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Definition of Economics All economic questions arise because we want more than we can get. Our inability to satisfy all our wants is called scarcity. Because we face scarcity, we must make choices. The choices we make depend on the incentives we face. An incentive is a reward that encourages a...

Definition of Economics All economic questions arise because we want more than we can get. Our inability to satisfy all our wants is called scarcity. Because we face scarcity, we must make choices. The choices we make depend on the incentives we face. An incentive is a reward that encourages an action or a penalty that discourages an action. © 2019 Pearson Education Ltd.  Definition of Economics Economics is the social science that studies the choices that individuals, businesses, governments, and entire societies make as they cope with scarcity and the incentives that influence and reconcile those choices. Economics divides in two main parts: Microeconomics Macroeconomics © 2019 Pearson Education Ltd.  Definition of Economics Microeconomics is the study of choices that individuals and businesses make, the way those choices interact in markets, and the influence of governments. An example of a microeconomic question is: Why are people downloading more movies? Would a tax on downloads change the number of movies downloaded? Macroeconomics is the study of the performance of the national and global economies. An example of a macroeconomic question is: Why does the unemployment rate fluctuate? © 2019 Pearson Education Ltd.  Two Big Economic Questions Two big questions summarize the scope of economics: How do choices end up determining what, how, and for whom goods and services get produced? When do choices made in the pursuit of self-interest also promote the social interest? © 2019 Pearson Education Ltd.  Two Big Economic Questions What, How, and For Whom? Goods and services are the objects that people value and produce to satisfy human wants. What? In the United States, agriculture accounts for less than 1 percent of total production, manufactured goods for 19 percent, and services for 80 percent. In low-income Ethiopia, agriculture accounts for 36 percent of total production, manufactured goods for 17 percent, and services for 47 percent. © 2019 Pearson Education Ltd.  Two Big Economic Questions Figure 1.1 shows these numbers for the United States, China, and Ethiopia. What determines these patterns of production? How do choices end up determining the quantity of each item produced in the United States and around the world? © 2019 Pearson Education Ltd.  Two Big Economic Questions How? Goods and services are produced by using productive resources that economists call factors of production. Factors of production are grouped into four categories: Land Labor Capital Entrepreneurship © 2019 Pearson Education Ltd.  Two Big Economic Questions The “gifts of nature” that we use to produce goods and services are land. The work time and work effort that people devote to producing goods and services is labor. The quality of labor depends on human capital, which is the knowledge and skill that people obtain from education, on-the-job training, and work experience. The tools, instruments, machines, buildings, and other constructions that businesses use to produce goods and services are capital. The human resource that organizes land, labor, and capital is entrepreneurship. © 2019 Pearson Education Ltd.  Two Big Economic Questions Figure 1.2 shows a measure of the growth of human capital in the United States since 1900—the percentage of the population that has completed different levels of education. Economics explains these trends. © 2019 Pearson Education Ltd.  Two Big Economic Questions For Whom? Who gets the goods and services depends on the incomes that people earn. Land earns rent. Labor earns wages. Capital earns interest. Entrepreneurship earns profit. © 2019 Pearson Education Ltd.  Two Big Economic Questions Do Choices Made in the Pursuit of Self-Interest also Promote the Social Interest? Every day, 325 million Americans and 7.4 billion people in other countries make economic choices that result in what, how, and for whom goods and services are produced. These choices are made by people who are pursuing their self-interest. Are they promoting the social interest? © 2019 Pearson Education Ltd.  Two Big Economic Questions Self-Interest You make choices that are in your self-interest—choices that you think are best for you. Social Interest Choices that are best for society as a whole are said to be in the social interest. Social interest has two dimensions: efficiency and fair shares. © 2019 Pearson Education Ltd.  Two Big Economic Questions Efficiency and Social Interest Resource use is efficient if it is not possible to make someone better off without making someone else worse off. Fair Shares and Social Interest The idea that the social interest requires “fair shares” is a deeply held one. But what is a fair share? © 2019 Pearson Education Ltd.  Two Big Economic Questions Questions about the social interest are hard ones to answer and they generate discussion, debate, and disagreement. Four topics that generate discussion and that illustrate tension between self-interest and social interest are: Globalization Information-age monopolies Climate change Financial instability © 2019 Pearson Education Ltd.  Two Big Economic Questions Globalization Globalization means the expansion of international trade, borrowing and lending, and investment. Globalization is in the self-interest of consumers who buy low-cost imported goods and services. Globalization is also in the self-interest of the multinational firms that produce in low-cost regions and sell in high-price regions. But is globalization in the self-interest of low-wage workers in other countries and U.S. firms that can’t compete with low-cost imports? Is globalization in the social interest? © 2019 Pearson Education Ltd.  Two Big Economic Questions Information-Age Monopolies The technological change of the past forty years has been called the Information Revolution. The information revolution has clearly served your self- interest: It has provided your cell-phone, laptop, loads of handy applications, and the Internet. It has also served the self-interest of Bill Gates of Microsoft and Gordon Moore of Intel, both of whom have seen their wealth soar. But did the information revolution serve the social interest? © 2019 Pearson Education Ltd.  Two Big Economic Questions Climate Change Climate change is a huge political issue today. Every serious political leader is acutely aware of the problem and of the popularity of having proposals that might lower carbon emissions. Burning fossil fuels to generate electricity and to power airplanes, automobiles, and trucks pours a staggering 28 billion tons—4 tons per person—of carbon dioxide into the atmosphere each year. © 2019 Pearson Education Ltd.  Two Big Economic Questions Two thirds of the world’s carbon emissions comes from the United States, China, the European Union, Russia, and India. The fastest growing emissions are coming from India and China. The amount of global warming caused by economic activity and its effects are uncertain, but the emissions continue to grow and pose huge risks. © 2019 Pearson Education Ltd.  Two Big Economic Questions Every day, when you make self-interested choices to use electricity and gasoline, you contribute to carbon emissions. You leave your carbon footprint. You can lessen your carbon footprint by walking, riding a bike, taking a cold shower, or planting a tree. But can each one of us be relied upon to make decisions that affect the Earth’s carbon-dioxide concentration in the social interest? Can governments change the incentives we face so that our self-interested choices are also in the social interest? © 2019 Pearson Education Ltd.  Two Big Economic Questions Economic Instability In 2008, banks were in trouble. They had made loans that borrowers couldn’t repay and they were holding securities the values of which had crashed. Banks’ choices to take deposits and make loans are made in self-interest, but does this lending and borrowing serve the social interest? Do banks lend too much in the pursuit of profit? © 2019 Pearson Education Ltd.  Economic Way of Thinking Six key ideas define the economic way of thinking: A choice is a tradeoff. People make rational choices by comparing benefits and costs. Benefit is what you gain from something. Cost is what you must give up to get something. Most choices are “how-much” choices made at the margin. Choices respond to incentives. © 2019 Pearson Education Ltd.  Economic Way of Thinking A Choice Is a Tradeoff The economic way of thinking places scarcity and its implication, choice, at center stage. You can think about every choice as a tradeoff—an exchange—giving up one thing to get something else. On Saturday night, will you study or have fun? You can’t study and have fun at the same time, so you must make a choice. Whatever you choose, you could have chosen something else. Your choice is a tradeoff. © 2019 Pearson Education Ltd.  Economic Way of Thinking Making a Rational Choice A rational choice is one that compares costs and benefits and achieves the greatest benefit over cost for the person making the choice. Only the wants of the person making a choice are relevant to determine its rationality. The idea of rational choice provides an answer to the first question: What goods and services will be produced and in what quantities? The answer is: Those that people rationally choose to buy! © 2019 Pearson Education Ltd.  The Economic Way of Thinking How do people choose rationally? The answers turn on benefits and costs. Benefit: What you Gain The benefit of something is the gain or pleasure that it brings and is determined by preferences Preferences are what a person likes and dislikes and the intensity of those feelings. © 2019 Pearson Education Ltd.  The Economic Way of Thinking Cost: What you Must Give Up The opportunity cost of something is the highest-valued alternative that must be given up to get it. What is your opportunity cost of going to a live concert? Opportunity cost has two components: 1. The things you can’t afford to buy if you purchase the concert ticket. 2. The things you can’t do with your time if you attend the concert. © 2019 Pearson Education Ltd.  The Economic Way of Thinking How Much? Choosing at the Margin You can allocate the next hour between studying and instant messaging your friends. The choice is not all or nothing, but you must decide how many minutes to allocate to each activity. To make this decision, you compare the benefit of a little bit more study time with its cost—you make your choice at the margin. © 2019 Pearson Education Ltd.  The Economic Way of Thinking To make a choice at the margin, you evaluate the consequences of making incremental changes in the use of your time. The benefit from pursuing an incremental increase in an activity is its marginal benefit. The opportunity cost of pursuing an incremental increase in an activity is its marginal cost. If the marginal benefit from an incremental increase in an activity exceeds its marginal cost, your rational choice is to do more of that activity. © 2019 Pearson Education Ltd.  The Economic Way of Thinking Choices Respond to Incentives A change in marginal cost or a change in marginal benefit changes the incentives that we face and leads us to change our choice. The central idea of economics is that we can predict how choices will change by looking at changes in incentives. Incentives are also the key to reconciling self-interest and the social interest. © 2019 Pearson Education Ltd.