ECON 2001 Macroeconomic Principles - Chapter 1 PDF

ECON 2001 Macroeconomic Principles Chapter 1 The Nature of Economics Chapter Outline 1.1 The Power of Economic Analysis 1.2 The Three Basic Economic Questions and Two Opposing Sets of Answers 1.3 The Economic Approach: Systematic Decisions 1.4 Economics as a Science 1.5 Positive ve...

ECON 2001 Macroeconomic Principles Chapter 1 The Nature of Economics Chapter Outline 1.1 The Power of Economic Analysis 1.2 The Three Basic Economic Questions and Two Opposing Sets of Answers 1.3 The Economic Approach: Systematic Decisions 1.4 Economics as a Science 1.5 Positive versus Normative Economics Copyright © 2021, 2018, 2016 Pearson Education, Inc. All Rights Reserved 1.1 The Power of Economic Analysis Economics ‒ Comes from the Greek word “Oikonomos”— one who manages a household. The economic way of thinking is a framework helps you 1. Understanding the world 2. Making informed decisions to many problems ‒ Your education, career, or financing your home ‒ Your involvement in the business world ‒ How do you vote Copyright © 2021, 2018, 2016 Pearson Education, Inc. All Rights Reserved 1.1 The Power of Economic Analysis Economics ‒ We never have enough of everything, including time, to satisfy our every desire, so we must make choices. ‒ The study of how people allocate their limited resources to satisfy their unlimited wants ‒ Not a study of material goods, services, and products, but a study of human actions (choices). — Ludwig Von Mises, Human Action, 1949. ‒ Individuals, businesses, and nations face alternatives, and choices must be made. Copyright © 2021, 2018, 2016 Pearson Education, Inc. All Rights Reserved 1.1 The Power of Economic Analysis Macroeconomics ‒ The study of the behavior of the economy as a whole/economywide aggregate:  The national unemployment rate  The rate of inflation  The total output of goods and services in a nation Microeconomics ‒ The study of decision-making undertaken by individuals, households, and firms:  Your reaction to changes in gasoline prices  A family’s choice of having a baby  An individual firm’s decision to advertise Copyright © 2021, 2018, 2016 Pearson Education, Inc. All Rights Reserved 1.1 The Power of Economic Analysis Economy-wide phenomena Individual/ household/ firm decisions  Modern economic theory blends micro and macro concepts. Copyright © 2021, 2018, 2016 Pearson Education, Inc. All Rights Reserved 1.2 The Three Basic Economic Questions and Two Opposing Sets of Answers Three basic economic questions in any economy: 1. What and how much will be produced? 2. How will items be produced? 3. For whom will items be produced? There are two opposing sets of answers depending on the economic systems: The institutional mechanism that determines how scarce resources are utilized to satisfy human wants Copyright © 2021, 2018, 2016 Pearson Education, Inc. All Rights Reserved 1.2 The Three Basic Economic Questions and Two Opposing Sets of Answers Two primary economic systems: ‒ Centralized command and control (central planning/ centrally planned): 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 Copyright © 2021, 2018, 2016 Pearson Education, Inc. All Rights Reserved 1.2 The Three Basic Economic Questions and Two Opposing Sets of Answers Copyright © 2021, 2018, 2016 Pearson Education, Inc. All Rights Reserved 1.2 The Three Basic Economic Questions and Two Opposing Sets of Answers Market System Command System Aka capitalism Aka socialism or communism Private property Government ownership of resources Freedom of enterprise and Decisions made by the government choice guided by self-interest Competition and prices No competition or price system Systems found in much of the Soviet Union, Eastern Europe, world North Korea, Cuba, etc. However, economic systems of many nations in the world today are somewhat mixed. Copyright © 2021, 2018, 2016 Pearson Education, Inc. All Rights Reserved  1.3 The Economic Approach: Systematic Decisions Due to the prevalence of icy roads, police corruption, and faked accident claims, more than one in four vehicles in Russia is equipped with a dashboard camera- Russian drivers have a strong incentive to use dash cameras. In general, people respond to incentives - rewards (or punishment) for engaging in a particular activity. Economists assume that people are rational: 1. Individuals act as if motivated by self-interest and respond predictably to opportunities for gain. 2. In other words, people do not intentionally make decisions that would leave them worse off Copyright © 2021, 2018, 2016 Pearson Education, Inc. All Rights Reserved 1.3 The Economic Approach: Systematic Decisions Rationality Assumption Quote from Leo Tolstoy “Anna Karenina” (1878) “Happy families are all alike; every unhappy family is unhappy in its own way. All correct and reasonable things are similar, while all erroneous and misguided things are diverse. Just like the broad road to prosperity, there is only one path, but there are many small, different paths branching off in various directions.” Copyright © 2021, 2018, 2016 Pearson Education, Inc. All Rights Reserved 1.3 The Economic Approach: Systematic Decisions “It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own interest.” —Adam Smith, An Inquiry into the Nature and Causes of the Wealth of Nations, 1776 The nature of self-interested responses to incentives or rationality assumption is the starting point for economics. For example, the annual income to earn a bachelor’s degree increased from $20,000 in 1975 to $58,000 in 2023. This explains why the percentage of U.S. adults holding college degrees increased from 13 percent to 33 percent. Copyright © 2021, 2018, 2016 Pearson Education, Inc. All Rights Reserved 1.3 The Economic Approach: Systematic Decisions Note that self-interest does not always mean increasing one’s wealth, it also includes things such as prestige, friendship, love, etc. For example, making a charitable donation, people are motivated by a desire to help others or by the benefit that governments provide to donors, such as tax deductions. Copyright © 2021, 2018, 2016 Pearson Education, Inc. All Rights Reserved 1.4 Economics as a Science Economics is a social science that employs the same kinds of methods used in hard sciences, such as biology. Economics uses models or theories to explain economic phenomena in the real world. ‒ Simplified representations of the real world used as the basis for predictions or explanations ‒ Captures 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 Copyright © 2021, 2018, 2016 Pearson Education, Inc. All Rights Reserved 1.4 Economics as a Science Assumptions ‒ the set of circumstances in which a model is based on Economics is an empirical science ‒ Real-world data are used to evaluate the usefulness of a model ‒ Empirical means that evidence (data) is looked at to see whether we are right Models of behavior, not thought processes ‒ Economic models predict how people react, not how they think Copyright © 2021, 2018, 2016 Pearson Education, Inc. All Rights Reserved  1.5 Positive versus Normative Economics As scientists, economists make positive statements describing what the world is (fact/fact). As policy advisors, economists also make normative statements: describe how the world should /out to be (opinion/ involves value judgments – whether things are good or bad). The first type of statement belongs to positive economics, and the second type belongs to normative economics. Copyright © 2021, 2018, 2016 Pearson Education, Inc. All Rights Reserved 1.5 Positive versus Normative Economics Which of the statements is “positive” and which is “normative”? Why 1. Prices rise when the government increases the quantity of money. Positive 2. The government should print less money. Normative 3. A tax cut is needed to stimulate the economy Normative Copyright © 2021, 2018, 2016 Pearson Education, Inc. All Rights Reserved