Introduction to Economics

Economics Definition

• Economics is a social science that studies how individuals, businesses, and nations make choices about allocating scarce resources to satisfy unlimited wants.

Economic Theory

• Economics uses the scientific method to create theories. This involves:
  • Observation: Studying real-world events.
  • Hypothesis Development: Creating testable explanations.
  • Data Collection: Gathering evidence.
  • Hypothesis Acceptance/Rejection: Evaluating hypotheses using data.
• Accepted hypotheses become theories, and repeated testing leads to established economic principles or laws.

Economic Models

• Economic models simplify reality, combining multiple theories into frameworks.
• They help understand and analyze complex economic situations, using simplified representations.

Scarcity and Opportunity Cost

• Resources are scarce and have alternative uses.
• Choosing one use means trading off other possibilities, which leads to an opportunity cost.

Purposeful Behavior

• Individuals make decisions with desired outcomes in mind.
• These choices are generally considered rational, aiming for the best possible result.
• Factors like personal situations, preferences, and information influence choices.
• Differences in choices do not automatically mean errors or irrationality.

Marginal Analysis

• Decisions involve weighing the marginal benefits and costs of a small change.

Microeconomics vs. Macroeconomics

• Microeconomics studies individual economic units and markets (individuals, firms, specific industries).
• Macroeconomics examines the entire economy, looking at broad measures like national output, inflation, and unemployment.

Theoretical vs. Policy Economics

• Theoretical economics analyzes objective reality and observable data.
• Policy economics incorporates values and judgments to create recommendations about what should be.

Logical Positivism

• Logical positivism emphasizes empirical verification as the basis for knowledge.
• It rejects concepts without empirical evidence (e.g., values, beliefs) as valid knowledge.
• Focuses on verifiable, measurable facts.

Value Judgments in Economics

• Economists strive to avoid subjective value judgments in their analysis. However, interpreting data and creating policies necessitates value judgments.
• Differing values lead to varying perspectives on economic performance (e.g., differing views on unemployment rates).

Positive vs. Normative Economics

• Positive economics describes facts, avoiding value judgments (e.g., "the unemployment rate is 5%").
• Normative economics prescribes what "should be" and offers policy recommendations (e.g., "the unemployment rate is too high and needs reduction").

Scarcity and Resources

• Scarcity is a fundamental economic issue facing all individuals, societies, governments, and organizations.
• Key resources for societies: land, labor, capital, and entrepreneurial ability.

Resources Explained

• Land: Natural resources (minerals, oil, gas, water, wind, solar).
• Labor: Human resources, skilled and unskilled.
• Capital: Manufactured resources used in production (tools, equipment, factories, transportation).
• Entrepreneurial Ability: The ability to combine land, labor, and capital effectively, taking risks in business decisions.

Production Possibilities Model

• Production Possibilities Curve (PPC) illustrates the maximum combinations of two goods an economy can produce, given resources and technology.
• PPC Assumptions:
  • Full employment of resources.
  • Fixed resources and technology.
• PPC Concepts:
  • Unemployment: Points inside the curve.
  • Inefficiency: Points inside the curve.
  • Full Employment: Points on the curve.
  • Economic Growth: Shifting the curve outwards.
  • Opportunity Cost: The trade-offs when increasing production of one good.
• Trade-offs demonstrate that increasing production of one good requires decreasing the production of another.

Example of the Production Possibilities Model

• Example uses pizza (consumer good) and industrial robots (capital good) to illustrate the PPC.
• Different points on the curve represent various combinations of goods produced.
• Points illustrate choices between consumer and capital goods production.
• The PPC's downward slope illustrates trade-offs: Shifting resources from one product to another involves an opportunity cost.
• The initial unit of a good means sacrificing a specific amount (opportunity cost) of another good

Opportunity Cost

Opportunity cost represents the cost of choosing one option by forgoing another.

• It is the value of the next best alternative.
• Moving from one point to another on the PPC demonstrates the opportunity cost.

Law of Increasing Opportunity Cost

• The PPC's concave shape shows increasing marginal opportunity costs as production of a good increases.
• This happens because resources are not equally suited for all activities.
• Initially, the most efficient resources are used, leading to a smaller trade-off.
• As production increases, less efficient resources are used, resulting in a larger opportunity cost.

Unemployment

• Unemployment lies inside the PPC, indicating unused resources and potential output below the economy's capacity.
• Consequences: Lost output, reduced income, decreased business revenue.

Economic Growth

• Economic growth is an outward shift of the PPC, due to increased resources and technology.
• This allows for greater production of all goods and services.