What is Economics? What do Economists do?

International Baccalaureate Economics

Economics

CHAPTER1

What Is Economics?

Economics and the world around us.

Defining Moments

Define Economics:

All economic problems arise because of scarcity: our wants exceed the resources available to satisfy them.

Rich and poor alike are faced with scarcity.

Scarcity means that there is not enough of that item to satisfy everyone who wants it. The opposite is abundance.

Things that are scarce are also know as Economic Goods, which means that if the good has no cost or is given away free, then the amount of the good that people want is greater than the amount that is available (e.g. clean air).

On the other hand a Free Good is a good with enough quantity to satisfy wants even at zero price (e.g. air with no pollution).

Thus, the basic and fundamental Economic Problem is Scarcity.

We can define Economics as the study of how people choose to use their scarce resources (land, labor, capital) to satisfy their unlimited wants.

Choice and Opportunity Cost (opp cost)

Where there is scarcity there has to be choice. Since your time is scarce you have to choose how to spend it. The money you own is scarce. You have to choose how to spend it. When you choose something it means that you have to give up, or forgo other things.
It is time to introduce a key economic concept, the concept of opportunity cost.
Any time you make choice, you give up other choices.
This act of giving up the other choices carries a cost with it – you have lost the value to you of the other choices.
When you came to this class, you gave up the chance to go to the cafeteria for cake and coffee with your friends, or you gave up the chance to lie around and sleep, etc.
The opp cost of any choice is the value of the best alternative forgone – the value of the best alternative you gave up. Opp cost is measured in goods and serves forgone not money cost. It includes time cost. If for example, you have to give up paid work to go to UWC, the lost wages are part of your opp cost of going to UWC. It also includes external cost (opp cost is borne by other people). For example, if the person next to you decided to take his shoes off and has a smelly feet, you bear part of the cost.
It is not the value of all the choices (you could not have had cake in the cafeteria and sleep simultaneously), just the value of the best alternative.
For a coffee-drinker, the opp cost of this lecture would be the value of the morning coffee. For a bed lover, the opp cost of this lecture would be the pleasure of sleeping the extra hour.
Note: our key point here is that given scarcity, any choice involves an opportunity cost.
Economists argue that people are rational self interest they make the best possible choice (give the greatest satisfaction), given the information they have.
Thus, economic agents (firms, households, and governments) choose an action only if the benefits from the action are greater than the costs from the action.
More precisely, these agents make their choices at the margin. That is they choose an action only if the marginal benefit (MB) (the extra benefit from the action) is greater than the marginal cost (MC) (the extra cost from the action – an opportunity cost).
Principle of substitution
opp cost of an activity ® substitution other activities

changes in MC (opp costs) and marginal benefits change incentives and actions

Questions Economists Try to Answer:

All economic choices come down to five big questions:

1) What? 2) How? 3) Who? 4) Where? 5) When?

1) What goods and services ( G&S) are produced and in what quantities?

Do we produce houses or camping vehicles?

2) How are goods and services produced?

Do we use people or machines to produce the goods?

3) Who consumes the G&S that are produced? For Whom

The answer depends partially on the distribution of income. Then, What determines what we earn?

4) Where ...

This is a preview of the whole essay

changes in MC (opp costs) and marginal benefits change incentives and actions

Questions Economists Try to Answer:

All economic choices come down to five big questions:

1) What? 2) How? 3) Who? 4) Where? 5) When?

1) What goods and services ( G&S) are produced and in what quantities?

Do we produce houses or camping vehicles?

2) How are goods and services produced?

Do we use people or machines to produce the goods?

3) Who consumes the G&S that are produced? For Whom

The answer depends partially on the distribution of income. Then, What determines what we earn?

4) Where are goods and services produced?

Do we produce goods in Japan, in Mexico, or in the US?

5) When are G&S produced?

Production varies over time: seasonal factors, business cycle

Eight ideas that define the Economic way of thinking

Idea 1: Every choice involves a cost.

Whatever we choose to do, we could have done something else instead. A choice is a tradeoff — we give up something to get something else — and the highest valued alternative we give up is the opportunity cost of the activity chosen.

Idea 2: We make choices in small steps, that is, at the margin... choices are influenced by incentives.

When deciding whether to allocate more or less resources to an activity, the decision is not “all or nothing” but “a little bit more” versus “a little bit less”: we make choices at the margin. MB vs. MC

Incentives are inducements to take particular actions. When marginal costs or benefits change, then this changes the incentives to take particular actions.

Idea 3: Voluntary exchange makes both buyers and sellers better off... and markets are generally an efficient way to organize exchange.

If neither buyers nor sellers are forced to participate in the transaction, then both parties must find it worth their while to do so: they are both better off than if they didn’t trade at all.

Markets send resources to the place where they are valued the most highly.

An alternative system is the command system. Markets are superior to the command system at organizing an entire economy.

Idea 4: The market does not always work efficiently and sometimes government action is necessary to make the use of resources efficient.

Market failure is a state in which the market does not use resources efficiently.

Markets may fail because of monopoly, or because the benefits (or costs) to individuals of their actions do not fully reflect the benefits (or costs) these actions generate for other people (externalities).

Idea 5: For the economy as a whole, expenditure equals income equals the value of production.

Whatever any one individual spends is income for someone else.

Idea 6: Living standards improve when production per person increases.

This increase in output per person will enable more people to own goods and services.

Idea 7: Inflation occurs when the quantity of money increases faster than production.

Inflation results from “too much money chasing too few goods.”

Idea 8: Unemployment can result from market failure but some unemployment is productive.

Some unemployment results from employees searching for a suitable job and employers searching for suitable workers. This unemployment improves productivity.

Some unemployment results from fluctuations in expenditure and can be wasteful.

What Economist Do?? Economic Science!!

The economy can be looked at with either a micro or a macro view.

Microeconomics is the study of individual people and businesses and the interaction of those decisions in markets.

Macroeconomics is the study of the national economy and the global economy. It seeks to explain average prices and total employment, income, and production.

Economics is a social science.

Economists try to understand how the economic world works.

Economists distinguish between two sorts of statements:

1) what is 2) what ought to be.

Statements about what is are called positive statements.

Can be proven right or wrong.
Can be tested by checking it against facts.
“Taxes will decrease for all Americans next year.”

Statements about what ought to be are called normative statements.

Depend upon personal values and cannot be tested.
“We ought to reduce our use of carbon-based fuels.”

The task of economic science is to discover and catalogue positive statements that are consistent with what we observe in the world and that enable us to understand how the economic world works.

An economic theory is a generalization that summarizes what we think we understand about the economic choices that people and firms make.

Cause and Effect / Logical Fallacies:

To understand the role of each factor in producing an effect, we want to hold all other factors constant and change just the factor we are interested in.

1) Ceteris Paribus Fallacy

Ceteris paribus is a Latin phrase, meaning “everything else remaining the same.”

E.g. if the price rises and sales rise as well, to conclude that a higher price brings about greater sales is a ceteris paribus fallacy. However, It is difficult to vary only one variable when testing economic models.

2) Fallacy of Composition

The statement that what is true of the parts is true of the whole, or what is true of the whole is true of the parts.

Example: “Speed kills.”

3) The False-Cause Fallacy or Post Hoc Fallacy

The error of reasoning that a first event causes a second event because the first occurred before the second.