Lecture Outlines - Week 1

Introduction

Overview:

• Develop an understanding of key economic fundamentals
• Engage in a brief overview of alternative methods of allocation
• Consider the difference between micro and macroeconomics
• Refresh memory on using diagrams and graphs

1. Economic Fundamentals

How would you define economics?

Economics is the study of how to allocate scarce resources, goods, and services among alternative uses.

What does scarcity mean?

Something that is scarce is valuable to people, and importantly, when the scarce thing is allocated to one use, a valuable alternative use must be given up.

What are some examples of things that are scarce?

What are some examples of things that are not scarce?

When people make allocation choice in the context of scarcity, that choice involves economics.

To make an allocation choice in the context of scarcity, people must somehow rank the various alternative uses of the item that is scarce. This involves a system of value. Individuals have values and preferences, and apply them to economic choices countless times each day, and frequently this process is so ingrained that we are not even aware of this ranking process. When society makes choices regarding the allocation of public resources, democratic process involves the aggregation of individual values and preferences.

Note: The implication is that we cannot make economic choices in the absence of values and preferences.

After ranking various alternative uses, we presumably select the best one. The value of the next best alternative is called the opportunity cost of that economic choice.

Allocation choices made in the context of scarcity have associated with them an opportunity cost. Thus the dumb old bromide "there isn't a free lunch," and that economics is the dismal science, derives from the fact that all economic choices involve an opportunity cost.

We say that an economic choice is rational when the value of the alternative that is selected exceeds the opportunity cost.

Three economic questions

a. What to produce?

-Resources or factors of production (inputs such as natural resources, labor, and capital) are scarce, and so the production of a particular good or service with these resources has an opportunity cost -- the highest valued alternative good or service that could have been produced.

b. How to produce?

-What production technology (the method by which factors of production are transformed into goods and services) should we employ?

c. For whom do we produce?

-How do we allocate the goods and services that we produce? Who gets them?

Production Possibilities Frontier (PPF). At any given point in time an economy with its resources fully employed can produce combinations of various goods and services. If one were to "connect the dots" of these alternative combinations, one would have drawn a PPF.

***DRAW PPF FOR A HERMIT, SHOWING FIBER (FOR SHELTER, FUEL, AND CLOTHING) AND FOOD COMBINATIONS. ***

Note that the PPF illustrates a number of fundamental economic concepts.

Scarcity and choice: Moving from one point to another along the PPF shows that to get more of one thing, one must give up some of the other.

Opportunity cost: The amount of the other thing that must be given up.

Economic Growth: Defined to be the increase in the value of output. Shifting out the PPF can occur for various reasons. What are they?

(more resources, tech. improvement).

Inefficiency or recession: When an economy is operating inside its PPF. Not all resources used fully and efficiently.

2. Brief Overview of Alternative Methods of Allocation

-Markets

-Socialism

-Gift

-Lottery

Other?

3. Market Failure and Government Failure

-Do any societies use a pure system of market capitalism? Why or why not?

-Fairness and equality

-Imperfect information

-Market power due to monopolies or cartels

-Environmental pollution problems

-Collectively consumed goods and services

Other?

-Have any societies completely eliminated the use of markets? Why or why not?

-Incentives provided by profit and prices.

-Difficulty of planners being able to replicate the allocation decisions made by millions of people interacting in markets.

-In the modern world, most societies have a mixture of markets and government, each with important roles and functions...

What is the difference between microeconomics and macroeconomics?

Micro: Studies the economic choices made by individuals and firms, the interaction of individuals and firms in markets, and the role and nature of regulation and other forms of government intervention. A key focus here will be on supply/demand interaction.

Macro: Studies economic aggregates such as gross domestic product (total output), inflation, unemployment, and economic growth, along with fluctuations in these (the business cycle), and government policy designed to dampen the business cycle.

What is the current state of the U.S. economy, and what is current macroeconomic policy?

Economic models as simplified metaphors of far more complex interactions in the real world. Can you think of any other examples of situations in which models are simplified versions of a more complex reality?

4. Graphing

Distinguish y and x axes. Which is the dependent variable? Independent? What is a positive or direct relationship between x and y? What is an inverse relationship between x and y?