Lecture 1 _22 Aug_ PDF

ECO 103: PRINCIPLES OF MICROECONOMICS CHAPTER 1: TEN PRINCIPLES OF ECONOMICS DR. SAHAR ARSHAD MAHMOOD ASSISTANT PROFESSOR SCHOOL OF ECONOMICS AND SOCIAL SCIENCES IBA , K ARACHI WHAT YOU WILL LEARN Principles that determine people decision making. Principles that determine how people interact....

ECO 103: PRINCIPLES OF MICROECONOMICS CHAPTER 1: TEN PRINCIPLES OF ECONOMICS DR. SAHAR ARSHAD MAHMOOD ASSISTANT PROFESSOR SCHOOL OF ECONOMICS AND SOCIAL SCIENCES IBA , K ARACHI WHAT YOU WILL LEARN Principles that determine people decision making. Principles that determine how people interact. How the economy as a whole works. 2 WHICH OF THE FOLLOWING TOPICS DO YOU THINK ECONOMICS CAN HELP US UNDERSTAND? Business cycle What causes unemployment? When does a mobile snatcher decide to steal a mobile? What causes inflation? How fast do people drive on highway? How to maximize profits? How much people eat in a buffet? How long a car owner waits before getting an oil change? How long students pay attention during economics lectures? 3 WHAT IS ECONOMICS? There are variety of definitions but simply it’s the study of human behavior. The word economy comes from a Greek word “oikonomos” which means “one who manages a household.” Aristotle (Greek philosopher) termed economics as a science of “household management”. 4 TEN PRINCIPLES OF ECONOMICS Scarcity: The limited nature of society’s resources. Society has limited resources, just like within a household. Cannot produce all good and services that people wish to have. Economics studies human behavior and how society manages scarce resources. Economist study how people make decisions, how they interact, and, and finally forces and trends that impact the economy. There are many disciplines in economics but some basic principles that appear in all disciplines. 5 HOW PEOPLE MAKE DECISIONS 1- People face trade-offs 2- The Cost of Something Is What You Give Up to Get It 3- Rational People Think at the Margin 4- People Respond to Incentives 6 1- PEOPLE FACE TRADE-OFFS There is no such thing as a free lunch. To get something you like, you might have to give up something that you like. Just like you as students face trade off between sleep and studying sometimes. Society faces similar trade-offs. Example (National defense vs consumer goods and services) resources devoted to national defense cannot be utilized for proposes like building roads, scholarships etc. 7 1- PEOPLE FACE TRADE-OFFS Another trade-off exists in the society i.e., between efficiency and equality. Efficiency: society is getting maximum benefits from its scarce resources. (size of pie) Equality: benefits are distributed uniformly among society’s members. (fair division of pie) So, the tradeoff can exist like within the distribution of pie or wealth by the government. 8 2- THE COST OF SOMETHING IS WHAT YOU GIVE UP TO GET IT Due to trade-offs, making decisions include comparing cost and benefits of alternative choices. Here, we refer to cost more generally and include everything we had to give up to get the alternative e.g. biryani. Hence, economist use the term opportunity cost. Opportunity cost: whatever must be given up to obtain an item. Example: Coming to this class. No money transaction for coming to this class. Simply time could be the opportunity cost here, but actually it’s the next best alternative use of that time or value of the time. 9 3- RATIONAL PEOPLE THINK AT THE MARGIN Rational people: systematically and purposefully do the best to achieve their objective. Rational people are aware that decisions are rarely black and white. For instance, during exams, your decision is not to blow off eating and study 24 hours but on how little time to spend on eating and take that extra time to study. Rational people make decisions by comparing marginal benefits and marginal costs. Marginal change: Small incremental adjustment to a plan of action. Where margin means edge. 10 3- RATIONAL PEOPLE THINK AT THE MARGIN Rational people take decision if and only if MB>MC. Cost of a phone call is Rs. 0.50/min. Cell phone service costs Rs 300/month. Average talk time is 100 minutes/month. You want to talk to a friend for 10 minutes that gives you marginal benefit of Rs 25. Should you make the call? Examples Studying for a test. Diamonds and water. 11 4- PEOPLE RESPOND TO INCENTIVES Incentive: something (punishment or rewards) that induces a person to act. Different types of incentive like economic incentives, social incentives and moral incentives. People respond differently to same incentives. For instance giving scores on a test. Policymakers makes need to remember that people respond to incentives. They think about marginal benefits and marginal costs. Seat belts case; oil reserves; cigarette taxes. 12 HOW PEOPLE INTERACT 5- Trade Can Make Everyone Better Off 6- Markets Are Usually a Good Way to Organize Economic Activity 7- Governments Can Sometimes Improve Market Outcomes 13 5- TRADE CAN MAKE EVERYONE BETTER OFF Everyone cannot be good at everything. Voluntary trade is not a zero sum game but a positive sum game. People benefit from trade as are able to buy variety of goods. Countries benefit from trade by getting good prices abroad for the goods they produce and buy cheaper products international that might cost more in local production. For instance, Pakistan exports rice and other goods while imports crude oil. 14 6- MARKETS ARE USUALLY A GOOD WAY TO ORGANIZE ECONOMIC ACTIVITY Market economy: an economy that allocates resources through the decentralized decisions of many firms and households as they interact in markets for goods and service. Organize economic activities refer to what to produce, how much to produce, and who would produce and consume. Firms decide who to hire and how much to make while household decide where to work and how much to buy. Prices and self interest guide the decisions. Free market economies are successful compared to planned economies. Adam smith (1776) in wealth of nations stated that: each of these household and firms interacting in markets act as if “led by an invisible hand” to promote general economic well being. 15 7- GOVERNMENTS CAN SOMETIMES IMPROVE MARKET OUTCOMES Then why do we need government if invisible hand is so great? Property rights (the ability of an individual to own and exercise control over scarce resource) are needed. Example restaurants. So governments are needed to enforce rules and maintain order. Governments promote efficiency. Avoid market failure (market lefts on its own fails to allocate resources efficiently). Market failure is caused by externality (impact of one person’s actions on the well-being of a bystander) like pollution. Market failure is also caused by market power (the ability of a single economic actor (or small group of actors) to have a substantial influence on market price) like monopoly. 16 7- GOVERNMENTS CAN SOMETIMES IMPROVE MARKET OUTCOMES Invisible hand can lead to increased disparities in economic well being. For instance, a cricketer vs some other athlete. Government promotes equality by using welfare policies or taxes to change how the pie is divided. 17 HOW THE ECONOMY AS A WHOLE WORKS 8- A Country’s Standard of Living Depends on Its Ability to Produce Goods and Services 9- Prices Rise When the Government Prints Too Much Money 10- Society Faces a Short-Run Trade-off between Inflation and Unemployment 18 8- A COUNTRY’S STANDARD OF LIVING DEPENDS ON ITS ABILITY TO PRODUCE GOODS AND SERVICES Productivity is directly related to living standard’s (individual or country). Productivity: the quantity of goods and services produced from each unit of labor input. The average income per month in Pakistan is $296, US is $7,900, India is $430, and China is almost $3000. (2024) Hence, growth rate of productivity determines the growth rate of its average income. Productivity is mainly dependent on education, skills, equipment and available technology to workers. International competition have far less impact on standards of living. 19 8- A COUNTRY’S STANDARD OF LIVING DEPENDS ON ITS ABILITY TO PRODUCE GOODS AND SERVICES 20 9- PRICES RISE WHEN THE GOVERNMENT PRINTS TOO MUCH MONEY When government prints too much money, it causes inflation. Inflation: an increase in the overall level of prices in the economy. Faster the government prints money, greater the inflation rate. Pakistan current inflation rate is 24.76% compared to 12.15% in 2022. 21 10- SOCIETY FACES A SHORT-RUN TRADE-OFF BETWEEN INFLATION AND UNEMPLOYMENT In long run, increasing quantity of money does lead to higher prices. But in the short run, there is a trade off between inflation and unemployment. For short run, economist argue that: Increasing quantity of money leads to higher spending and demand. This causes firms to hire more workers and produce more. This would lower unemployment. Ideally, we would want both to be low, but trade-off comes into play here. So, inflation and unemployment in short run pushed in opposite directions. Example US (Barack Obama, 2008-2009). 22 10- SOCIETY FACES A SHORT-RUN TRADE-OFF BETWEEN INFLATION AND UNEMPLOYMENT Business cycle: fluctuations in economic activity, such as employment and production. 23 SUMMARY Fundamentals about individual making decision. People face trade-offs among alternative goals. The cost of any action is measured in terms of forgone opportunities. Rational people make decisions after comparing MB and MC. People respond to incentives. Fundamentals about interactions among people. Trade can benefit. Markets are a good way of coordinating economic activity among people. Governments can help by preventing market failure or promoting economic equality. 24 SUMMARY Fundamentals about the economy as a whole. Productivity is the source of living standards. Growth in the quantity of money leads to inflation. Society faces short run trade-off between inflation and unemployment. 25 THANK YOU Dr. Sahar Arshad Mahmood [email protected] 26