Economics

Social science that studies choices that…

            -Individuals

            -Businesses

            -Governments

            -& Entire societies

make when they cope with…

1.    Scarcity

2.    Incentives that influence choices

3.    Arrangements that coordinate choices (price, allocation)

Micro Economics

The choices that individuals and businesses make

The way these decision makers respond to changes in scarcity, constraints, laws, technology, etc

Macroeconomics

Study of why the aggregate utilization of resources (total sum of individuals’, businesses, and govt’s demand) in the economy varies over time

Simplifying Assumption

1.   1. Preferences do not change over the course of study

2.    2. Changes in behavior is due to changes in constraints

3.    3. People make choices in line w/ preferences and minimizing adverse affects of constraints

4.    4. People are rational and self-interested (interested in “utility maximizing”)

Postulates of Behavior

1. People have preferences

2. More is preferred to less

3. People are willing to substitute one good for another

4. For all individuals & goods, marginal value of goods decreases as more of that good is consumed, ceteris paribus.

If people are rational and self-interested, how do you explain donating?

Donating gives people a good feeling, this is their benefit/utility

Positive Statement

Predicts how people will behave

Normative Statement

States how people ought to behave

Correlation vs Causation in regards to variables

Correlation: The tendency for two variables to move together

Causation: One variable directly impacts another

Nationally, is it better to import more or export more goods?

Export more. Lowers deficit and creates surplus.

If you import more, you create a deficit.

Explain how the decision process that leads to the production of goods is highly decentralized

No single person completely controls or gives orders to every single producer in the process of making a good.

Individual producers decide to voluntarily engage in this process in turn for wages/other benefits

In unplanned market economies, activities are based on what?

Mutual benefits coordinated by prices determined by the market.

What determines price?

Demand (actions of consumers)

and

Supply (actions of producers)

What does PRICE mean?

The willingness of consumers to forgo other goods in order to obtain that particular good

Are economic transactions zero-sum or positive sum?

Positive sum. In zero-sum situations, one person gains while the other loses. In economic situations, both parties gain.

What is the problem with “letting the facts speak for themselves”?

How do economists think differently than this way of thinking?

Problem: too many facts, many are irrelevant

Economists think within conceptual framework.

Facts are used only when relevant to certain theories.

Theory

Assertions and propositions we consider to be universally true.

-Helpful when they have simplicity and generality (but increasing either one of these often decreases the other)

-A good theory predicts well

Ad Hoc Theory

A theory that only explains one event.

Useless to economics

Refutable Propositions

Theories that could, in principle, be wrong

Affirming the consequent

When one uses a theory of "A implies/causes B" and incorrectly infers that B also causes A

Ex: Two triangles are congruent, so they are similar (true)

Two triangles are similar, so they are congruent (not true – affirming the consequent)

Spurious

When there is no causality between two factors, the correlation is spurious

Difference between scarce and limited goods

Scarce: Not enough of a certain DESIRABLE good

Limited: Not enough of a certain good

How does economics study scarcity?

Study of how scarce resources, that have alternative uses, are allocated amongst competing ends

How are scarcity and competition entwined?

Scarcity means that some people will get goods that others desire.

As long as goods are scarce, people will have to compete for these goods

Cost

Value of the next best alternative forgone.

EVERY human action has a cost associated with it b/c of scarcity

Demand

Consumer behavior regarding the goods they consume. Influenced by…

1. Constraints/opportunities

-MEASUREABLE

2. Tastes/Preferences

-NOT MEASUREABLE

Assumption about Demand and Tastes/Preferences

Tastes & preferences do not change during the course of investigation

Assumption about Demand and Constraints

All individuals strive to mitigate or reduce (rather than reinforce) adverse consequences of constraints

Law of Demand

As the price of a good increases, the quantity

demanded by consumers decreases, ceteris paribus

Law of Supply

As the price of a good increases, the quantity supplied

by producers increases, ceteris paribus

Demand Curve Slope

Negative because...

1. As prices increase, quantity consumed decrease

2. As quantity consumed increases, marginal value decreases, so consumers are less willing to buy an additional unit as they were w/ the last unit

Why is it that while output expands, the cost production tends to increase?

This is due to the inability to replicate the most efficient resources

Supply Curve

Price of a good and the willingness of individuals to offer the good for sale

Positive because...

1. Law of supply: As price increases, individuals are likely to supply more of that good

2. Law of diminishing returns: After some point, the value of producing one additional output declines

Market Equilibrium

Where the supply and demand curve meet

What is the conceptual framework, or paradigm of economics?

How market equilibrium occurs when constraints/opportunities change

What are the general mechanisms for determining and coordinating in a decentralized economy?

Actions are based on mutual benefits coordinated by price

Prices are determined by demand and supply

Why do we restrict science to positive rather than normative statements?

Because normative statements are value judgments, cannot be measured or proved right/wrong, and are therefore not a part of science

Why do we use the term refutable proposition as opposed to provable proposition?

It is logically impossible to prove theories

What is the true cost of attending college for four years?

Value of the second best alternative forgone 

This value = the money you would save not paying tuition + the money you can make at a job instead of at school

How is it that unplanned, “market” economies operate at all? What aspect of human behavior puts bread on the table?

Unplanned market economies work because many people perform decentralized activities based on mutual benefit, and coordinated by price.

Competition, because of scarcity, is what drives people to prefer more goods for themselves

Production is characterized by____, another way to say “division of labor”

Specialization

What drives production in a market economy?

Coordination of mutual gains through the price system

Prices, determined by supply and demand, give information about the cost of production and customer’s valuations of a good. This, along with mutual benefits from exchange of goods for money, drives a market economy

What mechanisms are there for correcting erroneous decisions about production levels?

If a seller cannot sell all of their goods, they will lower the price so that the demand increases and all of the goods will be sold

If a seller does not make enough of a good, they will raise prices so that the demand decreases, avoiding excess demand

Why is economics considered a science? What types of statements are to be avoided if the subject is to be scientific?

Science because:

-Seeks explanations of real-world events

-Uses a set of propositions to analyze human behavior

-These propositions can predict certain outcomes of situations

Is "scientific" the same thing as "true"?

No. Scientific statements are positive statements and can be true or false.

What is it that makes some proposition scientifically interesting and useful?

Propositions that could be wrong but are confirmed by the facts

Can theories be “proven?” Explain what it means to have “confirmed” a theory, or theoretical explanation of some event

No, theories cannot be proven.

Theories are refutable propositions that we consider to be universally true. They could be wrong, but consistently predict factual events.

Can propositions be “good in theory but lousy in practice?”

No, because by definition a good theory is good in practice.

Make up some examples of events which happen together, but for which neither event causes the other.

Fact: People who own running shoes are less likely to have heart disease

This does not mean running shoes cause lower rates of heart disease

People in the Pacific Northwest consume more water per person than people in the southwest. Does this mean that North westerners like water more, or are thirstier than South westerners?

In the NW, water is more plentiful, and therefore cheaper.

In the SW, water is scarcer and therefore more expensive.

According to the law of demand, at lower prices people consume more.

“If only people learned to love other people and respect differences, we wouldn’t live in such a competitive, unpleasant world.” Do you agree? What is the fundamental reason why competition for goods exists?

The fundamental reason for competition is scarcity, not a lack of love or respect.

Even if all people were angelic, distribution of goods would have some competition due to scarcity.

In some countries, a test that can determine the sex of a fetus is being used to abort female fetuses. As a result, 60% babies in these countries are male. What will be the long-term effects of this on traditional gender and marriage roles?

The supply of women decreased, so this would cause the value of women as wives and mothers to increase. This reinforces traditional marriage roles

A survey once showed that 70 percent of married men are bald. Does this mean that marriage leads to baldness? What general principle does this illustrate about the problem of inferring causality from correlation?

This is called affirming the consequent, which is when one takes a postulate in which A implies some event B, and then mistakenly assumes that that if you observe B, that A must be true.

Can a good be scarce for some people and not for others? If you think so, give some examples.

Yes, when demand is influenced by preferences. 

For example, meat is not a scarce for a vegetarian

What does free enterprise mean? Does it mean we are free to do anything we want?

Free enterprise is where individuals can own resources and use those resources how they choose, but these choices are constrained by laws.

Some define economics as the study of the proposition, “there’s no such thing as a free lunch.” Do you think this is a good definition?

This statement only refers to opportunity cost of lunch.

But, it does not clearly outline that economics is the study of how people respond to changes in the constraints that scarcity imposes.

Absolute Price

The price of a good in money terms

Incentive

A reward that encourages an action

or

A penalty that discourages an action

Scarcity

People have boundless needs and wants, and good wanted goods are limited. Even at the price of zero, there is not enough of that good.

Scarce Good

Limited AND wanted

Aggregate Demand

(Macro and Micro)

Macro: Sum of demands from customers, businesses, and government

Micro: Sum of individual demand curves into a market demand curve

Assertions vs Assumptions

Assertions: Universal postulates of a theory

Assumption: Simplifications to make a theory more usable

Asset / Capital

Resource/produced good that produces income in future

“Bad” or “Economic Bad”

Undesirable good. Something people would pay to have LESS of

Bilateral Trade

Exchange between two parties

Capital Gain

Increase in the market value of an asset between the time its bought and sold

Capitalism

Economic system wherein the means of production, capital and land are privately owned and operated in the pursuit of individual gain

“All else being equal”

Ceteris Paribus.

All other variables fixed to determine how changes in one specific variable would affect another specific variable.

Commodity

Any item that is bought and sold

Commodity Money

Item used as medium of exchange that also has nonmonetary value

Example: Gold

Efforts of parties to secure rights to scarce goods

Competition

Constraints

All things that impinge on behavior and are measureable

(As opposed to preferences)

Examples of Constraints

Income

Prices

Time

Technology

Education

Laws

Consumption

Spending by households on final goods

Demand Schedule

Table showing quantity demanded per specific prices

Derived Demand

Demand not for the good itself, but for what the good produces (Ex: Labor)

Double Coincidence of Wants

When I have what you want, and you have what I want

Durable Good

Goods that provide a service over a long period of time

Economic Behavior

When individuals strive to...

1. Mitigate adverse consequences &

2. Exploit beneficial consequences

Of changes in constraints

Economic Efficiency

Exhaustion of mutual benefits. When it is impossible to make one variable improve without hurting the other variable.

Economic Explanation

Based on responses to changes in constraints, using the postulates of economics

Economic Good

A good that is scarce (limited AND desirable)

Economic Growth

Increase in the real (inflation-adjusted) GNP of an economy

Economic Model

Simplified econ theory, or mathematical framework on an econ theory

Economic Problem

Scarcity exists, therefore competition exists. Competition means people have to make decisions about allocating goods.

Economic Profit

Total revenues MINUS total costs (including opportunity costs)

Empirical

Based on observations and experiments

Equilibrium

Also called “market clearing”

Quantity demanded = quantity supplied.

Consumers and producers have no incentive to deviate

Excess Demand

Quantity demanded > quantity supplied

Exports

Domestically produced goods which are sold abroad

Final good

Purchased by final customer (As opposed to customer re-selling good)

Free Good

When price is zero, availability still exceeds demand

Free Market

When sale and purchase of goods is mostly unhindered by government

Gold Standard

When a country’s paper money is redeemable in whole or part by gold

Impatience

Time preference. Good is valued higher when consumed now instead of later

Implicit Cost

Value of using factors in production for which no actual payment is made

Import

Domestic purchase of foreign good

Inefficient

When mutual gains are not exhausted

Possible to improve one variable while NOT making the other variable worse off

Not Relating to Money

Non-Pecuniary

Input

Something used in production process

Intrinsic Value

Supposed underlying worth of a good without reference to the value humans place on it.

NOT consistent with behavioral postulates. Economists say only intrinsic value is price.

Labor Market

Market where firms demand labor, households supply labor.

This determines the ‘price’ of labor, AKA wages

Leisure

An activity an individual does not consider work/will perform without compensation

Pareto Optimal / Pareto Efficient

When all mutual benefits are exhausted

Impossible to increase production of one good w/o decreasing production of another

Market Economy

Economy where resources are allocated by interactions of individual and firms in markets, as opposed to allocation by central planning and command

Market Value of Life

Value of life measured by amounts people accept in compensation for a higher probability of death

Market Wage

Wage people actually pay/receive for services

Maximizing

“Economic Behavior”

With changes in constraints, people

-Mitigate adverse consequences

-Exploit beneficial consequences

Mixed Economy

Market economy with governmental controls

Movement Along the Demand Curve

Changes in the quantity demanded

Movement Along the Supply Curve

Changes in the quantity supplied

Need

Good that has no present alternative other than death

Non-Economic Behavior

Behavior that violates postulates

Having to do with Money

Pecuniary

Nonprice Competition

Competition based on something other than price, like quality of service.

Nonrival in Consumption

A characteristic of a public good that one individual’s consumption of the good does not detract from anyone else’s consumption

Nonwage Income

Earnings received from activity other than in the labor force

Non-zero sum game

Mutual benefits and mutual losses are possible.

Sum of payoffs does NOT equal zero

Oligopoly

Form of imperfect competition where there are only a few firms in an industry, and some or all can influence the marketplace

Output

New good resulting from combined actions of inputs.

Outputs valued higher, by customers, than inputs.

Pareto Efficient/ Pareto Optimal

When all mutual benefits are exhausted

Pareto Superior

Allocation w/ the result where: A is better off, but B is not worse off

Is a person better off according to his or her own preferences?

Economics say YES

Preferences

Tastes; immeasurable influences on the choices consumers make

Prejudice

Inclination or taste for discrimination

Premium

Additional amount paid/charged, typically in compensation for added risk

Production

Process of combining inputs to yield goods and services (outputs) of greater value

Rent Maximization

Production of goods to obtain the highest amount of profit

Public Good

Consumed by many individuals at once, never any congestion

Real

Adjusted for inflation

Relative Price

Or REAL Price

Price of one good in terms of a quantity of another good

Resources

Anything of value

Commonly, goods that are NOT final

Substitution Postulate

Postulate of behavior

Individuals will substitute goods for other goods (make trade-offs)

Shortage

Continuing situation of excess demand

Only caused by government control of price

Skilled Worker vs Unskilled Worker

Skilled: Has special ability/training

Unskilled: No special ability/training

Private Cost vs External Cost vs Social Cost

Private: Cost incurred by individual or firm

External: Cost by firm (not taken into account), and incurred by third party

Social Cost: Private and external costs of an action

Socialism

Economic system where factors of production are owned publicly, and the government directs distribution of goods

Sunk Cost

A cost that is irretrievable and therefore irrelevant to the production decision

Supply Shock

Something that causes a change in supply

Theory

Assertions/Propositions considered to be universally true, used to explain or predict events

Utility

An ordinal measure of the satisfaction people get from consuming goods.

Utility Maximization

Choosing to gain the highest degree of satisfaction

Value-added

The difference between the value of a final good and the value of the intermediate goods used in production

Value Judgments

Statements about ones own assessment of the desirability of something

NOT scientific/ applicable to economics

Wage

The price for the service of labor

Often the opportunity cost of labor

Wealth

Net present value of a person’s assets (capital)

MINUS

liabilities

Windfall

Unexpected financial gain

Yield

The amount produced

Why are the behavioral postulates predict individual behavior, and not aggregate (group) behavior?

Group behavior cannot be predicted because groups have differing preferences

How does the law of diminishing marginal values contribute to variety of demand?

Because marginal value decreases as more of a good is consumed. 

Marginal value will eventually decrease until an alternative is valued more

Marginal Value

vs

Total Value

vs

Total Expenditure

vs

Consumer's Surplus

Marginal Value: Additional benefit of the consumption of a good. Also, the difference of two total values at two given prices

Total Value: Maximum amount a person is willing to pay to consume ALL units rather than none at all

Total Expenditure: What someone ACTUALLY paid for a good (Often less than, and never more than total value)

Consumers Surplus/Net Consumer's Gain: Difference between total value and total expenditure. “Monetary evaluation of benefits from purchasing goods at a given price”

When should a demand curve be straight?

When should a demand curve be curved?

Straight: When marginal value decreases at a constant rate

Curved: When marginal value does not decrease at a constant rate 

Price at the top of the demand curve

At this price, quantity demanded = ZERO

A consumer will buy a good as long as

_____ exceeds ______

By ordinal numbers (1st, 2nd, 3rd)

Or indifference

NOT cardinal numbers(measureable amounts)

"If you eat less broccoli, you can have more icecream."

According to the substitution postulate, what two goods in this tradeoff?

Good #1: Less Broccoli

Good #2:More icecream

Good #1: Opp cost of a new car

Good #2: Safety

Good #1:Drug Safety

Good #2:Available number of drugs

Good #1: Safety from criminals

Good #2: Protection of innocent

Two jobs that only differ in that one job has a higher risk of death. The riskier job comes w/ a higher wage. 

What theory does this follow?

What do you call the difference between these two wages?

Theory of compensating differentials. 

Difference = the premium for incr risk

also = market price for accepting that additional risk of death

What is the diamond-water paradox?

total expenditure does not = total value

Water

Total expenditure:Low (b/c of larger quantity of supply)

Marginal Value: VERY high with first units bought (b/c it is necessary)

                                 ^Causes higher total value

                      Low for normal quantities (b/c of large supply)

                                 ^Causes lower market prices

Total Value: High because dramatic high marginal value at 1st units are always added

Consumer's Surplus: High because of lower expenditure and higher total value

Diamonds

Total Expenditure: High (b/c of smaller quantity of supply)

Marginal Value: High, but no dramatic MV at 1st units

Total Value: Relatively low (b/c no dramatic MV at 1st units)

Consumer's Surplus: Relatively low because of higher expenditure and lower total value

Football players are paid a much higher salary than nurses. 

Does this mean society values football players more than nurses?

No, this just means the marginal value of a football player is higher than that of a nurse.

The market price (or wages) of these two professions do not reflect total value of the occupations

What is the price of present consumption?

Why do people's consumption vary less than their income?

Price of present consumption = amount of future consumption given up in order to consume a unit of present consumption

Consumption varies less than income b/c people borrow during times of low income and invest during times of high income

Customer will consume a good until marginal value falls to the market price

After that, the customer would not gain from consuming any more. 

Total sale of output

Same # as Total Expenditure (of consumers)

A grocery store threatens to relocate if city does not contribute to building improvements

A stadium threatens to relocate if city does not contribute to building improvements

What does the city do in both situations? Why? 

1. Grocery store: City does nothing

The grocery store will be replaced by another competitor

2. Stadium: City pays for improvements

The Stadium has a MONOPOLY, therefore total value of the stadium is higher

The price of a durable good decreases. 

People don't automatically rush out to buy the good because they already have it.

How does the law of demand apply?

No immediate change

But the RATE of consumption will increase over time after the price decrease