Market outcomes might ignore external factors like pollution

Market Economies and Equity

• Economically efficient outcomes aren't always desirable
• Less efficient outcomes can be fairer
• Equity means the fair distribution of economic benefits
• Governments face a trade-off between efficiency and equity
• Example: Income taxes might disincentivize work/business but fund programs for the poor

Economic Models

• Economists use models to analyze events/policies
• Building an economic model involves:
• Deciding on assumptions
• Formulating a testable hypothesis
• Using data to test the hypothesis
• Revising the model if needed
• Retaining the revised model

The Role of Assumptions in Economic Models

• Models require assumptions/simplifications to be useful
• Economic models make behavioral assumptions such as:
• Consumers maximize well-being
• Firms maximize profits
• Assumptions are testable and can be incorrect

Forming Hypotheses in Economic Models

• Hypotheses are statements about economic variables that may be correct or incorrect
• Economic variables are measurable with different values, like the number of manufacturing employees
• Example: increased industrial robot usage reduces manufacturing jobs

Testing Hypotheses in Economic Models

• Economists use statistical methods to evaluate hypotheses after data collection
• Establishing causality is difficult to show
• Declining manufacturing employment and increased robot usage, doesn't prove causation
• Economic models: are accepted if confirmed/not rejected by statistical analysis
• New info may reject prior hypotheses

Positive and Normative Analysis

• Economists use the scientific method like natural scientists, but economics is a social science
• Analysis includes:
• Positive analysis, which is concerned with what is
• Normative analysis, which is concerned with what ought to be
• Economists primarily conduct positive analysis

Economics as a Social Science

• Social sciences study individual actions
• Economics emphasizes how individual actions and decisions affect outcomes, like prices
• Economics considers actions in every context with increasing reliance from government policymakers

What Can Economics Contribute to the Debate over Tariffs?

• Governments use tariffs to raise revenue/discourage imports
• Economic theory identifies tariff winners and losers
• Economic analysis estimates dollar amounts gained/lost
• Economists generally discourage tariffs as typically losses outweigh the gains
• Policymakers may value certain groups' well-being, which involves normative judgement

Microeconomics and Macroeconomics

• Microeconomics studies: household/firm choices, market interactions, and government influence
• Macroeconomics studies: the economy as a whole, including inflation, unemployment, and economic growth

Issues in Microeconomics and Macroeconomics

• Microeconomics: Examining consumer reactions to price changes, price-setting by firms, government policies on opioid addiction, regulation to reduce pollution etc
• Macroeconomics: Investigating causes for economic recession and unemployment, causes of economic growth, determining factors for inflation and setting currency valies etc

Economic Skills and Economics as a Career

• Home inspectors describe problems and advise on solutions/costs
• Economists describe individual, business, and government choices and advise on better decisions

Applying Economics in a Career

• Careers include:
• Ford Motor Company- Forecast the demand for electric cars over the next 10 years
• Goldman Sachs - Use economic models to forecast future values of interest rates
• McDonald's - Determine whether the firm should open additional restaurants in China
• Pfizer - Analyze the financial cost and benefits of a new treatment for cancer.
• Wall Street Journal - Report on the Federal Reserve and interpret monetary policy for the paper’s readers.

Applying Economics in a Career Cont.

• Careers also include:
• Colleges - Teach economics and do research on economic issues
• Federal Reserve Branches - Forecast trends in employment and production in that region
• U.S. Federal Trade Commission - Gather and analyzing data on whether to allow to reduce competition in a market,
• World Bank - Write a report analyzing the effectiveness of a development program in a low-income country.

Important Economic Terms

• Economics uses specific terms
• Technology = firm's processes to produce goods and services
• Capital = manufactured goods used to make other goods and services

Appendix: Using Graphs and Formulas

• Graphs and formulas analyze economic situations
• A map= simplified model of reality with essential details only
• Economic models + graphs/formulas help understand economic situations like maps explain cities

Bar Graphs and Pie Charts

• Bar graphs display market share as bar height
• Pie charts display market share as the slice size

Time-Series Graphs

• Both show time-series graphs of Ford, 2006-2018
• The right panel truncates the vertical axis while the left does not, causing fluctuations to look smaller on the left

Plotting Price and Quantity Points in a Graph

• Two-dimensional grid measures price on the vertical (y) axis and quantity on the horizontal (x) axis
• Each point represents a price-quantity combination
• Connecting points better illustrates the relationship between the two variables

Calculating the Slope of a Line

• Slope = change in y-axis variable / change in x-axis variable
• For straight lines, the slope is constant

Calculating the Slope of a Line Formula

• Slope = Rise/Run
• Slope = Change in value on the vertical axis / Change in value on the horizontal axis
• Example: price decrease from $14 to $12, quantity increases from 55 to 65
• Slope = (12-14) / (65-55) = -2 / 10 = -0.2

Showing Three Variables on a Graph

• Pizza demand curve= relationship between price and quantity demanded
• Other factors held constant
• $14 pizza (A) + hamburgers from $1.50 to $2.00, pizzas increase 55 to 60 per week (B)

Showing Three Variables on a Graph Cont.

• Start on pizza price at $12 (point C), hamburgers $1.50 to $1.00
• Pizza 65 to 60 per week (point D)

Graphing the Positive Relationship between Income and Consumption

• Positive relationship: as one variable increases, the other increases
• Negative relationship: as one variable increases, the other decreases
• The figure shows the correlation between personal income and spending

Determining Cause and Effect

• Using graphs to draw conclusions about cause and effect is hazardous.
• Fires don't cause tree to lose leaves

Are Graphs of Economic Relationships Always Straight Lines?

• Two variables: is linear if represented by a straight line
• Few economic relationships are actually linear.
• Linear is simpler but good enough in modeling.

The Slope of a Nonlinear Curve

• Nonlinear curves have different slopes
• Slope can be approximated by measuring local slope as if the section is linear

The Slope of a Nonlinear Curve Continued

• Between points slope is greater/steeper
• Tangent lines shows the slope

Formula for a Percentage Change

• Percentage change = how much something varies from one period to the next
• US real GDP - $18,051B in 2017 to $18,566 in 2018 - 2.9% rate -Value in next time - first time / Value first time *100

Showing a Firm’s Total Revenue on a Graph

• Area of a rectangle = base x height
• Total revenue is quantity multiplied by the price
• Green region show the total revenue
• Total revenue shows a quantity of 125000 bottles
• Per bottle is $2, making $250k

The Area of a Triangle

• A=1/2 * base* height
• Base equals 25,000
• Height equals = $.50

Using Formulas

• Make sure understand the economic concept formula presents
• Make sure are using correct formula for the problems you are solving.
• Makes sure calculation is reasonable
• Answer is a number for firm’s revenue and your answer is a negative number
• This means you made a mistake.